Internal Control

Considerations
Chapter 6
 Internal Control
• process designed and effected to by
those charge with governance,
management and other personnel to
provide reasonable assurance about the
achievement of the entity’s objectives
 Objectives of IC

• Reliability of Financial Reporting

• Efficiency and Effectiveness of operation
• Compliance with laws and regulations
• Safeguarding of assets
 Functions

 Preventive Controls
- deter problems before
they arise
Detective Controls
- needed to discover problems before they
arise

Corrective Controls
- procedures taken to identify the cause of a
problem and correct errors/difficulties
 INTERNAL CONTROL

MANAGEMENT AUDITOR
- Establish and maintain I/C. - Understanding and testing
Independence issue control over financial
reporting
- I/C provide reasonable - Issue an audit report on the
assurance that F/S are fairly operating effectiveness of
presented control
- Report on operating
effectiveness of control
- Inherent limitation
 Auditor Responsibilities

 Understand I/C – to cover later in as much more details

 Primarily – Internal Control over Financial Reporting

 Secondary – Effectiveness and Efficiency

 Compliance with laws and regulations

ex. Tax issues

 Protection of assets
Fraud and misappropriation
 Auditor Responsibilities- Classes of
transactions

• Transactions rather account balances

Five Components of Internal Control
 Components of I/C

 Control Environment
 Risk Assessment
 Control Activities
 Performance Reviews, Information Processing, Physical
Controls, Segregation of duties

 Information and Communication

Systems
 Monitoring
 Information and Communication

 Effective Information and

Communication
 Ensures that RIGHT information is
provided to RIGHT individuals at
the RIGHT time and in the RIGHT
format.
 Monitoring

• assesses the
quality of internal
control over time
• two types: ongoing
monitoring
activities and
separate
evaluations
 Fraud Triangle

Opportunity

Pressures / Rationalization /
Incentives Attitude
 Limitations of Internal Controls

– Cost may exceed benefit

– Management can override controls
– Risk of collusion
– Errors may arise from misunderstandings of
instructions or mistakes of judgment
– Compliance may deteriorate
– over time
 Auditors' Overall Approach with Internal Control

• Overall approach of an audit

1. Plan the audit
2. Obtain an understanding of the client and its
environment,
including internal control
3. Assess the risks of material misstatement and design
further
audit procedures
4. Perform further audit procedures
5. Complete the audit
6. Form an opinion and issue the audit report
• Steps 2-4 relate most directly to the role of internal
control in financial statement audits
 Obtaining the Understanding
• Procedures include

• Walk-through test or audit trail

• Inquiring entity personnel

• Observing the application of specific controls
• Inspecting documents and reports
• Tracing transactions through the information
system relevant to financial reporting
• Analytical procedures
 Documenting the Understanding of Internal Control

•Questionnaires
Typically standardized by firm
•Written Narratives
Memos that describe flow of transactions
•Flowcharts
Systems flowcharts
Making a Preliminary Assessment of Control Risk
 Effectiveness of Design of Internal Control

• control procedure in order to be effective

must be:
designed to achieve its objectives;
provide management with assurance that financial
statement is free of misstatemet and;
theoretically sound
 Communication of Weakness

• PSA 265
• particularly to address the need to
communicate deficiencies in internal
controls
• Material weakness is a significant
deficiency more than remotely likely to
cause a material misstatement that will not
be prevented, detected
Our audit of the financial
statements will include obtaining
an understanding of internal
control sufficient to plan the audit
and to determine the nature,
timing and extent of audit
procedures to be performed.
An audit is not designed to
provide assurance on internal In
control or to identify significant
deficiencies or material
weaknesses. Our review and nd
a
understanding of the Plan's l s
ro r
internal control is not undertaken
nt to
for the purpose of expressing an o di
opinion on the effectiveness of l C u
na rA
internal control.
e r ou
n t Y
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