Chapter 7 - Systems And Controls

Question 1

Impact of tests of controls on the audit strategy and plan

Answer 1

If control risk is deemed low,

1. If tests of controls provide evidence that an effective control system is in place, this may allow the auditor to place more reliance on internal controls and evidence generated internally within the entity.
2. This increases the appropriateness of interim audit testing and reduces the quantity of detailed substantive procedures performed at final audit stage.
3. The audit strategy will be updated to reflect fewer substantive procedures or smaller sample sizes tested at final audit stage.

If control risk is deemed high, the auditor should

1. Increasing procedures conducted at and after year end
2. Increasing substantive procedures, e.g. tests of detail.
3. Increasing the locations included in the audit scope.
4. Placing less reliance on analytical procedures as the information procured by clients system is not reliable.
5. Placing less reliance on written representations from management if the control environment is considered weak.
6. Obtaining more evidence from external sources
7. Updating the audit strategy and plan to additional testing required at final audit stage.

Question 2

Internal control system

Answer 2

1. Control environment
   The governance and management function of an organisation.
   Focuses largely on the attitude, awareness and actions of those responsible for designing, implementing and monitoring internal controls.
2. Risk assessment process
   The basis for how management determines the business risks to be managed.
3. Information system
   All of the business processes relevant to financial reporting and communication.
4. Control activities
   All policies and procedures designed to ensure management directives are carried out throughout the organisation.

Authorisation: Approval of transactions prior to being processed.
e.g. A manager signing off an employee’s time sheet p.

Performance review: To identify unusual differences between data.
Managers should compare actual spend to budget to detect unusual fluctuations.
Managers may compare the company’s results with those of competitors as a benchmark.

Information processing: To ensure completeness and accuracy of processing.
e.g. Processing of a bank rec to ensure cash tans actions recorded accurately and completely.

Physical controls: To prevent physical access.
e.g. Password restrictions or keeping cash in a safe.

Segregation of duties: assigning responsibility to different employees to prevent risk of fraud and error.

e. g. Warehouse staff should not be involved for inventory count.
e. g. Employees who authorise transactions should not be the ones who originate the transaction.

Application controls
Are either manual or automated and operate at business process level.

General controls
Support the effective functioning of application controls by helping to ensure the continued proper operation of information systems.

5. Monitoring of controls
   The clients process of assessing the effectiveness of controls over time and taking action.
   Can be ongoing or performed on a separate evaluation basis.

Question 3

Testing the system

Answer 3

A test of control involves the auditor obtaining evidence that the client has implemented the controls that have worked effectively during the period.

1. Observation of control activities.
   e. g. Observing the inventory count to ensure it is conducted effectively and in accordance with the instructions.
2. Inspection of documents recording performance of the control.
   e. g. Inspecting an order for evidence of authorisation.
3. CAATs

Question 4

Sales system

Answer 4

1. Order received.
   Goods only supplied to customers who pay promptly and in full
   All orders are processed.
2. Goods despatched.
   Orders despatched promptly and in full to the correct customer.
   All orders are despatched.
3. Invoicing.
   All goods despatched are invoiced.
   Invoices are raised accurately.
4. Recording
   Only valid sales are recorded.
   All sales and related receivables are recorded and in correct accounts.
   Revenue is recorded in the period to which it relates.
   Sales are recorded accurately and related receivables are recorded at an appropriate value.
5. Cash received.
   Cash received is allocated against the correct customer and invoices to minimise disputes.
   Overdue debts are followed up on a timely basis.
   Irrecoverable debts identified and written off appropriately.

Question 5

Purchase system

Answer 5

1. Ordering.
   All purchases are made with suppliers who have been checked for quality, reliability and pricing.
   Purchases only made for a valid business use.
   Orders are placed taking consideration of delivery lead times to avoid disruption to the business.
2. Goods received.
   Only goods ordered by the company are accepted.
   Goods received are recorded promptly.
3. Invoice received.
   Invoices received relate to goods actually received.
   Invoices received relate to the company.
   Invoices received are correct in terms of quantities, prices, discounts.
4. Recording.
   All purchases and related payables are recorded.
   Purchases are recorded accurately and related payables are recorded at an appropriate value.
   Purchases are recorded in the period to which they relate.
   Purchases and payables are recorded in the correct accounts.
5. Cash payments.
   Payments are only made for goods received.
   Payments are only made once.
   All payments are made on time.

Question 6

Payroll system

Answer 6

1. Clock cards (time sheets) submitted.
   Employees only paid for work actually done.
2. Payroll calculation.
   Only genuine employees are paid.
   Employees are paid at the correct rates of pay.
   Gross pay is calculated and recorded accurately.
   Net pay is calculated and recorded accurately.
3. Standing data amendments.
   Standing data is kept up to date.
   Access to standing data is restricted to prevent fraud or error occurring.
4. Recording.
   All payroll amounts are recorded.
   Payroll amounts are recorded accurately.
   Payroll costs are recorded in the period to which they relate.
5. Payments to employees and tax authorities.
   Correct amounts are paid to the employees and taxation authorities.
   Payments are made on time.
   Payments are only made to valid employees.

Question 7

Inventory system

Answer 7

1. Goods received.
2. Receipt recorded.
3. Movements posted to nominal ledger and inventory cards.
4. Goods despatched.
5. Despatch recorded.
6. Movements posted to nominal and inventory cards.

Objectives:

1. Inventory levels meet the needs of production and customer demand.
2. Inventory levels are not excessive, preventing obsolescence and unnecessary storage costs.
3. Inventory is safeguarded from theft, loss or damage.
4. Inventory received and despatched is recorded on a timely basis.
5. All inventory is recorded.
6. Inventory recorded at lower of cost and NRV.
7. Only inventory recorded by the company is recorded.

Question 8

Cash cycle

Answer 8

1. Request for payment.
2. Payment authorisation.
3. Payment made/ Receipts.
4. Payment and receipts recorded.

Objectives:

1. Petty cash levels kept to a minimum, preventing theft.
2. Payments only made for legitimate business expenditure.
3. Cash can be withdrawn for business purposes.
4. Cash is safeguarded to prevent theft.
5. Receipts are banked on a timely basis to prevent theft.
6. Cash movements are recorded on a timely basis.