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2 Control objectives, controls and tests of controls

2 Control objectives, controls and tests of controls

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Assertion

Control objectives

Controls

Tests of controls

Rights and
obligations

 To ensure that
inventory records only
include items that
belong to the entity.

 Procedures in place to
include inventory held
at third parties and
exclude inventory held
on consignment for
third parties.

 Review entity's
procedures relating to
consignment
inventory.

Accuracy,
valuation and
allocation and
classification

 To ensure that
inventory quantities
have been accurately
determined.

 Periodic or annual
comparison of
inventory with amounts
shown in continuous
(perpetual) inventory
records.

 Review and test
entity's procedures for
taking physical
inventory.

 To ensure that
inventory is properly
stated at the lower of
cost and net realisable
value.

 Standard costs
reviewed by
management.

 Review and test
entity's procedures for
developing standard
costs.

 Review of cost
accumulation and
variance reports.

 Inspect variance
reports produced.

 Inventory managers
review inventory
regularly to identify
slow-moving, obsolete
and excess inventory.

 Discuss with inventory
managers how this is
done.

 All despatch documents
processed daily to
record the despatch of
finished goods.

 Inspect
documentation to
confirm daily
processing.

 All goods inward
reports processed daily
to record the receipt of
inventory.

 Inspect
documentation to
confirm daily
processing.

 Reconciliations of
inventory records with
general ledger.

 Review reconciliations
performed.

 To ensure that
inventory transactions
and balances are
properly identified and
classified in the
financial statements.

 Orders for materials
and production data
forms used to process
goods through
manufacturing.

 Review entity's
procedures and
documentation used
to classify inventory.

 To ensure that
disclosures relating to
classification and
valuation are
sufficient.

 Approval by Finance
Director.

 Review entity's
working papers for
evidence of review.

Cut-off

Presentation

 To ensure that all
purchases and sales
of inventory are
recorded in the
correct accounting
period.

 Observe the procedure
being performed.

Part C Internal control  10: Tests of controls

205

4 The bank and cash system
FAST FORWARD

Dec 07, June 10

Controls over cash receipts and payments should prevent fraud or theft.

4.1 Control objectives, controls and tests of controls
The following table sets out the control objectives, controls and possible tests of controls over cash
payments.
Assertion

Control objectives

Controls

Tests of controls

Occurrence

 To ensure that only
valid cash payments
are made.

 Separate responsibilities
for the recording,
payment and
reconciliation of cash.

 Observe the
processing of cash
and review the
entity's policies to
evaluate whether
proper segregation
of duties is
operating.

 Supplier statements
independently
reviewed and
reconciled to trade
payable records.

 Review procedures
for reconciling
supplier statements.

 Monthly bank
reconciliations
prepared and
reviewed.

 Review
reconciliations to
confirm whether
undertaken and
reviewed.

 Only authorised staff
can make electronic
cash payments and
issue cheques.

 Review delegated
list of authority for
cash payments.

 Electronic cash
payments and cheques
prepared only after all
source documents
have been independently
approved.

 Inspect relevant
documentation for
evidence of approval
by senior personnel.

 Separate responsibilities
for the recording,
handling and
reconciliation of cash.

 Observe the
processing of cash
and review the
entity's policies to
evaluate whether
proper segregation
of duties is
operating.

Completeness

206

 To ensure that all
cash payments that
occurred are
recorded.

10: Tests of controls  Part C Internal control

Assertion

Control objectives

Completeness

Accuracy,
valuation and
allocation and
classification

 To ensure that cash
payments are
recorded correctly in
the ledger.

 To ensure that cash
payments are posted
to the correct payable
accounts and to the
general ledger.

Controls

Tests of controls

 Supplier statements
independently reviewed
and reconciled to trade
payable records.

 Review procedures
for reconciling
supplier statements.

 Monthly bank
reconciliations prepared
and reviewed.

 Review
reconciliations to
confirm whether
undertaken and
independently
reviewed.

 Review of cash
payments by manager
before release.

 Inspect sample of
listings for evidence
of senior review.

 Daily cash payments
reconciled to posting to
payable accounts.

 Review a sample of
reconciliations for
evidence that they
have been done.

 Use of pre-numbered
cheques.

 Examine evidence of
use of prenumbered cheques.

 Reconciliation of daily
payments report to
electronic cash payment
transfers and cheques
issued.

 Review
reconciliation, to
ensure performed,
reviewed and any
discrepancies
followed up on a
timely basis.

 Supplier statements
reconciled to payable
accounts regularly.

 Review
reconciliations for a
sample of accounts.

 Monthly bank
reconciliations of bank
statements to ledger
account.

 Review bank
reconciliation for
evidence it was
done and
independently
reviewed.
Reperform a sample
of bank
reconciliations.

 Supplier statements
reconciled to payable
accounts regularly.

 Review
reconciliations for a
sample of accounts.

 Agreement of monthly
cash payments journal
to general ledger
posting.

 Review postings
from journal to
general ledger.

Part C Internal control  10: Tests of controls

207

Assertion

Control objectives

Accuracy,
valuation and
allocation and
classification

Controls

Tests of controls

 Payable accounts
reconciled to general
ledger control account.

 Review
reconciliation, to
ensure performed,
reviewed and any
discrepancies
followed up on a
timely basis.

Cut-off

 To ensure that cash
payments are
recorded in the
correct accounting
period.

 Reconciliation of
electronic funds
transfers and cheques
issued with postings to
cash payments journal
and payable accounts.

 Review
reconciliation and
check it is carried
out regularly.

Presentation

 To ensure that cash
payments are
charged to the
correct accounts.

 Chart of accounts.

 Review cash
payments journal to
assess
reasonableness of
charging of
accounts.

 Independent approval
and review of general
ledger account
assignment.

 Review assignment
of general ledger
account.

The following table sets out the control objectives, controls and possible tests of controls over cash
receipts.

208

Assertion

Control objectives

Controls

Tests of controls

Occurrence

 To ensure that all valid
cash receipts are
received and deposited.

 Separate
responsibilities for the
recording, receipt and
reconciliation of cash.

 Observe the
processing of cash
and review the
entity's policies to
evaluate whether
proper segregation
of duties is
operating.

 Use of electronic cash
receipts transfer not
received or deposited.

 Examine application
controls for
electronic cash
receipts transfer.

 Monthly bank
reconciliations
performed and
independently
reviewed.

 Review monthly
bank reconciliations
to confirm
performed and
reviewed.

 Use of cash registers
or point-of-sale
devices.

 Observe cash sales
procedures.

10: Tests of controls  Part C Internal control

Assertion

Control objectives

Occurrence

Completeness

 To ensure that all cash
receipts are recorded.

Controls

Tests of controls

 Periodic inspections of
cash sales procedures.

 Enquire of managers
about results of
inspections.

 Restrictive
endorsement of
cheques immediately
on receipt.

 Observe mail
opening, including
endorsement of
cheques.

 Mail opened by two
staff members.

 Observe mail
opening procedures.

 Immediate preparation
of cash book or list of
mail receipts.

 Observe preparation
of cash receipts'
records.

 Independent check of
agreement of
cash/cheques to be
deposited at bank with
register totals and
receipts listing.

 Review
documentation for
evidence of
independent check.

 Independent check of
agreement of bank
deposit slip with daily
cash summary.

 Review
documentation for
evidence of
independent check.

 Separate
responsibilities for the
recording, receipt and
reconciliation of cash.

 Observe the
processing of cash
and review the
entity's policies to
evaluate whether
proper segregation
of duties is
operating.

 Use of electronic cash
receipts transfer not
received or deposited.

 Examine application
controls for
electronic cash
receipts transfer.

 Monthly bank
reconciliations
performed and
independently
reviewed.

 Review monthly
bank reconciliations
to confirm
performed and
reviewed.
Reperform a sample
of the
reconciliations.

 Daily cash receipts
listing reconciled with
posting to customer
accounts.

 Review
reconciliation.

Part C Internal control  10: Tests of controls

209

Assertion

Control objectives

Completeness

Controls

Tests of controls

 Customer statements
prepared and sent out
on a regular basis.

 Enquire of
management about
handling of
customer
statements.
 Examine a sample
of customers and
note frequency of
statements.

Accuracy,
valuation and
allocation and
classification

 To ensure that cash
receipts are recorded at
correct amounts.

 To ensure that cash
receipts are posted to
correct receivables
accounts and to the
general ledger.

210

 Daily remittance report
reconciled to control
listing of remittance
advices.

 Review
reconciliations.

 Monthly bank
statement performed
and reviewed
independently.

 Review
reconciliations for
evidence they were
performed and
independently
reviewed.

 Daily remittance report
reconciled daily with
postings to cash
receipts journal and
customer accounts.

 Review
reconciliations.

 Monthly customer
statements sent out.

 Review entity's
procedures for
sending out
statements.

 Monthly cash receipts
journal agreed to
general ledger posting.

 Review journal and
posting to general
ledger.

 Receivables' ledger
reconciled to control
account.

 Review
reconciliations.

Cut-off

 To ensure that cash
receipts are recorded in
the correct accounting
period.

 Bank reconciliation at
period end.

 Review and test
reconciliation.

Presentation

 To ensure that cash
receipts are charged to
the correct accounts.



Chart of accounts
(COA) in place and is
regularly reviewed for
appropriateness and
updated where
necessary.

 Inspect any
documentary
evidence of review
(such as emails
requesting update to
COA as a result of
review).



Codes in place for
different types of
receipt.

 Test application
controls for proper
codes.

10: Tests of controls  Part C Internal control

5 The payroll system
FAST FORWARD

Dec 08, Dec 11, Dec 13, June 14

Key controls over payroll cover:





Documentation and authorisation of staff changes
Calculation of wages and salaries
Payment of wages
Authorisation of deductions

5.1 Control objectives, controls and tests of controls
Assertion

Control objectives

Controls

Tests of controls

Occurrence and
existence

 To ensure that payment
is made only to bona
fide employees of the
entity.

 Segregation of duties
between HR and
payroll functions.

 Review payroll and
HR job descriptions
and company
policies on payroll
process, to evaluate
whether proper
segregation of
duties is in place.

 Personnel files held for
all employees.

 Review a sample of
starters and leavers
in the year to ensure
correct
documentation is in
place.

 Authorisation
procedures for hiring,
terminating, time
worked, wage rates,
overtime, benefits etc.

 Review and test
authorisation
procedures in place.

 Any changes in
employment status of
employees (eg
maternity, special
leave) informed to
HR department.

 Review policies and
procedures in place
for changing status
and consider
whether adequate.

 Use of time clocks to
record time worked.

 Observe employees'
use of time clocks.

 Clock cards approved
by supervisor.

 Inspect a sample of
clock cards for
evidence of approval
by appropriate level
of management.

 Review personnel
files for a sample of
employees whose
status changed in
the year.

Part C Internal control  10: Tests of controls

211

Assertion

Control objectives

Occurrence and
existence

Completeness

Accuracy,
valuation and
allocation and
classification

212

 To ensure that all
payroll costs are
recorded for work done
by employees.

 To ensure that all
benefits and
deductions (tax,
pension etc) are
computed correctly.

10: Tests of controls  Part C Internal control

Controls

Tests of controls



Employee numbers
assigned to each
employee in the
payroll master file.
Only employees with
valid employee
numbers are paid.

 Review and test
procedures for
entering and
removing employee
numbers from the
payroll master file.



Payroll budgets in
place and reviewed by
management.

 Review budgeting
procedures.

 Pre-numbered clock
cards in use.

 Review numerical
sequence of clock
cards.



 Review a sample of
reconciliations to
ensure they are
properly carried out.
Reperform a sample
of reconciliations.

Regular
reconciliations carried
out of payroll records
and employee costs
recorded in the
general ledger.

 Comparison of
cheques and bank
transfer list with
payroll to ensure all
employees paid have
been recorded via
payroll.

 Enquire whether
comparisons are
being made between
payment records
and payroll and
inspect any
documentary
evidence of the
review.

 Preparation and
authorisation of
cheques and bank
transfer lists.

 Examine paid
cheques or a certified
copy of the bank list
for employees paid
by cheque or bank
transfer to ensure
proper authorisation.



Reperformance of a
sample of payroll
benefit and deduction
calculations.

 Review documentary
evidence that
recalculation
occurred (eg
spreadsheet
printout).



Payroll budgets in
place and reviewed by
management.

 Review budgeting
procedures.



Agreement of gross
earnings and total tax
deducted with taxation
returns.

 Inspect
documentation for
evidence of
management's
review.

Assertion

Control objectives

Controls

Tests of controls

Accuracy,
valuation and
allocation and
classification

 To ensure that payroll
transactions are
correctly recorded in
the accounting system.

 Changes to master
payroll file verified
through 'before and
after' reports.

 Review reconciliation o
'before and after'
reports to payroll
master file.

 Payroll master file
reconciled to general
ledger.

 Review reconciliation o
payroll master file to
general ledger.
Confirm whether
discrepancies are
followed up
promptly and
resolved.

 All starters, leavers,
changes to salaries
and deductions are
reported promptly to
payroll department and
changes are updated
in the payroll master
file promptly.

 Review entity's
procedures for
reporting changes
to the payroll
department.

 Chart of accounts.

 Review chart of
accounts.

 Independent approval
and review of accounts
charged to payroll.

 Review procedures
for classifying
payroll costs.

 Payroll budgets in
place and reviewed by
management.

 Review budgeting
procedures.

 To ensure that payroll
transactions are
recorded in the correct
accounting period.

Cut-off

Presentation

 To ensure that payroll
transactions are
properly classified in
the financial
statements.

 Verify sample of
starters and leavers.

The following question aims to link the aspects we looked at in Chapter 9 with the control objectives and
tests of control we have just looked at.
The audit of wages, particularly the internal controls around wages, is discussed in detail in an article in
Student Accountant in August 2013 called 'The Audit of Wages'. This article can be accessed via the
Technical Articles link on the ACCA website: www.accaglobal.com/gb/en/student/acca-qual-studentjourney/qual-resource/acca-qualification/f8/technical-articles.html.

Question

Payroll controls

A good understanding of internal controls is essential to auditors. This helps them to understand the
business and allows them to effectively plan and execute tests of controls together with an appropriate
level of substantive procedures.
A small manufacturing company, Westfield, pays its staff in cash and by bank transfer, and the payroll
department consists of a payroll clerk who maintains its payroll on a stand-alone laptop computer. The
payroll clerk is supervised by the chief accountant, who in turn reports to the managing director. You are
Westfield's auditor.
Required
(a)

For the payroll department at Westfield, describe the internal control objectives that should be in
place.
Part C Internal control  10: Tests of controls

213

(b)

Describe the internal control environment and internal control activities that should be in place to
achieve the internal control objectives in (a).

(c)

Using your answer above, suggest a control the auditor may seek to rely on when obtaining
evidence over occurrence and existence in relation to payroll, and explain why. State one test of
control the auditor might carry out to test the operating effectiveness of that control.

Answer
(a)

Internal control objectives
To ensure that:

(b)



Only genuine staff are paid for work performed.



Gross pay has been calculated correctly.



Deductions from gross pay are calculated and recorded accurately.



The correct employees are paid what they are entitled to.



Wages and salaries paid are accurately recorded in the bank and cash records.



The right amounts due in respect of tax and national insurance are paid to the relevant
authority on a timely basis.

Internal control environment and control activities
Internal control environment
The control environment includes the governance and management functions and the attitudes,
awareness and actions of management and those charged with governance in terms of the
importance of internal control within the business. More specifically it would include the following.
(i)

The way in which management communicate to staff the need for integrity and enforce it.

(ii)

The consideration which management gives to ensure that the payroll staff have the
requisite skills and knowledge through proper recruitment and training.

(iii)

Management's philosophy and operating style, including the way in which the importance
of internal control in the processing of payroll is translated into positive action, for example
providing sufficient resources to address security risks regarding access to the computer.

(iv)

The way that authority and responsibility is assigned. For example, the chief accountant
might act in a supervisory role while the payroll clerk is responsible for the detailed
calculations and processing.

Internal control activities

214

(i)

Responsibility for the preparation of the payroll should be delegated to a responsible,
adequately trained member of staff.

(ii)

For hourly paid employees, the payroll should be prepared on the basis of timesheets /
clock cards authorised by a factory supervisor.

(iii)

Standing data used by the computerised payroll system should be checked on a regular
basis eg gross pay to personnel records.

(iv)

Any changes should be authorised by the chief accountant eg change in pay rates, overtime,
joiners and leavers.

(v)

For a sample of employees, calculations for gross pay, net pay and deductions should be
reperformed by the chief accountant.

(vi)

The payroll software should include computerised controls eg hierarchical password access
and range checks. Exception reports should be produced and investigated.

(vii)

The managing director should review the payroll by comparing the total monthly cost with
the budget and previous months' actual figures.

(viii)

The bank transfer list and wage cheque should be authorised by the managing director.

10: Tests of controls  Part C Internal control

(c)

(ix)

Cash should be kept securely in the company safe until it is distributed.

(x)

There should be segregation of duties between the member of staff responsible for
processing the payroll and the individual handling the cash.

(xi)

The chief accountant should maintain and reconcile a wages and salaries control account.

Occurrence and existence
The segregation of duties between the member of staff responsible for processing the payroll and
the individual making the bank transfers or cash payments is a key control in preventing the setting
up of bogus employees and diverting funds to a private bank account.
This therefore helps fulfil the control objective that only genuine employees are paid and is one
control the auditor may seek to test and rely on, to gain evidence in relation to 'occurrence and
existence'.
The test of control would simply be to observe and evaluate proper segregation of duties.

6 Revenue and capital expenditure
FAST FORWARD

June 15, Specimen Paper

Most of the key controls over capital and revenue expenditure are the general purchase controls.
The nature of a statement of financial position and statement of profit or loss means that it is important to
classify capital and revenue expenditure correctly, or profit will be over- or understated. You should know
the distinction between them from your financial reporting studies.
The controls and tests outlined below are often considered and performed during the audit of non-current
assets (see Chapter 12), as this is where the main issue of capitalisation occurs.

6.1 Controls and tests of controls
Assertion

Control objectives

Controls

Tests of control

Authorisation

 To ensure that

 Orders for capital items
should be authorised by
appropriate levels of
management.

 Review policies and
procedures in place.

 Orders should be
requisitioned on
appropriate (different to
revenue) documentation.

 Examine a sample of orders
for appropriate
authorisation.

 Invoices should be
approved by the person
who authorised the order.

 Inspect invoices to verify the
invoice has been
appropriately approved.

 Invoices should be marked
with the appropriate
general ledger code.

 Inspect invoices to verify the
invoice has the correct
general ledger code marked
on it.

 All the standard controls
over purchases are
relevant here (see Section
2).

 See Section 2.

expenditure is
properly authorised.

Classification

 To ensure that
expenditure is
classified correctly in
the financial
statements as capital
or revenue
expenditure.

Part C Internal control  10: Tests of controls

215