Substantiative Testing of Sales. Auditing Course | CPA Exam

In this video, we explain substantiative testing of sales

Substantive Testing of Sales
Substantive testing of sales is an audit procedure used to evaluate the accuracy, completeness, and validity of an organization’s recorded sales transactions. The primary objective is to verify that the sales figures reported in the financial statements are free from material misstatements and conform to applicable accounting standards.

Purpose of Substantive Testing in Sales
Accuracy: Verify that sales are recorded at the correct amounts and in the appropriate accounting period.
Existence: Confirm that sales transactions actually occurred and are not fictitious.
Completeness: Ensure that all valid sales transactions have been recorded and none are omitted.
Cutoff: Check that sales are recorded in the correct reporting period to prevent timing errors.
Classification: Validate that sales are appropriately classified in the financial statements.

Substantive Testing Procedures for Sales
Inspection of Documentation:
Examine supporting documents such as sales invoices, customer orders, and shipping documents.
Ensure consistency among these records to confirm the legitimacy of sales transactions.

Reconciliation:
Reconcile total sales from the accounting system to the general ledger and financial statements.
Investigate and resolve any discrepancies.

Cutoff Testing:
Test transactions near the end of the reporting period to ensure they are recorded in the correct period.
Review shipping documents and sales invoices to validate the timing of revenue recognition.

Analytical Procedures:
Perform trend analysis or ratio analysis (e.g., sales growth, gross margin) to identify unusual patterns or variances.
Compare recorded sales to prior periods, budgets, or industry benchmarks.

Confirmation:
Send confirmation letters to customers to verify the accuracy of sales transactions and balances in accounts receivable.
Follow up on any discrepancies reported by customers.

Testing Revenue Recognition Policies:
Assess compliance with revenue recognition principles, such as IFRS 15 or ASC 606.
Verify that revenue is recognized only when performance obligations are satisfied.

Subsequent Receipts Testing:
Review cash receipts after the reporting period to confirm the realization of recorded sales.
Match receipts to corresponding invoices and shipping records.

Sampling:
Use statistical or judgmental sampling methods to select a subset of sales transactions for detailed testing.
Extrapolate findings to assess the risk of material misstatements in the overall population.

Review of Credit Notes:
Examine credit notes issued during and after the reporting period to ensure that they are legitimate and appropriately recorded.

Key Audit Assertions Addressed
Existence: Ensures that recorded sales represent actual transactions with customers.
Completeness: Confirms that all sales transactions have been captured in the financial records.
Accuracy: Validates that sales amounts are recorded without error.
Cutoff: Verifies proper timing of sales recognition.
Rights and Obligations: Ensures the company has the right to the sales revenue recognized.

Challenges in Substantive Testing of Sales
Fraudulent Transactions: Identifying fictitious or inflated sales can be challenging, especially in complex operations.
Revenue Manipulation: Deliberate misstatements, such as premature revenue recognition, require thorough scrutiny.
Large Volume of Transactions: Testing a representative sample of sales in high-volume businesses can be time-consuming.
Complex Revenue Arrangements: Multi-element contracts or deferred revenue arrangements may require specialized knowledge to audit.

Importance of Substantive Testing
Substantive testing provides auditors with reasonable assurance that sales figures are accurate and reliable. This ensures the integrity of financial reporting and helps stakeholders make informed decisions based on the audited financial statements.

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