The document discusses internal controls in auditing, including the objectives, components, and case studies related to internal controls. It describes the control environment, risk assessment, control activities, information and communication, and monitoring as the main components of internal controls. The document also differentiates between substantive tests and tests of controls in auditing.

1. INTERNAL CONTROLS IN AUDITING
Presented by: Hardik Shah
(S00096042)
Bing BingWang
(S00043503)

2.  Introduction
 Objectives of Internal control
 Components of Internal control
 Famous cases
 Substantive tests and Tests of control
 Case study analysis

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. 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. A C E
• Effective & Efficient operations
• Accurate and Reliable Financial • Compliance with laws and • Safeguarding of assets
information regulations

6. C • Control Activities
R • Risk Assessment Process
I • Information & Communication
M • Monitoring
E • Environment

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.  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.  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.  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. 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. The audit procedures designed to evaluate the
operating effectiveness of controls in
preventing, or detecting and correcting,
material misstatements at the assertion level.

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. 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. Case Study Analysis
The following is the description of the purchasing system at Dean. No other controls exist apart from
those 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 inward
department and copy 3 is sent to the supplier.”
“Goods are received, but not checked, by the goods inwards clerk. Once received, the advice note 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 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 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 purchase
ledger control account is reconciled monthly by the purchase ledger clerk who also reconciles suppliers’
statements.”

16. Case Study Analysis (contd..)
“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 inward department and copy 3 is sent to the supplier.”
“Goods are received, but not checked, by the goods inwards clerk. Once received, the advice
note 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 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 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
purchase ledger control account is reconciled monthly by the purchase ledger clerk who also
reconciles suppliers’ statements.”

17. Case Study Analysis (contd..)
“The company 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 inward department and copy 3 is sent to the supplier.”
“Goods are received, but not checked, by the goods inwards clerk. Once received, the advice
note 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 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 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
purchase ledger control account is reconciled monthly by the purchase ledger clerk who also
reconciles suppliers’ statements.”

18. Case Study Analysis (contd..)
“The company 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 inward department and copy 3 is sent to the supplier.”
“Goods are received, but not checked, by the goods inwards clerk. Once received, the advice
note 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 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 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
purchase ledger control account is reconciled monthly by the purchase ledger clerk who also
reconciles suppliers’ statements.”

19. Case Study Analysis (contd..)
“The company 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 inward department and copy 3 is sent to the supplier.”
“Goods are received, but not checked, by the goods inwards clerk. Once received, the advice
note 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 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 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
purchase ledger control account is reconciled monthly by the purchase ledger clerk who also
reconciles suppliers’ statements.”

20. Case Study Analysis (contd..)
“The company 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 inward department and copy 3 is sent to the supplier.”
“Goods are received, but not checked, by the goods inwards clerk. Once received, the advice
note 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 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 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
purchase ledger control account is reconciled monthly by the purchase ledger clerk who also
reconciles suppliers’ statements.”

21. Case Study Analysis (contd..)
“The company 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 inward department and copy 3 is sent to the supplier.”
“Goods are received, but not checked, by the goods inwards clerk. Once received, the advice
note 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 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 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
purchase ledger control account is reconciled monthly by the purchase ledger clerk who also
reconciles suppliers’ statements.”

22. 1st Weakness
 No buying department
 There is no buying department.
Error:
 Staff may not buy the cheapest products

23. 1st Weakness
 No buying department
 There is no buying department.
Error:
 Staff may not buy the cheapest products and may
duplicate products

24. 2nd Weakness
 Unnumbered Order Form
 The purchase order notes appear to be
unnumbered.
Error:
 So purchase order notes could go missing.

25. 3rd Weakness
 Goods not checked
 Goods are not checked for quality on arrival
Error:
 Dean may accept damaged goods. (the valuation
of inventory may be wrong)

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. 5th Weakness
 Purchase Day Book
 There is no purchase day book. (PDB) instead
Journals are used monthly
Error:
 So Dean will not know who they owe at any point.

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.  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.