Case 3 Internal Control Structure
Case 3 Internal Control Structure
Case 3 Internal Control Structure
CASE 3
Overview
• Discussion Questi ons
• Internal Control Structure
• Approach in the study and evaluati on of the
client’s internal control
DISCUSSION QUESTIONS
1. ANALYZE THE ENGAGEMENT LETTER PREPARED BY ABERNETHY AND
CHAPMAN. WHAT SPECIFIC RESPONSIBILITIES ARE BEING ACCEPTED
BY THE CPA FIRM? WHAT RESPONSIBILITIES ARE ASSIGNED TO THE
CLIENT COMPANY?
The degree of reliance that the auditor should place on each document
depends on the enti ty ’s internal control. If the controls are strong,
the reliability of these documents is higher than if the controls are
weak.
3. WHAT KINDS OF INFORMATION SHOULD ANDREWS HAVE GATHERED
DURING THE PRELIMINARY STAGE OF THIS AUDIT IN ORDER TO
ANSWER CLINE’S QUESTIONS? WHAT SOURCES ARE AVAILABLE TO
THE AUDITORS TO HELP UNDERSTAND AND ASSESS THE CLIENT’S
INTERNAL CONTROL STRUCTURE?
4. FRO THE INFORMATION PROVIDED TO THIS POINT, WHAT ANSWERS
CAN BE GIVEN TO CLINE’S QUESTIONS? MENTION THE STRENGTHS AS
WELL AS ANY WEAKNESSES THAT HAVE BEEN FOUND THAT WILL
HAVE A BEARING ON THE AUDITOR’S ASSESSMENT OF CONTROL
RISK.
5. AFTER THE PRELIMINARY ASSESSMENT HAS BEEN MADE OF
LAKESIDE’S CONTROL RISK, WHAT POSSIBLE ACTIONS CAN BE TAKEN
BY THE AUDITOR?
• Integrity of management
• Management experience and knowledge and changes in management
during the period
• Unusual pressures on management
• The nature of the enti ty ’s business
• Factors aff ecti ng the industry in which the enti ty operates
The factors to be considered in assessing inherent risk on account
balances and class of transacti on levels include: (SAS par. 12b)
In accordance with PSA 330 par. 6 , the auditor shall design and
perform further audit procedures whose nature, ti ming, and extent
are based on and are responsive to the assessed risks of material
misstatements at the asserti on level.
Internal control structure
UNDERSTANDING OF THE DESIGN AND EVALUATION
OF THE OPERATING EFFECTIVENESS OF INTERNAL
CONTROL
The nature, extent, and ti ming of the audit procedures to
be performed in gathering audit evidence related to class of
transacti ons, account balances and disclosures take their most
signifi cant momentum from a thorough understanding of the
design and evaluati on of the operati ng eff ecti veness of
Internal Control.
An auditor ’s approach in the study a nd evaluati o n of the client ’s interna l
control is generally consi st s of the fol lowi ng:
• Revenue Recogniti on
• Cash Receipts.
REVENUE RECOGNITION
CASH RECEIPTS
Transaction cycle
Transaction cycle
Step 2
M a ke a P r e l i m i n a r y A s s e s s m e n t
o f C o n t ro l R i s k
PSA 200 paragraph 13 (n) (ii)
Accordingly, some control risk will always exist . The PSAs provide
the conditi ons under which the auditor is required to, or may
choose to, test the operati ng eff ecti veness of controls in
determining the nature, ti ming and extent of substanti ve
procedures to be performed.
Why is there a need for risk assessment?
Abernethy and Chapman had already a conversati on with Rogers about the
informati on it needs. They also i nquired the King and Company which i s the
predecessor auditor for them to have knowledge about their new cli ent ’s
internal control system.
(b.) Analyti cal procedures. ( Ref: Para. A7-A8)
1. Organizati on chart
2. Symbols used by previous auditors in fl owchart
3. Revenue and Cash Receipts Cycle –
Distributorship:
(a) Revenue Recogniti on
(b) Cash Receipts
P o i n t e r s w h e n a s s e s s i n g c o n t r o l r i s
In additi onal, PSA 330 paragraph A5-A7 states that the nature of
an audit procedure refers to its purpose (i.e., test of controls or
substanti ve procedure) and its type (i.e., inspecti on, observati on,
inquiry, confi rmati on, recalculati on, reperformance, or analyti cal
procedure).
• Nature of the audit procedures is of most importance in responding
to the assessed risks.
• Timing of an audit procedure refers to when it is performed, or the
period or date to which the audit evidence applies.
• Extent of an audit procedure refers to the quanti ty to be performed,
for example, a sample size or the number of observati ons of a
control acti vity.
1. Unauthorized shipments
• Personnel such as producti on manager - identi fying supplies or
merchandise orders
• Finance manager - for authorizing such orders and providing
disbursements for payment
• The shipping company where the client is in contract with -
separately inquired
2. Goods properly shipped not billed - same test above could be done
but greater emphasis was put in inquiring the shipping company in
order to understand the reason why the order was not billed.
3. Bills sent but goods not shipped - same procedure as above but
document examinati on is done appropriately checking whether data
draft ed therefor is correctly included.
4. Bills not properly prepared, recorded - same as above but the
fi nance manager and his records was thoroughly inquired and
examine, respecti vely, to understand the reason for such.