Introduction, General and Field Standards
NUMBER 1
The internal control procedures that most likely would provide reasonable assurance that specific control objectives for the financial statement assertions regarding purchases and accounts payable will be achieved are
1. Proper authorization of requisitions by department head is required before purchase orders are prepared.
2. Purchasing department assures that requisitions are within budget limits before purchase orders are prepared.
3. The adequacy of each vendor's past record as a supplier is verified.
4. Secure facilities limit access to the goods during the receiving activity.
5. Receiving department makes a blind count of the goods received, independently of any other department.
6. The requisitioning department head independently verifies the quantity and quality of the goods received.
7. Requisitions, purchase orders, and receiving reports are matched with vendor invoices as to quantity and price.
8. Accounts payable department recomputes the mathematical accuracy of each invoice.
9. The voucher register is independently reconciled to the control accounts monthly.
10. All supporting documentation is required for payment and is made available to the treasurer.
11. The purchasing, receiving, and accounts payable functions are segregated.
NUMBER 2
Credit Manager
1. The credit manager approves credit for purchases on account from customers based on familiarity.
2. Bad credit can be extended to these customers increasing risk for the company.
3. A copy of the customer order form is not maintained by the credit manager.
4. A copy of the order form is not sent to shipping to generate a packing slip.
5. The credit manager does not prepare a monthly report about the collectibility of all past due accounts.
Accounts Receivable Supervisor
1. The accounts receivable supervisor should not be authorizing price changes because they are incompatible duties.
2. Sales and A/R should not be recorded until confirmation has been received that the goods have been shipped.
3. The A/R supervisor should not reconcile the A/R ledger with the control account.
4. The A/R supervisor should not receive the sales order form and record A/R.
5. The A/R supervisor does not account for the numerical sequence of customer sales orders.
6. The subsidiary A/R ledger is not reconciled to the general ledger.
7. Access to assets is not limited and controlled.
Cashier
1. The cashier should not supervise the cash register clerks.
2. The cashier should not be responsible for opening the mail.
3. Someone else in the mailroom should receive and prepare the check control listing.
4. One copy of the listing should be sent to the cashier.
5. The remittance advice and a copy of the control listing should be sent to the A/R supervisor.
6. Remittance advice should not be sent to the bookkeeper.
7. The cashier should not reconcile the bank account.
Bookkeeper
1. The bookkeeper should not receive A/R details from the accounts receivable supervisor.
2. The bookkeeper does not need remittance advice from the cashier to journalize and post to the general ledger.
3. The cashier provides a copy of the daily cash register summary for that purpose.
4. The bookkeeper should not mail monthly statements to customers.
5. An employee who does not handle cash receipts should mail monthly statements to customers.
6. The credit manager, not the bookkeeper, should authorize the write-off of uncollectible accounts.
7. The credit manager, not the bookkeeper, should decide whether to grant more credit to customers.
NUMBER 3
Flowchart
Symbol Letter Internal Control Procedure or Internal Document
c. Approve customer credit and terms.
d. Release merchandise to shipping department.
e. File by sales order number.
f. File pending receipt of merchandise.
g. Prepare bill of lading.
h. Copy of bill of lading to customer.
i. Ship merchandise to customer.
j. File by sales order number.
k. Customer purchase order and sales order.
l. File pending notice of shipment.
m. Prepare three-part sales invoice.
n. Copy of invoice to customer.
o. Post to (or enter in) sales journal.
p. Account for numerical sequence.
q. Post to customer accounts.
r. File by (payment due) date.
NUMBER 4
a. The procedures Hall should perform before accepting the engagement include the following:
1. Hall should explain to Adams the need to make an inquiry of Dodd and should request permission to do so.
2. Hall should ask Adams to authorize Dodd to respond fully to Hall's inquiries.
3. If Adams refuses to permit Dodd to respond or limits Dodd's response, Hall should inquire as to the reasons and consider the implications in deciding whether to accept the engagement.
4. Hall should make specific and reasonable inquiries of Dodd regarding matters Hall believes will assist in determining whether to accept the engagement, including specific questions regarding:
• Facts that might bear on the integrity of management;
• Disagreements with management as to accounting principles, auditing procedures, or other similarly significant matters;
• Dodd's understanding as to the reasons for the change of auditors.
5. If Hall receives a limited response, Hall should consider its implications in deciding whether to accept the engagement.
b. The additional procedures Hall should consider performing during the planning phase of this audit that would not be performed during the audit of a continuing client may include the following:
1. Hall may apply appropriate auditing procedures to the account balances at the beginning of the audit period and, possibly, to transactions in prior periods.
2. Hall may make specific inquiries of Dodd regarding matters Hall believes may affect the conduct of the audit, such as
• Audit areas that have required an inordinate amount of time;
• Audit problems that arose from the condition of the accounting system and records.
3. Hall may request Adams to authorize Dodd to allow a review of Dodd's working papers.
4. Hall should document compliance with firm policy regarding acceptance of a new client.
5. Hall should start obtaining the documentation needed to create a permanent working paper file.
NUMBER 5
a. In planning an audit, an auditor's understanding of the internal control structure elements should be used to identify the types of potential misstatements that could occur, to consider the factors affecting the risk of material misstatement, and to influence the design of substantive tests.
b. An auditor obtains an understanding of the design of relevant internal control structure policies and procedures and whether they have been placed in operation. Assessing control risk at below the maximum level further involves identifying specific policies and procedures relevant to specific assertions that are likely to prevent or detect material misstatements in those assertions. It also involves performing tests of controls to evaluate the operating design and effectiveness of such policies and procedures.
c. When seeking a further reduction in the assessed level of control risk, an auditor should consider whether additional evidential matter sufficient to support a further reduction is likely to be available, and whether it would be efficient to perform tests of controls to obtain that evidential matter.
d. An auditor should document the understanding of an entity's internal control structure elements obtained to plan the audit. The auditor also should document the basis for the auditor's conclusion about the assessed level of control risk. If control risk is assessed at the maximum level, the auditor should document that conclusion, but is not required to document the basis for that conclusion. However, if the assessed level of control risk is below the maximum level, the auditor should document the basis for the conclusion that the effectiveness of the design and operation of internal control structure policies and procedures supports that assessed level.
NUMBER 6
A. Prepare purchase order B. To vendor
C. Prepare receiving report D. From purchasing E. From receiving F. Purchase order no. 5 G. Receiving report no. 1 H. Prepare and approve voucher I. Unpaid voucher file, filed by due date J. Treasurer
K. Sign checks and cancel voucher package documents L. Canceled voucher package
NUMBER 7
61. M 62. Z 63. L 64. B 65. H 66. S 67. O 68. U 69. I 70. Q 71. N 72. T 73. Y
NUMBER 8
a. Reportable conditions are matters that come to an auditor's attention, which, in the auditor's judgment, should be communicated to the client's audit committee or its equivalent because they represent significant deficiencies in the design or operation of the internal control structure, which could adversely affect the organization's ability to record, process, summarize, and report financial data consistent with the assertions of management in the financial statements.
Material weaknesses are reportable conditions in which the design or operation of specific internal control structure elements do not reduce, to a relatively low level, the risk that errors or irregularities in amounts that would be material in relation to the financial statements being audited may occur and not be detected within a timely period by employees in the normal course of performing their assigned functions.
b. An auditor is required to identify reportable conditions that come to the auditor's attention in the normal course of an audit, but is not obligated to search for reportable conditions. The auditor uses judgment as to which matters are reportable conditions. Provided the audit committee has acknowledged its understanding and consideration of such deficiencies and the associated risks, the auditor may decide certain matters do not need to be reported unless, because of changes in management or the audit committee, or because of the passage of time, it is appropriate to do so.
Conditions noted by the auditor that are considered reportable should be reported, preferably in writing. If information is communicated orally, the auditor should document the communication. The report should state that the communication is intended solely for the information and use of the audit committee, management, and others within the organization.
The auditor may identify and communicate separately those reportable conditions the auditor considers to be material weaknesses, but may not state that no reportable conditions were noted during the audit. Reportable conditions may be communicated during the course of the audit rather than after the audit is concluded, depending on the relative significance of the matters noted and the urgency of corrective follow-up action.
NUMBER 9
106. D Decrease
107. I Increase
108. I Increase
109. I Increase
110. D Decrease
111. N No effect
112. D Decrease
113. I Increase
114. I Increase
115. D Decrease
116. I Increase
117. I Increase
118. N No effect
119. I Increase
120. I Increase
NUMBER 10
106. C.
107. G.
108. F.
109. K.
110. I.
111. B.
112. D.
113. L.
114. P.
115. C.
116. C.
117. P.
118. S.
119. P.
120. N.
NUMBER 11
The factors most likely to have an effect on the risk of material misstatements and their resulting effect include the following:
Effect on risk of
Environmental factor material misstatements
Government regulation over the banking industry is extensive. Decrease NFB operates profitably in a growing prosperous area. Decrease
Overall demand for the industry’s product is high. Decrease
Interest rates have been volatile recently. Increase
The availability of funds for additional mortgages is promising. Decrease The principal shareholder is also the chief executive officer and controls
the board of directors. Increase
Branch management is compensated based on branch profitability. Increase The internal auditor reports directly to the chairman of the board’s
audit committee, a minority shareholder. Decrease
The accounting department has experienced little turnover in personnel
recently. Decrease
NFB is a continuing audit client. Decrease
Management fails to establish proper procedures to provide reasonable
assurance of reliable accounting estimates. Increase Management has been receptive to Green’s suggestions relating to accounting
adjustments. Decrease
NFB recently opened a new branch office that is not yet profitable. Increase NFB recently installed a new sophisticated computer system. Increase
NUMBER 12
Young Computer Outlets, Inc.
Payroll
Internal Control Questionnaire
Question Yes No
1. Are payroll changes (hires, separations, salary changes, overtime, bonuses, promotions, etc.) properly authorized and approved?
2. Are discretionary payroll deductions and withholdings authorized in writing by employees?
Question Yes No 3. Are the employees who perform each of the following payroll functions
independent of the other five functions?
x personnel and approval of payroll changes x preparation of payroll data
x approval of payroll x signing of paychecks x distribution of paychecks x reconciliation of payroll account
4. Are changes in standard data on which payroll is based (hires,
separations, salary changes, promotions, deduction and withholding changes, etc.) promptly input to the system to process the payroll?
5. Is gross pay determined by using authorized salary rates and time and attendance records?
6. Is there a suitable chart of accounts and/or established guidelines for determining salary account distribution and for recording payroll withholding liabilities?
7. Are clerical operations in payroll preparation verified?
8. Is payroll preparation and recording reviewed by supervisors or internal audit personnel?
9. Are payrolls approved by a responsible official before payroll checks are issued?
10. Are payrolls disbursed through an imprest account?
11. Is the payroll bank account reconciled monthly to the general ledger?
12. Are payroll bank reconciliations properly approved and differences promptly followed up?
13. Is the custody and follow-up of unclaimed salary checks assigned to a responsible official?
14. Are differences reported by employees followed up on a timely basis by persons not involved in payroll preparation?
15. Are there procedures (e.g., tickler files) to assure proper and timely payment of withholdings to appropriate bodies and to file required information returns?
16. Are employee compensation records reconciled to control accounts?
17. Is access to personnel and payroll records, checks, forms, signature plates, etc. limited?
NUMBER 13
a. There are many fraud risk factors that are indicated in the dialogue. Among the fraud risk factors are the following:
x A significant portion of Mint's compensation is represented by bonuses and stock options. Although this arrangement has been approved by SCS's Board of Directors, this may be a motivation for Mint, the new CEO, to engage in fraudulent financial reporting.
x Mint's statement to the stock analysts that SCS's earning would increase 30% next year may be both an unduly aggressive and unrealistic forecast. That forecast may tempt Mint to intentionally misstate certain ending balances this year that would increase the profitability of the next year.
x SCS's Audit committee may not be sufficiently objective because Green, the chair of the audit committee, hired Mint, the new CEO, and they have been best friends for years.
x One individual, Mint, appears to dominate management without any compensating controls. Mint seems to be making all the important decisions without any apparent input from other members of management or resistance from the Board of Directors.
x There were frequent disputes between Brown, the prior CEO, who like Mint apparently dominated management and the Board of Directors, and Jones, the predecessor auditor. This fact may indicate that an environment exists in which management will be reluctant to make any changes that Kent suggests.
x Management seems to be satisfied with an understaffed and ineffective internal audit department. This situation displays an inappropriate attitude regarding the internal control environment.
x Management has failed to properly monitor and correct a significant deficiency in its internal control – the lack of segregation of duties in cash disbursements. This disregard for the control environment is also a risk factor.
x Information about anticipated future layoffs has spread among the employees. This information may cause an increase in the risk of material misstatement arising from the misappropriation of assets by dissatisfied employees.
b. Kent has many misconceptions regarding the consideration of fraud in the audit of SCS's financial statements that are contained in the dialogue. Among Kent's misconceptions are the following:
x Kent states that an auditor does not have specific duties regarding fraud. In fact, an auditor has a responsibility to specifically assess the risk of material misstatement due to fraud and to consider that assessment in designing the audit procedures to be performed.
x Kent is not concerned about Mint's employment contract. Kent should be concerned about a CEO's contract that is based primarily on bonuses and stock options because such an arrangement may indicate a motivation for management to engage in fraudulent financial reporting.
x Kent does not think that Mint's forecast for 1999 has an effect on the financial statement audit for 1998. However, Kent should consider the possibility that Mint may intentionally misstate the 1998 ending balances to increase the reported profit in 1999.
x Kent believes that the audit programs are fine as is. Actually, Kent should modify the audit programs because of the many risk factors that are present in the SCS audit.
x Kent is not concerned that the internal audit department is ineffective and understaffed. In fact, Kent should be concerned that SCS has permitted this situation to continue because it represents a risk factor relating to misstatements arising from fraudulent financial reporting and/or the misappropriation of assets.
x Kent states that an auditor provides no assurances about fraud because that's management's job. In fact, an auditor has a responsibility to plan and perform an audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether caused by error or fraud.
x Kent is not concerned that the prior year's reportable condition has not been corrected. However, Kent should be concerned that the lack of segregation of duties in the cash disbursements department represents a risk factor relating to misstatements arising from the misappropriation of assets.
x Kent does not believe that the rumors about big layoffs in the next month have an effect on audit planning. In planning the audit, Kent should consider this risk factor because it may cause an increase in the risk of material misstatement arising from the misappropriation of assets by dissatisfied employees.
c. In planning a financial statement audit, the auditor should document in the working papers evidence of the performance of the assessment of the risk of material misstatement due to fraud. Where risk factors are identified, the documentation should include those risk factors identified and the auditor's response to those risk factors, individually or in combination. In addition, during the performance of the audit, the auditor may identify fraud risk factors or other conditions that cause the auditor to believe that an additional response is required. The auditor should document such risk factors or other conditions, and any further response that an auditor concludes is appropriate.
NUMBER 14
1. B 2. C 3. A 4. D 5. A 6. B 7. C 8. B 9. D 10. A
NUMBER 15
AUDITING SIMULATION ABC Corporation
123 Main Street New York, NY Board of Directors:
In planning and performing our audit of the financial statements of the ABC Corporation for the year ended December 31, 20XX, we considered its internal control in order to determine our auditing procedures for the purpose of expressing our opinion on the financial statements and not to provide assurance on the internal control structure. However, we noted certain matters involving internal control and its operation that we consider to be reportable conditions under standards established by the American Institute of Certified Public Accountants.
Reportable conditions involve matters coming to our attention relating to significant deficiencies in the design or operation of internal control that, in our judgment, could adversely affect the organization’s ability to record, process, summarize, and report financial data consistent with the assertions of management in the financial statements.
During the prior audit, internal control deficiencies were suggested and agreement made that these deficiencies would be corrected. Our review disclosed that several important items were either not implemented or are not functioning properly.
We have noted a lack of appropriate reviews and approval of transactions in several important areas. Such reviews were not made, or review and approval actions not documented.
Two instances were noted where important assets were not properly safeguarded from loss, damage or misappropriation. In one instance, insurance was found to be inadequate and in the other, assets were not inventoried periodically as required and asset responsibility was not documented.
Details of these items are included in Exhibit A.
This report is intended solely for the information and use of the board of directors, the audit committee, and management.
Signature Date