Internal Controls

Question 1

What are company’s objectives

Answer 1

1. To ensure it reports its financial position correctly to its shareholders
2. To ensue it operates effectively and efficiently
3. To ensure it complies with relevant laws and regulations

To meet these objectives, the directors will
-identify the Erik’s that mean the objectives may not be fulfilled
-implement internal controls to mitigate this risk

Question 2

Information flows within an entity

Answer 2

-info is exchanged between people and systems within an entity
-the process by which info moves is called information flows and internal controls over that flow are vital to the business
-the controls over each part of that info flow will have bearing on the accuracy of the output which may be relied on to take crucial business decisions

Question 3

Limitations of internal control

Answer 3

1. Human element = human error, controls only function as well as people implementing them
2. Collusion = staff may bypass controls effectively and secretly working together
3. Unusual transactions = standard controls may not be relevant to the unusual transaction
4. Small companies = fewer employees meaning fewer involved meaning lack of segregation of duties

Question 4

Type of control

Answer 4

Preventative
-> designed to prevent error/fraud

Detective
-> designed to identify and correct any error/fraud

Auditor need to identify which controls are relevant to the audit. Professional judgement required
-where less reliance is reliance is placed on internal controls, more tests of detail will be carried out

Question 5

Components of a system of internal control

Answer 5

1. The control environment
2. The entity’s risk assessment process
3. The entity’s process to monitor the system of internal control
4. The information system and communication
5. Control activities

Question 6

1. Key responsibilities of the audit committee (IMPORTANT)

Answer 6

1. Review integrity if financial statements & performance announcements
2. Review internal financial controls & risk management systems
3. Monitor and review the effectiveness of internal audit
4. Recommend the reappointment or removal of external auditor
5. Monitor independence of external auditor
6. Implement policy on provision of non audit services by external auditor

Question 7

2. The entity’s risk assessment process

Answer 7

• identify relevant business risks
• estimate the significance of the risks
• assess the likelihood of occurrence
• decide upon the actions to address them

-> auditor will assess the entity’s risk assessment process during their audit risk assessment
-> if auditor identifies a risk that the entity did not then must evaluate what this means for the effectiveness of the entity’s risk assessment process

Question 8

Circumstances where risks can arise

Answer 8

-> changes (environment, staff, system, growth)
-> complexities (use of it, global operations)

Question 9

3. The entity’s process to monitor the system of internal control

Answer 9

• consistently reviewing overall control system to ensure still meets objectives, operates effectively and efficiently
• necessary corrections to the system to be made on a timely basis
• auditor to be aware of weakness found and to communicate control weaknesses observed to those charged with governance

Question 10

4. The information system and communication

Answer 10

-info system consists of infrastructure, software, people, procedures and data
-it records and processes transactions

Auditor will be interested in
1. The classes of transactions that are significant to the entity’s financial statements
2. Procedures by which transactions are initiated, recorded, processed, corrected, and reported
3. The related accounting records and supporting information
4. How the info system captures events other than transactions significant to financial statements
5. The process of preparing the financial statements

-> financial controller and use of journals
-> can they be overridden or ignored
-> are journals used

Question 11

5. Control activities

Answer 11

-policies and procedures that help ensure that management directives carried out
-are the most tangible internal controls that auditor will concentrate on
-auditor to understand if the controls can prevent or detect and correct an error
-control activities may be manual, or for computerised activities there may be computer specific control activities

5 types of control activity
1. Authorisation and approvals (approval of transactions)
2. Reconciliations (compare two or more data elements)
3. Verifications (comparing an item with a policy)
4. Physical or logical controls (physical security of assets, counting to compare with accounts)
5. Segregation of duties (assessing individuals responsibilities)

Question 12

Sources of info for recording internal control

Answer 12

1. Inspection= company manuals of control activities and copied of internal controls policies
2. Inspection= minutes of meetings of the risk assessment group
3. Inquires= talking to the people involved with internal control at all stages and asking what the controls are and why they have been implemented
4. Knowledge= previous year records and update for new policies in the current year and discussions with client staff
5. Observation= watch operations at a company to identify the control activities being put into action

Question 13

How do auditors document internal controls

Answer 13

1. Narrative notes
   -short notes on simple systems
   -background information
   -> less good for complex
2. Questionnaires
   -ensure have all bases covered but can lead to mechanical approach and not ask extra questions
3. Diagrams
   -flowcharts
   -organisational charts
   -family trees
   -records of related parties

Question 14

Revenue system

Answer 14

1. Order received
2. Goods dispatched
3. Invoice sent
4. Transactions recorded in books
5. Payment received

Question 15

Revenue custom controls

Answer 15

1. Goods sold to customer with poor credit
   -credit checks for new customers
   -manager sign off on new customers (authorisation)
   -regular review of credit limit
   -regular review for prompt payment by new customers
2. Orders mis recorded
   -confirm orders with customers
   -pro forma order forms, check sequence for completeness
3. Orders go unfulfilled and customer lost
   -regularly match customer orders to goods dispatched (GDN)
   -customer queries investigated promptly
4. Orders accepted at wrong price
   -standard price list
   -discounts must be approved
5. Despatching goods to a customer but nit invoicing for them
   -regularly match despatch records to invoices
6. Failure to record sales so payment not prompt
   -segregation of duties

Question 16

Purchase system

Answer 16

1. Order placed
2. Goods received
3. Invoice received
4. Transaction recorded in books
5. Payment made

Question 17

Purchase system controls

Answer 17

1. Unauthorised purchases made for personal use
   -authorisation limits for purchases
   -pre numbered purchase forms
   -segregation of duties
2. Goods and services not obtained on the most advantageous terms
   -approved supplier list
   -monitoring of supplier terms (bulk order and prompt payment discounts)
3. Accepting goods not ordered
   -matching goods received with orders
4. Goods accepted may be damaged
   -examination of goods inwards for quality and condition
5. Company may not take advantage of full credit period
   -monitoring of supplier terms
6. Invoices may be mislaid leading to non payment
   -regularly matching of goods received notes (GRN) to invoices
   -supplier statement reconciliations
7. Company may not record credit notes, resulting in paying involves not due
   -regular maintenance of payables ledger
   -supplier statement reconciliations
8. Payments might be made to the wrong person
   -segregation of duties

Question 18

Payroll system

Answer 18

1. Clock cards submitted and input
2. Gross pay, deductions and net pay calculated
3. Other amendments input
4. Final payroll calculated and payslips produced\
5. Payments to employees and tax authorities
6. Payroll costs and payments recorded /

Question 19

Payroll system controls

Answer 19

1. Employee paid for work they haven’t done
   -timesheets
   -clocking in/out
2. Gross pay incorrectly calculated
   -changes to standing data authorised
3. Net pay (deductions) wrongly calculated
   -non statutory deductions authorised by management
4. Changes to data not recorded
   -authorised by mangers
5. Incorrect recording of wages and cash paid
   -reconciliation of nominal ledger entries to payroll info
6. Employees are not paid
   -reconciliation of payroll info to bank transfer list
7. People who are not employees are paid
   -bank transfer lists agree to payroll