What Is Walkthrough Testing in Accounting and How Does It Work?

Walkthrough testing is a key procedure auditors use to assess the reliability of a company’s internal controls. By tracking a transaction from initiation to completion, auditors can identify weaknesses that might lead to financial misstatements. This process ensures compliance with accounting standards and regulatory requirements.

Purpose in Control Evaluation

Evaluating internal controls is critical for financial oversight, preventing errors and fraud. Walkthrough testing helps auditors determine whether controls are properly designed and functioning effectively. A failed test signals risks that could lead to financial misstatements or regulatory noncompliance.

Regulatory frameworks like the Sarbanes-Oxley Act (SOX) in the U.S. require companies to maintain effective financial reporting controls. SOX mandates that management and external auditors evaluate these controls annually. A failed walkthrough could indicate a material weakness, which must be disclosed in financial statements, attracting scrutiny from regulators and investors.

Beyond compliance, walkthrough testing helps organizations refine financial processes. If an auditor finds a control inconsistently applied or bypassed, management can take corrective action before issues escalate. Addressing weaknesses early reduces the likelihood of financial restatements, which can damage credibility and stock price.

Documentation and Transaction Focus

Auditors review documentation to understand how financial transactions are processed. This includes policies, procedural manuals, and system-generated reports to ensure guidelines are followed consistently. Without proper documentation, verifying financial data accuracy becomes difficult, increasing control risks.

Supporting documents such as invoices, purchase orders, and bank statements provide evidence that transactions have been authorized, recorded, and processed correctly. For example, when reviewing vendor payments, auditors check whether disbursements align with approved invoices and payment terms. Any inconsistencies may indicate lapses in oversight or fraud risks.

System access logs and approval workflows are also examined. Auditors assess whether employees handling transactions have appropriate access and whether approvals follow a structured hierarchy. If a company requires dual authorization for payments over $50,000, auditors verify whether this control is consistently enforced. Weak access controls could allow unauthorized transactions, increasing financial misstatement risks.

Steps to Execute

Walkthrough testing requires a structured approach to assess internal controls thoroughly. Auditors trace a transaction from initiation to completion, verifying that each stage aligns with documented policies and regulatory requirements. This involves observing workflows, reviewing supporting documents, and confirming that transactions are processed correctly.

Process Walkthrough

The first step is observing how a transaction moves through the financial system. Auditors interview employees responsible for initiating, approving, and recording transactions to understand their roles and responsibilities. This helps identify inconsistencies in procedures.

For example, in a payroll process walkthrough, an auditor may ask an HR representative how employee hours are recorded, how payroll calculations are performed, and how payments are authorized. If an automated payroll system is used, the auditor assesses whether system controls prevent unauthorized changes to pay rates. Deviations from standard procedures may indicate weaknesses, such as improper segregation of duties, which could lead to payroll fraud or errors in financial reporting.

Document Inspection

After understanding the process, auditors examine relevant documents to verify that transactions are properly recorded and supported. This includes reviewing contracts, receipts, reconciliations, and system-generated reports to ensure financial data accuracy.

For instance, when testing the accounts receivable process, an auditor may inspect customer invoices to confirm that sales transactions are recorded in the correct period. If an invoice dated December 28 is recorded in January, it could indicate a cutoff error affecting revenue recognition. Under Generally Accepted Accounting Principles (GAAP), revenue should be recognized when earned, not when cash is received. If such errors are common, they could lead to misstated financial statements, violating SEC reporting requirements.

Transaction Tracing

The final step involves tracing a sample transaction from initiation to completion, ensuring it follows the expected approval and recording process. This confirms that controls function as intended and no unauthorized changes occur.

For example, in an expense reimbursement walkthrough, an auditor may select a specific reimbursement request and track it from submission to payment. This includes verifying that the request was approved by the appropriate manager, matched with supporting receipts, and processed through the accounting system. If an expense is reimbursed without proper documentation, it could indicate a breakdown in controls, increasing fraud risk.

By tracing transactions, auditors identify gaps in oversight and recommend corrective actions. If discrepancies are found, management may need to implement additional review procedures or strengthen approval workflows to prevent future errors.

Recording Observations

Documenting findings during walkthrough testing ensures control deficiencies or inefficiencies are accurately captured. Auditors must record whether a control is in place and whether it operates effectively. This includes noting employee adherence to procedures, system functionality, and any deviations from expected workflows.

Clarity and precision in documentation support conclusions. Auditors typically use standardized checklists or workpapers to log findings, noting whether transactions followed prescribed approval hierarchies and compliance requirements. If discrepancies arise, auditors specify the issue, such as unauthorized approvals or missing documentation, and assess the potential financial impact. For example, if an expense approval threshold is set at $10,000 but transactions above this amount are processed without secondary authorization, it signals a breakdown in oversight that increases fraud risk.

Observations also consider operational efficiency. Even if a control functions, excessive manual interventions or redundant verification steps can create bottlenecks, delaying financial reporting. If journal entries require multiple layers of approval but lack automation, this could slow month-end close procedures, affecting the timeliness of SEC filings. Streamlining such processes while maintaining control integrity is often a recommended course of action.