TESTSOFCONTROLS
Questions
1.
Directly. Higher levels of control risk induce auditors to audit larger samples of
receivables, with confirmation date closer to the fiscal year end date. As for
nature of the procedures: higher levels of control risk induce auditors to use
positive confirmations instead of negative confirmations, and to consider
vouching subsequent payments by the customers.
2.
3.
4.
The internal auditors should, through periodic checks, ensure that the control
account is periodically reconciled to the customer subsidiary accounts, bank
statements are reconciled and that all prenumbered documents, especially
invoices, have all numbers accounted for. Some internal auditors also confirm
accounts receivable. Internal auditors also might review and evaluate customer
complaints for signs of weaknesses in the procedures leading to errors in
accounts receivable.
5.
The features of a cash receipts internal control system which would be expected
to prevent an employee from absconding with company funds and covering with
funds from the employee pension fund is the prohibition against one employee
having custody of company funds and noncompany funds. The auditor can
detect such transfers by controlling and counting both funds simultaneously.
The evaluation after the review phase was to determine which controls appeared
adequate as a basis for justifying a low control risk assessment. The final
assessment after test of controls auditing is to determine if the controls are
actually operating as well as they appeared to be.
7.
8.
If the credit limits are set and entered incorrectly, the credit approval process
will be systematically deficient.
9.
Tests of Controls
19-3
People have bad days and make mistakes; computers do not have bad days.
Murphys Law If it is possible to make an error, someone will find a way
to do it.
People initiate the transactions and will make errors.
All controls should be considered together (manual and computer).
Excellent computer controls cannot be relied upon if the related manual
controls are weak.
14. The purpose of the auditors search for unrecorded liabilities is to gather
evidence as to whether the liability assertion is true. The same concern exists in
the internal control objective all valid transactions are recorded and none are
omitted. From an evidence gathering perspective, it is much more difficult to
gather evidence on unrecorded transactions than to gather evidence that recorded
transactions (and account balances) are proper.
The search for unrecorded liabilities includes procedures in other audit areas
such as questions on bank and insurance confirmations and vouching the source
of funds for asset additions. Specific audit procedures in the search for
unrecorded liabilities include:
1.
2.
3.
4.
5.
15. A walk through involves following a transaction from initiation through the
various steps until the transaction is recorded in the formal accounting records.
In the conversion cycle, the following would constitute a complete walk
through:
Step
Documents Collected
Controls Noted
Prepare production
Production Order (P.O.) Support for P.O.
orders
Prepare bill of materials
and manpower needs
Separation planning
from production.
Tests of Controls
Assign job order and
foreman
19-5
Note separation
production supervisor
from foreman duties.
Approval by foreman of
hours.
Labor report (LR)
Observe timekeeping,
compare job tickets to
clock cards
Material used report
prepared
Summary entry
prepared.
Independent report of
production completed.
Independent check of
RUC.
Observe comparison
RUC and PRR
Job sheets closed out,
summary entry prepared
Trace summary entry to
General Ledger posting
Independent records of
units put into finished
goods inventory.
Records from separate
sources reconciled.
16. Weaknesses (lack of control where auditors believe one is necessary) are not
audited because auditors do not rely upon weaknesses to prevent, detect or
correct material errors. Auditors must consider the financial impact of
weaknesses on financial statements and plan substantive tests accordingly.
A control strength may be identified in interviews during the review phase (or in
preparing the flowcharts or questionnaires), but during test of controls auditing,
found to be nonexistent or operating ineffectively. For example, in the
conversion cycle the production management may state that foremen approve
workers job time tickets. However, when a sample of job time tickets are
examined by auditors for evidence of approval, none is found. Thus, a weakness
is not found until the control is tested. Therefore, control risk should not be
assessed low until evidence is gathered that the control is operating effectively.
17. The purpose of this review question is to foster discussion toward what
information an independent auditor needs to know. Items relevant to the
quotation might include:
1.
2.
3.
4.
5.
18. The surprise observation enables the auditor to see how the distribution system
really works and increases his chances of detecting fraud. Such an observation
involves taking control of paychecks, then accompanying a client representative
Tests of Controls
19-7
as the distribution takes place. The auditor checks to see that each employee is
identified and that only one check is given to each individual. Unclaimed
checks are controlled and examined to detect any fictitious persons on the
payroll.
19. A walk through of a personnel and payroll transaction would include
discussions with each person handling personnel and payroll records. The
following illustrates the steps and documents collected.
Steps
Hiring personnel dept.
Deductions personnel
dept.
Timekeeping
Shops
Cost distribution
Accounts payable
Cash disbursement
Document(s) Collected
Authorization to hire and rate assignment
Personnel forms, employee authorization for
deductions
Clock card
Job time ticket
Labor distribution sheet
Payroll voucher
Payroll checks
If the payroll is processed by computer, the clock cards and job time tickets
would be traced to batch control in the timekeeping and production departments,
to data preparation (keying to machine sensible form), to edit and validation
error reports and other computer output indicating control and finally to
computer prepared checks, labor distribution reports and summary general
ledger entries.
Multiple Choice Questions
1.
2.
3.
4.
c
c
b
c
5.
6.
7.
8.
a
c
c
b
9.
10.
11.
12.
d
b
a
a
13.
14.
15.
16.
b
a
c
d
17.
18.
19.
20.
d
d
c
b
Cases
1.
1.
2.
2.
3.
4.
The discussion could take several directions, including some or all of the
following:
1.
2.
Castro can collude with customers to rig low bids and take kickbacks,
thereby depriving the company of legitimate revenue.
Castro can direct purchases to favored suppliers, pay unnecessarily
high prices and take kickbacks. He might even set up a controlled
Tests of Controls
c.
d.
e.
3.
c.
d.
3.
19-9
The purpose of this question is to get the student to consider where the functions
that are considered incompatible in a manual system occur in a computer
system.
The functions should be separated in a manual or computer accounting system
such that different people authorize the sales transactions, record the
transactions, have custody to the assets (inventory) and reconcile the books to
the assets.
Different people should: indicate the sales order source document (authorize),
prepare the computer program (authorize and record), operate the computer
(record), have custody of inventory and correct errors (reconciliation).
4.
If the credit limits are set and entered incorrectly, the credit approval process
will be systematically deficient.
Memorandum
TO:
FROM:
DATE:
SUBJECT:
Tests of Controls
19-11
6.
a.
b.
2.
3.
2.
3.
4.
5.
Scan cancelled checks and cash disbursements records during the year
for:
a.
b.
names of payees,
consecutive numbers of checks to determine whether any payments
other than regular transfers to main office were made from this
account.
7.
6.
7.
1.
a.
b.
2.
a.
b.
3.
a.
b.
4.
a.
b.