Page 134 - DCOM204_AUDITING_THEORY

Auditing Theory

Notes as also to safeguard the assets. The auditor cannot rely on the controls of the auditee , for the
prevention and detection of fraud and errors. Therefore he is bound to obtain some degree of
assurance through his own substantive testing. The quantum would depend on the effectiveness
of the internal controls for preventing and detecting material errors.

7.6.5 Systems Control Evaluation

The Systems Control Evaluation (SCE) based on the questions and answers exercise illustrated
above, is thus designed to identify the controls in the system which would satisfy the general
audit objectives (prevent or detect the various types of material errors). Having identified the
controls, the auditor assesses the adequacy of the process. He would necessarily be required to
adopt a critical approach attempting to envisage situations in which they might fail to operate
and consequently result in the occurrence of an error or fraud. Further, the auditor should also
consider how promptly errors could be identified and the impact on the financial statements; in
the event of their remaining undetected. Such evaluation should necessarily cover the entire
operation of controls for the entire accounting period. This should be borne in mind while
conducting Compliance Testing. Having completed this evaluation, the auditor should then
formulate his assessment based upon the suggested guidelines and categorize the assessment of
internal controls.

7.6.6 Inherent Limitations of Internal Control

It is generally accepted that internal control procedures can provide reasonable and in no case,
absolute assurance, that the objectives of such controls relating to accounting systems are achieved.
This could be due to the possible existence of certain inherent limitations including:-

1. Management’s consideration that a control be cost effective
2. The fact that most controls tend to be directed at anticipated types of transactions and not
at unusual and unforeseeable transactions.
3. The potential for human error due to carelessness, distractions, errors of judgment and
misinterpretation of instruction.
4. The possibility of circumvention of controls through collusion with parties outside the
entity or with employees of the entity, (e.g. a lack of segregation of duties between
computer programmers and computer operations).

5. The possibility that a person responsible for exercising control could abuse that
responsibility.
6. The possibility that the procedures may become inadequate due to changes in conditions
and compliance with procedures may deteriorate.
7. Manipulation of transactions or estimates or judgments, required in the preparation of
financial statements.
However, despite the existence of certain possible inherent weaknesses that would exist in
almost every system, howsoever perfect in design, the corrective action taken for rectification
by the Management and its periodic assessment through the Systems Control Evaluation method
adopted in Systems Based Audit enables the fulfillment of the principal objectives of establishing
and effectively operating Internal Control Procedures.

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