ACCT3600 Lec 5 Testing Internal Controls, Use of Experts

Question 1

When must the auditor undertake tests of controls?

Answer 1

When control risk assessed less than high.

Question 2

When will control risk be assessed at high?

What is the one exception?

Give an example of an exception.

Answer 2

1. controls do not exist,
2. controls that do exist will not provide reliable evidence, or
3. it is more efficient or effective to gather the required evidence by undertaking substantive testing.

EXCEPTION: where substantive procedures alone may not provide sufficient appropriate evidence - e.g. ROUTINE RECORDING of significant classes of transactions, such as revenue or purchases. These systems are often HIGHLY AUTOMATED with little or NO MANUAL INTERVENTION.

e.g. airline ticket sales - auditor would only be able to verify a very very small proportion of these transactions by using substantive tests of transactions.

Question 3

What are the basic types of INTERNAL CONTROL PROCEDURES?

Answer 3

1. Independent Approval, Review, Checking or Recalculation
2. MATCHING of Independently Generated Documents
3. PRENUMBERING and Sequence Checking of Key Documents
4. Maintenance of INDEPENDENT CONTROL TOTALS
   - e.g. Recording of Cash Receipts Total Before Banking, Use of Batch Controls, Use of Control Accounts

Question 4

What are the 3 ASPECTS of IC for which evidence is gathered? And how are they tested?

Answer 4

1. Existence
   - sight signature
2. Effectiveness
   - re-preforming calculations.
   - running unauthorized transactions.
3. Continuity
   - ensure that sample of transaction are selected from throughout the yr.

Question 5

What are the 4 types of TEST OF CONTROL PROCEDURES?

Answer 5

1. Make inquiries of appropriate client personnel
2. Inspect documents, records and reports
3. Observe control-related activities
4. Re-perform client procedures.

Question 6

What is the AUDIT STRATEGY with routine and non-routine transactions?

Answer 6

1. Routine
   - e.g. credit sales to customers and cash collections from customers.
   - usually well controlled, and well suited to tests of controls.
2. Non-Routine
   - e.g. adjustments for return of merchandise, allowances for defective merchandise and write-offs or allowances for bad debts.
   - IC not well developed, more effective to undertake substantive tests of transactions.

Question 7

What if auditor finds that necessary degree of reliance cannot be placed on the control to reduce the risk of material misstatement to an acceptable level?

Answer 7

1. Identify compensating control and test this control.

2. Revise audit plan to undertake substantive procedures.

Question 8

Describe the AUDIT PROCESS for test of controls?

Answer 8

1. Key Assertion
2. Internal Control
3. Test of Control

Question 9

When are SUBSTANTIVE ANALYTICAL PROCEDURES applicable?

Give some examples

Answer 9

LARGE VOLUMES of transactions that tend to be PREDICTABLE OVER TIME (i.e. when there is a MATHEMATICAL RELATIONSHIP).

e. g. Payroll expense = No. of employees x fixed rates
e. g. Rental income = No. of apartments x rental rates x occupancy rates
e. g. Interest expense = Loans x interest rates

Question 10

How does the EFFECTIVENESS of IC relate to whether auditor can place reliance on substantive analytical procedures?

Answer 10

Input data from company’s IC system. e.g. occupancy rate from hotel reservation system.

Question 11

How does auditor’s responsibility change when using an expert?

Answer 11

Auditor still has SOLE RESPONSIBILITY to complete all procedures necessary to both form and issue the audit opinion.

Question 12

Should the auditor refer to the use of an expert in the audit report? Why or why not?

Answer 12

NO - unless required by law.

Reason: Readers should not be confused as to who is responsible for the opinion issued.

Question 13

What are the aspects that the auditor must evaluate about the expert?

Answer 13

1. Competence
2. Independence
3. Qualifications
4. Scope of Work
5. Knowledge and Expertise
6. Evidence Collected
7. Valid Opinion Based on Evidence

Question 14

In what circumstances can an auditor use an expert?

Give some examples.

Answer 14

When they require expertise outside accounting and auditing.

e. g. valuation of complex financial instruments, land and buildings
e. g. actuarial calculation of insurance contracts and employee benefit plans
e. g. estimation of oil and gas reserves
e. g. Valuation of environmental liabilities, site clean-up costs.
e. g. Legal interpretation of contracts, regulations etc.