Chapter Twelve – Tests of Details

Summary

This Chapter discusses tests of details as substantive audit procedures

and how they are built into Voyager. This Chapter also provides guidance
on when and how these tests are used in an audit.

Introduction
12.01 Tests of details are substantive audit procedures designed to identify the
correctness of the related account balances. While tests of details can
provide evidence to both balance sheet and income statement amounts,
most tests of details focus on determining whether the ending balance
sheet is materially correct.

12.02 Voyager suggests substantive procedures based on the audit team’s risk
assessments, including the determination of reasonably possible risks and
the intended control reliance. The procedures suggested ordinarily include
tests of details in addition to substantive analytical procedures. The
decision whether to use tests of details and which tests to apply may
include considerations such as:
 the risk of material misstatement
 whether the tests would likely provide the needed evidence for the
pertinent risks
 the costs and benefits of using tests of details versus applying other
procedures, such as analytical procedures
 the costs and benefits of performing tests of controls to achieve the
intended control reliance
Since the selection of procedures must be based on the facts and
circumstances of the specific engagement, the audit team should tailor the
procedures suggested by Voyager to the engagement.

Methods of Testing Details

12.03 The methods used to test details are:
 sampling
 one hundred percent (100%) examination
 tests of high value items (individually significant)
 identification and examination of key items

12.04 For a particular account balance, the audit team might use more than one
of these testing methods. For example, the audit team could decide to test
high value items and identify risk areas within the remaining population for
further testing.

12.05 Tests of details are performed using examination, observation or

confirmation procedures. Although tests of details may be used to test any
 risk, they are rarely used to test risks associated with presentation and
disclosure.

Sampling

12.06 Sampling procedures are used to test details by applying the audit
procedures to the individual items selected. Because the items examined
in a sample are representative of the total population, the audit team is
able to project the sample results to the total population. This is not the
case with other tests of details, where the audit team selects items
according to specific criteria that may not be representative of the whole
population. Thus, the results cannot be projected to the total population,
although the audit team does form a conclusion about the examined
items.

One Hundred Percent (100%) Examination

12.07 In some circumstances, it is appropriate to examine the entire population

(100%), such as when:
 the population consists of a small number of items
 the audit team is not willing to accept the sampling risk, perhaps due to
significant concerns about the area
 when computer assisted audit techniques (CAATs) can be used to test
the population

12.08 100% examination undoubtedly provides the strongest audit evidence for
risks associated with assertions such as valuation, existence and rights
and obligations, but is not feasible or cost effective in most audit
situations. Therefore, other methods of testing details, such as sampling
or those discussed below are usually applied.

Tests of High Value Items (Individually Significant)

12.09 In certain situations, the audit team may test high value items (other than
in connection with sampling). In Horizon, “individually significant” is the
term used to describe high value items.

12.10 When testing a population that includes individually significant items, the
audit team is separating the population into two populations: one
comprised of individually significant items and the other comprised of
items less than individually significant. Detailed audit procedures will be
performed on 100% of the population of individually significant items. The
population of items less than individually significant must also be
considered for testing. The nature and extent of testing should respond to
the risks present.

12.11 Ordinarily, the response is a combination of tests of controls and

substantive analytical procedures. However, in some circumstances, the
risk of material misstatement and the value of the untested population are
low and no further testing is necessary. In other circumstances, the risk of
material misstatements is so high that control tests and analytical
 procedures alone do not provide sufficient evidence and additional
substantive procedures must be performed.

12.12 The appropriate response is always a matter of judgment but the audit
team can only conclude on the population tested. Therefore, if the
appropriate response is to perform no audit procedures on the items in the
population that are less than individually significant, the audit team can
only conclude on the population of individually significant items.

12.13 When the population to be tested is available in electronic form, the use of
IDEA is recommended to identify the individually significant items to be
tested.

12.14 Individually significant items should be tested often in conjunction with

testing other key items discussed in the next section. Moreover, it may be
efficient to extend tests of significant items to include additional items that
may be large, but not individually significant if this will provide evidence
about a sizeable portion of the total population.

12.15 For example, suppose for a population totaling $500,000, there are two
individually significant items (defined as those over $100,000) totaling
$250,000. If there were three additional items over $50,000 totaling
$200,000, it would clearly be efficient to test all five. If the value of the
remaining items is less than tolerable error and presents no significant
risks, the audit team may decide to base audit conclusions on testing 90%
of a population's value.

Determining Individually Significant Items

12.16 For many entities, it is appropriate to use tolerable error to determine

individually significant items. This is consistent with the concept of
determining an amount to use as a scoping mechanism. By using
tolerable error as this scoping amount, the audit team achieves a high
level of assurance that misstatements above this amount will be detected.
However, for some entities, using this amount may result in the audit team
performing audit procedures on a large portion of the population.

Individually Significant Amounts Greater than Tolerable Error

12.17 For capital-intensive entities such as those engaged in banking,

telecommunications, and real estate, items comprising certain balance
sheet accounts can be so large in relation to tolerable error that virtually all
items in a population would be selected if tolerable error were used to
define the individually significant items. For these situations, it is
appropriate to consider defining individually significant relative to the
population rather than in terms of tolerable error.

12.18 The objective of any audit strategy is to obtain reasonable assurance that
material misstatements, if present, will be detected. Defining individually
significant as an amount greater than tolerable error means that there may
be items in the population greater than materiality that are not selected for
detailed substantive testing. Therefore, the audit team must determine that
 this strategy appropriately responds to the risks in the population and
satisfies the objective of obtaining reasonable assurance.

12.19 The risks in a given population will vary from client to client and industry to
industry. For example, a bank establishes internal controls around the
existence assertion of commercial loans to enforce management’s policies
and objectives. Typically, these controls operate on all loans regardless of
size. Therefore, testing the operating effectiveness of the controls
provides the audit team with a basis to use an individually significant
amount that exceeds tolerable error. If a bank did not have such controls
that operate on every transaction or they did not operate effectively, the
audit team would not use the audit strategy described above because they
cannot obtain reasonable assurance that all loans exist.

12.20 To define individually significant relative to the population (at an amount

greater than tolerable error), IDEA must be used. This is done as follows:
 segregate the population into discrete pools of related items (for
example, in a depository institution segregate the loan portfolio into
related pools of loans such as commercial, commercial real estate,
credit card, residential real estate and installment)
 for each pool, determine the average balance and the standard
deviation and stratify the population into eight to ten layers (see
example in Exhibit 12.1)
 define individually significant – ordinarily the average balance plus an
amount between one and two standard deviations

12.21 It is vital that the population be comprised of related items with similar
characteristics. Items are related when they share common attributes or
characteristics such as the type of loan. If, for example, a population of all
loans in a bank were used, two undesirable outcomes would transpire.
First, it would be unlikely that consumer, credit card, and other lower
balance loans would be subjected to any substantive testing. Second, the
lower balance loans would pull the average balance down and result in
selecting even more of the commercial and other higher balance loans for
substantive testing. The objective of this alternative method of determining
individually significant is to define that amount which allows stratification of
high monetary amounts relative to the population. When multiple or
disparate populations are included, the method will not work.

12.22 After the population is defined, stratify it into layers. Ordinarily, no more
than ten strata are required to analyze the composition of the population.
Divide the largest item in the population by one less than the required
number of strata to determine the interval.

12.23 After the population is stratified, the audit team can use the data to define
an individually significant amount. Remember, this is the amount above
which all items will be tested so it should not be set so low that a large
number of items will be selected, nor should individually significant be set
at an amount that exceeds the average balance in the population plus two
standard deviations. Ordinarily, the amount will fall somewhere between
the average balance of the population plus one or two standard
deviations.
 Identification and Examination of Key Items

12.24 The audit team may also identify key items (items with qualitative
characteristics, such as those that are unusual, prone to error, or have
other identified risks). Key items also may include items that are large in
amount, but not necessarily individually significant. The identification and
examination of these key items provide important audit evidence,
frequently in conjunction with other audit tests. For example, in Horizon,
the low risk strategy usually calls for the application of this procedure, in
conjunction with appropriate analytical procedures and tests of individually
significant items.

12.25 Testing key items is routinely performed in audits. In relation to the

important audit evidence provided, it costs relatively little to identify items
that have risk or appear unusual and to test them. In Horizon, scanning is
the term used to describe the process used to identify key items.

12.26 To assure the effectiveness of this procedure, the audit team should
define the key items during the risk assessment process. Further, the
audit team member, who reviews the client's records to identify the key
items for testing, should be suitably experienced and understand the entity
and its environment. An inexperienced staff member may select
inappropriate items for testing or fail to identify items that should be tested.

12.27 As discussed above, judgment is needed to identify key items. For

example, an item might be selected for testing for reasons such as the
following:
 susceptibility to misstatement
 the size of the item is larger or smaller than expected
 lack of activity for a lengthy period
 it involves a related party
 it is inconsistent with known information about the entity
 it appears outside the usual scope of the business
 it comes at or near year-end

12.28 The underlying records are usually available in electronic form, therefore,
use of CAATs using IDEA is strongly recommended to help identify items
to be tested.

12.29 Once key items are identified, they should be adequately tested. Inquiries
of client personnel without obtaining supporting evidence are inadequate
to justify reliance on the procedure. However, scrutiny of the population,
with a determination that no key items were identified may form a basis for
reliance, if the procedure is appropriately documented.

Choosing Between Sampling and Other Testing Methods

12.30 The following guidance may be helpful to the audit team in considering the
adequacy or appropriateness of the tests suggested by Voyager:
 Where a large amount of a population's value consists of only a few
items, testing those items and reviewing the rest against expectations,
 perhaps testing some, will often provide as much audit reliance as a
sample and will cost less than a sample.
 For reasonably possible risks where controls will not be tested or
control tests have failed, statistical sampling is the preferred response
because it provides a supportable estimate of error.
 There may be other situations influenced by the audit team's view of
the likelihood of errors, such as when the entity focuses attention only
on major accounts. For example, if the entity has four major
customers, and keeps these under scrutiny, while paying significantly
less attention to the rest, the audit team may be concerned about
errors in the smaller accounts and wish to use direct testing to address
the risk of misstatement in the smaller accounts, rather than restrict
testing to the major customers.
 When the sample size is small, other tests of details or substantive
analytical procedures should be considered, because the reliability of
the results of small samples is questionable.
 If the sample size is very large, the decision to sample should be
reconsidered to determine if there is a more efficient way to obtain the
necessary audit evidence (e.g., CAATs using IDEA). If the audit team
decides that the sampling is appropriate, the sample size calculator
inputs should be reexamined to ensure that a sample is not being
selected based on incorrect inputs or assumptions.

Extent of Audit Evidence Required

12.31 The extent to which the audit team places reliance on audit evidence
derived from tests of details varies according to the circumstances. In
general, it is a function of:
 the effectiveness of the particular procedure, and
 the scope of the procedure (i.e., the number and monetary value of the
items examined)

12.32 The effectiveness of the procedure increases with:

 the audit team's understanding of the entity and its environment
 the relevance and reliability of the audit evidence provided
 the extent to which it covers the population being audited

12.33 When considering the extent of audit evidence required to support risks
associated with the valuation – gross assertion, the number of items
examined is usually less relevant than the monetary value of the items
examined. Tests of higher proportions of a population's value provide
greater assurance with respect to the valuation assertion, and can often
be designed to give greater assurance as to existence and ownership
rights as well.

12.34 In Horizon, tolerable error is the precision measure for the application of
audit procedures.

12.35 Misstatements found while testing details should be added to the

Summary of Unrecorded Misstatements. The audit team should consider
the implications of any misstatements on risk assessments (inherent risk,
 control reliance, and fraud) and whether the results of the tests imply the
likelihood of additional misstatements in unexamined portion of the
population. If so, risk assessments should be reevaluated, audit programs
modified and additional testing performed.

12.36 In addition, misstatements identified by the audit team are direct

evidence that the internal controls failed to prevent an error. The audit team
should identify the underlying control deficiency, add it to the appropriate Design
Effectiveness tool in Voyager, and evaluate its severity. As discussed in Chapter
10, a misstatement is at least a significant deficiency and a strong indicator of a
material weakness.
Exhibit 12.1 - Using IDEA to Define Individually
Significant Items
This exhibit includes an example of how to determine individually
significant greater than tolerable error. It demonstrates how the power of
IDEA can be used to perform these procedures very quickly with minimal
effort.

Obtain the data in electronic format

The entity is a depository institution and the portfolio of loans was
obtained in Excel format. The data in Excel appears as follows:

To interrogate this data with IDEA, it will first be necessary to reorganize

the data. Notice that the heading is more than one line at the top of the file
– it is easiest to import files into IDEA with only one line. The first three
lines of the spreadsheet can be deleted in Excel itself. After this is done,
the file appears as follows:

It is also necessary to remove any totals or subtotals before importing the

file into IDEA. Note the totals of the “Net Balance” and “Accrued Int” fields
are $130,538,040 and $830,713, respectively. These totals should be
deleted.

Import the data into IDEA

Using IDEA’s import assistant, the data file can be imported into IDEA.
The first item under the File menu is the Import Assistant. Select this
option and “Import to IDEA”. The Import Assistant interface opens:
This is an Excel file, so we can highlight “Microsoft Excel”. Browse to find
the reformatted Excel file. Click “First row is field names” and click OK.

IDEA imports the data, which appears as follows:

Now the data is ready to interrogate using the power of IDEA. In most
circumstances, we would go to “Field Statistics” at this point and finish our
task of defining individually significant. However, for this entity, we still
have some work to do to get the data organized for our use. We can
review the field statistics to learn more information about the data. Click on
“Field Statistics” to review field statistics for selected numeric fields.

Verify the total of the “Net Balance” field is $130,538,040 that agrees to
the total of the original Excel file. If we review the field statistics for the
“Net Balance” population, we notice significant negative balances, which
are skewing the statistics. A quick inquiry of the client and a scan of the
data identify the problem. Many customers are listed several times as they
have more than one loan and payments are sometimes reflected as a line
item rather than a reduction of the loan. We can summarize the data by
customer and solve this problem. To do this, click on the Menu item
“Analysis”. Then click on “Summarization” from the drop down menu that
appears. The following interface appears:

Select “Short Name” as the field to summarize. Next, select “Net Balance”
as the numeric field to total. Click the “Fields” button to select the fields
that we want to see in the summarization. “Short Name” and “Net
Balance” are enough as we are only interested for this demonstration in
defining individually significant items.
When we click “OK”, IDEA will create a summarization of the data, which
appears as follows:
Now when we click on “Field Statistics” we see the following statistics:

Note the total of the “Net Balance” field is still $130,538,040 but now there
are no negative balances. The data is summarized in a form that is very
usable to us in defining individually significant. IDEA has totaled the
population and determined that the individual items range from $1,750 to
$6,000,000. The average amount is $672,876. The standard deviation is
$1,105,629. Now we can stratify this data and use this information to
define individually significant.

Stratify the data into 8 to 10 layers

IDEA easily performs this task for us. Begin by clicking on the Menu item
“Analysis.” Then click on “Stratification” from the drop down menus that
appear. This opens the following interface:
We need to tell IDEA how we want to stratify the data. As previously
mentioned, determine the interval by dividing the largest item in the
population by one less than the number of strata required. Remember that
$6,000,000 is the largest item in the population and the number of strata
required is ten. The calculated interval is $666,667 so we will round to
$650,000 to use as the interval. When we specify this amount, we can
click in the lower and upper limit columns to automatically populate each
stratum. This appears as follows:

From this information, IDEA produces the table below. We can now move
to the final step and define individually significant.

Define individually significant

As previously mentioned, ordinarily the amount defined as individually
significant will fall between one and two standard deviations plus the
average amount. Remember from the field stats that the average balance
is $672,876 and the standard deviation is $1,105,629. Thus, individually
significant should fall between $1,778,505 and $2,884,134.
From our stratification, the logical break point appears to be $2,600,000.
Defining individually significant at this amount will result in performing
detailed substantive procedures on 17 loans that total $61,949,375.
The population of loans below $2,600,000 would be audited using a
combination of tests of controls and less detailed substantive procedures.
These substantive procedures might include other analysis performed with
IDEA (unusual loan terms or interest rates, no recent payment history,
etc.) and testing the accuracy of the identified items.