ACCA Paper F 8
AUDIT AND ASSURANCE SERVICES (INTERNATIONAL STREAM)
Lecture 3 Control Environment and Control Procedures
DATE: June 2011
TUTOR: Feroza Cooper
Control Environment:
The control environment is design by the senior management
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Internal Control: Management Philosophy, Segregation, and Cash Controls, Lecture notes of Auditing
The internal control environment, focusing on management philosophy, segregation of duties, and cash controls. Management's approach to risk, reliance on informal contacts, attitudes towards reporting, and conscientiousness impact the control environment. Segregation of duties ensures effective checks and balances, while cash controls include measures like imprest systems, independent cash counts, and surprise attendance. The document also covers narrative notes, internal control questionnaires, and testing of controls.
What you will learn
- What are the factors that form part of a management's philosophy and operating style?
- What is the role of the board of directors and the audit committee in the control environment?
- What is the control environment in business?
- What are the advantages and disadvantages of using narrative notes and internal control questionnaires?
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ACCA Paper F 8
AUDIT AND ASSURANCE SERVICES (INTERNATIONAL STREAM)
Lecture 3 Control Environment and Control Procedures
DATE: June 2011
TUTOR: Feroza Cooper
Control Environment:
The control environment is design by the senior management
Factors that are included in the control environment are:
1. Management's philosophy and operating style
Characteristics that form part of a management's philosophy and operating style and which have an impact on the control environment include the management's:
- approach to the taking and monitoring of business risks;
- reliance on informal face to face contacts with key managers versus a formal system of written policies, performance indicators and exception reports;
- attitudes and actions toward financial reporting;
- conservative or aggressive selection of accounting principles from available alternatives;
- conscientiousness and conservatism in developing accounting estimates;
- attitudes towards information processing and accounting functions and personnel.
Methods of imposing control
The board of directors and the audit committee and the manner in which they exercise their governance and oversight responsibilities have a major impact on the control environment.
Factors include the:
- Proportion of outside directors and the establishment of an audit committee.
- Experience of members in audit committee.
- Extent of their involvement with and scrutiny of management's activities.
Degree to which they raise and pursue difficult questions with management.
Nature and extent of their interaction with internal and external auditors.
Internal audit
Internal audit function strengthens the control environment. To be effective, internal audit auditor need to:
- skilled
- integrity;
- Have appropriate access to the board of directors and the audit committee, and to the external auditors.
Personnel policies and practices
A fundamental concept of internal control is that it is affected or implemented by people. For the accounting and internal control systems to be effective, human resource policies and practices must ensure that entity personnel possess the expected integrity, ethical values and competence.
Such practices include:
- Developing appropriate recruiting policies.
- Screening prospective employees.
- Developing training policies that communicate prospective roles and responsibilities.
- Exercising disciplinary action for violations of expected behaviour.
- Evaluating, counselling and promoting people based on periodic performance appraisals.
- Implementing compensation programmes that motivate and reward superior performance while avoiding disincentives to ethical behaviour.
Control procedures:
Types of internal control
1. Segregation of duties:
No one person should be responsible for the recording and processing of the complete work. This reduces the risk of fraud or error.
2. Physical: To ensure that assets are safeguard and there is restriction the
access to the authorised personnel. E.g. using password locks.
3. Authorisation and approval. All transaction should require authorisation or
approval by an appropriate person.
4. Arithmetic and accounting. To ensure completeness and accuracy of recoding
e.g. Trial Balances, reconciliation’s and control accounts.
5. Personnel. Delegation of duties to people with appropriate skills.
6. Supervision: All actions by all levels of staff should be supervised. The
responsibility for supervision should be clearly set out.
7. Management: These are control exercised by management, which are outside
and over and above the day to day routine of the system.
Limitation of internal control
1. Cost of implementation internal control systems.
2. Potential human error due to stress of workload, or carelessness.
3. The possibility of circumvention of controls either alone or through collusion
with parties outside or inside the entity.
4. Abuse of responsibility.
5. Management override internal control
Methods of recording the internal control systems
1. Narrative Notes
Advantages
- (^) Useful when systems are elementary.
- (^) Capable of logical appraisal if properly compiled
- Documents listed in order of processing
- Cross-referenced to procedures performed on documents
- Division of duties indicated
- Authority levels and limit indicated
- Useful supplement to flowcharts and record exception routines (e.g. processing of credit notes in a sales system.
Disadvantages:
EXAMPLE: Internal control questionnaire for bank transactions
- How often is bank reconciliation prepared?
- (a) Is the person responsible for function independent of the receipts and payment function? (b) Alternatively is the reconciliation independently checked?
- Does the person preparing the bank reconciliation obtain statements direct from the bank and retain them until the reconciliation is effected?
- Does the independent reconciliation include? (a) A comparison of the debits and credits shown on the bank statements with the cashbook? (b) A comparison of paid cheques with the cashbook as to names, dates and amounts? (c) A test of the detailed paying-in-slip with the cashbook? (d) An enquiry into contra items? (e) Are items more than one month old investigated to?
3. Flowcharts
Advantages:
- Diagrammatic and shorthand symbols give perspective to the system’s description.
- They aid understanding and communications
- The discipline of construction ensures complete recording of processes, documents files, books and controls.
- Controls and weaknesses are easily highlighted
- Continuity of the audit is facilitated where audit staff changes take place.
- Review is facilitated by those not familiar with the client or system.
Disadvantages:
- Complex systems are difficult to evaluate by inexperienced staff.
- Changes in systems may require a complete redraft.
4. Internal Control Evaluation Questionnaires (ICEQ’s)
An ICQ tries to establish how good the system of controls is. The ICEQ tries to establish if specific errors and fraud are possible.
Method of evaluating an already ascertained system (e.g. by flowchart)
ICEQ is a list of supplementary questions to assess whether desirable controls are present which individually or collectively prevent or detect the error or fraud in the key questions.
Advantages
- Perform tests of control
At Final audit:
- Final audit of the company at year-end is to produce statutory financial statement.
- Audit concentrates on verifying the items and management assertions in the balance sheet and profit and loss contained in the financial statement.
- Complete substantive procedures, perform subsequent events review and obtain management representation and form an opinion.
- Report opinion
ISA 265: Communicating Deficiencies in Internal Control to Those Charged with Governance and Management.
‘Significant deficiencies = new term for ‘Material weaknesses’
Significant deficiencies in internal controls include:-
- Controls that are designed, implemented or operated in a way that they are unable to prevent or detect misstatements on a timely basis.
- Controls necessary to prevent and detect misstatement is missing.
The auditor should determine whether individually or in combination the identified deficiencies constitute a ‘significant deficiency.’ Significant deficiencies’ should be communicated to those charged with governance in writing.
Non significant deficiencies should be communicated to management.
Cash sales and collections:
Objective:
To ensure that all cash, to which the enterprise is entitled is received, and ensure that all such cash is properly accounted for and entered in the records.
Measures:
Authorised person should be responsible to receive cash for example sales assistants, cashiers.
Evidence of cash receipts for example pre-numbered duplicate receipts cash or cash registers with sealed till rolls. The duplicate receipts form books should be securely held and issue should be controlled.
A staff should be responsible for emptying cash registers at prescribed intervals and agreeing the amount present with till roll totals or internal registers.
Immediately banked the cash and payments for petty cash should be on imprest system.
Independent comparison of agreed till roll totals with subsequent banking records.
Persons handling cash should not have access to other cash funds or maintain sales ledger records.
Rotation of duties and cover for holidays and sickness.
Collections by sales should be banked intact daily. There should be independent comparison of the amount banked and records of the salesmen.
Bank balances :
Objective:
To prevent misappropriation of bank balance and to prevent teeming and lading.
Measures:
Reconciliation should be prepared on regular basis. The reconciliation should be performed by an independent person. Arrangement should be made for bank statements to be sent direct to the person responsible for the reconciliation. A comparison of debit and credit in the cash book with corresponding entries in the bank statements. A comparison of returned cheques with cash book entries noting dates, payee and amounts. A test of the details paying-in slips with cash book. All outstanding cheques and lodgements should be traced through to the next period and their validity verified. Any unusual items e.g. contras or dishonoured cheques should be investigated The balance at the bank should be independently verified with the bank at intervals. Special arrangement should be instituted on the controls and recording of trust monies e.g. employee’s sick pay or holiday funds, attachment of earnings.
Cheque payments:
Objective:
To prevent unauthorised payments being made from bank accounts.
Measures:
Control over custody and issue of unused cheque book. A register should be kept if necessary. Staff should responsible for preparation of cheques. Rules should be established for the presentation of supporting documents before cheques can be made out. Such supporting documents may include GRNs, purchase orders and invoices. All such documents should be stamped “paid by cheque no” with date. Established who should sign cheques. All cheques should be signed by a least two persons, with no person being permitted to sign if he is a payee. No cheque should be made out to bearer except for the collection of wages or reimbursement of cash funds.
All cheque should be restrictively crossed. The signing of blank cheques must be prohibited. Special safeguards should be implemented where cheques are signed mechanically or have pre-printed signatures. Such signing is often made for dividends payments, salary cheques and for others.
Rules to ensure prompt despatch and to prevent interception or misappropriation. Special rules for authorising and checking direct debits and standing orders.