Week 4 & 5: Systems audit pt2 - Test of control and Substantive testing Flashcards
What is a test of Control?
A test of control assesses the efficiency and effectiveness of internal control processes implemented in a business organisation.
For example: Inspecting a sample of supplier statement reconciliations for evidence that they have been reviewed by an appropriate level of management
If control risk (CR) is too high what do you have to do?
If control risk (CR) is too high you have to do Substantive Testing. The auditor cannot rely on the internal control processes of the audit client
If control risk (CR) is low what do you have to do?
If control risk (CR) is low you have to do a Test of Control. The auditor can rely on the internal control processes of the audit client
What is a test of control?
Elements of a Test of Control
Nature – decide on the type of tests, or type of evidence-gathering procedures (e.g. inspection, observation)
Timing – scheduled before year-end, then extended (rolled forward) until year-end.
Extent: the more the auditor relies on controls, the greater the extent of tests of controls
what is an audit trail?
An Audit trail is Audit methodology used by an auditor is dependent on the audit trail of documents which exist
Where no audit trail exists, a greater emphasis is placed on:
Observation
Inquiry of the control.
If audit trail does exist:
Inspect documentation associated with the transaction for evidence of the control.
what are the five main test of control in the exmaple of cash reciepts?
Controls are in place to ensure:
Occurrence—recorded cash receipts are for collection of receivables resulting from sales to customers of the entity.
Completeness—all cash receipts are recorded and deposited.
Accuracy—cash receipts have been recorded correctly as to amount.
Cut-off—cash receipts have been recorded in correct period.
Classification—cash receipts are classified in accordance with company policy.
Presentation—cash receipts are appropriately aggregated or disaggregated and clearly described, and related disclosures are relevant and understandable.
hwo to document the sales cycle in an audit file?
Each customer has a unique customer account # and this is used to enter sales orders when they are received in writing from customers.
The orders are entered by an order clerk and the system automatically checks that the goods are available and that the order will not take the customer over their credit limit.
For new customers, a sales manager completes a credit application, this is checked through a credit agency and a credit limit entered into the system by credit controller.
The company has a price list, which is updated twice a year. Larger customers are entitled to a discount. This is agreed by the sales director and set up within the customer master file.
What is an expenditure cycle?
Expenditure cycle – all transactions/events initiated when acquires assets or services used for cash or credit
Expenditure cycle may include the following:
Payroll
Property, plant and equipment
Inventory
Income taxes
Selling and administration expenses
what are the Primary Control-Related Features in expenditure cycles?
The primary control-related features of the expenditures cycle are concerned with:
Segregation of duties – especially between the handling and recording of assets, e.g., handling of inventory and the recording of inventory and cash payments.
Control over source documents – the source documents used in accounts payable processing should be pre-numbered,
Checks, approvals and reconciliations – comparing source documents, e.g., purchase order, receiving report and sales invoice; and the periodic reconciliation of physical holdings of assets to accounting records.
what are Substantive Procedures?
They are audit procedures that:
Provide evidence which supports the fairness of each of management’s financial statement assertions; or
Reveal monetary errors or misstatements in recording or reporting of transactions and balances
Substantive tests of transactions focus on the individual transactions that make up the balance
Substantive tests of balances substantiate the ending balance of an account (which is comprised of multiple transactions)
How can the audit team respond to the risk of material misstatement?
the audit team responds to the risk of material misstatement by:
Maintain professional skepticism
Assign more experienced staff
Incorporate unpredictability into audit procedures
Perform substantive procedures at period-end
What are key substantive procedures for the sales cycle?
key substantive procedures for the sales cycle:
External (debtors’) confirmation
Subsequent receipts review
Cut-off testing
Substantive analytical procedures
Tests of sales transactions
Review of aged trial balance
How do transactions affect inventory?
Increases when goods are purchased
Decreases when goods are sold
Why is inventory considered high risk?
inventory considered high risk:
Significant in income determination
High volume of activity
Complex accounting
Susceptible to manipulation
What are key assertions related to inventory?
key assertions related to inventory:
Valuation & Allocation
Existence
Rights & Obligations
How do auditors verify inventory valuation?
Vouch purchases to supplier invoices
Ensure inventory cost flow assumptions are valid
Test for obsolete, slow-moving, or excess items
Why is completeness a key assertion for accounts payable?
The most likely misstatement is understatement.
What procedures help test for completeness?
Search for unrecorded liabilities
Analytical procedures on related expense accounts
External confirmations to major suppliers
What is the common audit approach for payroll?
High reliance on tests of controls and analytical procedures
If controls are unreliable, perform substantive testing
What assertions are of interest for non-current assets?
Existence
Rights & Obligations
Valuation & Allocation
What are key procedures for Property, Plant & Equipment (PPE)?
verify valuation method (cost or revaluation)
Substantiate additions & retirements
Analytical procedures and depreciation recalculation
Identify impairments through observation & inquiries
When should an auditor consider using an expert?
When specialized skills or knowledge are needed
For valuation of assets like PPE or intangibles
How should an auditor assess an independent valuer?
Check competence, skills, and objectivity
Review the valuer’s report and basis of valuation
why is auditing intangible assets challenging?
Assertions like existence and valuation are subjective
What key audit procedures are used for intangibles?
Consider using experts
Physical examination
Confirmation & legal document inspection
Specialized valuation procedures
What is the key assertion for non-current liabilities & owners’ equity?
What audit procedures test this assertion?
Completeness
Q: What audit procedures test this assertion?
A:
External confirmations
Substantive analytical procedures
Recalculation & vouching
Reviewing meeting minutes & debt agreements
How does double-entry accounting impact audit procedures?
Testing one side of a transaction tests the other side.
How can auditors substantiate income statement accounts?
auditors substantiate income statement accounts:
Indirectly via accounts (e.g., sales → accounts receivable)
Directly with balance sheet accounts (e.g., PPE → depreciation)
Using analytical procedures (e.g., sales → sales commission)
Directly via significant transactions (e.g., discontinued operations)
