Auditing-5

INTERNAL CONTROL
 INTERNAL CONTROL
“Internal control is best regarded as indicating the whole system of
controls, financial and otherwise, established by management in
the conduct of a business, including internal check, internal audit
and other forms of control” WW Big

“Internal control comprises the plan of organization and all of the

coordinate methods and measures adopted within a business to
safeguard its assets, check the accuracy and reliability of its
accounting data, promote, operational efficiency, and encourage
adherence to prescribed managerial policies”
American Institute of CPAs
 WHY INTERNAL CONTROL
Complexities of modern business techniques and increased size of
business units have encouraged the adoption of methods which, while
increasing the efficiency of the business, also act as safeguards against
errors and frauds.
Internal control involved actions taken within an organization to
1. Protect assets
2. Protect against improper assets disbursement
3. Protect against the incurrence of improper liabilities
4. Assure the accuracy and dependability of all financial and
operating information
5. Judge operating efficiency
6. Measure adherence to the organization’s established policies
TYPES OF INTERNAL CONTROL
1. Administrative Internal Control: This kind pertains to activities which are not
directly financial in nature. Administrative internal control may include the
methods followed to protect assets, to judge operating efficiency and measure
adherence to the company established policies
2. Financial Internal Control: Financial internal control, pertains to financial
activities and may be exemplified by the separation of the duties of personnel
in handling cash and record related to cash transactions.
It is worth noting here that the internal control do not make fraud impossible by
any means. They, however, make it more difficult and the chances of detection
much greater.
INTERNAL CONTROL
While examining the system of internal control the auditor should consider the
following possibilities:
1. The possibilities of collusion between close relatives, such as husband and wife,
each working in related parts of the business.
2. The possibility of collusion as well as combinations of duties which would
enable one person to conceal irregularities.
3. A possible conflict of interest in the case of a responsible official having other business interest.
4. The extent to which employees in positions of trust, especially those handling cash, fail to take
regular holidays.
5. In the case for small business where there is insufficient staff to segregate duties, the extent to
which control is provided by the owner’s personal supervision
6. The operation of the system during absence.
PRINCIPLES OF INTERNAL CONTROL
The basic principles of financial internal control are explained below:
1. Financial and accounting operations must be separated.
2. Responsibility for the performance of the job must be clearly stated.
3. Too much confidence should not be pinned in one individual.
4. Rotation principle relating to transfer of an employee from one job to another should be followed
5. Mechanization of the work wherever feasible and practicable, should be resorted to.
6. The work should be so arranged that work done by one employee should be promptly checked by
another independent employee.
7. The arrangement of the work should be in such a manner that written record of the part played by
each employee should be maintained.
8. Clear and well defined rules should laid down for dealing of cash, ordering, receiving etc.
9. Employees must be in bond so that the tempted employee must be deterred from committing fraud.
10. Double entry system must be used.
SYSTEM OF INTERNAL CONTROL FOR SOME BUSINESS CONCERNS

SMALL CONCERNS:
1. Correspondence
2. Remittance and Deposits
3. Payment Authorization
4. Wages and Salaries
5. Goods
SYSTEM OF INTERNAL CONTROL FOR SOME BUSINESS CONCERNS

MANUFACTIRNG CONCERNS:
1. Access to Ledger
2. Correspondence
3. Remittances
4. Deposit
5. Printed Form
6. Cash Sales
7. Payment Authorization
8. Wages
SYSTEM OF INTERNAL CONTROL FOR SOME BUSINESS CONCERNS

MANUFACTIRNG CONCERNS:
9. Petty Cash
10. Purchases
11. Credit Notes
12. Statement of Accounts
13. Control Accounts
14. Mechanical Appliances
15. Stock and Stores
SYSTEM OF INTERNAL CONTROL FOR SOME BUSINESS CONCERNS

Stores:
1. Ordering level
2. Placing of order
3. Receipt of materials
4. Storing of materials
5. Record of materials
6. Payment for materials
7. Issuance of materials
8. Return of materials
9. Charging for materials
10. Periodical checking of materials
INTERNAL CHECK

Internal check is a method of organizing the accounts system of a business concern

or a factory where the duties of different clerks are arranged in such a way that the
work of one person is automatically checked by another and thus the possibility of
fraud, or error, or irregularity is minimized unless there is a collusion the clerks.
“System or method introduced with defined instructions given to staff as to their
sphere of work with a view to control and verification of their work and also
maintenance of accurate records as the ultimate aims” D.R Daver
“An arrangement of accounting routine that errors and frauds are automatically
prevented or discovered by the very operation of the bookkeeping itself” Dicksee
OBJECTIVES OF INTERNAL CHECK

1. Fraud Prevention
2. Asset Protection
3. Error Prevention
4. Fixing Responsibility
5. Moral Check
6. Recording Facts
7. Accounting System
FUNDAMENTAL PRINCIPLES OF INTERNAL CHECK
1. No single employee should have full control over operations of an important
character.
2. The same employee should not be allowed to control the financial operation of the
concern.
3. All officials who handle cash, securities or stock should be required to take an
annual holiday.
4. The respective duties of each member of the staff should be properly arranged.
5. The work of members of the staff should be changed from time to time.
6. Modern mechanical devices such as cash registers, should be introduced
7. Work of each employee must be checked by others.
8. Every transaction must pass through several hands in well defined manner
9. Various books, vouchers and sections of business must be linked in proper sequence.
ADVANTAGES OF INTERNAL CHECK

1. Moral Influence on Employees

2. Determination of Employees Liability
3. Less Possibility of Frauds
4. Increase in Efficiency
5. Auditing made Easy
6. Final Accounts can be prepared
7. Correct and complete Records of all Transactions
8. Detection of Dishonesty or Irregularity
9. Test Checking Possible
INTERNAL AUDIT

Internal audit is evaluation and analysis of the business operation conducted by the
internal audit staff. It is the part of over all system of internal control established in
an organization.
“Internal auditing consist of a continues, critical review of financial and operating
activities by a staff of auditors functioning as full time salaried employees”
Wlater B Meigs
“Internal Audit as a review of operations and records, some time continues,
undertaken within a business by specially assigned staff:
American Institute of Chartered Auditors.
OBJECTIVES OF INTERNAL AUDIT

1. To check the correctness and truthfulness of the transaction of accounts

2. To verify the existence of the assets and of the adequacy of the system of
custodianship and safeguarding of the assets.
3. The chartout procedures and policies for proper accounting of the transactions and
follow standard accounting practices.
4. To ensure that proper and adequate statistical records are maintained and furnish
information needed by the management
5. To analyze and plug the weakness in the internal control system.
6. To examine all the transactions carried out with proper authority and according to
policies.
7. To review the efficiency and effectiveness of the various functional areas
8. To suggest improvement in the financial and non financial control.
FUNCTIONS OF INTERNAL AUDIT

1. Analysis of internal check

2. Application of legal requirement
3. Verification of Accuracy
4. Confirmation of liability
5. Examination of assets protection
6. Detection of Frauds
7. Ascertain proper authority
8. Detection of errors
9. Make investigation
10. Performance appraisal
11. Give suggestion
DISTINCTION BETWEEN INTERNAL AND EXTERNAL AUDIT
1. Status
2. Attendance of meeting
3. Audit Report
4. Termination
5. Extent of work
6. Prosecution
7. Determination of Duties
8. Advisor Service
9. Conduct of audit
10. Remuneration
11. Appointment
12. Qualification
13. Nature of Work
14. Objectives
Auditing-6
AUDIT OF LIMITED COMPANY
 APPOINTMENT OF AUDITOR
The appointment of Auditors of a company is made according to the provisions of Section 252 of
companies act which are explained below:
First Auditors: Section 252(3)
The first auditor(s) of a company shall be appointed by the directors within sixty days of the date of
incorporation of the company. The auditor(s) so appointed shall hold office until the conclusion of the
first annual general meeting.
1. The company in a general meeting may remove any such auditor(s) and appoint in his or their place
any other person or persons who have been nominated for appointment by any member of the
company.
2. If the directors fail to exercise their powers, the company in general meeting may appoint the first
auditor or auditors
3. Appointment of partnership by the firm name to be auditor of a company shall be deemed to be the
appointment of all the persons who are partners in the firm of appointment.
 APPOINTMENT OF AUDITOR
Subsequent Appointment: Section 255(1), 253(1)
 Every company is required to appoint an auditor(s), at each general meeting, to hold office from the
conclusion of the next annual general meeting.
 A notice is required for a resolution at a company’s annual general meeting appointing as auditor a
person other than a retiring auditor.
 This notice is required to be given by a member of the company to the company not less than
fourteen days before the annual general meeting.
 The company shall send such notice to retiring auditor not less then seven days before the date fixed
for annual general meeting.
 A public limited company shall publish such notice in one issue each of a daily news paper in
English and Urdu having circulation in the Province in which the stock exchange on which the
company is listed is situation.
 Every company is required to send intimation to the registrar, within fourteen days from the date of
retirement, removal or otherwise ceasing to hold office of an auditor.
 APPOINTMENT OF AUDITOR
Casual Vacancy
 The directors may fill any casual vacancy in the office of an auditor. However, while any such
vacancy continue , the surviving or continuing auditor(s), if any, may act.
 Any auditor appointed to fill in any casual vacancy shall hold office until the conclusion of the next
annual general meeting.
No Appointment
The security & Exchange Commission of Pakistan may appoint an auditor to fill the vacancy in the
following situation.
• Where appointment for the first auditor is not made within 120 days of the date of incorporation of
the company.
• Where at an annual general meeting no auditors are appointed
• Where auditors appointed are unwilling to act as auditor of the company
• Where a casual vacancy in the office of an auditor is not filled within 30 days after the occurrence of
vacancy.
 REMUNERATION OF AUDITOR
The remuneration of the auditors of a company shall be fixed as under:
 If the auditor is appointed by the directors or by the SECP, then
directors or SECP shall fix the remuneration of auditors
 In All other cases, the company in general meeting or in such manner
as the general meeting may determine.
 However in all cases remuneration will be paid by the company
 QUALIFICATION AND DISQUALIFICATIONS OF
AUDITOR
QUALIFICATION:
For the appointment as an auditor of a public company or a private company which is subsidiary of
a public company he must be a chartered accountant with in the meaning of the Chartered
Accountants Ordinance 1961.
DISQUALIFICATIONS OF AUDITOR:
1. A person who is or at any time during the preceding three years was, a director, other officer
or employee of the company.
2. A person who is a partner of , or in the employment of, a director, officer or employee of the
company.
3. The spouse of a director of a company
4. A person who is indebted to the company and
5. A body corporate.
• If after appointment an auditor become disqualified he shall vacate his office.
STATUTORY RIGHTS AND POWERS OF A COMPANY AUDITOR
1. Right to access to the books etc.
2. Right to call for information and explanation
3. Right to receive notices and to attend general meeting
4. Right to report to members
5. Right to sign audit report
6. Right to visit branches
7. Right to seek legal and technical advice
8. Right to receive remuneration
9. Right to be indemnified or Granted Relief
10. Right of Lien- Auditor’s Lien
DUTIES OF A COMPANY AUDITOR
The basic duty of auditor is report to members of the company. Following are the statutory duties of
a company auditor:
1.Certification of Statutory Report.
An auditor is required to certify the statutory report of a public company, so for as it relates to:
1. The shares allotted by the company
2. Cash received in respect of shares issued
3. The receipts and payment made by the company
2.Report on the performance of the company to be included in the prospectus
When a prospectus is issued by the company, which is already carrying on business, prior to the
issue of prospectus the company’s auditor is required to made a report of:
4. The profit of the company of last 5 years
5. Dividends paid during last 5 years
6. Classes of shares
7. Cases in which no dividends were paid
DUTIES OF A COMPANY AUDITOR
3.Annual audit and submission of report to the shareholders.
The auditor is required to make a report to the members of the company on the accounts examined
by him and the balance sheet and profit and loss account laid before the company in the general
meeting during his tenure of office.
4.Report on the company’s solvency.
The auditor of a company is required to make a report on the company’s affairs in support of
director’s declaration of the company’s solvency if voluntary wind-up of the company under section
362 is proposed.
5. Assistance to advocate general in connection with the prosecution of the directors.
The auditor of the company if he is not defendant in the proceedings, is bound to give all assistance
to the Advocate General or public prosecutor in connection with the prosecution of the directors etc.
6. Purchase of Business
If a business is being purchased out of the proceeds of the issue of the shares or debentures, the
auditor is to make report on the profit of three years
STATUS OF A COMPANY AUDITOR
1. COMPANY AGENT
2. COMPANY OFFICER
3. COMPANY SERVANT