Test of Details

Definition:

Test of details is a substantive procedure.

It’s a response to the risk assessment.

Substantive procedures help the auditors to

• Obtain sufficient and appropriate audit evidence
• Confirm that the financial information is free from material misstatements. 

Test of details is testing the financial information by diving into the details of

• Transactions,
• Account balances, and
• Disclosures.

Here, we perform testing by verifying all the underlying supports. 

The reliability of support varies depending on its nature.

Chapter 1: How does the Auditor dive into details?

The auditor validates these account balances, transactions, or disclosures with supporting documents such as invoices, agreements, or company policy documents. The Audit team can also conduct inquiries to obtain more persuasive audit evidence.

How about an example?

Let us understand this concept through debt testing. Debt is one of the significant business liabilities. Current year transactions for this account balance primarily include new borrowings and repayments. Testing of these two debt components is done in the following manner:

New Borrowings

The first step is to verify and confirm the New Borrowings with the Loan agreements. The audit team also verifies the receipt of the amount by tracing it to the bank statements.

Note: Lenders sanction loans subject to terms & conditions such as Interest rates, Collateral Security, periodic submission of certain documents (Stock or book debts statement, Financials), etc. These terms & conditions are called covenants. The audit team shall test those covenants, especially if the loan is from related parties. This is because borrowers might charge exorbitant interest rates or impose unusual terms in case of related party transactions. Above all, the audit team shall also consider the nature of the transactions while performing testing procedures.

Recommended Article: Fictitious Assets

Repayments:  

Agreeing on the payment with the debt schedule helps the audit team understand if any payments are made over and above the required amounts as per the schedule. If this is the case, the audit team needs to understand the reasons by performing inquiries with management and requesting further support.

Why are beginning balances and Closing balances not considered in the above example?

In the case of recurring audits, the audit team agrees the beginning balance to the previous year’s audited ending balance. If the audit is for first-year engagements, the auditor needs to obtain the breakdown of the opening balance and test those balances in the same manner as above.

The closing balance is the balancing figure. With the abovementioned procedure, we are comfortable with the beginning balance, borrowings, and repayments. Therefore, the balancing figure is nothing but the debt-ending balance. We need not test it separately because we can recalculate the closing balance.

Additional Procedures:

In addition to the above procedures,

• The Auditor verifies if the recording of the accounting entries is accurate and

• Checks the occurrence of a transaction as per the entity’s policies. 

Conclusion for Example:

 So, the Auditor verifies the transaction’s authenticity by looking into its details. Here, the supports used by the audit team (loan agreements and bank statements) are not under the control of the entity under audit. These are third-party statements/supports, so the entity could not manipulate them. Therefore, the quality of audit evidence is high, enhancing the Auditor’s comfort with the financial information under audit.

Also Read: TDS Journal entry relating to Salary

Chapter 2: How is the Test of Details performed?

Auditors design these tests after considering the risk assessment results, the underlying account balance tested, the nature of the risk, and the previous year’s misstatements, if any. So, this substantive testing procedure gives more reasonable assurance.

Here’s an example:

“Always Correct” professionals are the auditors of “Failure Associates.” The audit team has obtained an understanding of the entity and its industry and also performed a preliminary risk assessment.

Further, all the Audit findings are below:

A) Understanding the entity and its industry

Failure Associates manufactures toothpaste. This Company is one of the major players in this rapidly growing segment of the Fast-Moving Consumer Goods industry.

Considering the economy in which this entity operates, the audit team believes that the business risk is lower due to the following:

• Unlike the technology industry, FMCG is not a rapidly changing sector. So, customer preferences will not change that quickly.
• The entity has built a good reputation over the last two decades. Due to this Brand power, the Company built trust and reputation among the consumers
• The company has agreements with the raw material suppliers and wholesale distributors for the next ten years. Therefore, there is no question about the non-continuity of the business

Note: The above considerations are very subjective and depend on auditors’ understanding of the entity and its industry. However, this example is to help readers provide an overview of how things work on the audit team’s side. So, use these as examples to brainstorm further and consider all the business-related factors to determine the business risk.

B) Account Balance

We will try to understand this aspect with a GL Account – Sales.

Companies often overstate profits to present themselves as strong performers. This enhances their credibility with financial institutions, allowing them to secure more funds at lower interest rates.

Note: Revenue is a higher risk account balance in most of the industry in general

Considering these, the Auditor decides to perform the Test of Details. The Auditor believes that risk is higher, so the team tests 100% of revenue without following the sampling technique. The audit team follows the Confirmation techniques for performing the Test of details.

Confirmation

Confirmation is when the audit team sends an electronic or physical copy of the information to the customers (in case of revenue confirmation) and requests that they respond to whether the information agrees or doesn’t agree with their financial records. There are two different types of confirmation requests. The one explained above is a positive confirmation request. 

In Negative confirmation requests, the third party (Respondent) has to respond only if the information that needs confirmation doesn’t agree with their books.

Therefore, there is less probability of a response for negative confirmation requests.

So, the audit team prefers sending positive confirmation requests to the customers for all the revenue recorded in the books of accounts. Based on the response, if the balance as per the requests agrees with the revenue balance as per the books, the auditor completes the revenue balance testing. If it’s not the case, then the auditor will understand the amount of difference and the reasons for the variance and investigate further, depending on the nature of the errors.

Chapter 3: What are the ways of performing Tests of details?

1. Vouching:

All the Entries accounted in the books of accounts are verified for accuracy and occurrence with the underlying supports. 

Example:

ABC Company records Repairs & Maintenance expenses amounting to $25,000 in May. The audit team obtains the bills/invoices relating to the expenses and checks the following:

• Whether the bills are in the name of the entity
• Confirms whether the date and year relate to the period under audit
• Verifies whether the nature of the expense corresponds to the entity. If a software entity purchases a lubricant, then the Auditor shall understand the need by performing inquiries, and shall also use their understanding of the industry in this context
• Verify whether accounting entries are reflected in the proper accounts
• Check if the expenses are eligible for capitalization based on their nature. The audit team can perform this check by obtaining the help of an Industry expert who is well aware of the nature of expenses.

2. Confirmations: 

Auditors obtain confirmation of the account balance from a third party. The entity cannot alter the information reported by the third party. Banks, Financial Institutions, and Creditors are examples of third-party confirmations.

3. Subsequent Receipts

An audit is to give an opinion on the financial statements or information. In general, the Auditor verifies the balance as of the period end. Accounts receivable and Accounts payable GLs can be tested by verifying the receipts or payments after the period ends. Refer to the AP article to understand the subsequent payment testing procedure.

Note: The auditor might choose to test 100% of the population or even adopt for sampling method. So, the nature and extent of misstatements are considered before deciding on which approach to follow.

How about an example?

Let’s say that the “ASAP” Company has debtors’ balances of $568,000 at the end of the year. Based on an understanding of the entity and industry, the team believes that the credit period of 30 days is appropriate for the audit.

So, the audit team must obtain the bank statements for the month after year-end. At the end of the period, management must present a complete breakdown of the debtors’ list.

All the debtor receipts are traced to bank statements.

Note: The period for which bank statements are required depends on the credit period.

Note: The percentage of testing generally depends on the risk factors. It’s a common practice to test 100% of the Population of Accounts Receivable and Revenue. However, other factors, such as entity under audit, risk assessed, entity industry, etc., are considered before deciding whether to test the 100% population or use a sampling technique.

A test of details might result in finding misstatements or errors. Read the article on Performance materiality to understand the different types of misstatements

4. Ancillary Procedures:

Ledgers Scrutiny is an ancillary procedure that aids in performing the test of details. The audit team performs sampling procedures for this substantive procedure. High-level scrutiny of Ledgers or Transactions will help the audit team identify odd transactions or ledgers.

How about an example here?

Every Business wants to survive for an infinite period. Some expenses may arise that aren’t eligible for tax deductions. A prime example is when a director records personal expenses in the books under the staff welfare GL Account. Tax authorities won’t allow this expense as a deduction from gross income. You should identify such transactions or ledgers by keyword searching or filtering to avoid this.

Test of details Conclusion:

In Conclusion, the Test of Details is a method of auditing financial information by digging deep into the details of transactions. To keep it simple, it is the process of obtaining comfort over the transactions by checking with the underlying supports. Vouching, Confirmations, and Subsequent receipts are the way to perform Tests of details. The approach is subjective and depends on the professional judgment of the Auditor. Further, it also differs from account to account. So, one method will not be a good fit for testing all the account balances. This is a key step in the audit of financial information. Therefore, the auditor shall use their professional judgment to select the appropriate testing method.