You are required to identify the circumstances when it is appropriate to use only a substantive approach in an audit and when a combination of compliance and substantive tests should be used.
Generally it is more appropriate to use a combination of compliance and substantive tests as it results in an overall saving in audit time. This occurs when the client has sufficient staff to allow an effective system of internal control to operate (usually with proper segregation of duties which will prevent or detect fraud and error) and there a large number of transactions. In such a situation using a substantive approach will not be effective since the auditor will require to test a large volume of transactions, whereas the auditor can rely on controls to reduce the level of substantive testing.
It is not appropriate to check internal controls when they are weak, as checking these will only confirm that control risk is high, so performing compliance tests will be a waste of time. Internal controls may be weak in small organizations where there are too few staff for a proper segregation of duties. Also in small organizations the owner will operate the system of internal check, but usually there is no control over his actions and this will create a weak system of control.
In very small organizations it is not appropriate to perform compliance tests, as it is quicker to check all, or a substantial proportion of the transactions during the year.
For large organizations with proper controls in place, auditors usually rely heavily on internal controls, which allows them to perform limited substantive tests. This reduces the audit time, compared with undertaking only substantive tests, and thus results in a cost effective audit.