Under what condition must tests of operating effectiveness be performed in compliance audits?

In compliance audits, tests of operating effectiveness are necessary when the risk assessment indicates that the effectiveness of controls is expected. This situation arises because auditors perform a risk assessment to identify areas where there could be significant risks of material misstatement or noncompliance. If the assessment suggests that the internal controls are designed effectively and are expected to operate as intended, the auditor will perform tests to confirm that these controls are indeed functioning as expected.

This approach is grounded in the principle of obtaining sufficient appropriate evidence to support the audit opinion. By testing operating effectiveness when there is a reasonable expectation of controls working properly, the auditor can gather adequate evidence to support their assertions about compliance and the reliability of financial reporting.

Other conditions, such as identifying significant deficiencies in controls or relying solely on substantive procedures, do not inherently require tests of operating effectiveness. In fact, if substantive procedures alone provide sufficient evidence, tests of operating effectiveness may not be necessary. Additionally, the absence of government regulations would not influence the requirement for testing operating effectiveness, as the decision should be based on the assessment of risks and the effectiveness of controls.