Test of Control

CHAPTER 19

Learning Objectives
Understand the nature and explain the rationale for conducting tests of controls Understand the relationship between controls and their effect on the assertions embodied in the financial statements Know what tests of controls may be undertaken on: Sales transactions Cash receipts transactions Purchases transactions Cash Payment transactions Payroll transactions Inventory warehousing transactions and the potential misstatements

Introduction

Two Basic types of Audit Tests: Test of controls Substantive tests

Test of controls are performed to determine whether a control is working. Test of controls may require inquiry, observations, or inspection of documents. These tests generally include the following types of procedures: Make inquiries of appropriate client personnel. Examine documents, records and reports. Observe control-related activities. Re-perform client procedures.

I. Sales Transaction
Assertions and Controls A. Existence/ B. Occurence Recorded sales are for shipments actually made to customers Potential Misstatements Audit Procedures Test of Controls

1. recording of sales is supported by customer orders approved by the credit department, and approved and executed shipping documents

Sales that did not occur may be recorded

Examine approved customer order, sales order, shipping document, and copy of sales invoice for a sample of entries in the sales journal

2. A clerk independent of accounts Errors in recording Observe procedure and receivable prepares and mails monthly sales may not be examine follow-up files statements to customers for all trade detected. accounts receivable and follows up on any complaints

C. Completeness All sales transactions that occurred are recorded 3. Pre-numbered shipping documents are accounted for to determine that a sales invoice is prepared for all shipments 4. Pre-numbered sales invoices are accounted for to determine that all sales are recorded 5. Procedures to ensure timely recording of sales and proper cut-off are established

Goods may be shipped but not billed.

Observe procedure. Examine copy of invoices for a sample of shipping documents

Unrecorded sales may exist

Observe procedure. Examine entries for a sequence of sales invoices in sales journal. Inquire how procedures are followed, observe procedures being followed, and inspect report on last shipment.

Sales transactions may be recorded I the wrong period

D. Rights and Obligation Sales recorded represent only sales transactions. Clerk checks sales order and sales invoice for terms to determine that transaction is a sale rather than a consignment. E. Valuation/ F. Measurement Sales are correctly billed and recorded For all goods shipped, goods are counted and descriptions and quantities are compared to quantities and descriptions on sales orders and shipping documents prior to shipping

Consignment transactions may be recorded as sales

Observe procedure.

More or fewer goods may have been shipped than ordered. Customer returns may occur.

Observe procedure. For a sample, examine signature on documents evidencing performance.

G. Presentation and disclosure Sales and accounts receivable are recorded to result in presentation and disclosure in accordance with PFRS An independent review Revenues may be is made of account misclassified coding for sales

Observe procedure. For a sample of invoices, recheck account coding.

II: CASH RECEIPTS TRANSACTIONS

Assertions and Controls A. Existence / B. Occurrence: - Recorded receipts represent actual collections of cash from customers. 1. A trustworthy employee prepares a prelisting of cash receipts before further processing. 2. A validated deposit slip is obtained for daily deposits and compared to the cash receipts summary. Potential Misstatements Audit Procedures Test of Controls

Cash receipts may Observe whether a be prelisting is prepared and misappropriated. inquire of preparer about the procedures followed. Cash receipts may For a sample of entries in be recorded that the cash receipts journal, were not deposited. reconcile the total to validated deposit tickets.

3. Duties of handling cash Cash may be Observe separation of receipts are segregated from misappropriated and duties and inquire of lapping may occur. posting to accounts personnel about their receivable. responsibilities. 4. A bank reconciliation is Bank reconciliations may Examine bank cover shortages. prepared monthly by a reconciliations and person not involved in determine that preparer handling cash, accounts does not have conflicting duties. receivable, or general ledger accounts. C. Completeness / D. Rights and Obligations - All receipts are processed and recorded. Cash may be Observe monitoring and misappropriated. 5. Prelisting of cash receipts inquire of prelister and cash and cash register procedures register operator about are monitored. procedures.

6. Checks are restrictively endorsed upon receipt.

Cash may be misappropriated.

Examine undeposited checks for endorsement.

7. Cash receipts are deposited intact daily.

Observe the procedure and inquire of personnel who perform the procedure. 8. A daily cash summary is Cash may be For selected day, trace misappropriated. prepared and reconciled to totals from cash receipts total of prelisting and over-thejournal to cash summary counter receipts and the cash and validated deposit receipts journal. ticket. 9. The cash receipts journal Credits posted to Observe the procedure total is independently customers' accounts and inquire of personnel reconciled to the total posted may be overstated or who perform the to accounts receivable. understated. procedure.

Cash may be unrecorded or misappropriated.

E. Valuation / F. Measurement - Debits to cash and credits to accounts receivable are valued at amounts received. 10. Cash receipts are recorded at the amount received. 11. A responsible person approves cash discounts taken.

A customer may be given credit for an amount greater than payment. A customer may take a larger discount than appropriate.

For a sample of entries in cash receipts journal, examine remittance advices. For a sample of entries in cash receipts journal, examine remittance advices for approval of discount taken.

G. Presentation and Disclosure - Cash receipts transactions are recorded to result in presentation and disclosure in accordance with PFRS. 12. A supervisor approves account classification made in journalizing.

Entries may be made to wrong accounts.

Observe procedure. Examine approvals by supervisor.

IV. Cash Payments Transactions

Assertions and controls Potential Misstatements

Substantive Audit Procedures

A. Existence / B. Occurrence checks may be written but Observe procedure. recorded cash payments occurred not issued ore released Examine documents Inquire about procedures . C. Completeness All cash payments are checks may be issued but Observe procedure; recorded not recorded account for sequence account may not reconcile Observe if the preparer of or discrepancy may not be bank reconciliation is disclosed independent of cash handling then inspect reconciliation.

D. Rights and Obligations All cash payments made are for Observe procedure obligations of the entity E. Valuation/ F. Measurement Observe procedure and examine Math errors or signature on invoice incorrect discounts

Unauthorized payments may be made Debits to various accounts and credits to cash are valued at proper amounts

G. Presentation and Disclosure Observe procedure.

Payments may be credited to wrong Examine chart of accounts and accounts signature of employee performing check

Cash payments are recorded to result in presentation and disclosure in accordance with PFRS

V. Payroll Transactions

Assertions and Controls A. Existence / B. Occurrence recorded payroll transactions occurred C. Completeness All payroll earned by employees is recorded

Potential Misstatements

Audit Procedures Test of Control

payroll may include fictitious employees, former employees or wrong rates paychecks may be issued but not recorded

Examine approval signature on authorization for pay rate change observe procedures Examine bank reconciliation

D. Rights and Obligations recorded payroll transactions are for services received E. Valuation/ F. Measurement Examine reconciliation

Observe procedure employees may be paid for Examine signature hours they did not work on cards paychecks may be payroll transactions are for wrong amounts recorded for the proper Employees may be amounts paid for hours they did not work

G. Presentation and Disclosure Examine chart of accounts and Wages expense may signature of employee performing be charged to wrong check accounts

payroll transactions are recorded to result in presentation and disclosure in accordance with PFRS

VI. Production Transactions

Substantive Tests of Transactions

Assertions A. Existence / B. Occurrence Recorded production transactions occurred.

Potential Misstatements

Substantive Audit Procedures

Transaction that did not For selected transactions, occur may be recorded. examine signed materials requisitions, approved labor tickets and allocation of overhead. Completed production may not be recorded. Goods may be issued but not recorded. Time may be work in production but not recorded. Account for a sequence of production reports. Account for a sequence of materials requisitions. Reconcile time cards and labor tickets.

A. Completeness / B. Rights and obligations All production transactions that occurred are recorded.

E. Valuation / F. Measurement Production transactions are recorded for the proper amounts.

Values may not be based on costs incurred.

Test cost records by tracing to underlying documents, such as bill of materials, labor tickets, authorized labor rates, and standard overhead rates. Review variances. Check accuracy of account coding by reference to chart of accounts.

G. Presentation and disclosure Costs may be Production transactions assigned to wrong are recorded to result in accounts. presentation and disclosure in accordance with PFRS.

C. Completeness: All inventory warehousing transactions that occurred are recorded. 3. Receiving reports and materials requisitions are p[renumbered an accounted by a clerk in inventory accounting. 4. An inventory clerk signs a copy of the receiving report after counting goods transferred to his or her area. Goods may be received or issued but not recorded. Observe procedure and account for a numerical sequence of receiving reports to determine that all have been recorded. Errors may be Observe procedure. Examine recorded in the signature on receiving quantity of reports. goods transferred. Goods may be Observe procedures. issued but not recorded.

5. Access to inventory is limited to personnel responsible for its custody.

B. Analytical Procedures
Appropriate analytical procedures include comparing actual costs per unit produced to: Budgeted costs Prior years costs Standard costs

VII. Inventory Warehousing Transactions

A. Existence / B. Occurrence: Recorded inventory warehousing transactions occurred. 1. A copy of receiving report signed by a receiving clerk is used by inventory accounting to record receipt of goods. 2. A materials requisition is prepared and signed by appropriate operating personnel.

Fictitious receipts may be recorded.

Observe separation of duties and examine approval signature on receiving report.

Observe separation of duties and examine approval signature on materials requisition.

Fictitious issues may be recorded.

D. Rights and Obligations: Inventory warehousing transactions are for goods that belong to the entity. 6. Goods received on consignment are Goods on Inquire about and observe the labelled and separated from the consignment may be procedure. goods the entity owns. treated as inventory. E. Valuation / F. Measurement: Inventory warehousing transactions are recorded for the proper amounts. 7. Costs assigned to work in process and Inventory may be finished goods are set by procedures misvalued. that are reviewed and periodically evaluated. Mathematical accuracy is tested.

Inquire about and observe evidence of standards setting, review of standards, and testing of standards.

G. Presentation and disclosure: Inventory warehousing transactions are recorded to result in presentation and disclosure in accordance with PFRS. 8. Chart of accounts adequately describes accounts to be used, and account coding is assigned by one person and checked by another.

Receipt or issue may be charged or credited to wrong accounts.

Examine chart of accounts. Examine signature of employee performing check.