&

Auditing
Assurance
Services(M)
Semester 1 2019
Semester 1: 2019 - Lecture 6 (Part 1)
UNIVERSITY OF ADELAIDE Business Processes and Internal Control
BUSINESS SCHOOL
Dr Phil Saj PhD CPA
University of Adelaide 2

The responsibility of management for The responsibility of management for

preparing the financial report preparing the financial report
“ Management is responsible for establishing an accounting ￭ Establish an accounting system to:
system to identify, measure, record and adequately disclose an ￭ identify, measure, record, and
entity’s transactions and other events that affect its financial
adequately disclose an entity’s
position and financial performance, including a system of
transactions and other events;
internal control to ensure that transactions are processed
completely, and accurately and to safeguard against fraud and ￭ including a system of internal control.
error. In addition, management is responsible for selecting
accounting principles that appropriately reflect events that
￭ Select accounting principles that appropriately
occur and for making other accounting estimates and
reflect events that occur and for making other
judgements.” accounting estimates and judgements.
(Understanding Financial Statement Audits: a guide for Financial Statement Users, Ch. 2)

The business cycle Sales & Collection Activity

(also called the revenue, receivables & receipts system)

General Cash ￭ Businesses generate income through sales of

goods and services.

Capital Acquisition ￭ Sales may be on credit or on a cash basis.

Activity Payroll &
Sales & ￭ Management puts in place processes and
Personnel
Collection Purchases & controls to ensure that sales and collections
Activity
Activity Payment Activity are properly executed and recorded.

Inventory & ￭ To understand a business, we need to consider

Warehousing the processes and controls; the documents
Activity used; and the accounts in which transactions
and events are recorded.

1
 Accounting for Sales Sale of goods to customers
and Collection Processes
Sales Cash at Bank 4 processes
Cash
sales
Accounts Receivable
Beginning Cash receipts
Cash Discounts Taken Bill
Sales on
balance
Process
account
Sales returns Grant Ship Customers
Sales on & allowances Sales Returns Customer
account & Allowances Credit Goods & Record
Order
Write-off of Sales
Ending Bad debts Prov. For Doubtful
balance Debts
Note: See pp.359-361 of Textbook for discussion of
documents and accounts.

1 Sales Credit Shipping Invoicing Accounting

Processes, Documents and Accounts Dept. Dept. Dept. Dept. Dept.
Sales Credit Sales Sales
sales processes Order 1 Approval
File
Order 2 Order 3 Invoice 2
Sales Order 2
Shipping
Sales Order 3 Pick and Order 2
Process pack
Grant Ship Bill Customers
Customer Compare goods.
Credit Goods & Record Sales Sales Order Prepare Reconcile
Order with Shipping Documents
& Prepare Enter in
customer’s Order Sales Invoice Sales
Customer Credit Shipping Sales Invoice; credit Journal
Order; approval Shipping 1
approval Order Sales Journal Order Invoice 1
Sales Order form Shipping
Invoice 2
Order 2 3
Shipping
Order 3 Invoice 3
N
N
A
Accounts: Sales and Accounts Receivable N
all documents To Customer To Customer
are prenumbered

Ace Pty Ltd Sales Order Date: July 22 2016 No. 678543
From: King Pty Ltd Deliver To: Shop Source Documents and Accounts
Account Number 321 Customer Order No. 4537 Authorised C M
Code Description Qty Price Total Ace Pty Ltd Tax Invoice Date: July 26 2016 No. 00231
432 Street Directory 2 30 60
To: King Pty Ltd Attention: C M
Delivery Instructions: Thursday morning 60
Acc. No. 321 Customer Order No. 4537 Salesperson J.L.
Ace Pty Ltd Shipping Order Date: July 23 2016 No. 034345
Code Description Qty Price Total
To: King Pty Ltd Carrier: Quick Smart Couriers
432 Street Directory 2 30 60
Account Number 321 Customer Order No. 4537 Stores Clerk B T
Code Description Qty Order Complete Amount Due 60
432 Street Directory 2 Yes
Checked By: H T Date Description Dr ($) Cr ($)
Ace Pty Ltd Tax Invoice Date: July 26 2016 No. 00231 26/7/2016 Accounts Receivable 60.00
To: King Pty Ltd Attention: C M
Sales 60.00
Account Number 321 Customer Order No. 4537 Salesperson J.L.
Code Description Qty Price Total To record the sale of goods on credit to King Pty Ltd
432 Street Directory 2 30 60
Amount Due 60

2
 Processes, Documents and Accounts
Receiving Cash
4 processes collections process
Process Process Provide Write-off
Process & Record & Record
for Bad & Uncollectible
Process Provide Sales
and Write-off Cash Returns & Doubtful Accounts
and for Bad Receipts Allowances Debts Receivable
Record Uncollectible
Record and
Sales Accounts Remittance Advice; Credit Note; General Uncollectable
Cash Doubtful Prelisting of Cash Sales Returns Journal. Account
Returns & Receivable Receipts; & Allowances Authorisation
Receipts Debts Cash Receipts Journal. Form;
Allowances Journal. General Journal.

Accounts: Cash at Bank; Accounts Receivable; Sales Returns &

Note: See pp.361-362 of Textbook for discussion of
documents and accounts. Allowances; Provision for Doubtful Debts; Bad Debt Expense.

Accounting for Sales The Role of Internal Control

(Understanding Financial Statement Audits: A Guide for
and Collection Processes Financial Statement Users, 2011, p. 8)

“ Management’s responsibility for establishing an

Sales Cash at Bank
Cash accounting system that enables the preparation of
sales
Accounts Receivable financial statements that present fairly the entity’s
Cash Discounts Taken
Sales on
Beginning Cash receipts financial position and financial performance include
balance
account
Sales returns the establishment of a system of internal control.
Sales on & allowances Sales Returns
account & Allowances The system of internal control provides checks
and balances within the accounting system to
Write-off of
Ending Bad debts Prov. For Doubtful safeguard against both deliberate and accidental
balance Debts error and ensures that transactions are
processed completely and accurately.”

Internal Control Components of Internal Control

Policies and process effected by the entity
to provide reasonable assurance of: the control environment

Reliability of financial reporting the entity’s risk assessment processes

Compliance with applicable laws
and regulations control activities

Effectiveness and efficiency of information and communication

operations
monitoring of controls
Safeguard assets

3
 Entity’s risk assessment
Control Environment processes
￭ Integrity and ethical values The entity’s processes for the
￭ Commitment to competence identification of business risk
￭ Participation by those charged with
Governance The entity’s processes for
responding to business risk
￭ Management philosophy and operating
style
In particular, those risks that relate to
￭ Organisational structure the preparation of financial reports
￭ Human resources

Control Activities Control Activities

Segregation Key processing activities are Adequate Design and processing of documents
of duties undertaken by different personnel documents to ensure timely, accurate and
and records complete recording of information
Processing occurs only with the
Authorisation sanction of someone in authority Independent Processing of information is checked
checks on by someone who was not involved
Physical Restrictions on access to assets performance in the routine processing
controls and document
Controls within IT applications to
Performance Information
Comparison of actual with budget ensure accuracy, completeness
processing
reviews and authorisation of transactions

Examples of Control Activities Examples of Control Activities

Separation of duties Authorisation/Approval

Are authorisation and execution of Purchases must be approved by the manager
transactions undertaken separately? before they are processed?

4
 Examples of Control Activities Examples of Control Activities

Physical Control
Access to documents and tangible assets Performance Review
is restricted Comparison of actual expenses incurred with budget

ABC Ltd Tax Invoice Date: August 24 2014 No. 00231

Examples of Control Activities To: XYZ Ltd Attention: C M
Account Number 241 Customer Order No. 4537 Salesperson J.L.
Code Description Qty Price Total
23 Radio 2 30 60
Amount Due 60

XYZ Ltd Receiving Note Date: August 6 2014 No. 27634

From: ABC Ltd Carrier: ABC
Account Number 241 Customer Order No. 4537 Stores Clerk B T
Code Description Qty Condition Order Complete
23 Radio 2 Good Yes
Document matching Notes:

(adequate documents and records) XYZ Ltd Purchasing Order Date: July 31 2014 No. 41895
To: ABC Ltd Deliver To: Central Stores
Cross-check corresponding documents, Account Number 241 Supplier No. 521 Authorised C M.

e.g. 3-way match of invoice, receiving report Code Description Qty Price Total
23 Radio 2 30 60
and purchase order. Delivery Instructions: Wednesday pm 60

ABC Ltd Tax Invoice Date: August 24 2014 No. 00231

To: XYZ Ltd Attention: C M Examples of Control Activities
Account Number 241 Customer Order No. 4537 Salesperson J.L.
Code Description Qty Price Total
23 Radio 2 30 60
Proceed with payment Amount Due 60

XYZ Ltd Receiving Note Date: August 6 2014 No. 27634

From: ABC Ltd Carrier: ABC
Account Number 241 Customer Order No. 4537 Stores Clerk B T
Code Description Qty Condition Order Complete
23 Radio 2 Good Yes
Notes:

XYZ Ltd Purchasing Order Date: July 31 2014 No. 41895

Independent Check on Performance
To: ABC Ltd Deliver To: Central Stores
A second clerk checks that account codings
Account Number 241 Supplier No. 521 Authorised C M.
Code Description Qty Price Total on source documents is in accordance
23 Radio 2 30 60 with the entity’s chart of accounts
Delivery Instructions: Wednesday pm

5
 Examples of Control Activities Information and
Communication System
■ The set of manual and/ or computerised
procedures that identifies, assembles, classifies,
analyses, records and reports on the entity’s
transactions; and maintains accountability for
related assets.

■ Includes infrastructure, such as hardware and

Information processing
other physical components; software; people;
Use of valid code test to ensure
correct price is charged procedures; and data.

Information System
General Controls
• Manual and computer controls
affecting the overall computer
General information system, to provide a
Controls reasonable level of assurance that 1: Segregation of I T duties
the overall objectives of internal
control are achieved.
2: Control over programs

3: Control over data

• Controls over the processing of
Application transactions within a specific
Controls 4: Other general controls
accounting application, such as
invoicing, purchasing and payroll

Application Controls Monitoring Controls

■ Data preparation
■ Prenumbered source documents
Ongoing assessment of the design and
■ Source documents are completed on a timely basis
■ Data entry
effectiveness of internal controls
■ User ID and password
■ Transaction processing and master file update
■ Controls to detect errors in data (incorrect data) Corrective action
■ Document and report generation
■ Error reports
■ Output is distributed only to authorised recipients
Internal / external

6
 SUMMARY
￭ Management has two broad responsibilities

&
with respect to the preparation of financial
reports:
Auditing
￭ Establish an accounting system; and
￭ Select accounting policies.
Assurance
￭ When conducting an audit, the auditor
(amongst other thigs):
￭ Gives consideration to the adequacy of the
Services(M)
accounting system, (including internal
controls);
Semester 1: 2019 Lecture 6 (Part 2):
￭ Determine the appropriateness of accounting Understanding and Assessing Internal Control
policy choices. Dr Phil Saj PhD CPA
University of Adelaide 38

Understanding Internal Control Internal Control

■ Policies, processes and procedures that are
■ Need to understand internal controls that are
put in place my management to provide a
relevant to the audit on every audit
reasonable assurance that the entity can
engagement (ASA315.12). meet its objectives regarding:
■ Assess the level of control risk based on the ■ the reliability of financial reporting
understanding obtained.
■ effectiveness and efficiency of operations
■ Influences decisions about the nature, ■ compliance with applicable laws
extent and timing of audit procedures.
■safeguarding assets and documents.

Internal Control Objectives Components of Internal Control

■ Risks are identified and minimised
■ Management decision making is effective
Control Environment
■ Transactions are carried out in accordance
with authorisation requirements
■ Prompt (timely) recording Risk Information Control Monitoring
Assessment System Activities Controls
■ Access to records and documents in
accordance with management instructions
■ Detection and correction

7
Steps in understanding internal controls
Obtain an understanding of the control environment
Understanding Internal Controls
Obtain an understanding of risk assessment processes
■ Auditability
Obtain an understanding of the information system
■ Potential material misstatements
Obtain an understanding of the control activities

Obtain an understanding of monitoring processes ■ Detection Risk

Document understanding of internal control
■ Design of tests
Make preliminary assessment Control Risk

Procedures for Understanding Procedures for Understanding

Internal Controls Internal Controls:
Need to Consider the Following
■ Consider past experience with client
■ Significant classes of transactions
■ Inquiries of key management
■ Initiation of transactions
■ Read policy and systems manuals
■ Records, documents and accounts
■ Inspectdocuments containing policies
and procedures ■ Accounting processes
■ Observe entity activities and operations ■ Controls around journal entries

Procedures for Understanding Internal

Controls: Need to Consider the Following Key decisions for the auditor:
(Example of Sales)
■ Financial reporting procedures

■ Processing of transactions and handling ■ Understand internal control for sales

of related assets
■ Transaction walk-through
■ Assess control risk for sales
■ The relationship between manual and
computerised processes
■ Determine the extent of testing for sales
■ Assertions at which controls are directed

8
 Is there adequate Are there proper
segregation of duties? authorisations?

Credit authorisation Generating sales Credit authorisation

Recording sales Access to cash Shipment of goods

Entering Performing Prices, including terms,

data verification checks freight and discounts

Are documents reconciled? Does the client use prenumbered

documents and perform sequence
Sales Order No. 089
ABC Pty Ltd ACN 236 checks?
Shipping Note No.135 Sales Order No.134
ABC Pty Ltd ACN 236

Sales Order No.135

Invoice No.103
ABC Pty Ltd ACN 236
Sales Order No.136
GM
GM

Are there physical controls over Are documents and records

source documents? adequate?
Clear and well designed
Sales Orders
Multi-copy, prenumbered forms

Shipping Orders Monthly statements to customers

Internal verification/ validity

9
 Assertions and Controls: Occurrence
Examples: Does the Credit Manager perform a
credit check for sales?
Understanding Control
Sales Order Credit File

Activities for Customer Name: Ace Ltd Customer Customer Credit

Customer No: 5601 Name Number Allowed

Particular Assertions Item A Ace 5601 $500

20 x $10.00 King 3487 $800

Total = $200 Queen 2145 $600

Controls /Assertions: Completeness Controls /Assertions: Accuracy

Are Shipping Orders prenumbered and
are sequences accounted for periodically?

Shipping Order No.134

Shipping
ABC Pty Ltd ACN 236 Order No.135
Date:ABC
04/06/X7 Shipping
Pty Ltd 236 Order No.136
No.1342
ACN
Supplier:
Date:XYZ Pty Ltd.
03/06/X7
ABC Shipping
No.1342
Pty Ltd ACN 236 Order No.137
5 Radios ModelDate:
Supplier: RF4 04/06/X7
XYZ Pty Ltd.
ABC Pty LtdShipping
No.1342
ACN 236 Order No.138
Supplier:
1 Radios Model RF4 XYZ Pty
Date: Ltd.ABC PtyNo.1342
04/06/X7 Ltd ACN 236 Reviews and Approvals
5 TVs Model RF4
Supplier: Date:
XYZ Pty05/06/X7
Ltd. No.1342
6 CDs Supplier: XYZ Pty Ltd.
Does the Financial Controller
8 TVs Model RF4 GM review supporting documentation prior
to making payment?

Controls /Assertions: Cut-off Controls /Assertions: Classification

Independent Check
Written procedures
Does the client have clear instructions Does a second Clerk check that account
for recording transactions codings on source documents are in
accordance with the entity’s chart of accounts?
around balance date?

10
 Controls/ assertions: Occurrence
Document the Understanding

Internal control questionnaires

Narrative memoranda
Segregation of Duties
Are authorising and executing Flowcharts
transactions undertaken separately?

Sales Credit Shipping Invoicing Accounting

Audit Planning 2 Dept. Dept. Dept. Dept. Dept.
Initial audit planning Sales Credit Sales Sales
Approval Order 3 Invoice 2
Order 1 Order 2
File
Sales Order 2
Shipping
Understand the entity and its environment Sales Order 3 Pick and Order 2
pack
Compare goods.
Sales Order Prepare Reconcile
Identify business risks that may result in material Shipping Documents
with & Prepare
misstatements in the financial statements customer’s Order Sales Invoice
Enter in
Sales
credit Journal
approval
Shipping 1 Invoice 1
Make a preliminary judgement about materiality Order
Shipping Invoice 2
Order 2
Shipping Invoice 3
Determine Make a preliminary Order 3 N
inherent risk assessment of control risk A N
N
All documents To Customer To Customer
Develop an audit strategy for significant assertions prenumbered

Steps in understanding internal controls Determine the Assessed Level of

Obtain an understanding of the control environment
Control Risk Based on the
Understanding Obtained
Obtain an understanding of risk assessment processes
■ Preliminary assessment of Control Risk.
Obtain an understanding of the information system
■ Determine how much reliance can be placed on
Obtain an understanding of the control activities evidence obtained from internal controls.

Obtain an understanding of monitoring processes ■ Leads to the development of an audit strategy.

Document understanding of internal control ■ Where the preliminary assessment suggests

that the controls are effective, the auditor
Make preliminary assessment Control Risk then tests these controls.

11
 Develop an Audit Strategy
Audit Strategy
N Is control risk assessed as high? Y

Tests of Substantive
Y
Perform TOC to support Controls Tests
C R assessment
Y Any compensating
controls? Low Control Risk
Any deviations found
Indicating less reliance N Combined Extensive Reduced
can be placed on ICs? Increase assessed Approach
level of CR
N High Control Risk
None:
Perform planned
Perform planned and Substantive Extensive
additional substantive Approach C R = 100%
substantive procedures procedures

12