ACCT3322 S220 Topic 5 Questions and Answers PDF

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Topic 5 Week 6 Tutorial Questions and Solutions...

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ACCT3322 Auditing Tutorial 5: Understanding a Client’s Internal Controls 6.11

What is internal control? Why is an auditor interested in a client’s internal control?

Internal control is defined as: The process designed, implemented and maintained by those charged with governance, management, and other personnel to provide reasonable assurance about the achievement of the entity’s objectives with regard to reliability of financial reporting, effectiveness and efficiency of operations, and compliance with applicable laws and regulations. (AUASB Glossary). Internal control is therefore the way that any entity organises itself to achieve its objectives. It is how managers run the organisation and control the employees so that they work towards achieving the organisation’s objectives and operate legally. Auditors are interested in internal control because it is the system that managers use to make sure transactions are recorded correctly and the accounting system is able to produce financial reports that are reliable. The auditor has to provide an opinion on the financial reports, so the auditor has to understand how well the internal control of an organisation works to produce reliable financial records.

6.12

Explain each of the seven generally accepted objectives of internal control activities.

Internal controls are designed and implemented to ensure that transactions are real, recorded, correctly valued, classified, summarised and posted on a timely basis.       

Real – only genuine transactions are recorded. Recorded – all genuine transactions are recorded (none are omitted). Correctly valued – all transactions are at the correct amount. Classified – all transactions are allocated to the correct account. Summarised – all transactions are correctly totalled. Posted – all transactions, or transaction totals, are posted to the correct ledger account. Timely – all transactions are recorded in the correct accounting period.

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ACCT3322 Auditing Tutorial 5: Understanding a Client’s Internal Controls 6.13

If an auditor does not intend to rely on internal controls in the audit, does the auditor need to obtain an understanding of the client’s internal control? Explain.

ASA 315 requires the auditor to obtain an understanding of internal control on all audit engagements. Therefore, even if the auditor intends to take an entirely substantive approach to the audit and not rely on internal controls, the auditor must obtain an understanding of internal control. This is because without gaining this understanding, the auditor will not fully understand the risks of material misstatement of the financial report. ASA 315 states that gaining an understanding of the entity and its environment, including its internal control, establishes a frame of reference within which the auditor plans the audit and exercises professional judgement throughout the audit. The standard allows the auditor to use professional judgement to determine the extent of the understanding of internal controls required in each case.

6.14

Explain the difference between entity-level controls and transaction-level controls. Is an auditor interested in both?

Entity-level controls are: 1. the control environment 2. the entity’s risk assessment process 3. the information system, including the related business processes, relevant to financial reporting, and communication 4. control activities 5. monitoring of controls. Each of these controls relates to the whole organisation. Transaction-level controls are controls that impact a particular transaction or group of transactions. Therefore, the difference is that entity-level controls have the potential to impact all of the processes in the organisation, including those that have a direct impact on the financial report and others, while transaction-level controls impact only a specific group of transactions. Transactions make up the financial report that the auditor is auditing, and can be impacted by both entity-level and transaction-level controls. This is why an auditor would be interested in both types of controls.

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ACCT3322 Auditing Tutorial 5: Understanding a Client’s Internal Controls

6.16

Why would an auditor be interested in a client’s control monitoring processes?

A client should have processes for monitoring the effectiveness of its internal controls because circumstances and conditions change over time and controls need to adjust accordingly. An out-of-date control system may not be able to alert management to new risks, or control new types of transactions. The monitoring process allows the client to assess the need for changes to internal controls. As such, the auditor will be interested in the effectiveness of the monitoring system and whether the client’s management are able to be sure that internal controls remain current and valid. The auditor will also be able to assess the client’s management attitude to internal control systems through evaluation of the monitoring processes within the client. 6.18

Explain the importance of segregation of incompatible duties. What sort of duties would be segregated within the sales process? Why?

Segregation of incompatible duties is a part of the control activities of an organisation. Control activities are policies and procedures that help make sure management’s directives are carried out. The concept of segregation of incompatible duties is that no one employee or group of employees should be in a position both to perpetrate and hide errors or fraud in the normal course of their duties. If these duties are not segregated, an employee could steal assets (such as cash or stock) and adjust the records to conceal the theft. If the duties are segregated, the employee stealing the assets would have to get the cooperation of another employee to adjust the records to hide the theft. Therefore, it is very important for the effective operation of a control system that incompatible duties are split between different employees. Within the sales process, the person making the sale is not responsible for recording the sale, and should not be able to process a sales return or other adjustment to a debtors account balance. If these duties were not segregated, the sales employee could record a sale to a fictitious customer and take the goods for themselves. To conceal the theft, the employee would later process a sales return or adjustment to eliminate the balance in the fictitious debtor’s account. The management letter would conform to the example in the text. It would be addressed to the chair of the board of Dolphin (Justin Morris). It would explain the deficiencies in internal control, as outlined in Professional Application Question 6.33, with the appropriate recommendations with respect to segregating duties and completion of documentation of policies and procedures.

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