•91



Provides auditor with evidence to support their
assessment of control risk. When control risk
assessed at less than high, necessary to gather
evidence that controls are working. This evidence
is gathered via test of controls.
If control risk is assessed at high, auditor will not
undertake test of controls.
Auditor selects most efficient and effective
combination of tests of controls, and substantive
tests of transactions and balances.
•92


To assess control risk as high, auditor must
expect that substantive procedures alone will
provide sufficient appropriate evidence.
Areas where substantive procedures alone may
not provide sufficient appropriate evidence
include routine recording of significant classes of
transactions, such as revenue or purchases.
These areas often highly automated with little or
no manual intervention.
•93
1.Nature – if controls exist that the auditor expects to rely
upon, undertake tests of these controls, otherwise undertake
substantive testing.
2.Timing – to aid ability to meet deadlines and scheduling of
staff, tests of controls sometimes scheduled before year-end.
Testing then extended (rolled forward) until year-end.
3.Extent – the more the auditor relies on controls, the greater
the extent of tests of controls. For tests of controls related to
documents, extent determined by reference
to sampling
theory.
4.Controls related to accounting routines (e.g. bank
reconciliations) usually tested by re-performing a small
number.
•94



For internal controls to provide audit evidence
about risk of material misstatements at the
assertion level, the auditor must collect audit
evidence about the existence, effectiveness
and continuity of controls.
Evidence of existence of controls is usually
gained when auditor is evaluating control risk.
Tests of controls are aimed at establishing
their effectiveness and continuity.
•95
•9-6


Dependent on the level of control risk the
tests must support.
The lower the planned assessed level of
control risk, the greater the amount of testing
that is required.
•97

Auditor should also consider:
◦ type and source of evidence
◦ timeliness
◦ interrelationship of evidence.
•98


Methods used by auditor is dependent on
whether a documentary audit trail exists.
Where no audit trail exists, greater emphasis
is placed on:
◦ observation
◦ inquiry of the control.

If audit trail does exist:
◦ Inspect documentation for evidence of the control.
•99


When auditor’s assessment of material
misstatement at assertion level includes an
expectation that controls are operating
effectively, the auditor should perform tests
of controls to obtain evidence that the
controls were operating effectively at relevant
times during the audit.
Controls that relate to the control
environment of a company’s internal control
system relate less directly to specific financial
report assertions.
•910

The information system, control activities and monitoring of
controls are built around major flows of transactions and
events. Possible to relate most tests of controls for these
elements to assertions about classes of transactions and
events:
(i) Occurrence – transactions and events that have been recorded,
have occurred and pertain to the entity;
(ii) Completeness – all transactions and events that should have
been recorded have been recorded;
(iii) Accuracy – amounts and other data relating to recorded
transactions and events have been recorded appropriately
(iv) Cutoff – transactions and events have been recorded in the
correct accounting period; and
(v) Classification – transactions and events have been recorded in
the proper accounts.
•911


Sales cycle involves all those transactions and
events that are initiated when an entity makes
a sale. It is commonly characterised by a high
volume of routine transactions.
Audit problems commonly related to clerical
processing rather than complex accounting
problems.
•912







Order entry and order approval by credit
department
Shipping
Invoicing
General ledger entry
Accounts receivable
Mail opening
Cashier functions.
•913
•914
•915

Routine transactions:
◦ credit sales to customers, cash collections from
customers (flowcharts), usually strong control
system, auditor considers (and usually undertakes)
tests of controls.

Non-routine transactions:
◦ adjustments to sales, and provisions for doubtful
debts. Less well controlled. Where material, auditor
undertakes substantive testing.
•916

Controls are in place to ensure that:
◦ Occurrence – all sales recorded are bona fide
transactions for merchandise actually shipped to
customers;
◦ Completeness – all sales shipped are invoiced and
recorded in accounting records;
◦ Accuracy – invoices have been recorded correctly as
to amount and summarised correctly;
◦ Cutoff – invoices have been recorded in correct
period;
◦ Classification – sales classified in accordance with
written policies.
•917
Special control
objectives
• Occurrence – All sales
recorded are bona fide
transactions for
merchandise actually
shipped to customers.
Common control
policies and
procedures
Tests of controls
• Policy of authorisation
of credit and terms
• Evidence of quantities
shipped reconciled to
quantities invoiced
• Select sample of sales
transactions from sales
journal (daily activity
report), check for
authorisation and trace
to shipping document
file
• Inspect reconciliation
of shipments to
invoices
•918

Controls are in place to ensure:
◦ Occurrence – recorded cash receipts are for
collection of receivables resulting from sales to
customers of the entity;
◦ Completeness – all cash receipts are recorded and
deposited;
◦ Accuracy – cash receipts have been recorded
correctly as to amount;
◦ Cutoff – cash receipts have been recorded in correct
period;
◦ Classification – cash receipts are classified in
accordance with company policy.
•919
Special control
objectives
Common control
policies and
procedures
• Occurrence – Recorded
• Cash receipts matched
cash receipts are for
collection of receivables
resulting from sales to
customers of the entity.
to specific sales
invoices in posting to
accounts receivable
master file.
Test of controls
• Select a sample of
entries in cash receipts
journal and review
evidence that matched
to specific sales
invoices.
•920

Generally result of:
◦ clerical mistakes;
◦ employee fraud;
◦ misapplied accounting principles, especially around
some revenue recognition issues;
◦ management fraud.
•921
Learning Objective 5:


Expenditure cycle — all transactions and
events initiated when an entity acquires
assets or services used for cash or credit.
Auditors (and many entities) often separate
this cycle into a number of sub-cycles, which
reflect various types of services and assets
that can be acquired.
•922

These sub-cycles are:
◦
◦
◦
◦
◦
◦
payroll
property, plant and equipment
inventory
income taxes
selling and administrative expenses
miscellaneous expenses paid from petty cash.
•923




Purchasing
Receiving
Accounts payable
Cash disbursements function.
•924
•9-25

Controls are in place to ensure:
◦ Occurrence – all recorded purchases are bona fide
transactions in that they relate to goods or services
authorised or received;
◦ Completeness – all purchases for the period of
inventory received are recorded;
◦ Accuracy – purchases of goods or services for
inventory are recorded correctly as to amount and
summarised correctly;
◦ Cutoff – purchase invoices have been recorded in
correct period;
◦ Classification – purchase are classified in
accordance with classification policies.
•926
Special control
objectives
• Occurrence – All
recorded purchases are
bona fide transactions
in that they relate to
goods or services
authorised or received.
Common controls
Tests of controls
• Approval of purchase
• Examine evidence of
order
• Goods received are
counted, inspected and
compared to purchase
order before acceptance
• Comparison of purchase
order, receiving report and
supplier’s invoice and
recomputation of
supplier’s invoice before
recording liability
approved purchase and
service orders
• Select a sample of order
entries in purchases
journal, trace back to
vouchers and inspect for
existence of supporting
document including
receiving report, ensuring
agreement of details and
indication of approval
From Table 9.6 (p. 422-3)
•927

Controls are in place to ensure:
◦ Occurrence – recorded cash disbursements are for
goods or services authorised and received;
◦ Completeness – all cash disbursements are
recorded;
◦ Accuracy – cash disbursements are recorded
correctly as to amount;
◦ Cutoff – cash disbursements recorded in correct
period;
◦ Classification – cash disbursements are recorded
correctly as to account.
•928
Special control
objectives
• Occurrence –
Recorded cash
disbursements are
for goods or
services authorised
and received.
Common control policies
and procedures
Tests of controls
• Cheques printed or prepared
• Select a sample of cash
only when receipt of goods or
services and approval are
documented (e.g. supporting
documents compared,
recomputed and voucher
approved)
• Cheques signed only after
viewing supporting
documentation and prior
approval
• Supporting documentation
cancelled and reference to
cheque number
disbursement transactions from
cash payments journal and
inspect supporting
documentation for indication of
checking, review and approval
• Observe and inquire about
cheque preparation and signing
and protection of unissued
cheques
• For the sample of cash
disbursement transactions
inspect supporting documents
for cancellation, cheque
number and endorsement
•929

As expenditure cycle involves disbursements
of cash there is a greater risk of fraud or
irregularity, including:
◦
◦
◦
◦
◦
classic disbursements fraud
kickbacks
illegal acts
unauthorised executive perks
kiting.
•930
Learning Objective 6:



Processing and related control policies and
procedures for selling and administrative
expenses are similar to those for purchases
of inventory.
Auditor will normally obtain comfort from
cash disbursement testing for inventory
purchases and perform minimal testing in
this area.
Analytical procedures (e.g. comparing
balance with prior periods) widely used as a
key type of testing.
•931


Petty cash disbursements are usually
immaterial in amount and therefore few, if
any, audit procedures are applied to this area.
Where the area is significant, emphasis is on
ensuring appropriate procedures are in place
to safeguard cash.
•932

The payroll function is usually audited in
either of two ways (or best combination):
◦ focusing on analytical procedures (there are
disaggregated and strong relationships in this area,
e.g. comparing fortnightly payrolls);
◦ an emphasis is placed on tests of transactions over
the payroll area with the key control being
appropriate segregation of duties in the hiring
function, approval of time worked, payroll
preparation and payroll distribution.
•933

If tests of controls are necessary the following
audit procedures may be undertaken:
◦ authorisation by supervisors of time worked;
◦ check signed time cards/sheets;
◦ check use of approved pay rates (personnel
department);
◦ check for reasonableness, compared with awards.
•934



Auditor usually takes a more substantive
approach, which includes checking terms and
conditions of contracts;
Auditor interested in the key control of
authorisation of the contract;
Accounting treatment of leases is complex,
and auditor might check controls that ensure
leases are properly accounted for.
•935
•936
•937