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Internal controls in auditing

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Internal controls in auditing

  1. 1. INTERNAL CONTROLS IN AUDITING Presented by: Hardik Shah (S00096042) Bing BingWang (S00043503)
  2. 2.  Introduction Objectives of Internal control Components of Internal control Famous cases Substantive tests and Tests of control Case study analysis
  3. 3.  Today, communication and Integrity of financial information is of utmost importance to the companies. Integrity function performed by the auditing profession Auditors need to obtain an understanding of internal control and an evaluation of the extent to which controls may be relied on to assure the accuracy and reliability of accounting records.
  4. 4. In accounting and auditing internal control is defined as: A process designed, implemented & maintained by Those charged with governance, Management, Other personnel To provide reasonable assurance About achievement of entity’s objectives with regard to..... Reliability of Compliance with Effectiveness & Safeguarding of Financial laws and Efficiency of assets Reporting regulations operations
  5. 5. A C E • Effective & Efficient operations• Accurate and Reliable Financial • Compliance with laws and • Safeguarding of assets information regulations
  6. 6. C • Control ActivitiesR • Risk Assessment ProcessI • Information & CommunicationM • MonitoringE • Environment
  7. 7.  Control activities – actions supported by management policies to address risk. Five specific control activities: - Adequate separation of duties - Proper authorization of transactions and activities - Adequate documents and records - Physical control over assets and records independent checks on performance
  8. 8.  Risk assessment - identification and analysis of risks relevant to financial reporting in accordance with accounting standards. Information and communication – ensuring that the entity’s control environment, risks, control activities and performance results are communicated company-wide.
  9. 9.  Monitoring – ongoing/ periodic assessment of the quality of internal control performance. Sources include, studies of existing internal controls, internal auditor reports and so on. Control environment – the actions, policies and procedures that reflect the overall attitudes of top management, directors and owners of an entity towards internal control. Sub-elements for the auditor to consider: - management’s philosophy and operating style - organizational structure - assignment of authority and responsibility - internal audit - human resources
  10. 10.  AWA Limited v Daniels – Auditors were sued for negligence as they failed to bring the deficiencies of internal control to the board of AWA limited The HIH collapse – Royal commission found that HIH failed to review its corporate governance model to assess its suitability for changing circumstances in the insurance industry. - Arthur Andersons failed to blow the whistle
  11. 11. There are 2 basic methods for testing the accuracy of the Financial Statements: Substantive Tests – where the contents of the FS are checked by looking for evidence that proves the figures and words are correct Tests of Controls – where the systems that produce and protect the contents of the FS are checked. If the systems work, then the resulting FS should be accurate.
  12. 12. The audit procedures designed to evaluate the operating effectiveness of controls in preventing, or detecting and correcting, material misstatements at the assertion level.
  13. 13.  A test of control focuses on assessing the quality of the evidence or information that has been processed by the accounting system. A substantive test of a transaction relates to only tracing the accounting information the source documents to journals and to the General ledger (and subsidiary ledgers).
  14. 14. Difference between a ‘test of control’ and a ‘substantive test of control’? The auditor would be testing to see whether the purchase has been recorded correctly in the accounting records, recognizing that the reliability of that recording can be enhance by the presence of internal controls along the processing stream A test of control focuses on the quality of the source documents whereas a substantive test of transaction concentrates on whether the source document has been recorded correctly in the accounting book.
  15. 15. Case Study AnalysisThe following is the description of the purchasing system at Dean. No other controls exist apart fromthose described.“The company has no buying department so employees place orders in their own area of responsibility.A three part order form is used; copy 1 is retained by the originator, copy 2 is sent to the goods inwarddepartment and copy 3 is sent to the supplier.”“Goods are received, but not checked, by the goods inwards clerk. Once received, the advice note andpurchase order for those goods are sent to the purchase ledger clerk.”“When the supplier’s invoice is received the purchase ledger clerk checks the calculations on it, initials itand staples the advice note and purchase order to it. She enters the invoice on to the purchase ledger.”“The invoice is then sent to the manager responsible for the employee who ordered the goods. Themanager codes the invoice and returns it to the purchase ledger clerk. Purchase invoices are coded,entered on an analysis sheet and posted to the nominal ledger monthly by journal entry.”“The cashier pays suppliers monthly on instructions from the purchase ledger clerk. The purchaseledger control account is reconciled monthly by the purchase ledger clerk who also reconciles suppliers’statements.”
  16. 16. Case Study Analysis (contd..)“The company has no buying department so employees place orders in their own area ofresponsibility. A three part order form is used; copy 1 is retained by the originator, copy 2 is sentto the goods inward department and copy 3 is sent to the supplier.”“Goods are received, but not checked, by the goods inwards clerk. Once received, the advicenote and purchase order for those goods are sent to the purchase ledger clerk.”“When the supplier’s invoice is received the purchase ledger clerk checks the calculations on it,initials it and staples the advice note and purchase order to it. She enters the invoice on to thepurchase ledger.”“The invoice is then sent to the manager responsible for the employee who ordered the goods.The manager codes the invoice and returns it to the purchase ledger clerk. Purchase invoicesare coded, entered on an analysis sheet and posted to the nominal ledger monthly by journalentry.”“The cashier pays suppliers monthly on instructions from the purchase ledger clerk. Thepurchase ledger control account is reconciled monthly by the purchase ledger clerk who alsoreconciles suppliers’ statements.”
  17. 17. Case Study Analysis (contd..)“The company no buying department so employees place orders in their own area ofresponsibility. A three part order form is used; copy 1 is retained by the originator, copy 2 issent to the goods inward department and copy 3 is sent to the supplier.”“Goods are received, but not checked, by the goods inwards clerk. Once received, the advicenote and purchase order for those goods are sent to the purchase ledger clerk.”“When the supplier’s invoice is received the purchase ledger clerk checks the calculations on it,initials it and staples the advice note and purchase order to it. She enters the invoice on to thepurchase ledger.”“The invoice is then sent to the manager responsible for the employee who ordered the goods.The manager codes the invoice and returns it to the purchase ledger clerk. Purchase invoicesare coded, entered on an analysis sheet and posted to the nominal ledger monthly by journalentry.”“The cashier pays suppliers monthly on instructions from the purchase ledger clerk. Thepurchase ledger control account is reconciled monthly by the purchase ledger clerk who alsoreconciles suppliers’ statements.”
  18. 18. Case Study Analysis (contd..)“The company no buying department so employees place orders in their own area ofresponsibility. A three part order form is used; copy 1 is retained by the originator, copy 2 issent to the goods inward department and copy 3 is sent to the supplier.”“Goods are received, but not checked, by the goods inwards clerk. Once received, the advicenote and purchase order for those goods are sent to the purchase ledger clerk.”“When the supplier’s invoice is received the purchase ledger clerk checks the calculations on it,initials it and staples the advice note and purchase order to it. She enters the invoice on to thepurchase ledger.”“The invoice is then sent to the manager responsible for the employee who ordered the goods.The manager codes the invoice and returns it to the purchase ledger clerk. Purchase invoicesare coded, entered on an analysis sheet and posted to the nominal ledger monthly by journalentry.”“The cashier pays suppliers monthly on instructions from the purchase ledger clerk. Thepurchase ledger control account is reconciled monthly by the purchase ledger clerk who alsoreconciles suppliers’ statements.”
  19. 19. Case Study Analysis (contd..)“The company no buying department so employees place orders in their own area ofresponsibility. A three part order form is used; copy 1 is retained by the originator, copy 2 issent to the goods inward department and copy 3 is sent to the supplier.”“Goods are received, but not checked, by the goods inwards clerk. Once received, the advicenote and purchase order for those goods are sent to the purchase ledger clerk.”“When the supplier’s invoice is received the purchase ledger clerk checks the calculations onit, initials it and staples the advice note and purchase order to it. She enters the invoice onto the purchase ledger.”“The invoice is then sent to the manager responsible for the employee who ordered the goods.The manager codes the invoice and returns it to the purchase ledger clerk. Purchase invoicesare coded, entered on an analysis sheet and posted to the nominal ledger monthly by journalentry.”“The cashier pays suppliers monthly on instructions from the purchase ledger clerk. Thepurchase ledger control account is reconciled monthly by the purchase ledger clerk who alsoreconciles suppliers’ statements.”
  20. 20. Case Study Analysis (contd..)“The company no buying department so employees place orders in their own area ofresponsibility. A three part order form is used; copy 1 is retained by the originator, copy 2 issent to the goods inward department and copy 3 is sent to the supplier.”“Goods are received, but not checked, by the goods inwards clerk. Once received, the advicenote and purchase order for those goods are sent to the purchase ledger clerk.”“When the supplier’s invoice is received the purchase ledger clerk checks the calculations onit, initials it and staples the advice note and purchase order to it. She enters the invoice onto the purchase ledger.”“The invoice is then sent to the manager responsible for the employee who ordered the goods.The manager codes the invoice and returns it to the purchase ledger clerk. Purchase invoicesare coded, entered on an analysis sheet and posted to the nominal ledger monthly by journalentry.”“The cashier pays suppliers monthly on instructions from the purchase ledger clerk. Thepurchase ledger control account is reconciled monthly by the purchase ledger clerk who alsoreconciles suppliers’ statements.”
  21. 21. Case Study Analysis (contd..)“The company no buying department so employees place orders in their own area ofresponsibility. A three part order form is used; copy 1 is retained by the originator, copy 2 issent to the goods inward department and copy 3 is sent to the supplier.”“Goods are received, but not checked, by the goods inwards clerk. Once received, the advicenote and purchase order for those goods are sent to the purchase ledger clerk.”“When the supplier’s invoice is received the purchase ledger clerk checks the calculations onit, initials it and staples the advice note and purchase order to it. She enters the invoice onto the purchase ledger.”“The invoice is then sent to the manager responsible for the employee who ordered the goods.The manager codes the invoice and returns it to the purchase ledger clerk. Purchase invoicesare coded, entered on an analysis sheet and posted to the nominal ledger monthly by journalentry.”“The cashier pays suppliers monthly on instructions from the purchase ledger clerk. Thepurchase ledger control account is reconciled monthly by the purchase ledger clerk who alsoreconciles suppliers’ statements.”
  22. 22. 1st Weakness No buying department There is no buying department.Error: Staff may not buy the cheapest products
  23. 23. 1st Weakness No buying department There is no buying department.Error: Staff may not buy the cheapest products and may duplicate products
  24. 24. 2nd Weakness Unnumbered Order Form The purchase order notes appear to be unnumbered.Error: So purchase order notes could go missing.
  25. 25. 3rd Weakness Goods not checked Goods are not checked for quality on arrivalError: Dean may accept damaged goods. (the valuation of inventory may be wrong)
  26. 26. 4th Weakness Goods Received Notes Dean does not generate Goods Received Notes. (GRN)Error: Dean will not be able to tell what stock has arrived.
  27. 27. 5th Weakness Purchase Day Book There is no purchase day book. (PDB) instead Journals are used monthlyError: So Dean will not know who they owe at any point.
  28. 28. 6th Weakness Lack of segeration The purchase ledger clerk perfoms all the duties in purchase orders.Error: So she could cover up the fraud.
  29. 29.  Normal Audit Procedures.  the normal method of auditing information in the income statement is to use control tests. Dean pruchases system  however, as can be seen that the Dean purchases system is very weak. Conculsion  so the Dean purchases will need substantive testing and this will increase audit duration.

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