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CIMA BA4 Fundamentals of Ethics, Corporate Governance and Business Law > Chapter 3 Controls > Flashcards

Chapter 3 Controls Flashcards

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1
Q

What is the responsibilities of the audit committee?

A
  1. Oversight of financial reporting
  2. Oversight of narrative reporting
  3. Internal controls and risk management
  4. Whistleblowing and fraud
  5. Internal audit
  6. External audit
  7. Reporting to the board
  8. Reporting on the above to the shareholders
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2
Q

What is the definition of internal control?

A

The process designed, implemented and maintained by directors and management to ensure the reliability of financial reporting, effectiveness and efficiency of operations & compliance with applicable laws and regulations

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3
Q

What are the 3 headings of key business risks?

A
  1. Financial risks - affect the company’s cash flow e.g. movement in interest rates or exchange rates
  2. Compliance risks - relating to laws and regulations e.g. health & safety
  3. Operational risks - relating to day-to-day operations of the business e.g. loss of key staff, inventory management
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4
Q

What are the 5 elements of an internal control system?

A
  1. Control environment - attitudes, awareness, and actions of management concerning company’s internal control and its importance in the company.
  2. The Company’s risk assessment process - process for identifying and controlling risks in the business
  3. The information system relevant to financial reporting
  4. Control activities - policies and procedures that help ensure management directives are carried out
  5. Monitoring of controls - considering whether they are operating as intended and that they are modified as appropriate for changes in conditions
  6. Monitoring of controls -
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5
Q

What are the limitations of internal control?

A
  1. Cost of the controls may outweigh the benefits
  2. Many controls only cover routine transactions
  3. Human error always possible
  4. Staff could collude
  5. Management override of controls
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6
Q

What is an audit?

A

An evaluation of an organisation, system or process.

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7
Q

Why are audits performed?

A
  1. To ascertain the validity and reliability of information

2. Assess a company’s system of risk management and internal control

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8
Q

What is an assurance service?

A

Where legally required to have an external audit performed by an external person who is entirely independent

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9
Q

What are the 5 key elements of an assurance service?

A
  1. Three party relationship
  2. Underlying subject matter
  3. Criteria
  4. Evidence to support the opinion
  5. A written report
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10
Q

What is an external audit?

A

This is an independent examination and expression of opinion on the financial statements of a company

  • Auditor examination is to obtain sufficient appropriate audit evidence
  • Opinion prepared for benefit of shareholders
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11
Q

What is meant by a true and fair view in external audits?

A

No strict definition but essentially that financial statements contain no significant/ material errors

True = Info is factual and complies with accounting standards

Fair = Info is clear, impartial, unbiased - reflecting substance of transactions, rather than the legal form

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12
Q

What are the three things for a financial statements to show a fair presentation?

A
  1. Complete - inc all necessary descriptions and explanations
  2. Neutral - (no bias)
  3. Free from error in -
    > process used to produce the reported info
    > how transactions are described
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13
Q

What is the expectation gap?

A
  • An audit does not provide absolute assurance or guarantee of correctness.
  • Misconceptions around this among users of audit reports are described as the ‘expectation gap’.
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14
Q

What is an audit engagement letter?

A

Details contract between client and audit firm before the audit.

  • Reviewed every year
  • Only reissued if changes to the terms of engagement or evidence that the directors misunderstand the nature of the audit.
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15
Q

What is stewardship?

A

The directors of the company are considered to be the “stewards” of the company, they are accountable to the owners for the performance of company.

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16
Q

How is a company run?

A

Company is owned by shareholders and run by directors. Directors and Shareholders interested in financial statements.
Auditor does independent examination of the financial statements
Auditor gives opinion to shareholders

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17
Q

What are the limitations of external audit ?

A

a) integrity of client management to provide necessary information
b) nature of financial reporting - involves judgement and subjective decisions
c) Limited amount of time - testing only a sample of items due to the fact that there is a cost element to auditing.
d) Auditors select samples for testing based according to where they judge there to be the greatest risk of material misstatements

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18
Q

What are the rights given to auditors by the law to enable them to perform their duties?

A
  1. Right to receive info and explanations from company personnel
  2. Right to receive notice of general meetings
  3. Right to speak at general meetings on matters that are related to the audit
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19
Q

What are the two audit tests?

A
  1. Controls testing - internal control systems in place are capable of preventing errors in the financial statements
  2. Detailed testing - on higher-risk areas to ensure that reported transactions and balances do not contain material misstatements
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20
Q

What are the 3 types of audit risk

A
  1. Inherent Risk - considered at a) financial statement level b) assertion level
  2. Control Risk - Material statements not picked up by accounting and internal control systems
  3. Detection Risk - Risk that the auditors procedures will not detect a misstatement
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21
Q

What is audit documentation?

A

Auditors required to document their work => ‘audit trail’

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22
Q

What makes audit evidence more reliable?

A
  1. From independent external source
  2. If internal, subject to effective control
  3. Obtained by the auditors themselves
  4. Documented not verbal
  5. In original form

Where evidence is less reliable (appropriateness), more will be needed (sufficiency)

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23
Q

What is an audit report?

A

Outlines in the audit opinion in writing to the shareholders of the company. Filed as a matter of public record.
> unmodified opinion - true and fair view

24
Q

What are the two levels of qualification if the financial statements are materially misstated?

A
  1. Isolated material misstatement => auditors conclude that financial statements true and fair EXCEPT for the issue
  2. Multiple/ Significant misstatements cause the auditors to believe financial statements do not give true and fair view => adverse opinion.
  • Auditors may not be able to get hold of info => not true and fair view. In extreme cases, they disclaim any opinion (disclaimer)
  • Auditors may highlight elements of the report to users
25
Q

What is the report on control deficiencies?

A

Report on significant matters to the board of directors. If they have discovered any significant deficiencies in internal controls of company.

  • Private to the board
  • Not comprehensive
26
Q

What is internal auditing?

A

Definition: Independent, objective assurance and consulting activity design to add value and improve organisations operations.

a) Focuses on accounting and internal control systems
b) Performed by employees of company
c) Qualified, experienced staff whose remuneration is controlled by audit committee

27
Q

What are the differences between external and internal auditors in their objectives?

A

External - add credibility and reliability to financial reports
Internal - Evaluate and improve effectiveness of governance, risk management and control processes

28
Q

What are the differences between external and internal auditors in their standards?

A

External - MUST follow international standards on Auditing (ISA’s)
Internal - CHOOSE to use guidelines on Institute of Internal Auditors (IIA)

29
Q

What are the differences between external and internal auditors in who they report to?

A

External - Report to shareholders via the audit report

Internal - Board of Directors or audit committee

30
Q

What are the differences between external and internal auditors in who their status?

A

External - Independent

Internal - Objective (generally and employee of company)

31
Q

What are the differences between external and internal auditors in their qualification?

A

External - Qualified accountant and a member of a recognised supervisory body
Internal - No formal qualifications required

32
Q

What is the relationship between internal audit and corporate governance?

A
  • Internal audit is not a statutory requirement, part of a sound risk management and have internal control system => good corporate governance
  • If no internal audit department, UK corporate governance code requires the audit committee to consider annually whether one is needed and make recommendations to the board.
33
Q

What are the limitations of the internal audit?

A
  1. To form an ‘independent’ opinion on company matters, despite being employees
  2. When insufficient resources
  3. Internal auditors unwilling to disclose to the board of directors
  4. IA normally report on findings to audit committee, may take a more objective view of the company than exec directors => outsource internal audit dept.
34
Q

What are the internal audit assignments?

A
  1. Reviewing the internal controls
  2. Reviewing accounting systems
  3. Reviewing key risk areas of the business
  4. Preparing schedules for the external auditors
35
Q

What is value for money audit (VFM)?

A

E - Economy => least costs, systems operate a minimum cost
E - Efficiency => best use of resources.
E - Effectiveness => organisational objectives will be achieved

36
Q

What is an IT audit?

A

Ensures organisation is controlling key risks surrounding its hardware, software, internet and overall IT environment

37
Q

What is regulatory compliance?

A

Ensure meeting key legal requirements needs to meet legal requirements relating to industry

38
Q

What are fraud investigations?

A
  1. Review internal controls, ensure there is no fraud

2. IA - Use lower materiality levels than external audit - detect smaller frauds

39
Q

What are the other types of audit?

A
  1. Customer service
  2. Operational
  3. Project audit
  4. Management audit
  5. Environmental audit
40
Q

What is the definition of materiality?

A

Transaction or balance considered material if its omission or misstatement could influence economic decisions of users

41
Q

What does the concept of materiality allow?

A

Use certain parameters in order to focus on significant areas of the financial statements
Areas to consider:
1. Quantity and nature of any misstatements
e.g. above 1% rev, above 1% total assets, above 5% PBIT
2. Quality - amount that might be low in value but could influence users decision
3. Small amounts of misstatements that cumulatively could have effect

42
Q

What is performance materiality?

A
  • Cumulative misstatements => external auditor set a lower materiality level = “performance materiality”
  • Recorded on schedule of Unadjusted Misstatements
43
Q

What is the definition of misstatement?

A

difference between amount, classifcation, presentation or disclosure of a financial statement item and figure that is required to be recorded according to applicable financial reporting framework

44
Q

How can misstatements arise and what are the three categories?

A
  • Can arise from error or fraud
    1. Factual misstatement
    2. Judgemental misstatements
    3. Projected misstatements (auditors best estimate)
45
Q

What are the two different types of error?

A

a) errors in the ledger accounts that cause the trial balance not to balance - relatively easy to spot
b) errors that are still there even if the trial balance agrees

46
Q

What errors cause an imbalance on the trial balance?

A
  1. Unequal amounts entry error
  2. Two debits/ two credit entry error
  3. Entry omission
  4. Balance calculation error
  5. Balance transfer error
  6. Balance omission
47
Q

What errors are not revealed by the trial balance?

A
  1. Error of omission
  2. Error of original entry
  3. Error of commission
  4. Error of principle
  5. Reversal of entries
48
Q

What is the definition of fraud?

A

It is the deprivation by deceit: the international misstatement or misappropriation of assets by an individual or group of individuals
- Primary responsibility relies with the management of the company

49
Q

What are the two forms of fraud?

A
  1. Removal of funds or assets:
    - Theft of cash/ inventory
    - Payroll fraud
    - Teeming and lading
    - Fictitious customers
    - Collusion with customers/supplier
  2. Intentional misrepresentation of the financial position of the company:
    - Over valuation of inventory
    - Not writing off irrecoverable debts
    - Fictitious sales
    - Manipulation of year end events
    - Understating expenses
    - Manipulating depreciation
50
Q

What are the circumstances under which fraud is likely to arise in a company?

A
  • Hiring disreputable employees
  • Lack of supervision
  • Lack of adequate controls
  • Poor rewards for staff
  • High value assets easily accessible
  • Lax security
  • Opportunities for collusion
  • Poor cultural influences
51
Q

What are the implications of fraud for an organisation?

A
  • Loss of assets
  • Poor morale
  • Loss of reputation for organisation
  • Paranoia
  • Increased security costs in future
  • Loss of privacy for staff
52
Q

What is role do external auditors have in preventing fraud?

A
  1. External auditors consider risks of material misstatement, whether caused by fraud or error, when they plan and perform their audit.
  2. Main focus is to ensure financial statements show true and fair view.
  3. Auditing standards require that they are aware of fraud and have a ‘professional scepticism’ throughout audit
  4. Have to consider which areas are likely to be susceptible to fraud
53
Q

Who should auditors report to in respect of identified fraud?

A
  1. Audit committee - responsible for maintaining high standard of governance
  2. Shareholders - members of company need to know if not true and fair view
  3. Relevant authority - if in ‘public interest’
  4. Money laundering officer - make a report to the national crime agency if needed when money laundering
54
Q

What are the control activities which help the companies management prevent fraud and ensure management directives are carried out?

A
  1. Authorisation - approval of transactions by responsible official
  2. Physical controls - restrict access to physical assets
  3. Segregation of duties - assignment of roles and responsibilities
  4. Information processing - arithmetic and accounting controls
  5. Documenting - procedures should be followed
55
Q

What test controls should a company’s management have to detect whether fraud has occured?

A
  1. Conduct spot checks
  2. Carry out substantive procedures
  3. Conduct performance reviews
  4. Compare info from accounting system with external evidence
  5. Prepare control caccounts
  6. Reconcile information in accounting system with external info and other internal info
56
Q

What is a fraud response plan?

A

Sets out plan of action in case of suspected cases of fraud, theft or corruption.

57
Q

What are the roles and duties of individual managers in the fraud detection and prevention process?

A
  • Vigilance
  • Collective responsibility
  • Communication to staff
  • Risk assessment
  • Cost-benefit analysis
  • Create culture and environment in which fraud is discouraged
  • Implement strong system of internal controls
  • Arrange regular audits of controls

> Approach to fraud in an organisation is overseen by the audit committee

CIMA BA4 Fundamentals of Ethics, Corporate Governance and Business Law (7 decks)

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