Which of the following is the first step of the substantive analytical procedures process?

1. Career development
2. 7 Examples of Substantive Procedures in Auditing (With Types)

By Indeed Editorial Team

Published July 27, 2021

The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.

An auditor is a professional who monitors finances for a company. They often exercise substantive procedures to collect evidence of the company's transactions and confirm that its financial status is correct. Understanding the significance of substantive auditing protocols can enable you to track the amount of money your organization spends or receives in return. In this article, we define substantive procedures in auditing and provide multiple examples of professionals performing audits in real-life scenarios.

Related: What Is Auditing?

What are substantive procedures in auditing?

Substantive procedures in auditing are processes or methods that auditors use in order to find or prevent miscalculations in financial records. Substantive procedures often provide a record of some financial activity that alerts professionals that the activity is happening and documents it for further review. Substantive procedures in auditing can include the following activities:

• Sharing account balances and transactions

• Testing transaction classes

• Making account records

• Examining financial materials

• Inquiring about certain transactions

Related: Audit: Definition, Types and Benefits

Why are substantive procedures in auditing important?

Substantive procedures in auditing are important because they prioritize thorough documentation of finances. As an auditor, it's essential for you to have evidence of every monetary transaction to draw conclusions about a financial status. The documents can include original receipts of purchases, bank statements and invoices that illustrate rendered services and compensation. Performing substantive procedures can help you justify your assertions. For instance, if you conclude a client has spent $1,000 in the past two weeks, you can use the documents that represent the client's activities, showing how you made your final assessment.

Keeping detailed records can be beneficial if an external auditor performs an audit on your organization. The documents can prove how you've tracked finances internally and that your tracking methods are objective and realistic.

Related: The 4 Types of Auditing Reports

Types of substantive procedures in auditing

There are two main types of substantive procedures in auditing. When performing audits, auditing professionals decide which substantive procedure type is best depending on the circumstances of the audit and the financial records their client has. The variations include:

Substantive analytical procedures

Substantive analytical procedures seek a realistic connection between financial and non-financial data. Once they identify the relationship, auditors can acquire proof that the amounts that appear on financial documents are rational. Analytics are typically appropriate when the transactions are accurate, which means there's little chance of material misstatement occurring. Auditors set their own standards when performing the audit and compare their predictions to the client's documents. Further testing is only necessary when there's a substantial discrepancy between what the auditor predicted and the figures on the client's record.

Substantive tests of detail

Substantive tests of details is an auditing protocol that's necessary when there's a high chance of material misstatement. Its purpose is to verify the auditor's conclusions about the amount of money in accounts and the figures that appear on the client's documents. Professionals gather proof to support their claims on financial statuses. It may be appropriate to use tests of detail when evaluating a significant amount of money.

Read more: Substantive Tests: Definition, How They Work and Example

7 examples of substantive procedures in auditing

Here are several examples of substantive procedures in auditing to help you understand the concept:

1. Counting inventory

Inventory protocol requires employees to confirm that the merchandise they have physically in stock matches their records. Counting inventory is common for professionals who work in retail. Management often divides the staff into teams and assigns them a section of materials to count. Next, the employees count how many items they have in the stockroom or the sales floor, and they update their documents if their physical counts mismatch the recorded count. For example:

In a home goods store, one employee counts 50 lanterns in stock, but the recorded inventory is 52, leaving two items unaccounted. The associate searches the sales floor for the missing items, but determines there's a discrepancy. Thanks to the substantive procedure, the store has an accurate count of how many lanterns they can sell to customers.

2. Monitoring purchases

When professionals sell products to consumers, they often keep purchasing records to track how many goods they've sold and the remaining items in their inventory. The substantive procedure occurs when associates compare their number of purchases with the number of goods they have yet to sell. For example, if they opened the store with 100 cupcakes, and their records indicate they've sold 50 of them, then they count the remaining cupcakes to confirm they have 50 left. Monitoring purchases can enable employees to track their sales numbers accurately.

3. Distributing invoices

Another example of substantive procedures in auditing is sending an invoice to the customer after they request a good or service. Invoices include the amount of money the customer owes the supplier, including a detailed list of fees associated with the purchase. It confirms the activities the supplier completed per the buyer's request and verifies the date the transaction occurred and personal information about the customer. It also represents an agreement that the bill aligns with what the customer bought. For instance:

A homeowner hires a finish carpenter to install crown molding in a primary bedroom. Once the process is underway, the carpenter sends an invoice to the homeowner with how much the installation costs, serving as a record of the client-tradesperson relationship. The homeowner remains informed that the crown molding they've chosen and the size of the room they want renovated costs a certain price, according to the invoice.

4. Verifying payments

Payment verification occurs when the supplier receives compensation for the services they rendered. They use the invoice to ensure the funds the customer sent match the amount on the invoice. If there is a discrepancy, the supplier can contact the customer and refer to the agreed figures the invoice stated.

Refer to the finish carpenter example. Suppose the invoice stated the crown molding installation cost $2,000 for one bedroom. The customer would send the payment, and the carpenter would then count the money to verify that they indeed received $2,000. Counting the funds received is an example of a substantive procedure in auditing.

5. Corroborating customer orders

With the invoice, the client exercises substantiative protocols to confirm their required payments match what they initially ordered. Here's an example:

In a business-to-business transaction, a technology company fulfills the request to send 12 desktop computers to a buyer. The invoice states the price of each computer and the total cost of the order. The buyer, an administration company, multiplies the individual computer costs by 12 to confirm that the total cost matches its calculations. It also physically counts the number of computers it received to ensure the technology company met its expectations correctly.

6. Collecting debt

Financial institutions perform auditing procedures to track the amount of money customers owe them. For instance, to fund your bachelor's degree program, you might need to borrow student loans each year until you graduate. Six months after earning your diploma, the corporation that provided the loans would send you a message with the amount you need to repay. In this case, the corporation calculated the costs you've collected throughout your education career, and they sent confirmation emails that the amount you received matches what you consented to borrow.

7. Confirming account balances

Banks use substantiative procedures in auditing to verify the amount of money in customers' accounts. Professionals make sure the balance on the financial statement aligns with the actual funds that the account possesses.

For instance, suppose a bank statement indicates a client has $100,000. The auditors determine how the client has distributed the funds to different locations. They determine the client withdrew $10,000 of the total amount in cash and transferred another $60,000 to a savings account at another bank. The remaining $30,000 served as an investment in stock in a foreign country. The auditing protocol enables professionals to count the monetary resources customers have and verify their amounts according to the statements.

What is the first step in performing analytical procedures?

What are substantive analytical procedures?

What are the five steps involved in analytical procedure?

What are the substantive procedures?