Points To Memorize

Question 1

External Financial Statement

Answer 1

• Benefits of multiple step comprehensive income:
  1) It shows gross profit
  2) Match operating income with operating expenses separately from non operating
  3) Commonly used by companies
• Common stocks features:
  1) Not entitled to dividends UNLESS declared by BOD
  2) Entitled to receive liquidation distributions AFTER all other claims including preferred stocks
  3) Have the right to elect BOD (voting rights)
  4) Have preemptive rights
• Preferred stock features:
  1) Receives dividends at fixed charge prior to common stocks
  2) Entitled to receive liquidation distributions BEFORE common stocks
  3) Cumulative preferred stocks (dividends in arrears)
  4) Convertible preferred stock - usually to common stocks at predetermined rate
• Trade loading ( Channel Stuffing ) instances :
  1) Cash that does not follow earnings
  2) Accruals that do not correspond to either earnings or revenues
  3) AR aging balance
  4) Shipment not supported by sales order

Question 2

Measurement, Valuation and Disclosures - Short Term Items (AR, Inventory and Investments)

Answer 2

• Write off AR under allowance method does not affect Income Statement NOR working capital NOR carrying amount of net AR
• Inventory estimation may be needed when:
  1) Exact count is not feasible
  2) For interim reporting purposes
  3) Records are destroyed
• Acquisition related cost are expenses as incurred. Issue cost of securities are reduced from additional paid in capital or reduced from the face amount of the debt.

Question 3

Measurement, Valuation and Disclosures - Long Term Items (Assets, Leases, Income tax..)

Answer 3

• Testing for impairment occurs when event or
  changes in circumstances indicate that the carrying amount may not be recoverable when market price reduce significantly OR the use or physical condition of the asset has changed.
• Under IFRS impairment has 1 step - Reversal MAY BE ACCEPTABLE (except for Goodwill) and it will only impact increase on income
• Under GAAP if a lease involves land and a building contains transfer of ownership Or BPO, land and building elements are treated separately. If it does not contain both elements are treated as single unit unlss the Land is 25% or more of the FV of leased property
• Under IFRS if a lease involves land and a building both elements are treated separately. The land element is classified as operating lease unless title passes to the lessee. The building is classified either as finance or operating lease based on regular criteria
• Deferred tax liability arises when Income under GAAP > Taxable income - higher taxes to be paid in the future. Example; the company uses for tax purposes accelerated depreciation method and for GAAP straight line method
• Deferred tax assets arises when Income under GAAP < Taxable income - lower taxes to be paid in the future. Example; Bad debt expenses under allowance method recognized in financial income, bad debt expense recognized under taxable income when it is written off

Question 4

Cost Management Concept

Answer 4

• Common costs are another type of indirect costs that incurs for the benefit of more than cost object
• Relevant Range is the level of volume or activity in which a company is expected to operate and cost relationships remains constant - used in describing foxed costs.
• Committed cost arises from holding PPE, they can’t be reduced by lowering short term level of production -
  fixed costs arises as a result of past decisions and it can’t be alerted at short run
• Incremental cost is the additional cost inherent in a given decision - In the short run management decisions are made in reference to incremental cost
• Standard costing is a system designed to alert management when actual costs of production differs significantly from standard cost
• Standard costing is determined independently from the budget and it is NOT just an average of past costs - least likely to involve top management in establishing it
• Setting ideal level of standard costing DOESN’T motivate employees, it is used to facilitate flexible budgeting.
• Standard costing represents what cost should be, budget cost represent expected actual cost.

Question 5

Cost Accumulation Systems (ABC, Process Costing ..)

Answer 5

• Unusual overnight power failure is considered as Abnormal spoilage
• Under Job Ordering Costing DM, DL are applied based on ACTUAL costs. MOH are applied based ESTIMATED (applied) costs.
• Under Process Costing DM, DL and MOH are applied based on actual costs
• Advantages and disadvantages of using weighted average method to calculate EUP:
  1) It is easier to use and calculation is simpler
  2) EUP cost includes both current and previous period costs
  3) Is APPROPRIATE when conversion cost, inventory levels and raw material prices are STABLE
• Advantages and disadvantages of using FIFO method to calculate EUP:
  1) Is based on work done in the current period
  2) Is APPROPRIATE when conversion cost, inventory levels and raw material prices re fluctuating
• Normal spoilage may affect current income if part of the spoiled goods got sold
• Advantages of ABC system:
  1) Uses process value analysis
  2) Reduces product under or over costing
  3) Uses with companies having high level of FIXED costs
  5) More useful when OH costs are relatively high
• Disadvantages of ABC system:
  1) Its cost and increased time and efforts
  2) Not useful if company produces only SINGLE product
  3) May not conform with GAAP
  4) Will have same result of cost allocation of traditional costing if the company have single product
  5) Service organizations may have some difficulties in implementing ABC because they tend to have high facility level costs
• Target costing is used to create competitive advantage and on products that have NOT been developed yet
• Value chain analysis is series of activities in which customer usefulness is added to the product
• Value engineering is a means of reaching targeted cost levels without reducing customer satisfaction though minimizing nonvalue adding costs

Question 6

Cost Allocation Techniques (Absorption, Variable costing and Service Departments)

Answer 6

• Under variable costing, FOH is considered as a cost on MAINTAINING CAPACITY NOT as PRODUCT COST
• The main advantage of variable costing is that income can’t be manipulated by management and marginal income concept leads to a better pricing decisions
• The difference in operating income between 2 methods is the difference in ending inventory if Beg inventory is Zero OR the difference between actual sales units and actual production units * FOH
• Questions regarding whether a particular part should be MADE or BOUGHT can more more effective under VARIABLE costing.
• Variable costing eliminates the possible difficulties of having to explain over - under applied factory OH to higher management
• Disadvantages of variable costing:
  1) DOESN’T provide proper matching of costs and benefits
  2) It requires separating all manufacturing costs into fixed and variable
• The Primary purpose for allocating common costs to joint product is to determine the inventory cost of joint product for financial reporting.
• To check if by product worth processing further we must check if the NRV is Zero or Negative. if so it should be discarded as scrap
• By product usually DON’T receive an allocation of joint costs
• The distinction between joint and by product is largely dependent on market value
• The 2 most appropriate factors for budgeting MOH expenses are management judgement and production volume.
• Normal rework costs incurred are charged to FOH control
• The reason behind allocating service department costs to production departments is to determine OH rates
• Four criteria’s to allocate service department costs:
  1) Cause and effect
  2) Benefit received
  3) Fairness
  4) Ability to bear - usually unacceptable because of it’s dysfunctional effect on managerial decisions.

Question 7

Operational Efficiency and Business Process Performance (JIT, TOC ..)

Answer 7

• Advantages of JIT
  1) Reduction in inventory levels
  2) Reduction in storage space
  3) Lower inventory taxes
  4) Lower obsolescence risk
  5) Lower manufacturing lead time
  6) Lower rework cost
• JIT is a PULL system i;e items are pulled through production by current demand
• Using JIT will eliminate the following:
  1) Due to lower inventory system, INTERNAL CONTROL will be reliminated
  2) Elimination of receiving areas, hard copies and storage areas
  3) The quality of the parts received by suppliers is verified by use of statistical controls rather than inspection of coming goods
• Master Production Schedule (MPS) is a statement of what a company expects to produce and purchase - related demand forecasts to SPECIFIC DATES for completion
• Material Requirement Planning (MRP) is a production planning and inventory control system based on forecast demand to schedule raw material deliveries of quantities - enables a company to efficiently fulfill goals of MPS.
• MRP (Material Requirement Planning) is a PUSH system i;e the demand of raw materials is driven by forecast and have 3 overriding goals:
  1) Arrival of the right PART
  2) In the right QUANTITY
  3) At the right TIME
• Enterprise Recourse Planning (ERP) is a software platform intended to integrate enterprise wide information system by creating ONE DATABASE to ALL of an organization’s application
• ERP eliminate the redundancy through the use of a central data base and improves business process
• Benefits of outsourcing: RRAA
  1) Reliable service
  2) Reduce cost
  3) Avoidance of the risk of obsolescence
  4) Access to technology
• Limitations of outsourcing:
  1) Dependence on a third party
  2) Loss of control over necessary functions
• Steps in a TOC analysis: IDMIRE
  1) Identify the constraint - the bottleneck operation where work in process backs up the most
  2) Determine the most profitable product mix given the constraint - basic and immediate principle of TOC is maximizing SHORT TERM profit that required maximizing the contribution margin through the constraints, called throughput margin. The manager should maximize the product with the highest throughput margin per unit
  3) Maximize the flow through the constraint - is managed through Drum-Buffer-Rope
  a. Drum is the bottleneck operation
  b. Buffer is a minimal amount of WIP to ensure that work is always in operation
  c. Rope is the sequence of activities preceding the bottleneck
  4) Increase capacity at the constraint - In the SHORT run manager is encouraged to make the best use of the bottleneck, in the MEDIUM term improving the process to increase capacity at the constraint
  5) Redesign the manufacturing process - through value engineering that balances product cost and customer satisfaction.
• Porter’s model of decision process for capacity expansion: IF APT
  1) Identify the market size, type and possible response by competitors
  2) Forecast demand, input costs and technology developments. Expansion itself may put pressure upward on input prices
  3) Analyze competitors to determine when each will expand
  4) Predict total industry capacity and firms market share
  5) Test for inconsistencies
• Value chain financial statements treats customer service as part of value chain and therefore associated as PRODUCT COST
• Value chain activities are 2:
  1) Primary activity deal with PRODUCT directly - Logistics, Operation,Marketing and Distribution, Service
  2) Support activity lend aid to primary activities - HR, IT, Finance
• A firm should estimate life time value with the net present value of his cash flow
• Process engineering is SIMILAR to value chain in which BOTH are designed to improve customer service, reduce cost and become more competitive
• Three common measures on process analysis:
  1) Product development time
  2) Break even time
  3) Customer response time
• Benchmarking steps: PRIME
  1) Prioritize the benchamrking and select organizing teams
  2) Record and document the internal process
  3) Identify and search best in class performance - MOST DIFFICULT step
  4) Make gap assessment and root cause analysis report
  5) Execute and evaluate
• Conformance costs types:
  1) Preventive - avoid defective output which includes preventive maintenance, employees training, review of equipment design, evaluation of supplier and process reengineering
  2) Appraisal - activities as statistical quality control programs, inspection, testing and testing finished product. Is the cost of detecting Nonconforming products
• Nonconformance costs types:
  1) Internal Failure - Detect before shipment which includes scrap, rework, downtime, retesting, reinspection, lost learning oppurtunities, unplanned manufacturing machine repairs and abnormal spoilage
  2) External Failure - lost profit from a decline in market share as dissatisfied customers, return products for refunds, cancel orders. Environmental costs such as fines for non adherence to environmental law and loss of customer goodwill

Question 8

Analysis And Forecasting Techniques (Correlation, Learning Curve, Balance Score Card)

Answer 8

• Forecasting is the basis for business plans and budgeting
• Simple regression equation:
  Y = A + Bx
  Y: Dependent variable - A negative Y intercept indicates that it is outside the relevant range
  A: The Y intercept - Fixed cost, it also means that it is the minimum amount regardless of level of independent variable
  B: The slope of regression - Variable cost
  X: Independent variable
• The linear relationship established for X and Y is only valid across the relevant range
• Regression analysis assumes that PAST relationships can be validly projected into the future
• A limitation of regression analysis that it can ONLY be used when cost patterns remain unchanged from prior periods
• Limitation of learning curve in practice that it is difficult in knowing the shape of the learning curve
• Expected value components:
  1) The decision - alternative is under the manager control
  2) State of nature - is the future event whose outcome the manager is attempting to predict. Also is uncontrollable future event that can affect the outcome of decision
  3) The payoff - is the financial result of the combination of the manager decision and the actual state of nature
• The expected value criterion is likely to be adopted by manager who is RISK NEUTRAL.
• Steps in Strategic management: MSSIC
  1) Mission statement - drafted by BOD
  2) SWOT analysis - also called situational analysis
  3) Strategy to be developed by upper management
  4) Implementation of strategy
  5) Controls and feedback - monitor progress, isolate problems and take corrective actions
• Porter model includes an analysis of the five competitive forces that determine long term profitability as measured by long term ROI
• Five porter competitive forces:
  1) Rivalry among existing firms - will be affected by many factors like stage of industry life cycle, capacity expansion, higher fixed costs indicates that competition will be intense and distinction among products. During growth stage a new product models and features are introduced
  2) Barriers to entry - Factors that increase threat of entry such as economic of scale is NOT significant, brand identity, cost of switching to substitute is low, exit barrier is low, government policy to encourage new entrants. The MOST favorable industry is one in which entry barriers are HIGH and exit barriers are LOW - increase the threat of new barrier
  3) Threat to substitutes - limit price increases and profit margins. Substitutes are TYPES NOT BRANDS of goods and service. Considerations affecting the threat of substitute:
  a. Relative prices
  b. Cost of switching to a substitute
  c. Customer inclination to use a substitute
  4) Threat of buyer bargain power - high switching costs decrease buyer bargaining power, buyers are in a stronger position when supplier products are undifferentiated, the more important the supplier is to the buyer the less bargaining power they have.
  5) Threat of supplier bargain power - buyer best response are to develop favorable, mutually beneficial relationships with supplier or to diversify their source of supply.
• Growth Matrix Share - frequently used for competitive analysis was created by Boston Consulting Group. It contains Market Growth Rate (MGR) which reflect the MATURITY and ATTRACTIVENESS of the market and the need for CASH to finance expansion and Relative Market Share (RMS) which reflects the SBUs competitive position in the market
• The growth matrix quadrants:
  1) Question marks - (Low RMS, High MGR) - weak competitors and they net large amount cash flow not only to finance growth but also to increase RMS
  2) Stars - (High RMS, High MGR) - strong competitors and their net cash flow are MODEST
  3) Cash Cows - (High RMS, Low MGR) - strong competitors, financing for expansion is not needed so excess cash can be used for investments in other SBU
  4) Dogs - (Low RMS, Low MGR) - weak competitors and their net cash flow are MODEST
• A portfolio SHOULDN’T have too many LOW RMS or too few HIGH RMS
• Growth Share Matrix strategies:
  1) Hold Strategy - strong cash cows
  2) Build Strategy - A question mark with potential star
  3) Harvest Strategy - Weak cash cows an possibly questions marks and dogs
  4) Divest Strategy - Question marks and dogs (Low RMS)
• Managers may find it difficult to measure market share and growth or even define SBU. Thus, Growth share matrix may have LIMITED strategic value
• Balance score cards KPI and measures: FLIC
  1) Financial (sales , profit through high ROI)
  2) Customer satisfaction - Economic value added is NOT customer satisfaction measure (can be measured through survey and results of market share, service response time)
  3) Internal business process - Cycle time is an internal process measurement, it’s the manufacturing time to complete an order (Quality through lower scrap cost, flexibility and response to change conditions and operating readiness)
  4) Learning and growth (Morale, development of new products and competence of work force)
• Problems in implementation of balance scorecard:
  1) Using too many measures
  2) Failing to evaluate personnel
  3) Including measures that will not have long term financial measures
  4) Trying to achieve improvement in ALL areas
  5) Not being aware that connection between nonfinancial measures and ultimate financial may not continue to be true
• MBO is based on philosophy that employees: they should participate in setting their objective
  1) Want to work hard if they know what is expected
  2) Like to understand what their job actually entail
  3) Are capable of SELF DIRECTION and SELF MOTIVATION
• Goal Congruence ensures harmonization of objectives, procedures and work as a team in order to realize company goals
• Characteristic of successful strategic plans: CMDL
  1) Clarity of purpose and realistic goals
  2) Monitoring, measurement and feedback
  3) Discipline and commitment
  4) Leadership

Question 9

Budgeting (Concepts, Methodology ..)

Answer 9

• Budget PLANNING steps are:
  1) Start with MISSION STATEMENT formulated by BOD and Senior Management
  2) Strategic Plan which is made of long term objectives
  3) Priorities to allocate limited resources
  4) Short term objectives
• Best practice guidance for the budget process: ACUS
  1) Automating the process
  2) Setting realistic goals
  3) Considering what if scenarios
  4) Updating budgets regularly to reflect current condition
• Standard costs are usually set for one year, can be measured in TOTAL cost or PER UNIT. Also can be used in costing for inventory
• Standard cost becomes more challenging as time process in an environment where continuous improvement exists, they become out dated.
• Standard prices are designed for INTERNAL performance measurement.
• Because of the impact of fixed costs, standard costs system is usually NOT effective unless it has flexible budgeting.
• Zero based budget divides the activities of individual responsibility center into a series of packages that are prioritized. It provides more efficient allocation of resources available.
• Incremental budgeting in which the CURRENT years budget is simply ADJUSTED to allow for changes planned for the coming year.
• Continuous (rolling) budgeting is one that is revised on a regular (continuous) basis. A principle advantage that manager is always thinking ahead. Disadvantage is the time spend on preparation.
• Cash budget is affected by sales credit policy, purchasing terms and planned capital acquisition. Prepared annually, quarterly, monthly or even weekly - Non-routine property sales could result in large fluctuations of cash and should be considered for medium and long term forecasts.
• Sales forecast start by looking back at historical trend to determine next years sales pattern. One of the most effective ways is regression analysis.
• Sales forecast is LEAST influenced by seasonal patterns to which demand for its products is subject
• The FIRST pro forma FS to be forecasted is IS

Question 10

Cost and Variance Analysis

Answer 10

• The significance of variances depends not only on their amount but also on Direction, Frequency and Trend. Persistent variances may indicate that standards need to be reevaluated.
• Management By Exception reduces information overload, unfocused management action and reports for production cost
• Flexible budget consist of costs that should have been incurred given the actual level of production. Is NOT appropriate to control FOH
• Advantages of Variance Analysis:
  1) Identify areas where actual differs from budget
  2) Provides accountability among personnel - assign responsibility
  3) Evaluates performance
  5) Identify if budget estimates requires revision
• Benefits for using variance analysis for measuring performance:
  1) Provide framework for judging performance
  2) Motivate managers and employees
  3) Promote communication and coordination
• Disadvantages of Variance Analysis:
  1) There is a focus on the past without looking at the future
  2) Lengthy process to identify problems and take corrective actions by management
• Assigning ALL favorable variance to COGS would result in a HIGHER income
• Disadvantage of static budget that it is made ONLY for ONE level of driver
• Standard costs MUST be kept CURRENT
• Standard cost focus on QUANTITATIVE NOT QUALITATIVE factors
• Flexible budget can be adjusted to different level of activities(series of budgets) for a SPECIFIC RANGE unlike static budget. It can be adapted for unanticipated level of production
• Flexible budget using standard costing EXCLUDES past inefficiencies and take into account expected future changes
• Sales department are responsible for FOH Variance
• Fixed OH spending Variance is more helpful in bringing attention to a potential short term problem in the control of OH. FOH Spending variance is the same as the fixed OH flexible budget variance
• Fixed OH Efficiency Variance is NEVER meaningful - NOT prepared for FOH
• Production Volume Variance is the amount of the Underapplied or Overapplied FOH
• Production Volume Variance measures the deviation from the normal or denominator level of activity

Question 11

Responsibility accounting

Answer 11

• A successful responsibility accounting system is dependent upon proper delegation of authorities
• The basic purpose of responsibility accounting system is motivation
• Not ALL factors are controllable by someone. Controllable costs is NOT a synonymous with variable cost for instance fixed cost of depreciation is controllable by the division vice president to which that manager report
• Along with RESPONSIBILITY a manager must be granted AUTHORITY to control factors on which his incentive package is based
• FOH SHOULDN’T be included in INTERNAL reports on a responsibility accounting centers as it CAN’T be controlled by a manager of responsibility center
• Profit center managers are MOST likely able to control and evaluate performance using contribution margin approach
• Profit center performance measurement techniques:
  1) Comparison between CY and PY income
  2) Compare with other profit center
  3) Contribution margin
• Under ROI it is difficult to compare divisions that vary in AGE because older assets will be removed (depreciated)
• A firm earning a profit can increase its return on investment by increasing sales revenues and operating expenses by the same percentage.
• Under ROI best comparison is when when long term assets are evaluated using CURRENT VALUE
• High inflation rate would result in a higher ROI. Divisions in areas of high inflation when valuing assets at net book value will result in the highest ROI since the ROI is calculated using local currency. The local currency will depreciate due to the inflation, which in turn inflates the ROI. High inflation would result in higher ROI.
• Each division in the firm should have an ROI based on the strategic goals of the firm
• Benefits of ROI:
  1) Improve projects
  2) Secure funding
  3) Comparative analysis
  4) Discontinue ineffective product or operations
• Residual Income is the excess of ROI over a firm cost of capital or over targeted amount.
• Residual income is a significant refinement of the ROI concept because it forces business unit managers to consider OPPORTUNITY COST OF CAPITAL
• Residual income is more likely to promote goal congruence in a low-profit location versus return on investment
• Issues other than accounting policies that might affect comparability for investment centers:
  1) Difference in tax systems
  2) The presence of items that are unusual or infrequent
  3) Allocation of common costs
  4) The varying availability of resources
• Allocation of common costs is allocated based on following reasons:
  1) BEST reason for allocation to remind managers that support service exists and the managers would incur these costs if their operations were independent
  2) Allocation reminds managers that profit center earning must cover come of support costs
  3) Departments or divisions should be motivated to use central support service
  4) Division managers will be encouraged to control their department costs as they CAN’T control support services cost - Department manager pressuring central managers is NOT a healthy organization dynamic
• The principle challenge is determining a price that motivates both selling and buying manager to pursue GOAL CONGRUENCE
• Transfer price used based on actual consts can lead to suboptimal decisions for the company as a whole. Setting the transfer price based on actual costs rather than standard costs would give the selling division little incentive to control costs

Question 12

Internal Controls / Corporate Governance

Answer 12

• Governance by definition is a combination of people, policies, procedures and processes that help ensure that an entity effectively and efficiently is achieving it’s objectives
• The organizational culture:
  1) Set value, objectives and strategies
  2) Defines rules and behaviors
  3) Measure performance
  4) Specific accountability
• Governance have 2 major components:
  1) Strategic direction
  2) Oversight
• Strategic direction determines:
  1) The business model
  2) Overall objectives
  3) The approach to risk taking
  4) The limits of organizational conduct
• Risk committee functions:
  1) Identify risk
  2) connect them to risk management process
  3) Delegate them to risk owners
  4) Consider whether delegated risks are within the company tolerance level
• FCPA consists of 2 provisions:
  1) Anti Bribery - applies on ALL domestic corporations engaged in interstate commerce
  2) Maintaining accounting records and IC - applies of companies registered under 1937 act (public). The accounting records MUST be in accordance to GAAP and the company to maintain accountability for assets
• Objectives of IC: ORC
  1) Operations - relate to achieving the entity mission through financial performance, productivity, quality, innovation and customer satisfaction along with safeguarding of assets
  2) Reporting - (Internal, external), (Financial, nonfinancial)
  3) Compliance with laws and regulations - compliance with internal policies and procedures is an OPERATIONAL matter
• IC is more likely to provide reasonable assurance of achieving REPORTING AND COMPLIANCE objectives
• Operational effectiveness may NOT be within the entity control because it is affected by human judgement and external factors.
• AICPA defines material weakness is a deficiency or combination of deficiencies in IC that results in reasonable possibility that a martial misstatement of FS will not be prevented or timely detected
• Components of IC: CRIME
  1) Control activities
  2) Risk assessment
  3) Information and communications
  4) Monitoring
  5) Control Environment
• Information and Communications - enables the organization to obtain, generate and use communication information to Maintain accountability and Measure and review performance
• Information and Communication principles:
  1) Relevant and quality information
  2) Internal communication
  3) External communication
• Monitoring is the a process that assess the quality of IC performance over time.
• Monitoring activities principles:
  1) Ongoing or separate evaluations or Both
  2) Evaluates and communicates control deficiencies
• Internal auditing definition under IIA is an INDEPENDENT, OBJECTIVE ASSURANCE and CONSULTING ACTIVITY designed to add value and improve an organizations operations. It helps an organization accomplish its objectives and to evaluate and improve the effectiveness of Governance, Risk management and Control
• Written Charter defined Purpose, Authority and Responsibility of internal audit activity (PAR)
• The charter establish internal audit activity position within the organization:
  1) Authorize access to records
  2) Authorize access to personnel
  3) Authorize access to physical properties
  4) Define scope of internal audit activities
• Audit plan should be flexible enough to permit adjustments during the year:
  1) It covers ALL MAJOR operations and functions
  2) The plan considers relevant work performed by others including management assessment and work performed by external auditor
• Scope of Internal Audit:
  1) Governance
  2) Risk Management
  3) Control
• Three principle functions of internal auditing within an organization is to aid:
  1) Upper management in the maintenance of firm IC
  2) Upper management in improving the efficiency of operations
  3) The external auditor in conducting the audit of FS
• Incidents that MUST be reported IMMEDIATELY to upper management and BOD:
  1) Fraud
  2) Illegal acts
  3) Material weakness in IC
  4) Significant penetration of information system
• Internal auditor reports fraud to BOD and Senior management if it has been established to a REASONABLE CERTAINTY
• Steps to be followed if internal auditor suspects wrong doing:
  1) Inform appropriate authorities WITHIN the organization
  2) Recommend any necessary investigation
  3) Follow up to see that internal audit activities has been met
• Due professional care that internal auditor must apply CARE and skill expected of a reasonably competent auditor
• Due professional care DOESN’T imply infallibility - النجاح المؤكد. Due professional care DOESN’T guarantee that ALL significant risks will be identified
• To improve efficiency, internal auditor may rely upon the work of external auditor if it is coordinated with internal audit work

Question 13

Internal Controls and Security Measures

Answer 13

• Types of controls:
  1) Primary controls
  2) Secondary controls
  3) Time based classification
  4) Financial and operating controls
  5) People and system based controls
• Control activities are designed and operated to ensure that management directives are executed. If controls are not always in FORCE, the CAN’T operate effectively no matter hoe effective their design
• How control procedures are being implemented:
  1) Segregation of duties
  2) Independent checks and verification
  3) Safeguarding of assets
  4) Prenumbered forms
  5) Specific document flow
• Combining timekeeping function and preparation of payroll entries is PROHIBITED, they must be segregated
• Sales department prepares aging report and shares it with credit department, credit department write off uncollectable accounts then treasurer reviews and approves it
• Best strengthen IC over custody of inventory at off site warehouses is by implementing regular reconciliation with physical inventory counts
• Independent checks and verification (reconciliation with accounts) , it must be performed by personnel unconnected with the original transaction and DOESN’T have custody of assets involved
• Frequency of reconciliation is dependent of NATURE, AMOUNT and COST
• Specific document flow consists of:
  1) Tracing that ensures that transaction is properly RECORDED
  2) Vouching that ensures that transaction is OCCURRED
• Three Goals for Information security: CIA
  1) Confidentiality - security of information
  2) Integrity - prevent access to unauthorized
  3) Availability - access to use computer for authorized
• Steering committee consists of IT manager and end user
• Steering committee function:
  1) Approve development budget
  2) Assign resources
  3) Review their progress
  4) Ensure that requests for new systems are aligned with entity objectives
• Logical controls - Limit system access:
  1) Authentication - is the act of ensuing that the PERSON attempting to access the system is in fact who he says he is through ID and passwords.
  2) Authorization - is the practice of ensuring that once in the system the user can only ACCESS THOSE PROGRAMS
• Input Controls provide reasonable assurance that data is Authorized, Accurate and Complete - Online or Batch
• Online input controls:
  1) Preformatting
  2) Edit checks - Is a preventive, detective and corrective action that should be performed on transaction PRIOR to updating master file
  3) Limit (reasonableness) checks
  4) Check digits - An algorithm, WONT detect transposition errors
• Preformatting is display of documents with blanks for data items to be entered by terminal operator. Prompting is an online data entry technique that can be employed when inexperienced personnel enters data
• A self checking digit is a control designed to catch errors at data entry level
• Batch input controls:
  1) Management release
  2) Record count
  3) Financial totals
  4) Hash totals - has no meaning, ensures that input data was not manipulated during processing
• Processing control provides reasonable assurance that all data submitted for processing is processed and only approved data has been processed:
  1) Validation - Determine existence
  2) Completeness - any record with missing data is rejected
  3) Arithmetic controls - cross footing and Zero balance
  4) Sequence check - tests for ordering NOT omission of records, used with BATCH inputs
  5) Run to run controls - check after EACH stage that all transactions have been processed
• Output controls provides reasonable assurance that processing was complete and accurate: Data control group should be responsible for processing the errors detected during the processing of data
  1) Audit trial
  2) Error listing report
• Spoofing is IDENTITY misrepresentation is CYBERSPACE using a false website to obtain visitor information
• Sniffing is the use of software to eavesdrop on information sent by user to the host computer of website
• Inherent risk of the internet: Confidential information can be intercepted
• Computer assisted audit techniques (CAATs): May use SYSTEM or TRANSACTION based
  3) Test data - Client program, auditor data with dummy inputs
  3) Parallel simulation - auditor program and client data. The auditor must have considerable technical knowledge
  4) Generalized audit software (GAS) - auditor program and client data, it gives major aid in retrieving information for computerized files. Example ACL, IDEA. The auditor can search for duplicated records, gaps in numerically sequenced records, high monetary amounts
  5) Spreadsheet analysis - easy analysis of huge number of clients data
  6) Integrated test facility (ITF) - the auditor creates fictitious entity (using wrong data) on the client LIVE system to determine if real time program contains adequate control. Considered as CONCURRENT audit technique
  7) Embedded audit module - Is an integral part of an application system which permits continuous monitoring of online real time system
• Concurrent audit techniques MUST be INCORPORATED with CLIENT system
• Computer security plan should be developed to safeguard physical facilities, hardware and integrity of data
• Disaster recovery plan is the process of RESUMING normal information processing AFTER the occurrence of MAJOR interruption
• Business continuity plan is the continuation of business DURING the period in which computer processing in UNAVAILABLE or LESS than NORMAL
• Proxy server is a firewall system that limits access to a computer by routing users to replicated websites. Also is a symbolic representation of the flow of documents are procedures