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Internal controls and control testing: Part 3. Chapter 10 – BPP SET TEXT. Aims. Understand the internal controls, internal control objectives, audit tests and audit assertions for: purchases, sales, inventory, cash/bank, wages/salaries, capital/revenue expenditure. Objectives.

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slide2
Aims
  • Understand the internal controls, internal control objectives, audit tests and audit assertions for: purchases, sales, inventory, cash/bank, wages/salaries, capital/revenue expenditure.

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objectives
Objectives

You should be able to:

  • Analyse the quality of system controls by

considering internal control objectives ,

assertions & actual controls.

  • Suggest internal control improvements for a

particular cycle.

  • Discuss assertions, control objectives, controls

and tests of controls for a particular cycle.

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sales system
Sales system
  • 3 main areas in a sales system:
  • Sell (authorisation)
  • Send goods outwards (custody)
  • Account for the transaction (recording)
  • 4 things to consider: audit assertion (auditor),

control objectives (business), controls (business),

test of controls (auditor).

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did you notice
Did you notice?

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directional testing
Directional testing
  • Direction matters!!!

When we tested for completeness we started at the shipping docs and followed this through to the sales ledger.

  • When we tested for existence/occurrence we selected sales invoices in the ledger and followed this through to the shipping docs and authorised order forms.

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purchases system
Purchases system
  • 3 main things happening:
  • Order goods (authorisation)
  • Receive goods (custody)
  • Account for goods (recording)

Same 5 assertions as for sales:

Existence/occurrence, cut-off, completeness,

classification, accuracy + rights and obligations

(which we said could be added to sales when we

made the link to debtors).

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remember
Remember

*SPELL IT OUT: invoice, shipping docs, authorised sales order form or supplier invoice, authorised purchases order form, GRN. Don’t be general and say things like supporting documents – WHICH SUPPORTING DOCS?

*USE VERBS – inspect, recalculate, inquire, observe, read , match NOT make sure, establish whether …

*When you review a reconciliation you have to follow balances being reconciled through to originating records/docs, re-calc recon for accuracy, investigate/inquire around reconciling items. Inspect for independent, snr authorisation

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auditing inventory
Auditing inventory

3 Scenario’s:

1.Entity has a perpetual system, ie inventory is

counted continuously. No year end count is

Performed. If controls risk is LOW follow a

controls based approach.

2. If the year end count is performed PRIOR to y/e and adjusted by perpetual inventory records for y/e value, control risk must be assessed as LOW.

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auditing inventory1
Auditing inventory
  • If inventory quantities are determined via y/e date count, a PURELY SUBSTANTIVE approach is taken. (Covered in chapter 13)
  • Note that most controls on inventory were covered under PURCHASES and SALES cycles.
  • Auditor now concerned with how business safeguards inventory & how movements are recorded.
  • Detailed tests on valuation are carried out @ substantive stage.

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assertions ob and tests
assertions, ob, and tests.

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assertions ob and tests1
assertions, ob, and tests.

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assertions ob and tests2
assertions, ob, and tests.

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assertions ob and tests3
assertions, ob, and tests.

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cash payments
Cash- Payments

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cash payments1
Cash- Payments

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cash payments2
Cash- Payments

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cash payments3
Cash- Payments

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cash payments4
Cash- Payments

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cash payments5
Cash- Payments

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cash receipts
Cash- Receipts

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cash receipts1
Cash- Receipts

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what does endorsing mean
What does endorsing mean

Endorse the check on the reverse :

Business Name, Your Name, and

position in the company.

Example: Jim's Hardware Store

James Smith Owner1

Write "For Deposit Only" below the

endorsement.

Write your account number below that.

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does it help if the cheque is crossed
Does it help if the cheque is crossed
  • No, you cannot subsequently endorse a crossed cheque.
  • A crossed cheque can only be paid into the account of the payee and is non-transferrable.

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cash receipts continued
Cash- Receipts continued…

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cash receipts continued1
Cash- Receipts continued…

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cash receipts continued2
Cash- Receipts continued…

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what on earth
**What on earth**

remittance advice? When a client sends money through the mail this should be accompanied by a remittance advice that gives details about the client account number, the amount paid, the invoice that this payment relates to.

A good control is the banking of the cash recorded by the mail openers by an independent person and the recording of the remittance advices by the accounts department.

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cash receipts2
Cash receipts

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cash receipts3
Cash receipts

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the payroll system
The payroll system

Key controls over payroll include:

Document and authorise changes in staff

Calculate the wages and salaries (gross, deductions, net)

Pay wages

Authorise deductions

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the payroll system1
The payroll system

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revenue and capital expenditure
Revenue and capital expenditure

What is the difference?

  • Revenue expenditure is expensed to the statement of comprehensive income.
  • Capital expenditure is capitalised to the statement of financial position (ie an asset.)

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revenue and capital expenditure1
Revenue and capital expenditure

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revenue and capital expenditure2
Revenue and capital expenditure

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revenue and capital expenditure3
Revenue and capital expenditure

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what if order docs for capital and revenue expenditure is the same
What if order docs for capital and revenue expenditure is the same?
  • Ask company what system is for recording and filing capital invoices?
  • If capital purchases are low, might be better to opt for substantive tests over non-current assets.

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homework
Homework
  • Read chapter 10 – p 159
  • Do question : Sales system p 163
  • Do question : Purchases controls p 167
  • Do question: System control weaknesses page 180
  • Do the quick quiz page 184

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homework continued
Homework continued
  • Construct grids/tables of common controls within a cycle and across cycles that address numerous control objectives and assertions.
  • For instance sequential numbering – always a control to achieve completeness.
  • How many assertions are covered by the bank recon?
  • Etc…

You will NOT get an answer sheet for this, this is really a

summary exercise to help you narrow down the work and

make it more digestible.

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tutorial questions
Tutorial questions

Q 1

Your are the auditor of PAKO, a private company that runs 7 local stores that sell fruit and vegetables. The subsidiary companies enjoy autonomy when it comes to maintaining the inventory levels and selecting suppliers. Pricing is established on a cost-plus basis.

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slide72

Each store maintains their accounts separately. Head office sends a representative to collect local accounts once every 2 months. This

representative does a small “audit” on 1 of the

stores on a rotation basis. Management accounts are prepared on a quarterly basis.

  • Describe the internal controls issues you’ve identified and the risks associated with each.
  • Make four recommendations to management to enhance internal controls and explain the advantages and disadvantages of each.

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slide73

Q 2

  • You’ve recently qualified as Chartered Accountant and joined the accounts department of Hit and Miss plc. – they sell tennis equipment to clubs around London. All sales occur on credit. Your direct manager asked you to read through their procedure documents for cash and bank in order to:
  • Identify internal control risk
  • Describe improvements to the current procedures in order to mitigate the risks.

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cash and bank procedures
Cash and bank procedures
  • One person opens the mail.
  • Any cash / cheque receipts and the accompanying remittance advices are taken to the accounts manager to be locked in the safe. Any remittance advices pertaining to direct deposits are stacked in the cash book clerk’s in-tray.

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slide75

Around 2pm each day the cash book clerk picks up the cash/cheques from the accounts manager, enters the details into the cash book and the individual debtors account, prepares the cash deposit book and banks the cash in the company’s bank account. The integrated accounting system automatically updates the cash ledger and debtors ledger.

  • The cash book clerk prints off a bank statement once a week. This is used to identify payments and direct deposit. Any payments are credited to the cash book and debited to a suspense account.

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slide76

Direct deposits from clients are matched to the remittance advices in the in-tray and debited to cash and credited to the individual debtors account. Any direct deposits for which there aren’t remittance advices are circled on the bank statement and filed in the outstanding deposits file – these are not entered into the cash book.

  • The outstanding deposits file is reviewed by management once a month. Bank reconciliations are prepared once a month by the cash book clerk and reviewed by the accounts manager.

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