Components of an Internal Control System - Case Study Example

Accounting Case Study Name Institution Course Tutor Date 6.25. Segregation of duties in small businesses Components of an internal control system of any entity comprises of the control environment, risk assessment, control procedures and monitoring process. The control environment is defined as the overall management attitude towards control systems. It therefore considers the control consciousness of the management in ensuring that organizational goals are achieved. Control consciousness refers to the degree of awareness of the control system of an entity. In auditing, this is usually influenced by the strength of control environment. It is apparent that the management of Big State computers do not have full understanding of how important it is by having a strong control system. The control environment is weak and that is why instituting and implementing effective control procedures is quite difficult. It is for this reason that the segregation of duties is not done effectively. The management doesn’t discern that there are important duties that should not be done by one individual. This is because it increases the risk of frauds and errors. Sally does more than one task and as matter of fact, she’s just a trainee and probably doesn’t possess enough skills to handle the tasks assigned to her. Lack of control consciousness in Big State computers premises increases the level of control risks. Control risk is the risk that a misstatement in the financial statements or records may result from the controls of the business. Poor segregation of duties and job assignment criteria and lack of management’s exercising their monitoring role suffice to make the control consciousness of this Big State Computer business as poor. The duties that should be segregated in Big State Computers are sales, administration, diagnosing and solving computer problems, banking, preparation of client’s statements, recording of receipts and payments and emergency routine repairs. These duties need to be segregated based on qualifications and experience of the staff working at Big Sate Computer business. In the allocation of duties, Betty should be responsible for diagnosis and repair of computers brought into the business. For Max, he can take on the administration responsibility while living the sales be done by the part-time staff. This will ensure that Max is not burdened with sales and administrative responsibility such that even monitoring other staff becomes difficult. With him concentrating on administration, he can effectively oversee the activities of other staff. Max as the overall administrator can undertake the banking of money too. In recording receipts and payments and preparing clients’’ statements, the junior trainee, Sally can handle that but under supervision. Before issuing statements to clients, approval should be obtained from an authorized person, who can be Max. Computer technician can help in computer repairs inside and outside the premises. This means that apart from dealing with repairs in the business, his responsibility should be extended to providing emergency repairs. Segregating duties in this manner will improve a lot if not completely strength of the internal controls of Big State. Whilst Sally will not be handling routine repairs now, she will focus on just preparing journal receipts and clients’ statements, solving the problem of not preparing the statement in four months. 7.31. Documentation What is the minimum standard that the audit documentation must meet? Audit documentation should be sufficient to enable the auditor support his or her audit opinion of the financial statement of the company. Sufficiency of an audit document would be determined by the scope of engagement with respect to letter of engagement and the nature of internal controls. An entity whose controls are weak would necessitate an auditor to obtain a lot of documents relevant for his audit. Additionally, where the error rate is high, the auditor is required to have sufficient documents which represent the working papers which will assist him in supporting his opinion. Sufficient and detailed audit working papers will also be of benefit to the internal auditors and inexperienced staff to understand the worn performed by the company’s auditor. Another minimum standards for audit documentation is that the working papers should be filed in their respective audit files and be appropriate. There are two audit files where working papers can be filed; permanent and current working audit files. Permanent files contains all files which can be of continuing importance in subsequent audits. This include documents such as the Memorandum and Articles of Association. Current files on the other hand, contain documents which are pertinent to the current year of auditing. This may include documents such as audit programs, management letter, copies of source documents among others. Therefore, audit documentation should be sufficient and must organize documents appropriately for easy retrieval. I would treat the corrections and assistant auditor’s recommendations and additional work of confirmation of receivables as unreliable sources of evidence. An auditor obtains audit evidence in order to support his or her audit opinion. Therefore, because he is help accountable by stakeholders the auditor strive to gather sufficient, appropriate and reliable audit evidence. On reliability of an audit evidence, it depends on the nature of the evidence, source and the person from whom it is collected. ASA 505 provides criteria for basing reliability. According to ASA 505, audit evidence is more reliable if it is obtained from independent sources. Additionally, the audit evidence is more reliable if obtained by the auditor himself and not indirectly. Accounts receivable is a very critical area as it is more vulnerable to fraud. For this reason, auditors would always prefer confirming account receivables themselves to obtain evidence. Therefore, it would be important that the auditor obtain confirmation directly from debtors or external sources. This would be more reliable than relying on the assistant auditors’ recommendations which may be subject to alteration by the management. Apparently, evidences from the company itself are subject to distortion and manipulation, making it risky to rely on them without external confirmation. As we have seen from the case study, the management can alter information in order to conceal some fraudulent acts. Therefore, the auditor should adopt procedures for confirmation as provided in ASA 505, both negative and positive confirmation. 8.23. Performance indicators The performance indicators included in the report are useful as audit evidence for the financial report. Performance indicators have largely been used by auditors as sources of audit evidence. For instance, high debts of the company and litigation cases facing are performance indicators as well as sources of evidence to prove the going concern of an entity. To start with, the number of orders processed per day not only indicates how effective controls are, but also helps compare existence and accuracy of receivables. Therefore, where an auditor through analytical review procedures identity significant deviation between orders processed and accounts receivables, then he can be able to detect the reasons for such significant variations. The assertions made in the accounts receivable can be proven to be accurate or reflecting the true value of debtors through auditing orders documentations. Detective controls can perfectly work here to identify errors and frauds. The tests and procedures that an auditor needs to device depends on the strength of controls and the amount of audit evidence required. For instance, if the time taken to backlog orders is higher than that of processing, then it may raise questions of effectiveness of the system. In addition to this, the backlog time can be compared to previous period’s backlog time and the differences analysed. This will eventually provide the auditor with an evidence of weak or strong controls and thereby, determining the level of reliance to be placed on controls. The auditor may then find this an interesting area to apply tests of controls and obtain evidence of misstatements in the financial statement. Overtime request by employees is useful as audit evidence for financial report. The controls in the payroll system may provide loopholes for perpetration of frauds. Where employees are requesting for overtime, the risk can be paying overtime for work not done. To confirm whether the payroll contains true workers and not ghost workers, the auditor may apply some tests of controls on the company’s control measures on payroll systems. As a result, the auditor will be able to conclude on the reliance of the payroll system based on evidence obtained. The outcome of this will then be reflected on the financial statements where the through substantive procedures, the auditor may be able to detect the differences in the assertions made concerning salaries and wages of workers in the income statement. The number of employees working for overtime may imply that the company’s performance is improving but again, this could be an opportunity for fraudulent activities within the company. 9.30. Persuasiveness of evidence from Analytical procedure Comparison of depreciation expense with the closing balance of depreciable class of assets Mathew would ask the following questions: 1. Were there sufficient data available to facilitate comparison of depreciation expenses? 2. What was the company’s policy regarding depreciation of assets? 3. Were relevant depreciation calculation methods used? 4. What was the book value of the assets in the previous and current year? Are there significant differences? 5. What was the value of depreciation charged in the current financial year and how different is it compared with the previous financial years. Recalculation of sales commission 1. How many sales commissions does the company have? Were there any additional sales person in the current year or not? 2. What is the company’s policy regarding percentage of commission to be paid? 3. What was the previous and current year’s total amount of commission? Comparison of payroll expanse 1. How many employees does the company have in their payroll system? 2. Are current years’ employees in the payroll system match the previous financial period’s payroll system? 3. What is the basis for paying salaries and wages? 4. Is the total amount of salaries and wages different from the previous’ year’s amount? If so, how material is it and what could have led to the difference? The evidence obtained from the first analytical procedure would be corroborative evidence. A corroborative evidence is that which provides support to an existing evidence. There is an initial evidence that an asset exists through physical observation or confirmation. There could also be evidence of existence and valuation. However, the valuation criteria need to be looked into substantively and identify any miscalculations whether intentional or not. Therefore, comparison of depreciation expenses would provide additional evidence to already existing evidence of the value of assets as asserted in the financial statements. The evidence obtained through recalculation of sales commission will be persuasive. This is because recalculation is usually done to confirm miscalculations. This applies where initial evidence regarding this item of the financial statement has been audited. Evidence obtained through recalculation also tend to increase the confidence level the auditor should have. In the comparison of payroll, the evidence obtained here is general, that is, can corroborate existing evidence and still persuade. The payroll system is usually evaluated through application of test of control to evaluate its effectiveness. In cases where an auditor identifies potential risks of error and frauds in the payroll system, further substantive procedures such as analytical review of payroll expenses will provide supportive evidence of existence of fraudulent activities in the business. On the other hand, evidence obtained through comparison of payroll expenses can be persuasive in the sense that if no test of controls were carried initially on the payroll system, significant differences in the values of payroll expense may provide useful insight. The auditor may be persuaded to believe that there might be fraudulent activities in the payroll system. Read More