What is the Audit Test of Controls?
Audit test in terms is a set of control procedure or process carried out by the auditors, being internal or external, which involves taking a sample of the group of similar transactions, to gauge the accuracy and fairness with which the financial statements of an individual or an organization are prepared before going ahead with the finalization of such financial statements and being presented to the stakeholders.
Purpose of Audit Test of Control
The main purpose of audit testing is to check and verify the level of effectiveness of controls followed by an organization while recording its financial transactions. It ensures that it tests and detects any error, omission, or material misstatements in the financial statementsFinancial StatementsFinancial statements are written reports prepared by a company's management to present the company's financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels.. Once an auditorAuditorAn auditor is a professional appointed by an enterprise for an independent analysis of their accounting records and financial statements. An auditor issues a report about the accuracy and reliability of financial statements based on the country's local operating laws. carries out testing, based on results, he may decide to further take some samples for testing or rely on clients’ internal controls.
Example of Audit Test
Let take an example.
AM Inc., a US-based company, is engaged in the business of manufacturing and producing certain antique pieces. Now, apart from this main objective, the company deals in accepting security deposits from various vendors, customers, and the common public for an interest in return.
People from whom the company has accepted deposits in any year, the average ranges from 10,000 to 12,000 at any given time. During the audit, the auditor decides to undertake the audit of the security deposit on a sample basis. He selects a sample of all deposit holders having a deposit of more than $10,000 at any given point in the year. Based on the results on such a test, the auditor may give his opinion on the aspect of security deposits.
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Types of Audit Test
#1 – Risk Assessment
Undertaken to identify and understand risks the company entails considering the environment within which it operates.
#2 – Test of Control
It aims to test the level of effectiveness of internal controlsInternal ControlsInternal control in accounting refers to the process by which a company implements various rules, policies, or procedures to ensure the accuracy of accounting and finance information, safeguard the various assets of the business, promote accountability in the business, and prevent the occurrence of frauds in the company. carried out by the company. The auditor undertakes a detailed examination of controls.
#3 – Substantive Test – Transactions
The main aim of this test is to identify whether any fraud or error or material misstatement exists in the organization.
#4 – Substantive Test – Procedures
It is similar to the test discussed above; however, this one aims at evaluating the financial statements by carrying out a detailed study of the relationship of actually recorded amounts with the expected. It involves financial as well as non-financial data.
#5 – Test of Balances
It focuses on the end balances of the general ledgersGeneral LedgersA general ledger is a book of accounts that records the everyday business transactions in separate ledger accounts. The entries made in a ledger can be verified by getting a NIL balance on summing up all the ledger account amounts in the trial balance., which are eventually carried forward to the balance sheet, which is the face of the company financials.
- It helps an auditor to select a few samples from a large group of transactions. Thus, it reduces the volume of work involved.
- Saves a lot of time;
- Eventually saves his workforce and labor to be employed.
- Saves on cost on account of lesser time involved and low workforce associated;
- From the auditors’ point of view, he shall be able to take up more clients.
- Improves efficiency, as auditing similar voluminous transactions can be tiring.
- The testing sample will give him comfort about the overall control over systems in an organization.
- Samples are selected randomly, and thus, there is no control by management or board of directors or accounting staff or any other person. Thus they remain alert and careful while posting financial transactions at each stage.
- It can help the auditor to assess the fairness of the preparation of the financial statements.
- The audit test selects sample transactions for testing, and it is very well possible that any transaction about fraud may get left out.
- The responsibility of the auditor increases, as he needs to be sure that the sample covers all the aspects of transactions being carried out by the organization, and he leaves no stone unturned to check on any undetected errors or frauds.
- Audit Testing may work where the volume of transactions is very high. It will make no sense to follow audit testing from organizations operating on a small scale.
- It is possible that since the management, board, and accounting staff knows’ that audit shall be done using sample testing method, they may remain careless in the hopes that any fraud or error may not get caught by the auditor.
- The auditor may leave complicated transactions out of its sample and only focus on simpler transactions to ease his work.
- Risky to be done in case there is no or weak internal controls.
Audit test is a procedure adopted by an auditor to test a sample of a similar group of transactions to conclude the fairness with which the transactions are recorded. It involves undertaking tests in five ways to arrive at a wholesome picture about the level of effectiveness of internal controls and whether there are any errors, omissions, or any material misstatements while preparing financial statements of the organization.
This article has been a guide to what is Audit Test and its definition. Here we discuss the audit test of control with types, examples, and benefits. You can learn more about accounting from the following articles –