IPCC Audit Notes: Internal Control & Auditor’s Review

CHAPTER 4

INTERNAL CONTROL

PART 2………

Internal control & Auditor Basics
  • Auditor should obtain an understanding of the accounting & internal control systems sufficient to plan the audit & develop an effective audit approach.

 

The auditor generally assesses control risk at a high level for some or all assertions when:

 

  • The entity’s accounting & internal control systems are not effective.
  • Evaluating the effectiveness of the entity’s accounting & internal control systems would not be efficient.

 

In the above 2 cases the auditor would obtain sufficient appropriate audit evidence from substantive procedures & from any audit work carried out in preparation of financial statements.

 

The preliminary assessment of control risk for a financial statement assertion should be high unless the auditor:

 

  • Is able to identify internal controls relevant to the assertion which are likely to prevent or detect & correct a material misstatement.
At the level of financial statements
  • The integrity of management.
  • Management’s experience & knowledge & changes in management during the period.
  • Unusual pressures on management.
  • Nature of entity’s business.
  • Factors affecting the industry in which the entity operates.
At the level of account balance & class of transactions
  • Quality of accounting system.
  • Financial statements are likely to be susceptible to misstatement.
  • The complexity of underlying transactions & other events which might require using the work of an expert.
  • The degree of judgment involved in determining account balances.
  • Susceptibility of assets to loss or misappropriation.
  • The completion of unusual & complex transactions, particularly, at or near period end.
  • Transactions not subjected to ordinary processing.
Review of internal control by auditor Basics
  •  Its an important part of overall audit program.
  • Auditor should gain an understanding of the accounting system & related internal controls & should study & evaluate the operations of these internal controls to determine the nature, timing & extent of audit procedures.
  • The review of internal controls helps the auditor to know:

 

-          Whether errors & frauds are likely to be located in the ordinary course of operations of business.

-          Whether an adequate internal control system is in use & operating as planned by the management.

-          Whether an effective internal auditing department is operating.

-          Whether any administrative control has a bearing on his work.

-          Whether the controls adequately safeguard the assets.

-          How far & how adequately the management is discharging its function in so far as correct recording of transactions is concerned.

-          How reliable the reports, records & the certificates to the management can be.

-          The extent & depth of the examination that he needs to carry out in the different areas of accounting.

-          What would be appropriate audit technique & the audit procedure in the given circumstances?

-          What are the areas where control is weak & where its excessive.

-          Whether some worthwhile suggestions can be given to improve the control system.

Internal control review methods Narrative record
  • This is a complete & exhaustive description of the system as found in operation by the auditor.
  • Actual testing & observation are necessary before such a record can be developed.
  • Its used in cases where no formal control system is in operation & the scale of operation is small.
  • Basic disadvantages are:

 

-          To comprehend the system in operation is quite difficult.

-          To identify weaknesses or gaps in the system.

-          To incorporate charges arising on account of reshuffling of manpower.

Check list
  • This is a series of instructions and/or questions which a member of the auditing staff must follow and/or answer.
  • Answers to the check list are mostly yes, no or not applicable.
  • Examples are:

 

-          Are tenders called before placing orders?

-          Are purchases order forms pre-numbered?

 

  • The checklist is studied by Principal/Manager/Senior to ascertain existence of internal control & evaluate its implementation & efficiency.
Internal control questionnaire
  • This is a comprehensive series of questions concerning internal control.
  • It’s the most widely form for collecting info about the existence, operation & efficiency of internal control in an organization.
  • Its given to the client & the client is requested to fill it.
  • If on perusal of answers, inconsistencies are noticed, the matter is further discussed by auditor’s staff with the client’s employees.

 

Advantage:

 

  • Omission of significant internal control review procedure is less.
  • All internal evaluation can be completed at one time or in sections.
  • Review can be more easily made on an interim basis.
  • It provides an orderly means of disclosing control deficiencies.
Flow chart
  • It’s a graphic presentation of each part of the company’s system of internal control.
  • Its considered as the most concise way of recording the auditor’s review of the system.
  • It minimizes the amount of narrative description & thereby achieves a consideration or presentation not possible in any other form.
  • It gives a bird’s eye view of the system & the flow of transactions & integration & in documentation, can be easily spotted & improvements can be suggested.

 

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