1. Part Three Tests of Controls and Tests of Details
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

2. Chapter 9 Tests of controls
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

3. Learning objective 1: Tests of controls
When control risk is assessed at less than high, it is necessary to gather evidence that controls are working. This evidence is gathered via a test of controls.
If control risk is assessed at high, the auditor will not undertake test of controls.
Auditor selects most efficient and effective combination of tests of controls, and substantive tests of transactions and balances.
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

4. Assessing control risk
To assess control risk as high, auditor must expect that substantive procedures alone will provide sufficient appropriate evidence.
Areas where substantive procedures alone may not provide sufficient appropriate evidence include routine recording of significant classes of transactions, such as revenue or purchases. These areas are often highly automated with little or no manual intervention.
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

5. Planning the scope of tests of controls
Nature: if controls exist that the auditor expects to rely upon, undertake tests of these controls, otherwise undertake substantive testing.
Timing: to aid ability to meet deadlines and scheduling of staff, tests of controls sometimes scheduled before year-end. Testing then extended (rolled forward) until year-end.
Extent: the more the auditor relies on controls, the greater the extent of tests of controls. For tests of controls related to documents, extent determined by reference to sampling theory. Controls related to accounting routines (e.g. bank reconciliations) usually tested by re-performing a small number.
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

6. Learning objective 2: Existence, effectiveness and continuity of controls
For internal controls to provide audit evidence about risk of material misstatements at the assertion level, the auditor must collect audit evidence about the existence, effectiveness and continuity of controls.
Evidence of existence of controls is usually gained when auditor is assessing control risk.
Tests of controls are aimed at establishing their effectiveness and continuity.
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

7. Aspects of internal control
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

8. Learning objective 3: Sufficiency and appropriateness
Dependent on the level of control risk the tests must support.
The lower the planned assessed level of control risk, the greater the amount of testing that is required.
Auditor should also consider:
Type and source of evidence
Timeliness
Interrelationship of evidence.
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

9. Effect of documentation of controls: audit trail
Method used by auditor is dependent on whether a documentary audit trail exists.
Where no audit trail exists, 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.
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

10. Relationship between tests of controls and assertions
Auditor is require to assess risk of material misstatement at the assertion level for classes of transactions, account balances and disclosures.
When auditor’s assessment of material misstatement at assertion level includes an expectation that controls are operating effectively, the auditor should perform tests of controls to obtain evidence that the controls were operating effectively during the audit.
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

11. Assertions and testing control activities
For the first two elements of IC (control environment and entity’s risk assessment process), controls relate less directly to specific financial report assertions.
For the remaining three elements of IC (information system, control activities and monitoring of controls), controls are built around major flows of transactions and events and related accounts (e.g. sales, receivables and cash receipts). For these elements it is possible to link many controls to assertions about classes of transactions and events and related account balances (e.g. occurrence — controls which help ensure that transactions and events that have been recorded, have occurred and pertain to the entity).
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

12. Learning objective 4: Revenues, receivables and receipts (sales cycle)
Sales cycle involves all those transactions and events that are initiated when an entity makes a sale. It is commonly characterised by a high volume of routine transactions.
Audit problems commonly related to clerical processing rather than complex accounting problems.
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

13. Key functions in typical sales cycle
Order entry and order approval by credit department
Shipping
Invoicing
General ledger entry
Accounts receivable
Mail opening
Cashier functions
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

14. Typical credit sales flowchart
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

15. Typical cash collection flowchart
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

16. Sales cycle: routine and non-routine transactions
Credit sales to customers, cash collections from customers (flowcharts), usually strong control system, auditor considers (and usually undertakes) tests of controls.
Non-routine transactions:
Adjustments to sales, and provisions for doubtful debts. Less well controlled. Where material, auditor undertakes substantive testing.
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

17. Control objectives for sales system
Controls are in place to ensure that:
Occurrence — all sales recorded are bona fide transactions for merchandise actually shipped to customers
Completeness — all sales shipped are invoiced and recorded in accounting records
Accuracy — invoices have been recorded correctly as to amount and summarised correctly
Cutoff — invoices have been recorded in correct period
Classification — sales classified in accordance with written policies.
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

18. Special control objectives Common control policies and procedures
Example of linking objectives to control policies and tests of controls for sales (Ref. Table 9.4, p. 411)
Special control objectives
Common control policies and procedures
Tests of controls
Occurrence — All sales recorded are bona fide transactions for merchandise actually shipped to customers.
Policy of authorisation of credit and terms
Evidence of quantities shipped reconciled to quantities invoiced
Select sample of sales transactions from sales journal (daily activity report), check for authorisation and trace to shipping document file
Inspect reconciliation of shipments to invoices
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

19. Control objectives for cash receipt system
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
Cutoff — cash receipts have been recorded in correct period
Classification — cash receipts are classified in accordance with company policy.
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

20. Special control objectives Common control policies and procedures
Example of linking control objectives to control policies to tests of controls: cash receipts (Ref. Table 9.5, p. 413)
Special control objectives
Common control policies and procedures
Test of controls
Occurrence — Recorded cash receipts are for collection of receivables resulting from sales to customers of the entity.
Cash receipts matched to specific sales invoices in posting to accounts receivable master file.
Select a sample of entries in cash receipts journal and review evidence that they were matched to specific sales invoices.
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

21. Types of misstatement in sales cycle
Generally result of:
Clerical mistakes
Employee fraud
Misapplied accounting principles, especially around some revenue recognition issues
Management fraud.
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

22. Learning objective 5: Expenditures, payables and disbursements
Expenditure cycle: all transactions and events initiated when an entity acquires assets or services used for cash or credit.
Auditors (and many entities) often separate this cycle into a number of sub-cycles, which reflect various types of services and assets that can be acquired, including:
Payroll
Property, plant and equipment
Inventory
Income taxes
Selling and administrative expenses
Miscellaneous expenses paid from petty cash.
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

23. Key functions within the inventory sub-cycle
Purchasing
Receiving
Accounts payable
Cash disbursements function
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

24. Typical purchases and cash payments flowchart
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

25. Control objectives for purchases of inventory
Controls are in place to ensure:
Occurrence — all recorded purchases are bona fide transactions in that they relate to goods or services authorised or received
Completeness — all purchases for the period of inventory received are recorded
Accuracy — purchases of goods or services for inventory are recorded correctly as to amount and summarised correctly
Cutoff — purchase invoices have been recorded in correct period
Classification — purchase are classified in accordance with classification policies.
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

26. Special control objectives
Example of linking control objectives, controls and test of controls: purchases
Special control objectives
Common controls
Tests of controls
Occurrence — All recorded purchases are bona fide transactions in that they relate to goods or services authorised or received.
Approval of purchase order
Goods received are counted, inspected and compared to purchase order before acceptance
Comparison of purchase order, receiving report and supplier’s invoice and recomputation of supplier’s invoice before recording liability
Examine evidence of approved purchase and service orders
Select a sample of order entries in purchases journal, trace back to vouchers and inspect supporting documentation including receiving report, ensuring agreement of details and indication of approval
From Table 9.6 (pp. 422–3)
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

27. Control objectives in a cash disbursements system
Controls are in place to ensure:
Occurrence — recorded cash disbursements are for goods or services authorised and received
Completeness — all cash disbursements are recorded
Accuracy — cash disbursements are recorded correctly as to amount
Cutoff — cash disbursements recorded in correct period
Classification — cash disbursements are recorded correctly as to account.
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

28. Special control objectives Common control policies and procedures
Example of linking control objectives, controls and test of controls: purchases: cash disbursements (Ref: Table 9.7, p. 423)
Special control objectives
Common control policies and procedures
Tests of controls
Occurrence — Recorded cash disbursements are for goods or services authorised and received.
Cheques printed or prepared only when receipt of goods or services and approval are documented (e.g. supporting documents compared, recomputed and voucher approved)
Cheques signed only after viewing supporting documentation and prior approval
Supporting documentation cancelled and reference to cheque number
Select a sample of cash disbursement transactions from cash payments journal and inspect supporting documentation for indication of checking, review and approval
Observe and inquire about cheque preparation and signing and protection of unissued cheques
For the sample of cash disbursement transactions inspect supporting documents for cancellation, cheque number and endorsement
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

29. Potential misstatements in expenditure cycle
As expenditure cycle involves disbursements of cash there is a greater risk of fraud or irregularity, including:
Classic disbursements fraud
Kickbacks
Illegal acts
Unauthorised executive perks
Kiting.
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

30. Learning objective 6: Selling and administrative expenses
Processing and related control policies and procedures for selling and administrative expenses are similar to those for purchases of inventory.
Auditor will normally obtain comfort from cash disbursement testing for inventory purchases and perform minimal testing in this area.
Analytical procedures (e.g. comparing balance with prior periods) widely used as a key type of testing.
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

31. Petty cash disbursements
Petty cash disbursements are usually immaterial in amount and therefore few, if any, audit procedures are applied to this area.
Where the area is significant, emphasis is on ensuring appropriate procedures are in place to safeguard cash.
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

32. Payroll
The payroll function is usually audited in either of two ways (or best combination):
Focusing on analytical procedures (disaggregated and strong relationships in this area, e.g. comparing fortnightly payrolls)
Tests of transactions over the payroll area with the key control being appropriate segregation of duties in the hiring function, approval of time worked, payroll preparation and payroll distribution.
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

33. Payroll (cont.)
If tests of controls are necessary, the following audit procedures may be undertaken:
Authorisation by supervisors of time worked
Check signed time cards/sheets
Check use of approved pay rates (personnel department)
Check for reasonableness, compared with awards.
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

34. Interest, rent, lease and insurance payments
Auditor usually takes a more substantive approach, which includes checking terms and conditions of contracts.
Auditor interested in the key control of authorisation of the contract.
Accounting treatment of leases is complex, and auditor might check controls that ensure leases are properly accounted for.
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

35. Learning objective 7: Testing controls in client computer programs
Separate techniques have to be developed for testing programmed controls. These are:
Test data
Integrated test facility
Controlled processing, reprocessing or parallel processing
Review program code and results of job processing.
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

36. Test data
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

37. Integrated test facility
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

38. Auditing through computer: processing client data
Controlled processing: auditor establishes control over processing of client’s data.
Controlled reprocessing: auditor reprocesses client data.
Parallel processing: simultaneously processes client data through client and auditor programs.
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

39. Auditing through computer: other approaches
Program code review: involves reviewing relevant code line by line, considering whether processing steps and control procedures are properly coded and logically correct.
Review of job accounting data: involves reviewing printed log of jobs, looking for excessive processing time, abnormal halts etc.
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

40. Advanced CAATs Systems control audit review file (SCARF) Snapshot
Audit modules embedded in programs to monitor transaction activity.
Snapshot
Transactions are tagged and then identified at certain points during processing to see how program is treating them.
Audit hooks
Points in program that allow auditor to insert commands for special processing.
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett