W10 Test of Controls

Question 1

What is a test on control

Answer 1

An audit procedure that will provide evidence as to whether the control procedure is in place and working effectively

*Only controls relevant to auditor are ones that prevent, detect, and correct material misstatements

Question 2

What methods are used in test of controls

Answer 2

Observation of control activities e.g observing inv count to ensure that it is controlled effectively and in accordance with the count instructions

Inspection of documents recording performance of the control
e.g inspecting an order for evidence of authorisation

Computer assisted audit techniques (CAATS)
e.g test data - involves the auditor submitting ‘dummy’ data into the client’s systems

Question 3

The relationship between test of controls and substantive procedures

Answer 3

Test of controls only provide indirect probabilistic evidence with regard to the absence of misstatements within the financial statements

Substantive procedures provide direct evidence

Question 4

Test of controls and the audit risk formula

Answer 4

Where test of controls show that internal control is strong == control risk is low

given that the auditor will already have determined an acceptable level of audit risk, a lower assessed control risk would allow the auditor to accept a higher detection risk == other procedures can be reduced

Question 5

If control risk is low what does that mean in practice

Answer 5

The auditor can place more reliance on internal controls and evidence generated internally by the entity.

This increases the appropriateness of interim audit testing and allows the auditor to reduce the quantity of detailed substantive procedures performed at the final audit stage

Question 6

If control risk is high what does that mean in practice

Answer 6

The auditor will

• increase the volume of procedures conducted at and after the year end
• increase the level of substantive procedures, in particular, tests of detail
• place less reliance on audit procedures as the information produced by the clients systems is not reliable

-place less reliance of written representations from management

• obtain more evidence from external sources

Question 7

What are the limitations of internal controls

Answer 7

Some substantive procedures must be done for every material aspect of the financial statements, no matter how low the risk of misstatement

-human error (mistakes made by those responsible for performing controls)

• ineffective controls (controls which do not work as intended)
• collusion of staff (to bypass the control of segregation of duties)