Substantive Testing by Area (Including Inventory Counts)

Learning objectives

• Design substantive procedures that target key assertions for major balance areas, including trade receivables, trade payables, inventory, cash and bank, non-current assets, and provisions.
• Plan, perform, and evaluate attendance at an inventory count, including actions to obtain evidence before, during, and after the count.
• Select procedures that respond directly to specific assertions (existence, completeness, rights and obligations, accuracy, cut-off, classification, valuation, and presentation).
• Evaluate audit evidence, quantify misstatements, and determine appropriate follow-up work where results are inconsistent or incomplete.
• Document clear, assertion-linked conclusions that address identified risks and explain how the evidence obtained supports the reported balances and disclosures.

Overview & key concepts

Substantive testing provides direct evidence about whether transactions, balances, and disclosures are materially misstated. It is performed at the assertion level and is especially important where inherent risk is high, controls are weak, or reliance on controls is limited.

Substantive work commonly takes two forms:

• Tests of details: inspection, confirmation, recalculation, reperformance, observation, and enquiry applied to selected transactions or balance items (for example, agreeing an invoice to the ledger or confirming a receivable with a customer).
• Substantive analytical procedures: evaluating financial information by studying plausible relationships (for example, comparing gross margin trends to prior periods and investigating unexpected movements with corroborating evidence).

Substantive procedures do not “change” the accounting equation. Their purpose is to detect misstatements that would distort reported assets, liabilities, income, and expenses.

Note on wording: in practice, accuracy often relates to correct recording (amounts, dates, coding), while valuation focuses on appropriate measurement and recoverability of balances.

Substantive procedures by area

Inventory counts

Inventory is often high risk because misstatements can arise from:

• Existence: recorded inventory may not be physically present, or quantities may be inflated (including double counting).
• Completeness: items held may be omitted from records (including goods in transit, items stored off-site, or inventory held by third parties).
• Valuation: incorrect costing, inaccurate standard costs, unrecorded write-downs, or inclusion of obsolete/slow-moving items at inappropriate values.
• Cut-off: purchases and sales recorded in the wrong period can misstate inventory, cost of sales, revenue, and trade payables/receivables.

What attendance at a count does and does not prove
Attending a count does not provide a guarantee that all inventory exists. Attendance provides evidence about:

• whether the entity’s count process appears capable of producing a reliable inventory listing; and
• the auditor’s own test counts on selected items.

Attendance alone does not usually provide sufficient evidence over rights and obligations (for example, consignment stock, goods held for third parties, or inventory subject to retention of title) or completeness (for example, goods held at external locations). These typically require additional work such as third-party confirmations, review of consignment and delivery terms, and cut-off testing using goods received and goods despatched documentation.

Trade receivables and revenue-related balances

Revenue and receivables are commonly exposed to overstatement risk (for example, premature recognition, fictitious sales, or failure to recognise credit notes and returns).

Evidence that often helps includes:

• External confirmations (customer confirmations): can support existence and accuracy for the items confirmed, but they have limits. Non-responses require alternative procedures; disputed balances need investigation; and there is a risk of management interference if the process is not properly controlled by the auditor. Confirmations also do not, by themselves, demonstrate recoverability—valuation requires additional follow-up.
• Subsequent receipts testing: agrees cash received after period end to individual customer balances, supporting existence and giving some evidence about collectability.
• Credit note and returns testing: reviews post year-end credit notes and returns to identify possible overstatement at period end.
• Loss allowance (expected credit losses) (often called a doubtful debts allowance): evaluates whether receivables are stated at an amount expected to be collected, using ageing analysis, customer-specific information, post year-end receipts, and support for assumptions.

Trade payables and purchase-related balances

Trade payables are commonly exposed to understatement risk (for example, unrecorded supplier invoices, goods received not invoiced, or cut-off errors).

Evidence that often helps includes:

• Supplier statement reconciliations: reconciles supplier statements to the payables ledger to identify missing invoices, unrecorded credit notes, or timing differences.
• Search for unrecorded liabilities: inspects evidence after period end to identify obligations that existed at period end but were not recorded, and to detect cut-off errors. Common sources and what to look for include:
  • Post year-end payments: match payments to invoices and receiving documentation; identify invoices that relate to pre year-end goods/services but were not accrued.
  • Unmatched goods received notes / receiving reports (including GRNI listings): identify goods received before year end where the supplier invoice has not yet been recorded.
  • Unmatched supplier invoices: identify invoices recorded after year end that relate to pre year end receipts.
  • Supplier statements and post year-end credit notes: identify missing invoices, unrecorded credits, returns, or period allocation errors.
• GRNI / accrual testing: tests the completeness and cut-off of liabilities arising from goods received before year-end but invoiced after year-end.

Cash and bank

Cash is exposed to risks around existence, completeness, rights, and presentation (including overdrafts and restricted balances).

Evidence that often helps includes:

• Bank confirmations: independent evidence of balances and, depending on the scope requested, banking arrangements such as loans, overdraft limits, and security.Where requested, confirmations can also provide evidence about guarantees and similar arrangements.
• Bank reconciliation testing: agrees the reconciliation to bank statements and the cash book, and tests reconciling items for validity and clearing after period end.
• Cash book review: scans for unusual entries, large manual journals, round-sum postings, and period-end transactions that may indicate cut-off manipulation.

Non-current assets (property, plant and equipment and similar)

Common risks include existence (assets no longer in use but still recorded), valuation (incorrect depreciation or impairment), and completeness (unrecorded additions).

Evidence that often helps includes:

• Additions testing: agrees additions to invoices, contracts, authorisations, and evidence of receipt and use.
• Disposals testing: agrees disposals to sale documentation and ensures derecognition from the register, including correct treatment of accumulated depreciation and gain/loss.
• Depreciation recalculation: tests depreciation based on cost, residual value, useful life, and the date available for use.
• Impairment indicator review: looks for evidence that carrying amounts may not be recoverable (for example, idle assets, damage, adverse performance against budgets, adverse market changes, or restructuring decisions in minutes).

Provisions and other liabilities

These balances are sensitive to judgement and can be biased or incomplete.

Evidence that often helps includes:

• Understanding the underlying event: identify what gave rise to the potential obligation (contracts, claims correspondence, board minutes, HR files, or legal letters).
• Challenging the amount recorded: check arithmetic accuracy and evaluate whether key assumptions are reasonable, using independent support where possible.
• Using later information appropriately: review outcomes after period end for consistency with the year-end estimate, distinguishing between information that confirms circumstances existing at year end and genuinely new events arising after year end.

Core theory and frameworks

Designing substantive procedures

Effective substantive procedures start with clear links between:

1. the balance or disclosure being tested;
2. the relevant assertions;
3. the specific risk(s) of misstatement identified; and
4. the procedure(s) that can produce evidence directly responsive to those risks.

To keep answers disciplined and exam-appropriate, frame procedures as:

• Procedure → Assertion(s) → Risk addressed → Evidence expected

Example (receivables):

• Inspect post year-end receipts and match to customer balances → existence/valuation → risk of overstated receivables → evidence that the balance was real and some cash was collected.

Example (payables):

• Review unmatched GRNs and trace to invoices/ledger period → completeness/cut-off → risk of unrecorded liabilities → evidence that goods received were accrued where required.

Inventory counts

Attending an inventory count: what the auditor is trying to achieve

When attending a count, the auditor is not “re-counting the warehouse”. The purpose is to judge whether the entity’s count process is likely to produce a reliable final inventory listing and to obtain independent test evidence from selected items.

1) Understand the count setup (before counting starts)
Read the count plan with professional scepticism. Focus on whether it addresses common failure points: movement control, clear marking of counted areas, treatment of damaged and mixed items, and supervision of count teams. Map locations (including external sites) and identify where error risk is highest (high-value lines, small portable items, bulk materials, messy storage, or multiple similar items). Decide how cut-off references will be captured by recording the last despatch and receipt references around the reporting date.

2) Obtain test evidence while the count is happening
Observe what actually happens in practice. If movement continues, recounts occur without explanation, or labelling is inconsistent, increase the extent of testing.

Two ways to pick test counts (use both):

• Start with what you can see: choose items on the floor (especially high-value or easy-to-move lines) and prove they appear once, correctly described, in the count records. This helps address inflation and duplication risk.
• Start with what’s recorded: choose entries from the count sheets/listing (including unusual descriptions or unexpectedly low quantities) and locate them physically. This helps address omission risk and poor identification.

Record enough identifiers (location, unit, condition, and product code where available) so the item can be matched back to the final listing without ambiguity. Note items that appear damaged, slow-moving, or obsolete so they can be followed up in valuation work.

3) Link what you observed to the final numbers (after the count)
Trace test counts into the final inventory listing and investigate differences. Reconcile listing totals to the general ledger and obtain explanations for adjustments made after the count. Then move beyond quantity: test pricing and costing, and consider whether recorded amounts are likely to be recovered through sale or use. Finally, complete cut-off work for goods received and goods despatched around the reporting date so that inventory, cost of sales, revenue, and related payables/receivables are recorded in the correct period.

A practical cut-off approach is to select a sequence of last goods despatched notes and last goods received notes around year-end and trace each to invoices and ledger posting dates to confirm the correct period has been used.

Worked example

Narrative scenario

ABC Ltd is a wholesaler with a year-end of 31 December. The company holds a mixed inventory range, including high-value electronics and slow-moving accessories.

During the year, the following occurred:

1. Sold goods for £50,000 on credit to Northbridge Ltd.
2. Received £30,000 from Northbridge Ltd relating to previous sales.
3. Purchased inventory for £20,000 from Larch & Co, payable in 30 days.
4. Paid £15,000 to Larch & Co relating to previous purchases.
5. Recognised a provision of £5,000 for a legal claim.
6. Disposed of an old machine for £10,000. It originally cost £25,000 and had accumulated depreciation of £18,000 at disposal date.
7. Purchased a new machine for £52,000 and depreciates it on a straight-line basis over 8 years with a residual value of £4,000.
8. A physical inventory count was performed on 30 November, with records subsequently adjusted for purchases and sales up to year-end.
9. During the count work, obsolete inventory with a carrying amount of £2,000 was identified.
10. Bank charges of £500 were identified that had not yet been recorded in the cash book.
11. A £1,200 cash book error was identified and corrected in December.
12. A bank confirmation reported a year-end bank balance of £100,000.

Required

• Compute the closing balances for trade receivables and trade payables (using the information given).
• Set out the year-end bank reconciliation approach and identify any cash book adjustments required.
• Calculate depreciation for the new machine for the year (assume a full year’s depreciation is appropriate for this example).
• Explain the inventory adjustments required for obsolescence and for rolling forward a count from 30 November to 31 December.
• Document conclusions that link evidence obtained to the assertions addressed.

Solution

1) Trade receivables and trade payables (closing balances)

Trade receivables (Northbridge Ltd)
Closing balance = Credit sales − Cash received (opening balance not provided)

• Credit sale: £50,000
• Cash received: £30,000

Closing trade receivables = £20,000

Journal entries (for context)

• Credit sale:
  • Dr Trade receivables £50,000
  • Cr Revenue £50,000
• Receipt from customer:
  • Dr Bank £30,000
  • Cr Trade receivables £30,000

Trade payables (Larch & Co)
Closing balance = Credit purchases − Cash paid (opening balance not provided)

• Credit purchase: £20,000
• Cash paid: £15,000

Closing trade payables = £5,000

Journal entries (for context)

• Credit purchase (inventory):
  • Dr Inventory £20,000
  • Cr Trade payables £20,000
• Payment to supplier:
  • Dr Trade payables £15,000
  • Cr Bank £15,000

2) Bank reconciliation (what can be concluded from the given facts)

The bank confirmation shows a year-end bank balance of £100,000. The only item explicitly identified as missing from the cash book is bank charges of £500, which must be posted to the cash book.

Cash book adjustment

• Dr Bank charges (expense) £500
• Cr Bank £500

A full bank reconciliation also requires details of timing differences (for example, outstanding payments and outstanding lodgements) and the cash book balance at 31 December. Those figures are not provided here. In practice, the reconciliation would be prepared by:

• obtaining the year-end bank statement and the cash book balance;
• identifying timing differences between the two; and
• verifying reconciling items and checking that they clear shortly after period end.

3) Depreciation for the new machine

Depreciation per year = (52,000 − 4,000) ÷ 8 = £6,000

Journal entry (for context)

• Dr Depreciation expense £6,000
• Cr Accumulated depreciation £6,000

4) Disposal of the old machine (profit/loss check)

• Proceeds: £10,000
• Cost: £25,000
• Accumulated depreciation: £18,000
• Carrying amount: £25,000 − £18,000 = £7,000
• Profit on disposal: £10,000 − £7,000 = £3,000

Journal entry (for context)

• Dr Bank £10,000
• Dr Accumulated depreciation £18,000
• Cr Non-current assets (cost) £25,000
• Cr Profit on disposal (income) £3,000

5) Inventory: obsolescence and rolling forward a 30 November count

Obsolescence (valuation)
Obsolete inventory with a carrying amount of £2,000 should be written down to net realisable value (NRV) — the amount expected to be realised from sale after allowing for any selling and completion costs. If NRV is assumed to be nil for this example:

• Dr Cost of sales (or inventory write-down expense) £2,000
• Cr Inventory £2,000

Rolling forward the count from 30 November to 31 December (existence, completeness, cut-off)
Because the physical count occurred before year-end, the year-end inventory figure must be supported by movement testing from 1 December to 31 December, including:

• purchases/receipts into inventory (goods received documentation and supplier invoices);
• sales/despatches out of inventory (dispatch notes and sales invoices); and
• cut-off testing around 31 December to ensure goods received and goods despatched are recorded in the correct period, with related receivables and payables appropriately recognised.

The earlier the count date, the more the auditor must rely on movement records and controls and extend roll-forward and cut-off testing (often increasing sample sizes).

Where inventory is held at third parties or subject to consignment/retention terms, additional procedures such as third-party confirmations and contract/terms review are required to support rights and completeness.

6) Provision for the legal claim

Provision recognised: £5,000

Journal entry (for context)

• Dr Legal expense £5,000
• Cr Provision £5,000

Substantive work focuses on identifying the underlying event and evaluating whether the amount recorded is a reasonable estimate based on available evidence, including later information where it helps assess circumstances existing at year end.

Conclusions linked to assertions

• Trade receivables (£20,000): existence and accuracy supported by customer confirmation (where obtained) and/or subsequent receipts testing; valuation supported by post year-end receipts, dispute review, and assessment of the loss allowance (expected credit losses).
• Trade payables (£5,000): completeness and cut-off supported by supplier statement reconciliation, unmatched GRNs/GRNI testing, and post year-end payments testing.
• Cash at bank: existence and rights supported by bank confirmation; accuracy supported by posting missing cash book items (bank charges) and by testing the bank reconciliation and clearing of reconciling items.
• Non-current assets: depreciation recalculation supports valuation; impairment indicator review supports measurement where indicators exist; disposal documentation supports derecognition and accurate profit on disposal.
• Inventory: count attendance supports evidence over the counting process and test counts; valuation supported by NRV testing and write-downs for obsolete items; completeness/rights and cut-off supported by roll-forward movement testing, third-party confirmations where relevant, and goods received/despatched testing around year end.
• Provisions: evidence supports the underlying event and management’s estimate through documentation, calculation checks, independent support for assumptions where available, and review of later outcomes for consistency with the year-end estimate.

Common pitfalls and misunderstandings

• Treating attendance at an inventory count as proof that all inventory exists: attendance supports the process and selected test counts, not a guarantee over the full balance.
• Over-claiming what confirmations prove: non-responses, disputes, and interference risk must be addressed; recoverability needs additional work.
• Failing to search for unrecorded liabilities using multiple sources (post year-end payments, unmatched GRNs, supplier statements): focusing only on the ledger can miss understatement.
• Reconciling only the totals on bank reconciliations: each reconciling item must be supported and shown to clear after period end.
• Ignoring post year-end credit notes and returns: these can signal overstatement of revenue and receivables at period end.
• Misstating disposal accounting: derecognition requires removing both cost and accumulated depreciation, with gain/loss based on carrying amount.

Summary and further reading

Substantive testing provides direct evidence about whether balances and disclosures are materially misstated. Effective procedures are assertion-led and risk-focused: define the population, target high-risk items, obtain independent evidence where possible, test cut-off around period end, and evaluate estimates for both arithmetic accuracy and reasonableness.

Inventory work often requires a combination of count attendance, roll-forward movement testing, valuation procedures (including NRV), and cut-off testing. Receivables work commonly focuses on existence and recoverability, payables work prioritises completeness, and cash work relies heavily on independent confirmations and a well-supported reconciliation. Provisions and other estimates require a disciplined focus on evidence for the underlying event and the reasonableness of management’s estimate.

FAQ

What are substantive procedures?

Substantive procedures are audit procedures performed to obtain direct evidence about whether transactions, balances, and disclosures are materially misstated. They include tests of details and analytical procedures that investigate unexpected relationships or movements.

Why is inventory frequently high risk?

Inventory can be misstated through incorrect quantities, inappropriate costing, failure to write down slow-moving or obsolete lines to NRV, and cut-off errors affecting both inventory and profit. Multiple locations and high volumes can further increase error risk.

How is cut-off tested in practice?

Cut-off testing examines transactions around the reporting date. A practical approach is to select the last goods despatched notes and goods received notes around year-end and trace each to sales/purchase invoices and ledger posting dates to confirm the correct period has been used.

What does a bank confirmation cover?

A bank confirmation provides independent evidence of balances at the reporting date and, depending on the scope requested, may also confirm loans, overdraft facilities, and security. Where requested, it may also provide evidence about guarantees and similar arrangements.

How is completeness of payables tested?

Common approaches include supplier statement reconciliations, review of unmatched GRNs/GRNI listings, inspection of post year-end payments, and testing invoices received after year end that relate to pre year end receipts.

What does attending an inventory count actually prove?

Attendance provides evidence about whether the entity’s count process appears reliable and supports the auditor’s test counts on selected items. Additional procedures are usually needed for rights/obligations (for example, consignment) and completeness (for example, external locations) as well as valuation and cut-off.

Glossary

Substantive procedures
Audit procedures performed to obtain direct evidence about whether transactions, balances, and disclosures are materially misstated, using tests of details and/or analytical procedures.

Tests of details
Substantive procedures applied to selected transactions or balance items (for example, inspecting invoices, recalculating depreciation, or agreeing balances to external evidence).

Substantive analytical procedures
Substantive procedures that evaluate financial information by analysing relationships and investigating unexpected movements using corroborating evidence.

Receivables confirmation
A request sent to customers asking them to confirm amounts owed (or other details) at a specified date. Responses can support existence and accuracy for the items confirmed, subject to follow-up for disputes and non-responses.

Subsequent receipts testing
Testing cash received after period end and matching it to specific receivable balances to support existence and provide evidence relevant to collectability.

Supplier statement reconciliation
Comparing supplier statements to the payables ledger and investigating differences to identify missing invoices, unrecorded credit notes, or timing issues.

Search for unrecorded liabilities
Procedures aimed at identifying obligations existing at period end that are missing from the ledger, commonly using post year-end payments, unmatched GRNs/GRNI listings, invoices received after year end, and supplier statements.

Bank confirmation
Independent evidence obtained from a bank covering balances and, where requested, key arrangements such as loans, overdrafts, security, and guarantees.

Bank reconciliation
A reconciliation between the cash book and bank statement that explains differences through timing items and corrects cash book errors or omissions.

Inventory count attendance
Attendance at a physical count to observe the entity’s counting process and perform test counts, supporting evidence over selected quantities and informing follow-up valuation and cut-off work.

Cut-off testing
Testing whether transactions are recorded in the correct accounting period, particularly around the reporting date for sales, purchases, and inventory.

Provision (audit-focused)
A liability where the amount and/or timing is uncertain. Audit work focuses on whether there is evidence of an obligation at the reporting date, whether settlement is likely to require an outflow, and whether the recorded amount is a reasonable estimate supported by available evidence.

Valuation testing
Procedures that assess whether recorded amounts are reasonable and appropriately measured (for example, testing inventory write-downs to NRV, depreciation calculations, or the reasonableness of estimates).