AUDITING

Course No:207
Chapter # 3
Learning Objective
• Internal Control System : definition,
features, Objective, basic principles,
advantages & limitation of internal control
• Internal Control System in Particular
Cases:
• Cash Payment
• cash received
• Cash Sales
• Credit sales
The components of an internal control system
This is further developed by ISA 315 (Revised) Identifying and
Assessing the Risks of Material Misstatement Through
Understanding the Entity and its states that auditors need to
understand an entity's internal controls.
The control environment includes the governance and
management function of an organisation. It focuses largely on the
attitude, awareness and actions of those responsible for
designing, implementing and monitoring internal controls.
The control activities include all policies and procedures designed
to ensure that management directives are carried out throughout
the organisation.
:
Definition of Internal Control
Internal control is one of the basic factors in the management of
an organization. It is a system which normally applied in the
financial and organizational sector of a Business. The production
cost, development of product, budget etc are also included in
internal control system. The definition of internal control system is
given by different writer and organizations.
According to spicier and peglar, “Internal control is best regarded
as the whole systems of controls, financial and otherwise,
established by the management in the conduct of a business
including internal check, internal audit and other forms of control.”
According to AICPA “Internal control is the plan of organization
and all of the co-ordinate methods and measures adopted within a
business to safeguard its assets, check the accuracy and
reliability of its accounting data, promote operational efficiency
and encourage adherence to prescribed managerial policies.
 Importance of internal control

• At the beginning of 19th century most business were small in size

and owner operated. These owner managers were involved with
most of the decision making. As business grow larger in size and
complexity. Professional managers replaced the owner operators.
At the passes of time the importance of internal control in
business operation are describe below.
• Processional mangers do not have the same first hand knowledge
of all aspects of the business as did the owner operators,
consequently, they rely heavily on the information supplied to
them by the accounting and other information systems.
• To assure management that the information it receives is both
reliable and accurate, as system of internal control is developed.
Internal control system also helps ensure that assets
are secure and that management policy is being
followed.
Not only management but also the independent
auditors heavily rely on the system of internal control in
determining the timing, nature, and extent of their audit
work.
The existence of a good internal control system
reduces to a great extent the work of an independent
auditor.
Where, good internal system is existence, an
independent auditor examining a representative
sample.
A good internal control system ensuring accuracy,
completeness, reliability, and timely preparation of
accounting data.
Essential features of Internal Control System:-
• There are some fundamental features in proper and system ethic
internal control system. These features are dies-cussed below: -
There are some fundamental features in proper and System.
These features are discussed below:-
• 1. Distribution of specific duties responsibilities: Specific duty
should be distributed among different level according to the skill
and fitness of employees. Concerned employees to the duty can
be responsible as a result of specific distribution of duly among
the employees.
• 2. Division of labor and specialization: Duties and
responsibilities are distributed according to division and
specialization of labor in internal control system. As a result the
interest of employees in the business firm increase as well as their
skill and experience also magnify. In such a system skills and
experience of the employees are valued very importantly.
3. Ability of staff: Necessary knowledge, skills
and awareness required to perform duties
imposed properly and beautifully are needed to
be available in the organization
4. Recording of each type of work: Recording
and evaluating is another feature of internal
control system.
5. Valuation of work: - there must have the
system of valuating of perform manna of employs
6. Controlling over accounts: Controlling over
accounts must be to show the true and logic
accounts of the organization.
7. Verification of assets with its accounts:
whether every assets in the business is recorded
or not that must be verified.
8. Protection of Assets: Duty and responsibility
to prepare papers of buying and selling must be
given on authorized and responsible employee.
9. Sound environment of work: It must be assured that the
sound environment in every department of the organization.
10. Specific rules of distinction of capital and revenue
transaction: There must have the accurate principles of
differentiation between capital oriented income-expenditure and
profit-oriented income-expenditure and that must be foll0wed
properly.
11. Supervision by management authority: Management
authority should supervise whether the internal control system
properly followed or not.
The internal control system is says to be proper and efficient if the
above features of internal control system are available in any
organization.
Objective of internal control systems
• Now the objectives of internal control system are discussed below-
• (1) Saving of Assets : To save the assets from different types of
unfavorable situation such as fraud or errors, firing or any other
accident is an important objective of internal control system.
• (2) Development of Accounting System: Development of
accounting system of an organization is another objective of internal
control system.
• (3) Implementation of rules and regulations: Internal control
system also observes those rules and regulation which are
following in Accounting and management process of the
organization.
• (4) Maintaining of fixed assets: There are so many fixed assets in
an organization internal control system also trying to maintain those
fixed assets appropriately.
(5) To ensure the correction of Account: Sometime different types of errors
are account by the clerks. Internal control system tries to removes those errors
by observing the duties of clerks appropriately.
(6) To express real and reliable condition in financial statement: Internal
control system tries to implement real and reliable condition in case of
preparing financial statement.
(7) Developing the adroitness of workers: Adroitness of workers is very
important for every organization. Internal control system tries to measure the
efficiency or adroitness of workers by division of labor.
(8) Helps in administration and management process:-Internal control
system also helps administrating and management process so that an
organization performs their duties appropriately.
(9) To stop fraud client work: Internal control system plays an important role
in case of stop at fraudulent work by maintaining the accounts appropriately.
Internal control system tries to stop different types of fraudulent works.
(10) To control producer and other cost: Manufacturing organization always
tries to control production cost and other cost which is related in production
activity. Internal control system helps the manufacturing organization for
controlling production cost.
Basic principles of Internal Control system
• Division of work: - Division of work is a basic and fundamental principle in
Internal Control Systems. It means divide the works and responsibilities to the
adroit or expert parsons.
• Increasing of efficiency:- Increasing of efficiency of an organization is another
important principle of internal control system. Normally internal control system
tries to increase the efficiency of on organization by developing workers
efficiency.
• Saving the Assets:- There are different types of asset, cornets assets in an
organization such as Fixed Asset, current Assets etc. Saving all types of Assets,
from unfavorable situation is also a fundamental principle of internal control
system.
• Showing respect ness on principle: Every workers of an organization should
be showed respect ness on their organizational principle. Internal control
systems try to motivate the workers for following that principle.
• Increasing the reliability or faith ness: Reliability or faith ness is a big asset of
an organization. Internal control system can try to increase the faintness of
people by developing its rules and regulation.
 Scope of Internal Control
• Accounting controls: Accounting controls comprise primarily the plan of
organizations the methods and procedures that are concerned with the
safeguarding of assets, prevention and detection of fraud and error,
accuracy and completeness of accounting records, and timely preparation
of reliable financial information.
• Administrative controls: Administrative controls include all other
managerial controls concerned with the decision making process. An
example of administrative controls is the maintenance of record giving
details of customers conducted by the salesmen. The distinction between
accounting controls and administrative controls is significant. An auditor of
financial information is primarily concerned with the accounting controls
since these have a direct and significant bearing on the reliability of
financial information. Administrative controls, on the other hand, have only
those administrative controls which have a bearing on the reliability of
financial records. Thus, the auditor of financial information may not
normally be interested in evaluating the system of getting the production
managers approvals of the samples of a manufactured product.
Need For Evaluation of Internal Control

• The auditors are increasingly recognizing the importance of evaluating

internal controls before undertaking specific audit tests.
• Various professional accounting bodies now recognize the fact that the
evaluation of internal control system helps in formulating a programmed of
detailed verification. In the context of an audit of financial inform, SAP 1,
Basic Principles Governing an Audit, states: “The auditor should gain an
understanding of the accounting system and related internal controls and
should study and evaluate the operation of those internal controls upon
which he wishes to rely in determining the nature, timing and extent of
other audit procedures. Where the auditor concludes that he can rely on
certain internal controls, his substantive procedures would normally be less
extensive that would otherwise be required and may also differ as to their
nature and timing.”
• If an auditor finds that internal controls in certain areas are inadequate, he
may decide to apply more effective substantive procedures, or change the
timing of the tests to be applied, or extend his audit tests to carry out a
more detailed examination of the unsatisfactory aspects of the system.
Internal control and Auditor:
• The work of auditors depend much on a good internal control.
Because of good internal control auditor can be certain about
protection of assets and transaction dependence. So, it
depends on internal control of a company how much make
wide auditor his works. Auditor can decrease his working
criteria if he certain about that the control of the company is
good. If auditor does not satisfied about the internal control he
would examine the transactions properly. So, it can be said
that, the internal control system and its apply is duty of the
management, auditor have not duty on it. But he can advise to
eliminate the errors. At least it can be said that how much a
auditor depends on internal control system is a matter of his
personal decision, of course, according to how he can not be
left from his self-created responsibility.
Testing internal controls
Internal controls can be tested by the following mechanisms:

• Enquiry. Ask employees how they carry out certain

transactions. Seek management’s views by asking them if
they feel the system of internal control is operating
effectively. Ask management how internal control could
be improved. You might be able to find some evidence of
management views by looking into board minutes or the
minutes of departmental meetings.

• Inspection. Look at a result of internal control procedures.

For example, inspect the file of paid supplier invoices to see
if they have indeed been cancelled or initiated in some way
proving that they had been paid
• Observation. Watch employees as they carry out certain
transactions and procedures..

• Recalculation and re-performance. For example,

recalculate the invoice, or the wages and salaries. Re-
perform what the employees have done to make sure that
they have done it correctly.

• Testing: This refers to the internal controls operating on a

computerized accounting system.
The sales system

A good internal control system for sales will ensure:

• Orders are accepted from credit-worth customers only.
• The ordered goods are promptly dispatched
• The goods are received by customers
• All deliveries are invoiced promptly and accurately.
• Invoices are entered properly into the receivables ledger.
• Payment is received when due
• Receipts form customers are accurately recorded
• Credit control procedures should target long-outstanding
receivables
• It should be possible to trace from order through to cash account
entry and from cash account entries back to orders and dispatch
notes.
The purchases system

A good internal control system for purchases will

ensure:
• Goods are ordered only as and when needed
• They are ordered at competitive prices, in the required
quantities and are of the required quality
• They are ordered from authorized suppliers
• The goods are received as expected (correct time, type,
quantity and condition)
• They are booked into inventory
• Invoices are checked to goods received noted and orders
• Invoices are entered properly into the payables ledger
• Payments are made properly to suppliers.
The wages and salaries system/ Payroll Systems

A good internal control system for wages and salaries

will ensure:
• Employees are hired only as necessary
• Employees are paid competitive rates
• Hours worked are accurately recorded
• Overtime is authorized
• Net pay and deductions are accurately calculated
• Payments are made accurately to employees, the
government and others as necessary
• Employees leaving are promptly removes form the wages
system
Limitation of Internal control
• (1) Costly: Internal control system so costly so many organizations do not
take this system in this organizational process.
• (2) Lack of implement of work field: In most of the cases, it has seen that
the governing bodies breaks the rules and regulation of Internal control
system. As a result some unfavorable situation will arise.
• (3) Errors: Some errors can be aroused in internal control system because
of increasing the business transaction.
• (4) Creation of frauds:Inspite of internal control system in different
position of organization some frauds can be raised be dishonest
communication of clerks’ or workers.
• (5) Lack of controlling system over special work: In most of the cases,
general organizational activities are included in internal control system. As
a result, there has some possibility of damagers in case of special work.
Thank
You