Financial integrity is the foundation of business success and investor confidence. Major financial scandals, like Enron or WorldCom, highlight the critical importance of thorough financial examination. So, companies need reliable methods to verify their financial health and regulatory compliance.
Behind every reliable annual report and earnings statement stands a solid verification process. This post breaks down the two critical approaches used to catch financial reporting problems and discrepancies before they become disasters. We’ll compare how they work, when to use each, and why the strongest organizations use both to protect what they’ve built.
What Is Substantive Testing?
Substantive testing is when audit teams collect and check sample records for significant accounting errors. The goal is to confirm that financial records are complete and accurate.
Substantive audit procedures prove that all material assertions in the financial statements are true. Yet, tests may also reveal monetary errors or misstatements in the presentation of transactions and balances.
Substantive testing is performed according to Generally Accepted Auditing Standards (GAAS). The standards require auditors to understand the company’s audit controls and check whether they can prevent or catch important errors in financial statements.
Types of Substantive Tests
There are three types of substantive tests.
- Analytical procedures: These compare financial and operational data to see if trends and relationships make sense. This helps auditors spot potential problems in financial records that need more investigation.
- Test of details of transactions: This focuses on individual transactions that make up an account balance. Auditors check a sample to confirm that they match the company’s books.
- Tests of details of balances: This checks for important errors in account balances on financial statements. It confirms that both control tests and transaction tests show reasonable results.
Key Factors That Influence Substantive Testing
Auditors decide what kind of audit tests to run, how many, and when to perform them based on how much risk they are willing to accept and previous risk assessment evaluations.
- Nature: This is the type and strength of the testing method. If the risk of error is low, the auditor will use more detailed and costly procedures. If the risk is higher, simpler and less expensive methods may be used.
- Extent: This is how much evidence the auditor collects. When acceptable risk is low, more tests and larger sample sizes are needed. If risk is high, fewer tests and smaller samples may be enough.
- Timing: This is when the tests are done. If risk is low and controls are strong, the auditor may test earlier in the month. If risk is higher, the auditor may audit closer to month- or year-end if the expected risk is high.
What Is Control Testing?
Control testing is an audit procedure to determine whether internal control systems effectively prevent or discover material misstatements at the appropriate assertion level.
Control tests determine whether a policy or practice is well-designed to prevent, detect, or reduce the risk of material misstatements in a financial statement. The operating effectiveness of controls focuses on three questions:
- How is the control applied?
- Is the control consistently applied during the year?
- Who applies it?
Auditors use several techniques to understand control procedures. For example, they focus on high-risk areas where problems are most likely to happen. This helps them find issues and suggest ways to improve the effectiveness of internal controls.
Types of Control Tests
There are two types of testing to identify points of control weaknesses.
- Concurrent test: The auditor tests the understanding of a process to check the effectiveness of the control policy or practice. These tests are performed based on the discretion of the auditor. For example, auditors may inquire about the budgeting system to verify users’ familiarity with the processes.
- Planned test of control: An auditor will look for evidence of proper and consistent application of control policies and procedures throughout the audited year.
Best Practices for Control Testing
The following best practices can help you test controls more effectively.
- Prioritize testing of controls: Large organizations may have hundreds or even thousands of documented controls. For each control under review, assess its impact to determine the nature and frequency of testing and testing procedures. Also, consider the specific regulations or compliance standards the organization must follow, such as the Sarbanes-Oxley Act (SOX) or General Data Protection Regulation (GDPR). These standards often guide the testing process and help identify which controls to test first.
- Design an appropriate test for each control: The nature of the control determines the best testing approach. If a control addresses significant risks, it should be tested more frequently. You may also want to evaluate the design of the control before testing how it operates.
- Document and track identified problems: An essential part of control testing is resolving issues found during the process. Always verify corrections by rerunning the test after remediation to ensure the problems have been fixed.
- Incorporate walkthroughs to validate understanding: Performing walkthroughs with process owners help confirm your understanding of how control works in practice and can uncover gaps between source documents and actual procedures.
How Do the Main Objectives of Tests of Controls and Substantive Procedures Differ?
When we talk about control tests, we refer to audit procedures that verify the operating effectiveness of controls. Controls are put in place to prevent or detect material misstatements. This is not the same as substantive testing, which is a phase in the audit process that determines the fairness of financial information.
The key differences in their objectives are:
- Control testing evaluates the performance of internal controls within the accounting system.
- Substantive testing provides sufficient and appropriate audit evidence regarding the completeness, accuracy, and validity of the actual financial data.
In terms of sequence and relationship:
- Control testing is typically completed before substantive testing.
- The results of control testing influence the scope of substantive testing. For instance, if controls are found to be weak, auditors may recommend more detailed substantive testing.
Although they serve different purposes, both procedures:
- Are essential audit techniques
- Play a vital role in ensuring effective internal controls within a business
What Are Substantive Procedures?
Substantive procedures are tests auditors use to check financial statements. They gather evidence to verify that financial records are complete, accurate, and properly valued.
The main goal of substantive procedures is to make sure financial records have no important errors and all necessary information is correctly shown. These procedures include:
- Testing transactions, account balances, and disclosures
- Comparing financial statements and notes to accounting records
- Reviewing important journal entries and adjustments made when preparing financial statements
- Making inquiries about any suspicious transactions
What Are Examples of Substantive Analytical Procedures?
Substantive analytical procedures rely on expected relationships between financial data to evaluate the accuracy and reasonableness of reported numbers.
For example, if payroll has historically been around 30% of total expenses, auditors may expect a similar ratio. Any major deviation would prompt further investigation. Known patterns are used for comparisons to form conclusions about the reliability of financial statements.
Here are some common examples of how auditors apply these procedures:
- Testing occurrence
- Compare monthly sales of the current year to the previous year
- Compare the percentage of expenses to sales year-over-year
- Testing cut-off
- Compare profit margins from the last few months of the audit period to those immediately after year-end
- Testing solvency and going concern
- Compare the current ratio to the prior year to assess liquidity
- Testing accuracy and occurrence
- Compare current and prior year profit margins to identify unusual fluctuations
- Testing completeness and accuracy of pension/post-employment benefits
- Divide actual plan assets by accrued liabilities and compare to the previous year
- Testing financial strength and going concern
- Divide total debt by total assets and compare to prior year results
- Testing inventory existence and occurrence
- Divide cost of goods sold by average inventory and compare to previous year ratios
Can Control and Substantive Testing Be Used Together Effectively?
Yes. Control testing and substantive testing can—and often should—be used together to strengthen audit outcomes. Together, these tests create a layered approach that increases confidence in both the control environment and the accuracy of the underlying data.
This approach is especially valuable when auditing in complex environments where systems, data flows, and controls are closely linked. Relying on just one method can leave gaps, like control testing may not catch data errors, while substantive testing may overlook systemic weaknesses.
Advanced methodologies like parallel simulations, integrated test facilities, and embedded audit modules also benefit from a combined testing strategy. These tools allow simultaneous control validation and data accuracy checks.
Drive Efficiency in Your Internal Controls Using ZenGRC
Developing strong control testing habits starts with simplifying the audit process and using the right tools. ZenGRC helps collect and document control evidence in a structured way.
The platform also provides valuable benchmarks, such as audit completion time, issue counts, and resource effort. These real-time insights allow you to track performance and spot areas that need improvement.
Schedule a free demo to learn how ZenGRC helps you simplify internal control management.