Tests of Details
Tests of details, also known as substantive tests or detailed tests, are audit procedures used by auditors to verify the accuracy and completeness of account balances, transactions, and disclosures in an entity’s financial statements. While tests of controls assess the effectiveness of a company’s internal controls, tests of details directly examine the underlying financial data and corroborate the amounts reported in the financial statements.
Here are the primary objectives of tests of details:
- Validation of Transactions: Ensure that recorded transactions have actually taken place (existence), that all transactions that occurred are recorded (completeness), and that they are recorded accurately.
- Verification of Account Balances: Confirm the accuracy and validity of ending balances in the financial statement accounts.
- Examination of Disclosures: Ensure that financial statement disclosures are complete, accurate, and presented in accordance with the applicable financial reporting framework.
Common tests of details include:
- Vouching: Starting with a recorded financial transaction or balance and tracing it back to the original supporting documentation to verify its validity. For instance, vouching a sample of sales transactions in the ledger back to the original sales invoices and shipping documents.
- Tracing: Beginning with the source documents and tracing forward to ensure the transaction or balance is accurately reflected in the financial statements. For instance, tracing from received purchase invoices to the ledger entries.
- Confirmation: Seeking validation from third parties regarding certain balances or transactions. A common example is sending bank confirmation letters to validate cash balances.
- Reconciliation: Checking the agreement of balances or transactions with an independent source, such as reconciling a company’s cash balance with its bank statement.
- Analytical Procedures: Evaluating financial information by studying relationships among financial and non-financial data. For example, analyzing the year-to-year percentage change in certain expenses to detect any anomalies.
- Physical Inspection: Physically verifying assets. For instance, counting inventory items in a warehouse to validate the inventory balance on the balance sheet.
Example of Tests of Details
Let’s delve deeper into the concept of tests of details with a more comprehensive and illustrative example:
Suppose an auditor is examining the financial statements of “NovelReads,” a large bookselling company. One critical account for NovelReads is “Inventory,” given that unsold books constitute a significant asset. The balance at the end of the fiscal year for Inventory is reported as $2 million.
Tests of Details for the Inventory Account:
- Physical Inspection:
- Scenario: The auditor decides to conduct a surprise physical inventory count at one of NovelReads’ primary warehouses.
- Outcome: The count reveals that the physical books present align closely with the inventory records for that location.
- Scenario: The auditor selects a sample of inventory transactions recorded near the year-end. They verify these transactions by checking the corresponding purchase invoices, receipt confirmations, and payment details.
- Outcome: Two transactions had discrepancies between the recorded value and invoice value, indicating possible errors in recording.
- Scenario: The auditor picks several purchase invoices from suppliers and traces these transactions to ensure they are recorded in the inventory ledger and that the amounts match.
- Outcome: All traced transactions are accurately reflected in the ledger.
- Scenario: Since NovelReads consigns some books from authors directly, the auditor sends out confirmations to a few authors to verify the quantities and values of consigned books.
- Outcome: Responses from authors match NovelReads’ records.
- Analytical Procedures:
- Scenario: The auditor evaluates the year-over-year change in the inventory turnover ratio. A significant deviation from industry norms or the company’s historical trend could be a red flag.
- Outcome: The turnover ratio is consistent with previous years and industry standards, suggesting no apparent issues with the inventory’s valuation or movement.
- Scenario: The auditor reconciles the inventory ledger with the general ledger to ensure that the amounts match and there are no discrepancies.
- Outcome: The reconciliation is successful, with no differences identified.
After conducting these tests of details, the auditor gains confidence in the reported Inventory balance’s accuracy and completeness. However, they’ll address the discrepancies found during vouching, requesting explanations and any necessary adjustments.
This scenario provides a glimpse into how an auditor would apply various tests of details to validate a specific financial statement account.