LECTURE AND TUTORIAL OUTLINE FOR LECTURE 6: WEEK OF APRIL 8th 2019

PART 1: BUSINESS PROCESSES, INTERNAL CONTROLS AND THE PREPARATION

OF FINANCIAL STATEMENTS

In Lecture 6 (Part 1) we “step back” for a moment and consider the subject matter of the
audit by examining the decisions that those preparing the financial statements (management
on behalf of the board) make. The responsibilities of those preparing financial reports are
succinctly stated in the document titled, “Understanding Financial Statement Audits: a Guide
for Financial Statement Users”, which, at Ch.2 states,

“Management is responsible for establishing an accounting system to identify,

measure, record and adequately disclose an entity’s transactions and other events
that affect its financial position and financial performance, including a system of
internal control to ensure that transactions are processed completely and accurately
and to safeguard against fraud and error. In addition, management is responsible for
selecting accounting principles that appropriately reflect events that occur and for
making other accounting estimates and judgements.”

Thus, management has two broad responsibilities regarding the preparation of the financial
report: (1) the accounting system and internal control; and (2) selecting accounting policies
and making estimates and judgements. In this lecture, we examine management’s
responsibilities for the accounting system and internal control. To do this, we consider
business processes, documenting business processes, and recording events and
transactions in the accounting system. Importantly we explore how an entity puts in place a
system of internal controls to ensure, amongst other things, that an auditable set of financial
statements can be produced.

It is important to understand the systems, processes and policies that management typically
puts in place in order to be able to account for and report on the entity’s economic
transactions and events at this stage of the course because later we will consider how the
auditor evaluates transaction processing and the decisions that managers make when
preparing the financial statements. In so doing, we review some material that students will
have previously encountered in their accounting studies.

2: LEARNING OBJECTIVES
1. Understand the activities and processes typically undertaken by a business.
2. Understand the nature of the documents and accounts used in the sales and
collections and purchases and payments activities.

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 3. Understand the basic internal control systems put in place by a business to ensure
that it can prepare financial reports (and operate effectively and efficiently and
comply with the law).
4. Understand the controls over transaction processing that a business can deploy.

REFERENCES

Textbook: Audit and Assurance First Edition, Chapter 8

Handbook: Understanding Financial Statement Audits: A Guide for Financial Statement

Users. International Federation of Accountants, 1990.

Readings:
Reading 5: Trotman, K. and Gibbins, M. (2016). Financial Accounting An Integrated
Approach, 6th Edition, Accounting Books and Records, pp. 140-147. South Melbourne,
Thomson.

Additional Guidance:
Source Documents. Please note that as well as the guidance on source documents there
are some examples of source documents (Credit Approval Form, Sales Order, Shipping
Note, and Sales Invoice). These will be used as lecture illustrations

LECTURE AND TUTORIAL OUTLINE - LECTURE 6 (PART 2):

UNDERSTANDING AND ASSESSING INTERNAL CONTROL

1: INTRODUCTION
Lecture 6 (Part 2) completes the coverage of audit planning and risk assessment by
examining the consideration given to internal controls by the auditor. Internal controls are
put in place by management in order to ensure that operations are conducted effectively and
efficiently, to ensure compliance requirements are met, to ensure that assets are
safeguarded, and for the preparation of financial reports.

Auditors have a significant interest in the auditee’s internal control system because it
influences their choice of audit strategy. If the internal controls are working well, the auditor
can place a degree of reliance on them that permits the auditor to reduce the extent of
substantive audit testing. Conversely, if the auditee’s internal controls are poor, the auditor
will pursue an audit an audit strategy involving predominantly (or only) substantive testing.
When planning an audit, the auditor gains an understanding of the internal controls, and
makes a preliminary assessment of their effectiveness, which is expressed as an

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assessment Control Risk. Where the preliminary assessment of Control Risk is found to be
less than high, the auditor tests the controls to confirm the preliminary assessment.

2: LEARNING OBJECTIVES
1. Understand the objectives of internal control and how they relate to audit objectives.
2. Understand why it is necessary for the auditor to understand and assess the auditee’s
internal control system.
3. Understand the steps undertaken by the auditor to obtain an understanding of the
auditee’s internal control system and assess control risk.
4. Understand the development of an overall audit strategy.

3: REQUIRED READING

Textbook: Audit and Assurance First Edition, Chapter 8

Handbook:
ASA 315 Understanding the Entity and its Environment and Assessing the Risks
of Material Misstatement
ASA 500 Audit Evidence
ASA 610 Considering the Work of Internal Audit

Film: A Few Minutes With…Film 9 Understanding Internal Control

4: WEEKLY QUESTIONS (To be completed prior to tutorials in the week of April 29th)

QUESTION 1
(a) Place the following documents in the order in which they would be generated in the
sales and collections system: Uncollectible Account Authorisation Form; Shipping
Order; Sales Order; Sales (Tax) Invoice; Remittance Advice; Credit Note; Credit
Approval Form.

QUESTION 2: Explain what is involved in document matching. Use as an example, the

document matching that an accounts clerk performs in order to pay a supplier’s invoice.

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QUESTION 3
For the following internal control objective, provide an example of an internal control that
management could put in place.

Internal Control Internal Control

Objective
Occurrence
Completeness
Accuracy
Cut-off
Classification

QUESTION 5: Explain what is meant by the internal control environment and why it is
important.

QUESTION 6: Compare and contrast an audit strategy where the auditors preliminary
assessment of the client’s internal controls suggests that the internal controls are effective
with one that suggests internal controls are not effective.