Page 192 - DCOM204_AUDITING_THEORY

Auditing Theory

Notes 2. Internal controls testing involves the assessment of the effectiveness of an entity’s suite of
controls, concentrating on such areas as proper authorization, the safeguarding of assets,
and the segregation of duties. This can involve an array of tests conducted on a sampling
of transactions to determine the degree of control effectiveness. A high level of effectiveness
allows the auditors to scale back some of their later audit procedures. If the controls are
ineffective (i.e., there is a high risk of material misstatement), then the auditors must use
other procedures to examine the financial statements. There are a variety of risk assessment
questionnaires available that can assist with internal controls testing.
3. Substantive procedures involves a broad array of procedures, of which a small sampling
is:
(a) Analysis: Conduct a ratio comparison with historical, forecasted, and industry results
to spot anomalies.

(b) Cash: Review bank reconciliation, count on-hand cash, confirm restrictions on bank
balances, issue bank confirmations.
(c) Marketable securities: Confirm securities, review subsequent transactions, verify
market value.
(d) Accounts receivable: Confirm account balances, investigate subsequent collections,
test year-end sales and cutoff procedures.
(e) Inventory: Observe the physical inventory count, obtain confirmation of inventories
held at other locations, test shipping and receiving cutoff procedures, examine paid
supplier invoices, test the computation of allocated overhead, review current
production costs, trace compiled inventory costs to the general ledger.

(f) Fixed assets: Observe assets, review purchase and disposal authorizations, review
lease documents, examine appraisal reports, recalculate depreciation and
amortization.
(g) Accounts payable: Confirm accounts, test year-end cutoff.
(h) Accrued expenses: Examine subsequent payments; compare balances to prior years,
recomputed accruals.
(i) Debt: Confirm with lenders, review lease agreements, review references in board of
directors minutes.
(j) Revenue: Examine documents supporting a selection of sales, review subsequent
transactions, recalculate percentage of completion computations, and review the
history of sales returns and allowances.
(k) Expenses: Examine documents supporting a selection of expenses, review subsequent
transactions, and confirm unusual items with suppliers.

An audit is the most expense of all the types of examination of financial statements. The least
expensive is a compilation, followed by a review. Due to its cost, many companies attempt to
downgrade to a review or compilation, though this is only an option if it is acceptable to the
report recipients.

10.2 Financial Statement Audit Procedures

Auditors verify financial statements for accuracy and completeness. Auditors who review firms’
financial statements focus on internal controls and processes, operating guidelines, business
risks and policies in financial reporting programs. They also may evaluate human resource

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