Sources of Audit Evidence

• tests of control, and/or
• substantive procedures.

Tests of controls

Tests of control are designed to evaluate the operating effectiveness of controls in preventing or detecting and correcting material misstatement.

In order to design further audit procedures the auditor must assess the risk of material misstatement in the financial statements. Internal controls are a vital component of this risk model; they are the mechanisms that clients design in an attempt to prevent, detect and correct misstatement. This is not only necessary for good financial reporting it is necessary to safeguard the assets of the shareholders and is a requirement of corporate governance.

The fundamental principle is: the stronger the control system the lower the risk of material misstatement in the financial statements.

Therefore auditors can seek to place some reliance on internal control systems and, as a result, reduce the substantive testing performed. In order to be able to do this they need to:

• Ascertain how the system operates;
• Document the system in audit working papers;
• Test the operation of the system;
• Assess the design and operating effectiveness of the control system; and
• Determine the impact on the audit approach for specific classes of transactions, account balances and disclosures. 

Substantive procedures

Substantive procedures are designed to detect material misstatement. They consist of both:

• Tests of detail: designed to verify specific transactions and balances; and
• Substantive analytical procedures: these involve the evaluation of financial information through analysis of plausible relationships among both financial and non-financial data.

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