Chapter 3: Internal Control Systems

Question 1

What does internal control mean? (3)

Answer 1

The process designed and effected by those charged with governance, management and other personnel

To provide reasonable assurance about the achievement of the entity’s objectives

With regard to the reliability of financial reporting, effectiveness and efficiency of operations and compliance with applicable laws.

Question 2

What internal controls could help a company achieve its objectives and mitigate risk? (4)

Answer 2

1. Quality control can prevent the production of poor quality goods.
2. Credit control can limit the level of bad debts.
3. Controls over inventory ordering can prevent running out of stock and ensure an optimal inventory level to minimise holding costs.
4. A compliance department can implement policies to ensure the business complies with the relevant laws.

Question 3

What do internal controls consist of? (5)

Answer 3

1. The control environment.
2. The entity’s risk assessment process.
3. The information system including the related business processes relevant to financial reporting and communication.
4. Control activities.
5. Monitoring of controls.

Question 4

What does the control environment include? (1)

What does it focus on? (1)

Answer 4

The governance and management of an organisation.

It focuses on the attitude, awareness and actions of those responsible for designing, implementing and monitoring internal controls.

Question 5

What elements does the control environment include? (4)

Answer 5

1. Communication and enforcement of integrity and ethical values.
2. Commitment to competence.
3. Participation by those charged with governance.
4. Management’s philosophy and operating style.

Question 6

The information system is all of the business processes relevant to financial reporting and communication.

What are the information system procedures designed to do? (5)

Answer 6

1. Initiate, record, process and report transactions.
2. Maintain accountability for assets, liabilities and equity.
3. Resolve incorrect processing of transactions.
4. Transfer information to the general ledger.
5. Ensure information required to be disclosed is appropriately reported.

Question 7

What are control activities (1) and what are they a component of? (1)

Answer 7

Policies and procedures that help ensure that management directives are carried out.

They are a component of internal controls.

Question 8

What do internal controls rely on to succeed? (8)

Answer 8

1. Segregationist of duties= no one employee should be able to fully record and process a transaction.
2. Physical controls= custody of assets and records are kept safe.
3. Authorisation and approval= all transactions require approval.
4. Management= management controls outside of day to day business eg internal audits and budget control.
5. Supervision= supervision by management.
6. Organisation= there must be a well defined structure showing authority and responsibility.
7. Accounting= controls that check the totals of reconciliations and control accounts.
8. Personnel= a system only functions properly if employees are well motivated, competent and honest.

Question 9

What is control monitoring? (1)

Answer 9

Assessing a control’s effectiveness and taking appropriate action.

Question 10

What factors mean that no system of internal controls can ever mitigate risks entirely? (6)

Answer 10

1. Human error= mistakes by people responsible for control.
2. Unusual transactions= tend to be outside the scope of the control system.
3. Collusion= staff work together to bypass the segregation of duties.
4. Special considerations in small companies.
5. Informal nature= eg lack of documentation.
6. Limited number of staff= makes segregation of duties difficult.

Question 11

What is essential in order for the controls to be maintained? (2)

Answer 11

1. Segregation of duties= person raising the order should be independent from ledger keeping, stock recording and payments.
2. Supervision= there must be an overall systems of review by a responsible official.

Question 12

What are the 2 types of tests that auditors carry out? (2)

Answer 12

1. Compliance tests= test of controls to provide evidence as to whether or not the auditor can rely on them functioning during the review.
2. Substantive tests= tests of transactions, account balances, the existence of assets and liabilities, their accuracy, completeness and their valuation.

Question 13

What are internal control questionnaires? (1)

Answer 13

ICQs are a set of yes or no questions to discover the existence of internal controls and to help discover any weaknesses.

Question 14

What are the objectives of control in the sales system? (5)

Answer 14

1. Ordering= all orders are processed and can be fulfilled, orders are not accepted from non creditworthy customers.
2. Despatch= all orders are despatched promptly, in full and to the correct customer.
3. Invoicing= all goods despatched are invoiced and all invoices are correct.
4. Recording= only valid sales are recorded, all sales and related receivables are recorded in the correct accounts and period they relate to.
5. Cash received= cash is allocated to the correct customer accounts, overdue debts are chased and irrecoverable debts are written off.

Question 15

An internal control questionnaire for the sales system (Yes or No).

Answer 15

Question 16

What are the objectives of control in the purchase system? (5)

Answer 16

1. Ordering= all purchases are for a valid business use from suppliers who have been checked for quality, reliability and pricing.
2. Goods received= only goods ordered by the company are received and promptly recorded.
3. Invoice received= invoices received relate to goods actually received, the current company and have the correct quantity, prices and discounts.
4. Recording= all purchases are recorded and are recorded accurately at the correct value, in the correct accounts and in the period they relate to.
5. Cash payments= payments are only made for goods received once received.

Question 17

An internal control questionnaire for the purchase system (Yes or No).

Answer 17

Question 18

Additional purchase controls are added for more significant expenses.

The objectives of these controls are to ensure that: (7)

Answer 18

1. Assets are only purchased if there is a business need for them.
2. Assets are purchased at an appropriate price.
3. The company can afford the capital expenditure proposed.
4. Capital expenditure is appropriately treated in the accounting records.
5. Capital expenditure is completely and accurately recorded.
6. Assets are covered by insurance to prevent loss.
7. Documents relating to assets are safeguarded from damage or theft.

Question 19

What are some additional controls for purchasing non current assets? (8)

Answer 19

1. Requisitions should be made by an appropriate person.
2. Authorisation for large purchases should be at a senior level.
3. Multiple quotes should be obtained before purchase to obtain the best price.
4. Authorisation should only be given for budgeted capital expenditure.
5. Regular review of revenue expenditure should be done so capital items aren’t accidentally expensed.
6. A fixed asset register should be maintained including cost, depreciation, insurance, location etc.
7. Adequate insurance cover should be purchased.
8. Assets documents eg deeds and insurance policies should be stored safely.

Question 20

What are the objectives of the payroll system? (5)

Answer 20

1. Timesheets= employees are only paid for work actually completed.
2. Payroll calculations= only genuine employees are paid and are paid at the correct rates.
3. Standing data amendments= standing data is kept up to date and restricted to prevent theft or fraud.
4. Recording= all payroll amounts are recorded accurately in the period they relate to.
5. Payments to employees and tax authorities= correct amounts are paid and payments are made on time.

Question 21

An internal control questionnaire for the payroll system (Yes or No).

Answer 21

Question 22

An internal control questionnaire for the payroll system (Yes or No).

Answer 22

Question 23

The objectives of the inventory system are to ensure that: (4)

Answer 23

1. General= inventory levels meet the needs of production (raw materials) and the customer (finished goods) but don’t cause excessive storage costs.
2. Inventory is kept safe.
3. Receipt and despatch= inventory received and despatched is correctly recorded on a timely basis.
4. Recording= all inventory owned by the company is recorded at an appropriate value.

Question 24

What are the controls of the inventory system? (4)

Answer 24

1. Levels= inventory should be kept at an appropriate level using automatic systems so levels can be checked before ordering.
2. Safeguards= inventory should be kept at appropriate conditions, with insurance and appropriate security.
3. Receipt and despatch= inventory movements should be recorded using goods received and despatched notes.
4. Inventory counts= physical quantities should be reconciled with records to ensure accuracy and that’s there no damage.

Question 25

What are the objectives of the cash system? (4)

Answer 25

1. General= petty cash levels are kept to minimum and are safeguarded to prevent theft. 2. Authorisation= payments must be for legitimate business expenses. 3. Receipts= receipts are banked on a timely basis to prevent theft. 4. Recording= cash movements are recorded on a timely basis.

Question 26

What are the 3 main payment types? (3)

Answer 26

1. Cheques. 2. Electronic transfers (BACs or FP). 3. Cash payments.

Question 27

What are the fundamental principles of cheques? (3)

Answer 27

1. Division of duties= the person signing cheques should be separate from the authorisation, recording and custodial functions. 2. Custody= all cheques should be issued in a controlled sequential order with “AC payee only” marked to minimise fraud, unused cheques should be kept under lock and key. 3. Authorisation= no cheque should be prepared without supporting documents eg an invoice or signed payroll.

Question 28

What are the fundamental principles of electronic transfers? (2)

Answer 28

1. Division of duties= people processing transfers should be separate from the authorising and recording functions. 2. Authorisation= no transfer should be processed without supporting documents.

Question 29

What are the fundamental principles of cash payments? (3)

Answer 29

1. Custodial procedures= all post should be opened by 2 responsible officials, cash received should be recorded and banked on the same day. 2. Separation of duties= different members of staff should be responsible for opening the post, preparing paying in details and controlling the SL. 3. Recording controls= cash receipts should be checked by regular bank reconciliations.

Question 30

What are the main areas that a system weakness could impact? (9)

Answer 30

1. Assets. 2. Liabilities. 3. Income. 4. Expenses. 5. Theft/ fraud. 6. Morale. 7. The system’s efficiency. 8. Business reputation. 9. Time taken to produce information.

Question 31

What is an internal audit? (1)

Answer 31

An independent, objective assurance and consulting activity design to add value and improve an organisation’s operations.

Question 32

What are the types of control activities? (8) SPAMSOAP

Answer 32

1. Segregation of duties= keeping custodial, authorisation, recording and execution functions separate. 2. Physical controls= restrict access. 3. Authorisation= approval by a responsible person. 4. Management= controls used by management outside the day to day routine of the system. 5. Supervision. 6. Organisation= a structure showing the delegation of authority and responsibility. 7. Accounting= eg controls accounts, reconciliations, sequential documents. 8. Personnel= staff that are honest and competent enough for their tasks.