1. Topic 6: Tests of controls
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2. Topic learning outcomes
Identify factors impacting the auditors assessment of the sufficiency and appropriateness of the evidence gathered by tests of controls
Understand the audit approaches to testing controls through the computer
Describe the audit procedures for testing controls in the revenues, receivables and receipts system
6.1
6.2
6.3
6.4
Understand audit procedures for testing other controls.
If controls are found lacking look for alternate controls that cover the required assertions or move to substantive testing. 1
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3. Audit risk don’t forget
6.1
Audit risk don’t forget
Auditors can’t change this
But can obtain evidence to support an assessed level
Auditors can’t change this either!
This is where the auditor can reduce audit risk 2
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4. Audit strategies and internal control
6.1
Audit strategies and internal control
What level of detection risk (DR) is acceptable given assessed level of control risk (CR) and inherent risk (IR)?
Low control risk approach - test of controls must be undertaken 3
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5. Assessing control risk
6.1
Assessing control risk
To assess control risk as high, auditor must expect that substantive procedures alone will provide sufficient appropriate evidence.
Areas where they may not provide sufficient appropriate audit evidence include routine recording of significant classes of transactions, such as revenue or purchases.
Often highly automated with little or no manual intervention.
Therefore, it makes sense to undertake tests of controls.
If not some sort of control texting would be required.
If no effective controls are evident and substantive testing will not provide sufficient appropriate evidence then some qualification of the auditor’s opinion would be required. 4
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6. 6.1
Tests of controls
Objective is to gain reasonable assurance that controls associated with the processing of a particular class of transactions are working as expected.
This allows a reduction in substantive tests
Most common types tests for controls are:
Enquiry
Observation
Inspection
The auditor may also need to undertake
Re-performance and
Re-calculation 5
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7. 6.1
Tests of controls
Difference between tests of controls and substantive tests of transactions:
Tests of controls do not measure monetary error in accounting records
Tests of controls as dual-purpose tests
Some control test evidence can also be used as evidence in substantive testing (more on this in topic 7). 6
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8. Planning the scope for tests of controls
6.1
Planning the scope for tests of controls
Nature: if controls exist that the auditors expect to rely on, then they designs tests to test them.
Timing: does not all have to be at 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 is determined by reference to sampling theory
Controls related to accounting routines (e.g. bank reconciliations) usually tested by re-performing a small number 7
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9. Purpose for tests of controls
6.1
Purpose for tests of controls
Tests of controls assess one or more of the following:
Existence
Effectiveness: is the control operating effectively?
Continuity: did the control operate throughout the period of intended reliance?
Note: all of the above must be tested for each control 8
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10. Purpose for tests of controls: examples
6.1
Purpose for tests of controls: examples 9
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11. Tests of controls and assertions
6.1
Tests of controls and assertions
Most controls relate directly to financial report assertions but SOME are less likely to, for example:
Controls that relate to the control environment
Controls that relate to the entity’s risk assessment process
The information system, control activities and monitoring of controls ARE built around major flows of transactions and events
It’s therefore possible to relate most tests of controls for these elements to assertions about classes of transactions and events:
Occurrence
Completeness
Accuracy
Cut-off
Classification
Test of controls over account balance do exist – e.g. valuation of Accounts Receivable (are debt recovery procedures followed – monthly reports reviewed/authorised) 10
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12. Misstatement in revenue, receivables and receipts cycle
6.2
Misstatement in revenue, receivables and receipts cycle
Misstatements are generally the result of:
Clerical mistakes;
Employee fraud;
Management fraud; or
Misapplied accounting principles. 11
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13. Revenues, receivables and receipts cycle
6.2
Revenues, receivables and receipts cycle
Involves all those transactions and events initiated when an entity makes a sale
commonly characterised by a high volume of routine transactions.
audit problems commonly related to clerical processing rather than complex accounting problems.
Key functions in this cycle:
Order entry and order approval by credit department
Shipping
Invoicing
Accounts receivable
General ledger
Credit collection:
Mail opening
Cashier 12
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14. Revenues, receivables and receipts cycle
6.2
Revenues, receivables and receipts cycle
Accounting recording in the credit sales cycle:
Recognition of revenue and increases in accounts receivable
Recording of cash receipts and reduction in receivables owed
Reduction in receivables for returned merchandised
Allowances for bad debts
Recognition of cost of sales and the reduction in inventory (perpetual system)
Adjustments to inventory as a result of:
Any returned items
Any write-off of returned items
Any allowance for defective or obsolete inventory (though this does not directly relate to the RR&R cycle)
Cash receipts include cheques and EFT (including credit cards)
Over arching is a separation of duties
Order entry
Controls
Sales order (preferably pre-numbered)
Customer number
Limit and credit worthiness verification (within system or by the credit department)
Shipping order (or a duplicate portion of the sales order
Aged Open order report
Shipping
Picking list if the warehousing/shipping function is separate
Physical control of the documents
Inspection of items and verification to sales order/shipping notice
Shipping documents/shipping notice (bill of lading)
Copy of shipment notice is sent to relative department(s) or entered into the system to show order has been filled
Invoicing
Completes invoice (usually pre-numbered) after confirmation of shipment and cross check of documentation i.e. customer order (if applicable), sales order and shipping order.
Multiple copies of invoice – one for customer – one for account receivable processing area.
Provide a summation of invoices for the general ledger area to post to control accounts.  
Accounts receivable/General ledger
Separation of information between the two
Reconciliation of the general ledger to the accounts receivable master file
Cash collection
Listing cheques received via mail (better if two people are present for this)
Cheques are sent to the cashier department for preparation of bank deposits
Banking should be conducted daily
Remittance advices are sent to accounts receivable area to be posted to subsidiary ledgers
Total of remittances (cheque listing) sent to general ledger area to up-date control accounts
Computer systems generate a variety of reports that can be used as controls e.g. aged orders reports, daily sales reports that can be verified to master accounts or general ledger accounts (though electronic systems up-date across different files simultaneously).
If a more manual process batches will be used for posting sales and cash receipts to subsidiary ledgers, totals of batches must agree to the individual amounts. Batch totals will be separately recorded and used to up-date general ledger control accounts.
Further controls in accounts receivable
Aged receivable report
Actioning of outstanding debtors
Policy & procedures followed
Verification/authorisation of action by senior personnel
Paperwork (documentation) of follow-up actions 13
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15. Typical credit sales flowchart
6.2 14
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16. Sales cycle: routine & non-routine transactions
6.2
Sales cycle: routine & non-routine transactions
Routine transactions:
Credit sales to customers, cash collections from customers (flow-charts), usually strong control system
Auditor considers (and usually undertakes) tests of control
Non-routine transactions:
Adjustments to sales, and provisions for doubtful debts, less well controlled
Where material, auditor undertakes substantive testing 15
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17. Linking control objectives and tests of controls for a sales system18
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18. insert my footer 19
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19. 20
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20. Typical cash collection flowchart
6.2
Typical cash collection flowchart
Also on p.401 19
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21. Control objectives for a cash receipts system
6.2
Control objectives for a cash receipts system
Assertion
Objective
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 20
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22. 6.2
Linking objectives to control policies and tests of controls for cash receipts: an example
Special control objectives
Common control policies and procedures
Tests of controls
Occurrence - recorded cash receipts are for the 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 sample of entries in cash receipts journal and review evidence that matched specific sales invoices 21
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23. Please note, you should ensure you understand the controls, their relationship to the assertions and the tests used for other areas. 24
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24. Testing controls in client computer programs
6.3
Testing controls in client computer programs
Separate techniques have to be developed for testing programmed controls. These include:
test data
integrated test facility
controlled processing, reprocessing or parallel processing
review program code and results of job processing 23
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25. 6.3
Test data 24
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26. Integrated test facility
6.3
Integrated test facility 25
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27. Test of Controls in other systems
6.4
Test of Controls in other systems
The other broad area where controls need to be tested is expenditure, payable and disbursements (cash payments). Sub-areas here include:
Purchase of good and services for inventory
Manufactured or retailed
Costs and liabilities
Payroll costs and liabilities
Salaries and wages
Accruals
Related benefits
Other selling and administrative expenses
Purchase of Non-current assets (PP&E)
Depreciation expenses
Taxes