CHAPTER 9 TESTS OF CONTROLS

Transcription

1 CHAPTER 9 TESTS OF CONTROLS 1

2 TESTS OF CONTROLS Provide auditor with evidence to support their assessment of control risk. When control risk assessed at less than high, necessary to gather evidence that controls are working. Auditor will select most efficient and effective combination of tests of controls, and substantive tests of transactions and balances. Auditor must consider: Design Operation of internal control structure 2

3 PLANNING THE SCOPE OF TESTS OF CONTROLS Nature: If controls exist that auditor expects to rely upon, undertake tests of these controls, otherwise undertake substantive testing. Timing: To aid ability to meet deadlines and scheduling of staff, tests of controls sometimes scheduled before year-end. Testing then extended (rolled forward) until year-end. Extent: For tests of controls related to documents, extent determined by reference to sampling theory. Controls related to accounting routines (e.g. back reconciliations) usually tested by reperforming a small number. 3

4 TESTS OF CONTROLS AIMED AT DESIGN Generally include: Inquiries of company personnel Inspection of documents and reports Observation of the application of specific internal control policies and procedures 4

5 TESTS OF CONTROLS AIMED AT OPERATION Should provide evidence that the: Control actually existed Control was effective in achieving its objectives Control operated continuously throughout the period of intended reliance 5

6 SUFFICIENCY AND APPROPRIATENESS OF TESTS OF CONTROLS Dependent on level of control risk the tests must support The lower the planned assessed level of control risk, the greater the amount of testing that is required 6

7 OTHER FACTORS AFFECTING SUFFICIENCY AND APPROPRIATENESS Auditor should also consider: Type and source evidence Timeliness Interrelationship of evidence 7

8 EFFECT OF DOCUMENTATION OF CONTROLS: AUDIT TRAIL Methods used by auditor dependent on whether a documentary audit trail exists Where no audit trail exists, greater emphasis on: Observation Inquiry of the control If audit trail does exist: Inspect documentation for evidence of the control 8

9 REVENUES, RECEIVABLES AND RECEIPTS (SALES CYCLE) Sales cycle involves all those transactions and events that are initiated when an entity makes a sale. Characterised by a high volume of routine transactions. Audit problems tend to be related to clerical processing rather than complex accounting problems. 9

10 KEY FUNCTIONS IN TYPICAL SALES CYCLE Order entry and order approval by credit department Shipping Invoicing General ledger entry Accounts receivable Mail opening Cashier functions 10

11 TYPICAL CREDIT SALES FLOWCHART 11

12 TYPICAL CASH COLLECTION FLOWCHART 12

13 SALES CYCLE ROUTINE AND NON-ROUTINE TRANSACTIONS Routine transactions: credit sales to customers, cash collections from customers (flowcharts), usually strong control system, auditor considers (and usually undertakes) tests of controls. Non-routine transactions: adjustments to sales, and provisions for doubtful debts. Less well controlled. Where material, auditor undertakes substantive testing. 13

14 CONTROL OBJECTIVES FOR SALES SYSTEM Controls are in place to ensure that: All sales recorded are bona fide transactions for merchandise actually shipped to customers. All sales for the period of merchandise shipped are invoiced and properly recorded in accounting records. Invoices have been recorded correctly as to amount and period and summarised correctly. Sales are disclosed and classified in accordance with disclosure policies. From Table 9.4 (p. 397) 14

15 EXAMPLE OF LINKING OBJECTIVES TO CONTROL POLICIES AND TESTS OF CONTROLS FOR SALES (From Table 9.4 p. 397) Special control objectives Common control policies and procedures Tests of controls All sales recorded are bona fide transactions for merchandise actually shipped to customers Policy of authorisation of credit and terms Quantities shipped periodically reconciled to quantities invoiced independently of shipping and invoicing Monthly statements mailed to customers Signed acknowledgment that goods are received by customers Select a sample of sales transactions from sales journal (daily activity report), check for appropriate authorisation and trace to shipping document file Inspect reconciliation of shipments to invoices Observe mailing of monthly statements, examine customer correspondence file and investigate non-cash credits to accounts receivable 15

16 CONTROL OBJECTIVES FOR CASH RECEIPTS SYSTEM Controls are in place to ensure that: Recorded cash receipts are for collection of receivables from customers All cash receipts are recorded and deposited Cash receipts have been recorded correctly as to account, amount and period Ref.: Table 9.5 (p. 400) 16

17 EXAMPLE OF LINKING CONTROL OBJECTIVES TO CONTROL POLICIES TO TESTS OF CONTROLS: CASH RECEIPTS (Ref.: Table 9.5 p. 400) Special control objectives Recorded cash receipts are for collection of receivables from customers Common control policies and procedures Cash receipts matched to specific sales invoices in posting to accounts receivable master file Test of controls Select a sample of entries in cash receipts journal and trace to remittance advices or sales invoices 17

18 TYPES OF MISSTATEMENTS IN SALES CYCLE Generally result of: Clerical mistakes Employee fraud Misapplied accounting principles Management fraud 18

19 EXPENDITURES, PAYABLES AND DISBURSEMENTS Expenditures cycle all transactions and events initiated when an entity acquires assets or services used for cash or credit. Auditors (and many entities) often separate this cycle into a number of sub-cycles, which reflect various types of services and assets that can be acquired. 19

20 SUB-CYCLES IN EXPENDITURES, PAYABLES AND DISBURSEMENTS These sub-cycles are: Payroll Property, plant and equipment Inventory Income taxes Incurrence of selling and administrative expenses Miscellaneous expenses paid from petty cash 20

21 KEY FUNCTIONS WITHIN THE INVENTORY SUB- CYCLE Purchasing Accounts payable Cash disbursements function 21

22 TYPICAL PURCHASES AND CASH PAYMENTS FLOWCHART 22

23 CONTROL OBJECTIVES IN A PURCHASES OF INVENTORY SYSTEM Controls are in place to ensure that: All recorded purchases are bona fide transactions in that they relate to goods or services authorised or received. All purchases for the period of inventory received are recorded. Purchases of goods or services for inventory are recorded correctly as to account, amount and period, and summarised correctly. Purchases are disclosed and classified in accordance with disclosure policies. From Table 9.6 (p. 409) 23

24 EXAMPLE OF LINKING CONTROL OBJECTIVES, CONTROLS AND TESTS OF CONTROLS: PURCHASES Special control objectives All recorded purchases are bona fide transactions in that they relate to goods or services authorised or received Common control policies and procedures Goods received are counted, inspected and compared to purchase order before acceptance Services received are acknowledged in writing Comparison of purchase order, receiving report and supplier s invoice and recomputation of supplier s invoice before recording liability Tests of controls Select a sample of order entries in purchases journal, trace back to vouchers and inspect for existence of supporting document including receiving report, ensuring agreement of details and indication of approval Observe and inquire about receiving procedures From Table 9.6 (p. 409) 24

25 CONTROL OBJECTIVES IN A CASH DISBURSEMENTS SYSTEM Controls are in place to ensure that: Recorded cash disbursements are for goods or services authorised and received. All cash disbursements are recorded. Cash disbursements are recorded correctly as to account, amount and period. From Table 9.7 (p. 410) 25

26 EXAMPLE OF LINKING CONTROL OBJECTIVES, CONTROL AND TESTS OF CONTROLS: CASH DISBURSEMENTS (Ref.: Table 9.7 p. 410) Special control objectives Recorded cash disbursements are for goods or services authorised and received Common control policies and procedures Cheques printed or prepared only when supporting documents compared, recomputed and voucher approved Cheques signed only after viewing supporting documentation and prior approval Cheque signing independent of initiating or approving purchases, cheque preparation and accounting functions Supporting documentation cancelled and reference to cheque number Tests of controls Select a sample of cash disbursement transactions from cash payments journal and inspect supporting documentation for indication of checking, review and approval, and reperform checking Observe and inquire about cheque preparation and signing and protection of unissued cheques For the sample of cash disbursement transactions inspect supporting documents for cancellation, cheque number and endorsement 26

27 POTENTIAL MISSTATEMENTS IN EXPENDITURE CYCLE As expenditure cycle involves disbursements of cash there is a greater risk of fraud or irregularity, including: Classic disbursements fraud Kickbacks Illegal acts Unauthorised executive perks Kiting 27

28 SELLING AND ADMINISTRATIVE EXPENSES Processing and related control policies and procedures for selling and administrative expenses are similar to those for purchases of inventory. Auditor will normally obtain comfort from cash disbursement testing for inventory purchases and perform minimal testing in this area. Analytical procedures (e.g. comparing balance with prior periods) widely used as a key type of testing. 28

29 PETTY CASH DISBURSEMENTS Petty cash disbursements are usually immaterial in amount and therefore few, if any, audit procedures are applied to this area. Where the area is significant, emphasis is on ensuring appropriate procedures are in place to safeguard cash. 29

30 PAYROLL The payroll function is usually audited in either of two ways (or best combination): Focusing on analytical procedures (there are disaggregated and strong relationships in this area, e.g. comparing fortnightly payrolls); or An emphasis on tests of transactions over the payroll area with a key control being appropriate segregation of duties of hiring function, approval of time worked, payroll preparation and payroll distribution. 30

31 TESTS OF CONTROLS IN PAYROLL If tests of controls are necessary the following audit procedures may be undertaken: Authorisation by supervisors of time worked Check signed time cards/sheets Use of approved pay rates (personnel department) Check for reasonableness, compared with awards 31

32 INTEREST, RENT, LEASE AND INSURANCE PAYMENTS Usually a substantive approach of checking terms and conditions to contracts. Auditor interested in the key control of authorisation of the contract Accounting treatment of leases complex, and auditor might check controls to ensure properly accounted for 32

33 TESTING CONTROLS IN CLIENT COMPUTER PROGRAMS Separate techniques have to be developed for testing programmed controls. These are: Test data Integrated test facility Controlled processing, reprocessing or parallel processing Review program code and results of job processing 33

34 TEST DATA Figure 9.4 (p. 416) 34

35 INTEGRATED TEST FACILITY Figure 9.5 (p.417) 35

36 AUDITING THROUGH COMPUTER PROCESSING CLIENT DATA Controlled processing. Auditor establishes control over processing of client s data. Controlled reprocessing. Auditor reprocesses client data. Parallel processing. Simultaneously processes client data through client and auditor programs. 36

37 AUDITING THROUGH COMPUTER NON-PROCESSING APPROACHES Program code review. Involves reviewing relevant code line by line, considering whether processing steps and control procedures are properly coded and logically correct. Review of job accounting data. Involves review printed log of jobs, looking for excessive processing time, abnormal halts, etc. 37

38 ADVANCED CAATs Systems control audit review file (SCARF) Audit modules embedded in programs to monitor transaction activity Snapshot Transactions are tagged and then identified at certain points during processing to see how program is treating them Audit hooks Points in program that allow auditor to insert commands for special processing 38

39 IMPACT OF STRATEGIC BUSINESS RISK ON TESTS OF CONTROLS Approach increases emphasis on nonroutine transactions and decreases emphasis on routine transactions: Expect a satisfactory IC structure around routine transactions; therefore must undertake tests of controls to support this expectation Therefore either no change or increased emphasis on tests of controls 39