AC2104 - SEMINAR 11

MINI PRESENTATION

GROUP 3 CAI WEIMING // GAO XINJUAN // LAU KAI CHING // SHERMAINE ANG // YEO KHAI SERN
“ Why does the auditor generally follow a substantive
strategy when auditing long-term debt and capital
accounts?

Under what conditions might the auditor follow a

reliance strategy?

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 Substantive VS Reliance Strategies
Substantive audit strategy: the auditor
has made a decision not to rely on the
entity's controls and to audit the related
financial statement accounts directly.
Control risk is set at the maximum
when a substantive audit strategy is
followed.
Reliance strategy: the auditor relies on the
entity's controls and sets control risk below
the maximum. The reliance strategy
requires a more detailed understanding and
documentation of internal control than that
of the substantive strategy. The auditor
also plans and performs tests of controls
to support the lower assessed level of
control risk.
Why follow a substantive strategy?

▰ Inherent risk for long-term debt (notes and bonds) would normally be assessed as
low to moderate because the volume of transactions are low, the accounting is
not complex, and the client often receives third-party statements or amortization
tables.
▰ However, the amounts are usually large and the financial markets have
developed sophisticated instruments that have characteristics of both debt and
equity. The inherent risk associated with these instruments is normally high.
▰ Normally more cost-effective to conduct substantive tests of the transactions
that compose of the account balances.
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When to use a reliance strategy?

▰ The auditor may follow a reliance strategy for entities that engage in frequent
financing activities.
▰ When substantive procedures alone do not provide sufficient appropriate
evidence.
▰ If the test of controls on financial records are performed in order to set control
risk.

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“
During the year, Broadwall Company Pte. Ltd. obtained a long-term
loan from a local bank pursuant to a financing agreement.

The financing agreement provided the following terms

▰ The loan was to be secured by the company’s inventory and AR
▰ The company was not to pay dividends without the permission from
the bank
▰ Monthly installment payments were to commence on 1 Mar 2017
“
Maxwell LLP has been engaged to examine the financial statements
of Broadwell Company Pte. Ltd. for the year ended 30 Sep 2017.

For the purpose of the audit for the financial statements of

Broadwall, what procedures should Maxwell employ in examining
the described loans?
 Substantive tests for borrowings

Maxwell should conduct substantive tests to examine the long term loan.

▰ Examine board of directors’ minutes

1) Loan was properly initiated and authorized
2) No dividends were approved or paid out without the bank’s approval

▰ External positive confirmation with the bank

1) Confirms the existence of the loan and its classification as a long term debt
2) Permission was indeed granted by the bank should any dividends be paid out
3) Monthly installment payments were timely made after 1 Mar 2017
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 Substantive tests for borrowings

Maxwell should conduct substantive tests to examine the long term loan.

▰ Substantive Analytical Procedures (SAPs)

1) Recomputation of interest expense and payables to arrive at an estimate
2) Ensure that they were reasonably recorded in the general ledger by comparison

▰ Assessment of the Valuation of Inventory and AR

1) Checking loan principal amount against inventory and AR values
2) Ensure that loan was indeed secured by the company’s inventory and AR

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“ Why might an auditor perform test of details and vouch
selected transactions in income statement accounts such
as legal, travel and entertainment expenses?
Account balances of intrinsic interest

▰ These accounts are not directly affected by a business process and/or may
contain sensitive information or unusual transactions.
▰ For these accounts, detailed information is needed for tax return, specific
disclosure requirements or other schedules included in the financial
statements. Thus, they may be overlooked due the nature of the expense while
there is a likelihood of entities using these accounts to conduct fraudulent
activities.
▰ Hence, the auditor conducts account analysis and vouch to these accounts to
ensure that they have indeed occurred and are not misstated due to fraudulent
acts. 11
Any questions?

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