In auditing, substantive procedures and tests of controls are two distinct types of procedures used to gather evidence and assess the reliability of financial statements. Here’s a breakdown of the differences:
1. Purpose
Substantive Procedures:
Purpose: To detect material misstatements in the financial statements. These procedures are aimed at verifying the accuracy, completeness, and validity of financial information.
Focus: Directly on the financial statements and the transactions and balances they include.
Tests of Controls:
Purpose: To evaluate the effectiveness of an organization’s internal controls. These tests assess whether the controls put in place to prevent or detect misstatements are operating effectively.
Focus: On the processes and controls designed to ensure that financial reporting is accurate and reliable.
2. Nature of the Procedures
Substantive Procedures:
Include procedures like substantive tests of details and substantive analytical procedures.
Substantive Tests of Details: Involves checking individual transactions or account balances (e.g., verifying invoices or confirming bank balances).
Substantive Analytical Procedures: Involves evaluating financial information by studying plausible relationships among both financial and non-financial data (e.g., comparing financial ratios to industry averages).
Tests of Controls:
Involve procedures to test the operating effectiveness of controls (e.g., inspecting documents, observing processes, and performing walkthroughs).
Examples: Testing whether a control designed to approve transactions is functioning as intended, or whether segregation of duties is being maintained.
3. Timing and Application
Substantive Procedures:
Typically performed after the controls have been tested and are often conducted at year-end or during the period of the audit.
Applied when auditors want to directly gather evidence regarding the assertions made in the financial statements.
Tests of Controls:
Often performed earlier in the audit process to evaluate the internal control environment and determine the nature, timing, and extent of substantive procedures.
Applied to understand how well controls are working and to determine if reliance can be placed on them.
4. Reliance on Controls
Substantive Procedures:
Performed regardless of the effectiveness of internal controls. They are necessary if controls are not relied upon or if control testing is insufficient.
Tests of Controls:
Used to determine if the auditor can rely on the internal controls to reduce the extent of substantive testing. If controls are effective, substantive procedures may be reduced; if not, more substantive procedures will be needed.
Summary
Substantive Procedures: Focus on verifying the accuracy of financial statements directly.
Tests of Controls: Focus on evaluating the effectiveness of internal controls that aim to prevent or detect misstatements.
Both types of procedures are crucial in an audit, but they serve different roles in assessing the overall reliability of financial reporting.
