- Describe the seven types of audit procedures in AU-C 500.
- Select the procedure type that best addresses a given assertion and risk.
- Explain why inquiry alone is not sufficient for a relevant assertion.
Risk assessment, tests of controls, substantive procedures
Audit procedures serve three purposes. Risk assessment procedures identify and assess risks; AU-C 315.14 requires inquiries, analytical procedures, and observation and inspection. Tests of controls evaluate operating effectiveness. Substantive procedures detect material misstatement at the assertion level and include tests of details and substantive analytical procedures (AU-C 330.04).
The same procedure types serve all three purposes. AU-C 500.A51-.A64 describes them.
The seven procedure types
Inspection (AU-C 500.A51) is examining records or documents, internal or external, in any form, or physically examining an asset, in person or with remote tools. Inspecting a signed contract gives evidence of terms; inspecting equipment gives evidence of existence but not of ownership or value.
Observation (AU-C 500.A52-.A54) is looking at a process performed by others, such as an inventory count or a control being performed. Its evidence is limited to the moment you watch, and people may behave differently when observed.
External confirmation (AU-C 500.A55) is evidence obtained as a direct written response to you from a third party, on paper, electronically or through direct access to the third party's data. AU-C 505 governs the process. Control of the request and response is what makes it reliable.
Recalculation (AU-C 500.A56-.A57) tests mathematical accuracy, manually or with automated tools. Automated tools let you recalculate entire populations, such as interest on every loan.
Reperformance (AU-C 500.A58) is your independent execution of a control or procedure the entity originally performed, such as reperforming a bank reconciliation or an aging calculation.
Analytical procedures (AU-C 500.A59-.A61) evaluate financial information through plausible relationships among financial and nonfinancial data, and include investigating fluctuations that are inconsistent or differ from expected values by a significant amount. AU-C 520 governs substantive analytics.
Inquiry (AU-C 500.A62-.A64) is seeking information from knowledgeable persons inside or outside the entity. It is used throughout the audit, and evaluating the responses is part of the procedure. An inquiry of an outside party is not an external confirmation, but the response can still be reliable evidence.
Choosing a procedure
Match the procedure to the assertion and the risk:
| Assertion and risk | Stronger procedure |
|---|---|
| Existence of receivables | External confirmation, subsequent receipts |
| Existence of inventory | Observation of the count plus test counts |
| Completeness of liabilities | Search for unrecorded liabilities (inspection of later payments) |
| Accuracy of depreciation | Recalculation |
| Operating effectiveness of a review control | Inspection of evidence plus reperformance |
| Reasonableness of payroll expense | Substantive analytical procedure with a precise expectation |
Inquiry is never enough alone
AU-C 330.10(a) requires you to perform other procedures in combination with inquiry to obtain evidence about the operating effectiveness of controls. For substantive work, inquiry rarely provides sufficient appropriate evidence for a relevant assertion of a significant account. AU-C 315.30(b) also requires procedures beyond inquiry to determine whether an identified control has been implemented. Files with "per discussion with controller" as the only support for a significant conclusion are a frequent review finding.
Common mistakes
- Observation of a count with no test counts, so the evidence is limited to the existence of a process.
- Analytics labeled substantive with no expectation or threshold set before comparing to recorded amounts. See the analytical procedures guide.
- Confirmations where the client mailed the requests or received the replies.
- Recalculations of a client schedule without testing the inputs.
The confirmations guide and the tick mark legend help you document what you did on each item.
Selecting procedures for an equipment loan
Oak Valley Brewing Co. has one equipment loan with a December 31 balance of $1,180,000, a fixed rate of 6.5% and monthly payments. Performance materiality is $30,000. Risks: existence and completeness of the debt, and accuracy of interest expense.
The team selects procedures:
- External confirmation with the lender: balance, rate, collateral and covenants. Response confirms $1,180,000.
- Inspection of the loan agreement and any amendments, abstracted into the permanent file as AU-C 230.10 requires for significant contracts.
- Recalculation of interest. Using the average of month-end balances, $1,236,000, the expectation is $1,236,000 x 6.5% = $80,340. Recorded interest is $81,900. Difference: $1,560, below the $5,000 threshold set for this test, so no further work.
- Inquiry of the CFO about other borrowing, corroborated by inspecting board minutes and the bank confirmation's section on other liabilities.
Conclusion: debt and interest are not materially misstated. Each procedure is tied to an assertion in the workpaper.
Self-check
Answer each question before you open the answer.
What is the difference between recalculation and reperformance?
Show answer
Recalculation tests the mathematical accuracy of information. Reperformance is the auditor independently executing a procedure or control the entity originally performed, such as a reconciliation (AU-C 500.A56 and .A58).
Why is observation limited as evidence?
Show answer
It covers only the point in time when it happens, and the act of being observed may change how the process is performed (AU-C 500.A54).
Is a phone call to a customer about its balance an external confirmation?
Show answer
No. An external confirmation is a direct written response to the auditor. An inquiry of an outside party can still be reliable evidence under AU-C 500, but it does not meet the AU-C 505 definition.
Can inquiry alone support operating effectiveness of a control?
Show answer
No. AU-C 330.10(a) requires other procedures in combination with inquiry, such as inspection or reperformance.
Use it on the file
- StandardAU-C 500: Audit Evidence: SAS 142, Reliability, IPE and Selecting Items to Test
- GuideAudit Confirmations Under AU-C 505: Bank and Accounts Receivable Confirmation Letters
- GuideAnalytical Procedures Under AU-C 520: Planning, Substantive Testing and the Final Review
- TemplateAudit Tick Mark Legend and Usage Log
- ToolAnalytical procedures expectation tool for AU-C 520
Sources
Standards are paraphrased from the primary sources listed above; read the source before relying on a requirement. This lesson is training material, not professional advice. Report an error