Chapter 17

1. Chapter 17 Information Systems Auditing and Assurance

2. Objectives for Chapter 17 • The purpose of an audit and the basic conceptual elements of the audit process • Difference between internal and external auditing and the relationship between them • How auditing objectives and tests of control are determined by the control structure of the client firm • Audit objective and tests of control for each of the nine general control areas • Auditing techniques used to verify the effective functioning of application controls • Auditing techniques used to perform substantive tests in a CBIS environment

3. Attestation vs. Assurance • Attestation: • an engagement in which a practitioner is engaged to issue, or does issue, a written communication that expresses a conclusion about the reliability of a written assertion that is the responsibility of another party (SSAE No. 1, AT Sec. 100.01) • Assurance: • professional services that are designed to improve the quality of information, both financial and non-financial, used by decision-makers • includes, but is not limited to, attestation

4. Attest and Assurance Services Assurance Management Consulting Attestation

5. What is Auditing? • An independent attestation by a professional (CPA) regarding the faithful representation of the financial statements • Three phases of a financial audit: • Familiarization with client firm • Evaluation and testing of internal controls • Assessment of reliability of financial data

6. External Auditing versus Internal Auditing • External auditors represent the interests of third party stakeholders, while internal auditors serve as an independent appraisal function within the organization. • Internal auditors often perform tasks which can reduce external audit fees and help to achieve audit efficiency and reduce audit fees.

7. Information Technology (IT) Audit • Since most information systems employ information technology, the IT audit is typically a significant component of all external (financial) and internal audits. • IT audits: • focuses on the computer-based aspects of an organization’s information system • assessing the proper implementation, operation, and control of computer resources

8. Elements of an Audit • systematic procedures are used • evidence is obtained • tests of internal controls • substantive tests • determination of materiality for weaknesses found • prepare audit report and audit opinion

9. Phases of an IT Audit SUBSTANTIVE TESTING PHASE AUDIT PLANNING PHASE TESTS OF CONTROLS PHASE Review of Organization’s Policies, Practices, and Structure Perform Substantive Tests Perform Tests of Controls Start Evaluate Test Results Evaluate Results and Issue Auditor’s Report Review General Controls and Application Controls Plan Tests of Controls and Substantive Testing Procedures Determine Degree of Reliance on Controls Audit Report

10. Audit Risk is the probability the auditor will issue an unqualified (clean) opinion when in fact the financial statements are materially misstated.

11. Components of Audit Risk • Inherent risk is associated with the unique characteristics of the business or industry of the client. • Control risk is the likelihood that the control structure is flawed because controls are either absent or inadequate to prevent or detect errors in the accounts. • Detection risk is the risk that auditors are willing to take that errors not detected or prevented by the control structure will also not be detected by the auditor.

12. Tests of General Controls • Our primary purposes are to understand: • auditing objectives in each general control area • the nature of the tests that auditors perform to achieve these objectives

13. Tests of General Controls Our discussion is organized around the following: 1. Operating system controls 2. Data management controls 3. Organizational structure controls 4. Systems development controls 5. Systems maintenance controls 6. Computer center security and controls 7. Internet and Intranet controls 8. Electronic data interchange controls 9. Personal computer controls

14. Organizational Structure Internet & Intranet Internet & Intranet Data Management Operating System Systems Development Personal Computers Systems Maintenance EDI Trading Partners Applications Computer Center Security General Control Framework for CBIS Risks

15. 1. General Control Tests Operating System Objective:verify that the security policy and control procedures are rigorous enough to protect the operating system against: • hardware failure • software efforts • destructive acts by employees or hackers • virus infection

16. 1. General Control Tests Operating System Controls: access • privilege controls • password control • virus control • fault tolerance control

17. 2. General Control Tests • Data Management Objective: • protect against unauthorized access to or destruction of data and inadequate data backup • Controls: • access- encryption, user authorization tables, inference controls, and biometric devices are a few examples • backup- grandfather-father-son and direct access backup; recovery procedures

18. 3. General Control Tests Organizational Structure Objectives: • determine whether incompatible functions have been identified and segregated in accordance with the level of potential exposure • determine whether segregation is sustained through a working environment that promotes formal relationships between incompatible tasks Controls: • review organizational and systems documentation, observe behavior, and review database authority tables

19. 4. General Control Tests Systems Development Objectivesensure that: • SDLC activities are applied consistently and in accordance with management’s policies • the system as originally implemented was free from material errors and fraud • the system was judged to be necessary and justified at various checkpoints throughout the SDLC • system documentation is sufficiently accurate and complete to facilitate audit and maintenance activities

20. 4. General Control Tests Systems Development Controls: • systems authorization techniques • good development procedures • internal audit team participation • appropriate testing of system

21. 5. General Control Tests Systems Maintenance Objectives: determine that: • maintenance procedures protect applications from unauthorized changes • applications are free from material errors • program libraries are protected from unauthorized access

22. 5. General Control Tests Systems Maintenance Controls: • authorization requirements for program maintenance • appropriate documentation of changes • adequate testing of program changes • reconciling program version numbers • review programmer authority table • test authority table

23. 6. General Control Tests Computer Center Objectives determine that: • physical security controls are adequately protecting the organization from physical exposures • insurance coverage on equipment is adequate to compensate the organization for the destruction of, or damage to, its computer center • operator documentation is adequate to deal with routine operations as well as system failures • the organization’s disaster recovery plan is adequate and feasible

24. 6. General Control Tests Computer Center Controls: • well-planned physical layout • backup and disaster recovery planning • review critical application list

25. 7. General Control Tests Internet & Intranet Objectives determine that communications controls: • can detect and correct messages lost due to equipment failure • can prevent and detect illegal access both internally and from the Internet • will render useless any data that are successfully captured by a perpetrator • are sufficient to preserve the integrity and security of data connected to the network

26. 7. General Control Tests Internet & Intranet Controls: • Equipment failure: line checks (parity & echo) and backups • Subversive threats: access controls, encryption of data, and firewalls • Message control: sequence numbering, authentication, transaction logs, request-response polling

27. 8. General Control Tests EDI Objectives determine that: • all EDI transactions are authorized, validated, and in compliance with organizational policy • no unauthorized organizations gain access to database records • authorized trading partners have access only to approved data • adequate controls are in place to ensure complete EDI transactions

28. 8. General Control Tests EDI Controls: • sophisticated authorization and validation techniques • access controls • audit trail modules and controls

29. 9. General Control Tests Personal Computers Objectivesdetermine that: • adequate supervision and operating procedures exist to compensate for lack of segregation between the duties of users, programmers, and operators • access to microcomputers, data files, and program files is restricted to authorized personnel • backup procedures are in place to prevent data and program loss from hardware failures • systems selection and acquisition procedures produce applications that are high quality, free from errors, and protected from unauthorized changes

30. 9. General Control Tests Personal Computers Controls: • increased supervision • access and security controls • backup controls • systems and acquisition controls

31. Computer Applications Controls • Techniques for auditing computer applications fall into two classes: • techniques for testing application controls • techniques for examining transaction details and account balances--substantive testing

32. Testing Application Controls • Black Box Approach - understanding flowcharts, input procedures, and output results • White Box Approach - understanding the internal logic of the application • authenticity (access) tests • accuracy tests • completeness tests • redundancy tests • audit trail tests • rounding error tests

33. Auditing Around the Computer - The Black Box Approach Input Auditor reconciles input transactions with output produced by application. Application under review Master File Output

34. White Box Testing Techniques • Test Data Method - testing for logic or control problems; good for testing new systems or systems that have undergone recent maintenance • Base Case System Evaluation (BCSE) - using a comprehensive set of test transactions • Tracing - performs an electronic walkthrough of the application’s internal logic • Test Data Methods are not fool-proof • a snapshot-one point in time examination • high-cost of developing adequate test data

35. Auditing through the Computer: The Test Data Technique Test Data Test Data Auditor prepares test transactions, test master files, and expected results. Test Data Application under review Predetermined Results Test Master Files After test run, auditor compares test results with predetermined results. Test Results

36. White Box Testing Techniques • Integrated Test Facility (ITF) - an automated, ongoing technique that enables the auditor to test an application’s logic and controls during its normal operation • Parallel Simulation - auditor writes simulation programs and runs actual transactions of the client through the system

37. Auditing through the Computer: The Integrated Test Facility Technique Auditor enters test transactions along with production transactions and calculates expected results. ITF Transactions Production Transactions Production Application with Embedded ITF Modules Production Master Files ITF Master Files Expected Results ITF Test Results After testing, auditor compares ITF results with expected results. Production Reports

38. Auditing through the Computer: The Parallel Simulation Technique Production Transactions Auditor uses GAS to produce simulation of application under review Application Specifications Production Transaction File Actual Production Application Generalized Audit Software (GAS) Simulation Program Production Master Files Simulation Output Production Output Auditor reconciles simulation with production output

39. Substantive Testing Techniques • Search for unrecorded liabilities. • Confirm accounts receivable to ensure they are not overstated. • Determine the correct value of inventory, and ensure they are not overstated. • Determine the accuracy of accruals for expenses incurred, but not yet received (also revenues if appropriate).

40. Embedded Audit Module (EAM) • An ongoing module which filters out non-material transactions • The chosen material transactions are used for sampling in substantive tests • Requires additional computing resources by the client • Hard to maintain in systems with high maintenance

41. Substantive Testing: The Embedded Audit Module Production Transactions Auditor sets materiality threshold for capturing transactions. Production Application Production Master Files EAM Auditor reviews audit file and prepares a list of material transactions for use in substantive tests. Production Output Audit File Production output goes to users. Transactions List

42. Generalized Audit Software (GAS) • Very popular and widely used • Can access data files and perform operations on them: • screen data • statistical sampling methods • foot and balance • format reports • compare files and fields • recalculate data fields

43. Substantive Testing - GAS: Complex File Structure Access DBMS Utility Program Database Auditor specifies which database records to copy into flat file. DBMS produces a flat file of a portion of a database. Flat File GAS retrieves selected records from the flat file. GAS Auditor determines the selection criteria used by the GAS. Transactions List