Tests of Controls

8/11/2019 Tests of Controls

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TESTS OF CONTROLS



ACCOUNTING AND INTERNAL CONTROL

ASSESSMENT

1. Understanding of internal control structure

elements

2. Plan the assessed level of control risk(Preliminary assessment)

3. Performance of tests of controls (IFAPPROPRIATE)

4. Reassessment of control risk

5. Final assessment of control risk



Internal Control

Assessment

1. Understanding ofinternal controlstructure

2. Preliminaryassessment of control

risk

3. Tests of controls

4. Reassessment

5. Final Assessment

Transaction Cycles:

1. Treasury – financing cycle

2. Purchasing – disbursementcycle

3. Payroll cycle

4. Conversion Cycle

5. Revenue – receipt cycle



Internal Control

Assessment

1. Understanding ofinternal controlstructure

2. Preliminaryassessment of control

risk


4. Reassessment

5. Final Assessment

Transaction Review

Checks the completenessand accuracy of therecorded understanding.

The auditor should trace atransaction of each typethrough the entire system,

comparing the processing tothose recorded in the flowchart/narrative.



Internal Control

Assessment

1. Understanding of

internal control

structure

2. Preliminaryassessment ofcontrol risk


4. Reassessment

5. Final Assessment

CONTROL RISK MAY BE ASSESSEDAT EITHER:

1. Maximum Level

2. Less than Maximum Level



Internal Control

Assessment

1. Understanding of

internal control

structure



4. Reassessment

5. Final Assessment

Control risk may be assessed at ahigh/maximum level in any of

the following conditions:

1. The entity’s accounting andinternal control systems are not

effective.

2. Evaluating the effectiveness ofthe entity’s accounting and

internal control systems wouldnot be efficient.



Internal Control

Assessment

1. Understanding of

internal control

structure



4. Reassessment

5. Final Assessment

Illustration:

►In obtaining an understanding ofthe internal control policies andprocedures, the auditor notedthat the incompatible functions

of handling inventory items andmaintaining inventory recordsare delegated to one employeeof the company.



Internal Control

Assessment

1. Understanding of

internal control

structure



4. Reassessment

5. Final Assessment

Illustration:

►In this situation, the auditor shouldassess control risk at themaximum level for the inventoryexistence and valuation

assertions. No further tests ofcontrols should be made. Theauditor should instead performextensive substantive tests. Also,

these tests should be performedat year-end rather than at aninterim date.



Internal Control

Assessment

1. Understanding of

internal control

structure



4. Reassessment

5. Final Assessment

Preliminary Assessment:

Guides the auditor indetermining which auditapproach to use:

SUBSTANTIVE APPROACH or

RELIANCE APPROACH.



Internal Control

Assessment

1. Understanding of

internal control

structure



4. Reassessment

5. Final Assessment

When CR is assessed at less than themaximum level, the auditor

should:

1. Identify specific control policiesand procedures that are likely to

prevent/detect misstatements.

2. Perform tests of controls(compliance tests) to evaluate

the effectiveness of such policiesand procedures.



Internal Control

Assessment

1. Understanding of

internal control

structure

2. Preliminary

assessment of controlrisk


4. Reassessment

5. Final Assessment

Tests of controls are necessary in twocircumstances:

1. When the auditor’s riskassessment includes anexpectation of the operating

effectiveness of controls.

2. When substantive proceduresalone do not provide sufficient

appropriate audit evidence atthe assertion level.



Internal Control

Assessment

1. Understanding of

internal control

structure

2. Preliminary



4. Reassessment

5. Final Assessment

Tests of controls should provideevidence about the:

1. Effectiveness of the design of thepolicies and procedures.

2. Operating effectiveness of suchpolicies and procedures.



Internal Control

Assessment

1. Understanding of

internal control

structure

2. Preliminary



4. Reassessment

5. Final Assessment

To determine the Effectiveness of thedesign, the following procedures

may be performed:

1. Inquiries of appropriatepersonnel and observation of

client activities2. Inspection of documents

3. Reperformance of internalcontrols



Internal Control

Assessment

1. Understanding of

internal control

structure

2. Preliminary



4. Reassessment

5. Final Assessment

To determine the Effectivenessinternal control

policy/procedure, the auditor isconcerned with the following:

1. How the policy or procedure was

applied2. Whether there is consistency in

the application of the policy orprocedure

3. The personnel involved inapplying the policy orprocedure.



Internal Control

Assessment

1. Understanding of

internal control

structure

2. Preliminary



4. Reassessment

5. Final Assessment

Transaction Cycles PotentialMisstatements

Tests of Controls

1. Purchases

Transactions

Purchased that did

not occur may berecorded.

Examine approval

signature.

2. PayrollTransactions

Payroll may includefictitious or formeremployees.

Examine approvalsignature onauthorization forpay rate change.

3. ConversionTransactions

Fictitious time maybe assigned to jobs.

Examine labortickets.

4. Cash Receipts

Transactions

Cash receipts may

bemisappropriated

Observe whether a

prelisting isprepared andinquire a preparerabout theproceduresfollowed.



Internal Control

Assessment

1. Understanding of

internal control

structure

2. Preliminary



4. Reassessment

5. Final Assessment

Based on the results of the testsof control, the auditor shouldevaluate whether the internal

controls are designed and

operating as contemplated Inthe preliminary assessment of

control risk.



Internal Control

Assessment

1. Understanding of

internal control

structure

2. Preliminary



4. Reassessment

5. Final Assessment

Tests of Controls

Documents

Transcript of Tests of Controls