Lesson 21
SUBSTANTIVE PROCEDURES
Auditing
Auditor’s Opinion
(depends upon)
Reasonable Assurance (depends
upon)
Sufficient Appropriate
Audit evidence
(depends upon)
Audit procedures
» Test of Control
» Substantive
Procedures
Test of Control
The auditor is required
to perform tests of controls:
• Test of details
• Analytical
procedures
• When
the internal controls
are operating effectively or
• When substantive
procedures alone do not provide sufficient appropriate audit evidence at
the
assertion level.
Tests of controls
comprise of testing three things:
1. Design – that the
internal controls are properly designed to cover the risk it is meant for.
2. Implementation – that
the internal controls have been put into operation.
3. Operating
effectiveness – that the systems of internal control were operating effectively
at
relevant times during
the period.
How to perform test of
control
• Testing the
Design:
– Proper design of
internal control is tested through ICQs and ICEC.
• Testing the
Implementation:
– Implementation of
internal control is tested through walk through test with a little sample
size.
• Testing the Operating
effectiveness:
– Here the test is
performed through a compliance test based on a judgmental sample.
Substantive Procedures
Substantive procedures
are performed in order to detect material misstatements at the assertion level
(like;
occurrence,
completeness, accuracy, valuation, existence, rights and control), and include
tests of details of
classes of transactions,
account balances and disclosures and substantive analytical procedures.
The auditor plans and performs
substantive procedures to be responsive to the related assessment of the
risk of material
misstatement.
Irrespective of the
assessment of risk of material misstatement, the auditor should design and
perform
substantive procedures
for each material class of transactions, account balance, and disclosure.
78
The auditor’s
substantive procedures should include the following audit procedures related to
the financial
statement closing
process:
• Agreeing the financial
statements to the underlying accounting records; and
• Examining material
journal entries and other adjustments made during the course of preparing
the financial
statements.
When the auditor has
determined that an assessed risk of material misstatement at the assertion
level is a
significant risk, the
auditor should perform substantive procedures that are specifically responsive
to that
risk.
Types of Substantive
Procedures
• Test of details
– Land
Registry
– Debtors
Circular
– Building rent
Deed/Agreement
• Analytical procedures
– Payroll
Turnover ratio
Comparing with previous
month’s salary
– Production Cost
Comparing with the number of
units
produced
Comparing with the previous month’s
cost
of production
Nature of Substantive
Procedures
Substantive analytical
procedures are applied on large volume of transactions, which are predictable
over
time.
• Tests of details are
ordinarily more appropriate to obtain audit evidence regarding certain
assertions
about account balances,
including existence and valuation.
• Analytical procedures
are applied on large volume of transactions, which are predictable over time.
(cost of goods sold,
payroll, sale)
In designing substantive
analytical procedures, the auditor considers such matters as the following:
• The suitability
of using
analytical procedures given the assertions.
If controls, over sales
order processing, are weak; the auditor may place more reliance on tests of
details
rather than substantive
analytical procedures for assertions related to debtors.
When auditing the
collectibility of accounts receivable, the auditor may apply substantive
analytical
procedures to an aging
of customers’ accounts in addition to tests of details on subsequent cash
receipts.
• The reliability
of the data;
In determining whether
data is reliable for purposes of designing substantive analytical procedures,
the
auditor considers the
following:
o Information is
ordinarily more reliable when it is obtained from independent sources outside
the
entity
o Comparability of the
information available
o Nature and relevance
of the information available (whether budgets have been established as
results to be expected
rather than as goals to be achieved.
o Controls over the
preparation of the information (controls over the preparation, review and
maintenance of budgets)
• Whether the
expectation is sufficiently precise
to identify a
material misstatement at the desired level of
assurance.
For this the
auditor considers the following facts:
i. The accuracy with which
the expected results of substantive analytical procedures can be
predicted (comparison of
GP ratio should be consistent rather than the ratio of discretionary
expenses like
entertainment)
79
ii. The degree to which
information can be disaggregated (effective analysis will be of a component
not of the entity as a
whole)
iii. The availability of
the information, both financial and non financial (budgets are financial,
whereas units of
production are non financial)
• The amount of any
difference in recorded amounts
from expected
values that is acceptable.
Depends upon
the:
i. materiality
ii. Possibility of
misstatement in the specific account balance, class of transactions, or
disclosure
Timing of Substantive
Procedures
YEAR END SUBSTANTIVE PROCEDURES
ARE ALWAYS MORE RELIABLE
When substantive
procedures are performed at an interim date, the auditor should perform further
substantive procedures
or substantive procedures combined with tests of controls to cover the
remaining
period that provide a
reasonable basis for extending the audit conclusions from the interim date to
the
period end.
In considering whether
to perform substantive procedures at an interim date the auditor considers such
factors as the
following:
• The control
environment and other relevant controls. (Like payroll disbursement)
• The availability of
information at a later date that is necessary for the auditor’s procedures
(prov for
doubtful debts can be
investigated interim but debtor and inventory can be verified at the year end).
• The objective of the
substantive procedure.
• The assessed risk of
material misstatement (prefer always at year end).
• The nature of the
class of transactions or account balance and related assertions (like frequency
of
occurrence of the transactions
e.g. salaries are paid monthly whereas bonuses are paid annually).
• The ability of the
auditor to perform appropriate substantive procedures or substantive
procedures
combined with tests of
controls to cover the remaining period in order to reduce the risk that
misstatements that exist
at period end are not detected (staffing problem that cannot make the
auditor able to extend
till the year end)
If substantive
procedures are performed at an interim date, the auditor may sometimes consider
applying
tests of controls also
on the transactions of remaining period while extending his substantive
procedures
from interim date to the
period end.
In situations of actual
or expected fraud, auditor may prefer applying substantive procedures at period
end.
If misstatements are
detected in classes of transactions or account balances at an interim date, the
auditor
ordinarily modifies the
related assessment of risk and the planned nature, timing or extent of the
substantive
procedures covering the
remaining period.
Substantive procedures
applied in a prior period are not sufficient to address a risk of material
misstatement
in the current year
except in certain circumstances.
Extent of performance of
substantive procedures
Greater the risk of
material misstatement due to weaknesses in the system of internal control, the
greater
would be the risk of
material misstatement in the financial statements.
In designing tests of
details, the auditor may use either audit sampling or may choose to select
items to be
tested by some other
selective means of testing.
Adequacy of Presentation
and Disclosure
The auditor should
perform audit procedures to evaluate whether the overall presentation of the
financial
statements, including
the related disclosures, are in accordance with the applicable financial
reporting
framework.
Assertions in obtaining
Audit Evidence
(a) Assertions about
classes of transactions
and events for the
period under audit;
i. Occurrence –
transactions and events that have been recorded have occurred and pertain
to the entity;
80
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 proper period.
v. Classification –
transactions and events have been recorded in the proper accounts.
(b) Assertions about
account balances
at the period end.
i. Existence – assets,
liabilities, and equity interests exist;
ii. Rights and
obligations – the entity holds or controls the rights to assets, and
liabilities are
the obligations of the
entity;
iii. Completeness – all
assets, liabilities and equity interests that should have been recorded
have been recorded;
iv. Valuation and
allocation – assets, liabilities, and equity interests are included in the
financial
statements at
appropriate amounts and any resulting valuation or allocation adjustments
are appropriately
recorded.
(c) Assertions about
presentation and disclosure
:
i. Occurrence and rights
and obligations – disclosed events, transactions and other matters
have occurred and
pertain to the entity;
ii. Completeness – all
disclosures that should have been included in the financial statements
have been included;
iii. Classification and
understandability – financial information is appropriately presented and
described, and
disclosures are clearly expressed;
iv. Accuracy and
valuation – financial and other information are disclosed fairly and at
appropriate amounts.
Audit Procedures for
obtaining Audit Evidence
The auditor uses one or
more types of audit procedures described below:
(i) Inspection of
Records or Documents
It consists of examining
records or documents whether internal or external, in paper form, electronic
form,
or other media.
Inspection provides evidence of varying degrees of reliability depending on
their nature and
source and in the case
of internal records, on effectiveness of controls over their production.
(ii) Inspection of
Tangible Assets
It consists of physical
examination of the assets. It may provide reliable audit evidence of their
existence
cannot necessarily about
other assertions.
(iii) Inquiry
It means seeking
information of knowledgeable persons throughout the entity or outside the
entity. Those
may be formal written or
informal oral. It provides an auditor with new information or corroborative
evidences. It may also
bring to high information different from the one possessed by the auditor.
Certain
oral inquiries might be
got confirmed through written representations.
(iv) Confirmations
It is a specific type of
inquiry. It is the process of obtaining a representation of information or an
existing
condition directly from
a third party. Confirmations are sought from debtors, creditors, bankers, legal
advisors etc.
81
Lesson 22
AUDIT EVIDENCE
Auditor should obtain
sufficient appropriate audit evidence to be able to draw reasonable conclusions
on
which to base the audit
opinion.
Concept of Audit
Evidence
Audit evidence is all
the information used by the auditor in arriving at the conclusions on which his
opinion
is based and includes
the information contained in the accounting records underlying the financial
statements and other
information. It is obtained from audit procedures performed during the course
of
audit and may include
audit evidence obtained from other sources such as pervious audits and a firm’s
quality control
procedures for client acceptance and continuance.
Accounting records generally
include the records of initial entries and supporting records, such as checks
and records of
electronic fund transfers; invoices; contracts; the general and subsidiary
ledgers, journal
entries and other
adjustments to the financial statements that are not reflected in formal cost
allocations,
computations,
reconciliations and disclosures. The entries in the accounting records are
often initiated,
recorded, processed and
reported in the electronic form. In addition, the accounting records may be
part of
integrated systems that
share data and support all aspects of the entity’s financial reporting,
operations and
compliance objectives.
Auditor obtains most of
the audit evidence from accounting records of the entity. If accounting records
do
not provide sufficient
audit evidence, the auditor obtains other audit evidence.
Other information that
the auditor may use as audit evidence includes:
• minutes of
meetings;
• confirmations from
third parties,
• analysis’
reports;
• comparable data about
competitors (benchmarking);
• controls manuals;
• information obtained
by the auditor from such audit procedures as inquiry, observation; and
inspection;
• and other information
developed by, or available to, the auditor that permits the auditor to
reach
conclusions through
valid reasoning.
Sufficient appropriate
Audit Evidence
Sufficiency: The
measure of quantity of audit evidence.
Appropriateness: The
measure of quality i.e. relevance and reliability in providing support of
detecting misstatements
in account balance classes of transactions and disclosures and relevant
assertions.
The quantity of audit
evidence needed is affected by:
- the risk of
misstatement (the greater the risk, the more audit evidence is likely to be
required); and
- the quality of such
audit evidence (the higher the quality, the less may be required).
Accordingly sufficiency
and appropriateness are interrelated. However, merely obtaining more
audit
evidence may not
compensate for its poor quality.
Audit evidence obtained
through same audit procedures may be relevant to certain assertions but not
relevant to other
assertions.
The auditor often
obtains evidence about an assertion from different sources or of different
nature.
Evidence about an
assertion is not a substitute for evidence regarding another assertion.
Sources of obtaining
Audit Evidence
i) Internal source -
through accounting system, management, employees, underlying documentation
etc.
ii) External source -
third parties, i.e. suppliers, customers bankers legal advisers and other
parties
who have knowledge of
the enterprise.
82
Nature of Audit Evidence
i) Visual
ii) Oral
iii) Documentary
Reliability of Audit
Evidence - Generalizations
Following
generalizations are considered useful in assessing the reliability of audit
evidence (subject to
certain important
exceptions):
i) Audit evidence
obtained from independent sources outside the entity is more reliable.
ii) Evidence
generated internally is more reliable when related controls are effective.
iii) Evidence
obtained by an auditor directly is more reliable than that obtained indirectly
or by
interference e.g. Bank
balance confirmation certificate received by an auditor is more reliable than
the bank
statement obtained from
the management or observation of a control rather than making inquiry about the
application of a
control.
iv) Written evidence is
more reliable than oral representation.
v) Audit evidence
provided by original documents is more reliable than that provided by
photocopies and
facsimiles.
Other factors relating
to Audit Evidence
i) Information on which
audit procedures are based should be sufficiently accurate and
complete. Therefore,
auditor should also test the system for generating such information
while using it for his
procedures.
ii) Auditor’s reliance
increases when audit evidence obtained from one source is consistent
with another source; if
it is inconsistent further procedures may be performed.
iii) Cost of obtaining
the audit evidence is also considered when obtaining it.
iv) While forming an
audit opinion, the auditor does not have to examine all the items or
obtain all the evidences
which might be available. He can reach a conclusion by examining
a sample of such
transactions. He also relies on persuasive evidences. However, if evidence
is less than persuasive,
he does not consider it reliable.
Assertions in obtaining
Audit Evidence
(a) Assertions
about classes of transactions and events for the period under audit;
(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 proper period.
(v) Classification –
transactions and events have been recorded in the proper
accounts.
(b) Assertions
about account balances at the period end.
(i) Existence – assets,
liabilities, and equity interests exist;
(ii) Rights and
obligations – the entity holds or controls the rights to assets, and
liabilities are the
obligations of the entity;
(iii) Completeness – all
assets, liabilities and equity interests that should have been
recorded have been
recorded;
(iv) Valuation and
allocation – assets, liabilities, and equity interests are included in
the
financial statements at
appropriate amounts and any resulting valuation or
allocation adjustments
are appropriately recorded.
(c) Assertions
about presentation and disclosure:
(i) Occurrence and
rights and obligations – disclosed events, transactions and other
matters have occurred
and pertain to the entity;
(ii) Completeness – all
disclosures that should have been included in the financial
statements have been
included;
83
(iii) Classification and
understandability – financial information is appropriately
presented and described,
and disclosures are clearly expressed;
(iv) Accuracy and
valuation – financial and other information are disclosed fairly and
at appropriate
amounts.
Audit procedures for
obtaining audit evidence
Auditor performs audit
procedures to obtain an understanding of the entity, its environment and to
assess
risks of material
misstatement. Procedures are also applied to test operating effectiveness of
internal
controls and for
detection of material misstatements at assertion level.
The auditor always
performs risk assessment procedures to provide a satisfactory basis for
assessment of
risks at financial
statement level. In addition to these risk assessment procedures, which alone
are not
sufficient, the auditor
performs audit procedures in the form of tests of control and substantive
procedures.
Tests of controls are
applied when auditor expects to rely on operating controls. Through tests of
controls,
he tests the controls to
support the risk assessment. These are also applied when substantive procedures
alone do not provide
sufficient appropriate audit evidence.
Nature and timing of
audit procedures may be affected by the entity’s data retention policies or
their
practice to convert
source documents into computer images through scanning, means of communication
being used by the entity
e.g. electronic messaging rather than written purchase orders.
The auditor uses one or
more types of audit procedures described below:
(i) Inspection of
Records or Documents
It consists of
examining records or documents whether internal or external, in paper form,
electronic form,
or other media. Inspection provides evidence of varying degrees of reliability
depending on their
nature and source and in the case of internal records, on effectiveness of
controls over
their production.
(ii) Inspection of
Tangible Assets
It consists of
physical examination of the assets. It may provide reliable audit evidence of
their
existence cannot
necessarily about other assertions.
(iii) Inquiry
It means seeking
information of knowledgeable persons throughout the entity or outside the
entity.
Those may be
formal written or informal oral. It provides an auditor with new information or
corroborative
evidences. It may also bring to high information different from the one
possessed by
the auditor.
Certain oral inquiries might be got confirmed through written representations.
(iv) Confirmations
It is a specific
type of inquiry. It is the process of obtaining a representation of information
or an
existing condition
directly from a third party. Confirmations are sought from debtors, creditors,
bankers, legal
advisors etc.
(v) Recalculation
It consists of
checking the mathematical accuracy of documents or records. It can be performed
through use of
information technology.
(vi) Re-performance
It is the
auditor’s independent execution of procedures or controls that were originally
performed
as part of the
entity’s internal control, either manually or through the use of CAATs, for
example,
re-performing the
aging of accounts receivable.
(vii) Analytical
procedures
It consists of
evaluations of financial information made by a study of plausible relationship
among
both financial and
non-financial data. It includes investigation of significant fluctuations found
and
the relationship
that are inconsistent.
84
Lesson 23
SUFFICIENT APPROPRIATE
AUDIT EVIDENCE
AND
TESTING THE SALES SYSTEM
Recap:
Audit evidence includes:
the information contained in the accounting records underlying the financial
statements.
Audit evidence might
include:
• Documents (invoices,
credit notes, cash receipts)
• Accounting entries
(write down to NRV, depreciation)
• Answers from the
management (Provisions)
• Information from third
parties (banks, debtors)
• Computations
(depreciation, accruals, provisions)
• Observations
(inventory count)
Sufficiency: The
measure of quantity of audit evidence.
Appropriateness: The
measure of quality i.e. relevance
and reliability of
audit evidence.
Key questions for the
auditor to consider therefore will be:
1. Do I have enough
evidence to reach a conclusion on this audit area?
2. Is the evidence that
I have, reliable enough to, allow me to reach a conclusion on this area of
the
audit?
Assertions in obtaining
Audit Evidence
(a) Assertions about
classes of transactions
and events for the
period under audit;
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 (accruals &
depreciation);
iii. Accuracy – amounts
and other data relating to recorded transactions and events have been
recorded appropriately.
(valuation and estimations)
iv. Cutoff –
transactions and events have been recorded in the proper period.
v. Classification –
transactions and events have been recorded in the proper accounts.
(b) Assertions about
account balances
at the period end.
i. Existence – assets,
liabilities, and equity interests exist;
ii. Rights and
obligations – the entity holds or controls the rights to assets, and
liabilities are
the obligations of the
entity;
iii. Completeness – all
assets, liabilities and equity interests that should have been recorded
have been recorded;
iv. Valuation and
allocation – assets, liabilities, and equity interests are included in the
financial
statements at
appropriate amounts and any resulting valuation or allocation adjustments
are appropriately
recorded.
(c) Assertions about
presentation and disclosure
:
i. Occurrence and rights
and obligations – disclosed events, transactions and other matters
have occurred and
pertain to the entity;
ii. Completeness – all
disclosures that should have been included in the financial statements
have been included;
iii. Classification and
understandability – financial information is appropriately presented and
described, and
disclosures are clearly expressed;
iv. Accuracy and
valuation – financial and other information are disclosed fairly and at
appropriate
amounts.
Audit procedures for
obtaining Audit Evidence
The auditor uses one or
more types of audit procedures described below:
85
(i) Inspection of
Records or Documents
It consists of
examining records or documents whether internal or external, in paper form,
electronic form,
or other media. Inspection provides evidence of varying degrees of reliability
depending on their
nature and source and in the case of internal records, on effectiveness of
controls over
their production.
(ii) Inspection of
Tangible Assets
It consists of
physical examination of the assets. It may provide reliable audit evidence of
their
existence cannot
necessarily about other assertions.
(iii) Inquiry
It means seeking
information of knowledgeable persons throughout the entity or outside the
entity.
Those may be
formal written or informal oral. It provides an auditor with new information or
corroborative
evidences. It may also bring to high information different from the one
possessed by
the auditor.
Certain oral inquiries might be got confirmed through written representations.
(iv) Confirmations
It is a specific
type of inquiry. It is the process of obtaining a representation of information
or an
existing condition
directly from a third party. Confirmations are sought from debtors, creditors,
bankers, legal
advisors etc.
(v) Recalculation
It consists of
checking the mathematical accuracy of documents or records. It can be performed
through use of
information technology.
(vi) Re-performance
It is the
auditor’s independent execution of procedures or controls that were originally
performed
as part of the
entity’s internal control, either manually or through the use of CAATs, for
example,
reperforming the
aging of accounts receivable.
(vii) Analytical
procedures
It consists of
evaluations of financial information made by a study of plausible relationship
among
both financial and
non-financial data. It includes investigation of significant fluctuations found
and
the relationship
that are inconsistent.
TESTING THE SALES SYSTEM
Control Objectives
For many businesses,
sales are made on credit and so objectives for the sales cycle includes control
debtors
as well.
These control objectives
include:
a) Customers' orders
should be authorized, controlled and recorded in order to execute them
promptly
b) Goods shipped and
work completed should be controlled to ensure that invoices are issued and
revenue recorded for all
sales.
c) Goods returned and
claims by customers (for example, in respect of damaged goods) should be
controlled in order to
determine the liability for goods returned and claims received. .
d) Invoices and credits
should be appropriately checked for accuracy and should be authorized before
being entered in the
receivables' records.
e) Authorized customer
transactions, and only those transactions, should be accurately entered in the
accounting
records.
f) There should be
procedures to ensure that sales invoices are subsequently paid by customers and
that doubtful amounts
are identified in order to determine any provisions or write offs
required
Control procedures over
sales and debtors
There are a large number
of controls that may be required in the sales cycle due to the importance of
this
area in any business and
the possible opportunities that exist for diverting sales and cash receipts
away from
the business.
Typical control
procedures at key stages of the sales cycle are:
1. Orders
2. Dispatch
3. Invoicing and credit
notes
86
4. Returns inwards
5. Receivables
6. Bad Debts
(a) Orders
(i) Existing customers
should be allocated a credit limit and it should be ascertained whether this
limit
is to be exceeded if the
new order is accepted. If so the matter should be referred to credit control.
(ii) Any new customer
should be referred to the credit control department before the order is
accepted.
(iii) All orders
received should be recorded on pre-numbered sales order documents so that a
check can
be made that all orders
have been dealt with -a completeness check.
(iv) All orders should
be authorized before any goods are dispatched.
(v) The sales order
document should be used to produce a dispatch note for the goods outwards
department. No goods may
be dispatched without a dispatch note.
(b) Dispatch
(i) Dispatch notes
should be pre-numbered and a register kept of them to enable them to be matched
with relate to sales
invoices and customer orders.
(ii) Dispatch notes
should be authorized before goods leave the company.
(iii) Regular checks
should be made to ensure that all dispatches have been invoiced.
(c) Invoicing and Credit
Notes
(i) Sales invoices
should be authorized by a responsible official and matched with the authorized
order
and dispatch note.
(ii) All invoices and
credit notes should be entered In daybook records, the sales ledger, and sales
ledger control account.
Batch totals should be maintained for this purpose.
(iii) Sales invoices and
credit notes should be checked for prices. casts and calculations by a person
other than the one
preparing the invoice.
(iv) All invoices and
credit notes should be serially pre-numbered and regular sequence checks should
be carried out.
(v) Credit notes should
be authorized by someone unconnected with dispatch or sales ledger functions.
(vi) Copies of cancelled
invoices should be retained.
(vii) Any cancellation
of an invoice should lead to a cancellation of the related dispatch note.
(viii) Cancelled (and
free of charge) invoices should be signed by a responsible official.
(ix) Each invoice should
distinguish between different types of sales and, if relevant, different rates
of
VAT or sales tax. Any
coding of invoices should be periodically checked independently
(d) Returns
(i) Any goods returned
by the customer should be checked for obvious damage and, when accepted. a
document should be
raised.
(ii) All goods returned
should be used to prepare appropriate credit notes
(e)
Receivables/Debtors
(i) A receivables ledger
control account should be prepared regularly and checked to individual sales
ledger balances by an
Independent official.
(ii) Receivables ledger
personnel should be independent of dispatch and cash receipt functions.
(iii) Statements should
be sent regularly to customers.
(iv) Formal procedures
should exist for following up overdue debts which should be highlighted
either
by the preparation of an
aged list of balances or by the preparation of regular customer statements.
(v) Letters should be
sent to customers for collection of overdue debts. A policy should be in place
for
the Institution of legal
proceeds where appropriate.
f) Bad debts
(i) The authority to
write off a bad debt should be in writing. Appropriate adjustments should be
made to the sales ledger
and the control account
87
(ii) The use of court
action or the writing-off of a bad debt should be authorised by an official
independent of the cash
receipt function.
Tests of Control
Tests of control should
be designed to check that the control procedures are being applied and that
objectives are being
achieved. Tests may be appropriate under the following broad headings.
(a) Carry out sequence
test checks on invoices, credit notes, dispatch notes and orders. Ensure that
all
items are included and
that there are no omissions or duplications.
(b) Check the existence
of evidence for authorization in respect of:
i. acceptance of the
order (the creditworthiness check)
ii. dispatch of
goods
iii. raising of the
invoice or credit note
iv. pricing and
discounts
v. write-off of bad
debts.
Check both that the
relevant signature exists and that the control has been applied.
(c) Seek evidence of
checking of the arithmetical accuracy of:
i. invoices, including
pricing, and VAT and sales tax calculations
ii. credit notes,
This is often done by
means of a 'grid stamp' containing several signatures on the face of the
document.
Ensure that the control
has been applied by checking the accuracy of such invoices and credit
notes.
(d) Check dispatch notes
and goods returned notes to ensure that they are matched with invoices and
credit notes.
(e) Check that control
account reconciliations have been performed and reviewed.
In all cases, tests
should be performed on a sample basis.
88
Lesson 24
TESTING THE SALES SYSTEM
Control Objectives
For many businesses,
sales are made on credit and so objectives for the sales cycle includes control
debtors
as well.
These control objectives
include:
a) Customers' orders
should be authorized, controlled and recorded in order to execute them
promptly
b) Goods shipped and
work completed should be controlled to ensure that invoices are issued and
revenue recorded for all
sales.
c) Goods returned and
claims by customers (for example, in respect of damaged goods) should be
controlled in order to
determine the liability for goods returned and claims received. .
d) Invoices and credits
should be appropriately checked for accuracy and should be authorized before
being entered in the
receivables' records.
e) Authorized customer
transactions, and only those transactions, should be accurately entered in the
accounting
records.
f) There should be
procedures to ensure that sales invoices are subsequently paid by customers and
that doubtful amounts
are identified in order to determine any provisions or write offs
required
Control Procedures over
Sales and Debtors
There are a large number
of controls that may be required in the sales cycle due to the importance of
this
area in any business and
the possible opportunities that exist for diverting sales and cash receipts
away from
the business.
Typical control
procedures at key stages of the sales cycle are:
1. Orders
2. Dispatch
3. Invoicing and credit
notes
4. Returns inwards
5. Receivables
6. Bad Debts
(a) Orders
(i) Existing customers
should be allocated a credit limit and it should be ascertained whether this
limit
is to be exceeded if the
new order is accepted. If so the matter should be referred to credit
control.
(ii) Any new customer
should be referred to the credit control department before the order is
accepted.
(iii) All orders
received should be recorded on pre-numbered sales order documents so that a
check can
be made that all orders
have been dealt with -a completeness check.
(iv) All orders should
be authorized before any goods are dispatched.
(v) The sales order
document should be used to produce a dispatch note for the goods outwards
department. No goods may
be dispatched without a dispatch note.
(c) Dispatch
(i) Dispatch notes
should be pre-numbered and a register kept of them to enable them to be matched
with relate to sales
invoices and customer orders.
(ii) Dispatch notes
should be authorized before goods leave the company.
(iii) Regular checks
should be made to ensure that all dispatches have been invoiced.
(d) Invoicing and credit
notes
(i) Sales invoices
should be authorized by a responsible official and matched with the authorized
order
and dispatch note.
(ii) All invoices and
credit notes should be entered In daybook records, the sales ledger, and
sales
ledger control account.
Batch totals should be maintained for this purpose.
89
(iii) Sales invoices and
credit notes should be checked for prices. casts and calculations by a person
other than the one
preparing the invoice.
(iv) All invoices and
credit notes should be serially pre-numbered and regular sequence checks should
be carried out.
(v) Credit notes should
be authorized by someone unconnected with dispatch or sales ledger functions.
(vi) Copies of cancelled
invoices should be retained.
(vii) Any cancellation
of an invoice should lead to a cancellation of the related dispatch note.
(viii) Cancelled (and
free of charge) invoices should be signed by a responsible official.
(ix) Each invoice should
distinguish between different types of sales and, if relevant, different rates
of
VAT or sales tax. Any
coding of invoices should be periodically checked independently
(e) Returns
(i) Any goods returned
by the customer should be checked for obvious damage and, when accepted. a
document should be
raised.
(ii) All goods returned
should be used to prepare appropriate credit notes
(f)
Receivables/Debtors
(i) A receivables ledger
control account should be prepared regularly and checked to individual sales
ledger balances by an
Independent official.
(ii) Receivables ledger
personnel should be independent of dispatch and cash receipt functions.
(iii) Statements should
be sent regularly to customers.
(iv) Formal procedures
should exist for following up overdue debts which should be highlighted
either
by the preparation of an
aged list of balances or by the preparation of regular customer statements.
(v) Letters should be
sent to customers for collection of overdue debts. A policy should be in place
for
the Institution of legal
proceeds where appropriate.
g) Bad debts
(i) The authority to
write off a bad debt should be in writing. Appropriate adjustments should be
made to the sales ledger
and the control account
(ii) The use of court
action or the writing-off of a bad debt should be authorized by an official
independent of the cash
receipt function.
Tests of Control
Tests of control should
be designed to check that the control procedures are being applied and that
objectives are being
achieved. Tests may be appropriate under the following broad headings.
(a) Carry out sequence
test checks on invoices, credit notes, dispatch notes and orders. Ensure that
all
items are included and
that there are no omissions or duplications.
(b) Check the existence
of evidence for authorization in respect of:
iii. acceptance of the
order (the creditworthiness check)
iv. dispatch of
goods
v.
raising of the invoice
or credit note
vi. pricing and
discounts
vii. Write off debtors
as bad debts.
Check both that the
relevant signature exists and that the control has been applied.
(c) Seek evidence of
checking of the arithmetical accuracy of:
viii. invoices,
including pricing, and VAT and sales tax calculations
ix. credit notes,
This is often done by
means of a 'grid stamp' containing several signatures on the face of the
document.
Ensure that the control
has been applied by checking the accuracy of such invoices and credit
notes.
(d) Check dispatch notes
and goods returned notes to ensure that they are matched with invoices
and
credit notes.
(e) Check that control
account reconciliations have been performed and reviewed.
In all cases, tests
should be performed on a sample basis.
90
Lesson 25
TESTING THE PURCHASES
SYSTEM
Control Objectives
Purchases are often made
on credit and so the purchases cycle includes payables. You also need to bear
in
mind that 'purchases'
has a wide meaning in terms of the purchases cycle as purchases will include
not only
inventory items but also
all types of expense and the purchase of non current assets.
The control objectives
are as follows. To ensure that:
e) Purchased
goods/services are ordered under proper authority and using proper procedures
f) Purchased
goods/services are only ordered as necessary for the proper conduct of the
business
operations and are
ordered from suitable, approved suppliers
g) Goods/services
received are inspected for quality, quantity and description
h) Invoices and related
documentation are properly checked and approved as being valid before
being entered as trade
creditors
i) All valid
transactions relating to payables (suppliers' invoices, credit notes and
adjustments), and
only those transactions,
should be accurately recorded in the accounting records.
Control Procedures over
Purchases and Payables
As with the sales system,
there are a large number of controls that may be required in the purchases
cycle
due to the importance of
this area in any business and once again, the following list is classified by
type of
control.
(a)
Orders
(i) Requisition notes
for purchases should be authorized.
(ii) All orders should
be authorized by a responsible official whose authority limits should
be pre-defined.
(iii) Major items e.g.
capital expenditure, should be authorized at an appropriate level,
possibly by the Board of
Directors
(iv) All orders should
be recorded on official documents showing suppliers' names,
quantities ordered and
price.
(v) Copies of orders
should be retained as a method of following up late deliveries by
suppliers.
(vi) Re-order levels and
quantities should be pre-set and preferably recorded in advance on
the requisition note.
(b)
Receipt of goods
(i) Goods inwards areas
should be identified to deal with the receipt of all goods.
(ii) All goods should be
checked for quantity, quality and description. Goods received
notes should be raised
for all goods accepted. The GRN should be signed by a
responsible
official.
(iii) GRNs should be
checked against purchase orders and procedures should exist to
notify the supplier of
under or over-deliveries. GRNs should be sequentially
numbered and checked
periodically for completeness.
(c)
Invoicing and returns
(i) Purchase invoices
received should be stamped with an approval grid and given a
unique serial number to
ensure purchase invoices do not go astray.
(ii) Purchase invoices
should be matched with goods received notes and company orders
and should not be
processed until this is done.
(iii) The invoice should
be checked against the order and the GRN, and casts and
extensions should also
be checked.
(iv) The invoices should
be signed as approved for payment by a responsible official
independent of the
ordering and receipt of goods functions.
(v) Invoice sequential
numbers should be checked against purchase day book details.
(vi) Input VAT should be
recorded separately from the expense element of the invoice
total.
91
(vii) Invoices should be
properly allocated to the nominal ledger accounts, perhaps by
allocating expenditure
codes. A portion of such coding should be checked
independently.
(viii) Batch controls
should be maintained over the posting of invoices to the purchases day
book, nominal ledger and
purchase ledger.
(ix) A record of goods
returned should be kept and checked to the credit notes received
from suppliers.
(d)
Purchase ledger and suppliers
(i) A payables ledger
control account should be maintained and regularly checked
against balances in the
purchase ledger by an independent official.
(ii) Payables ledger
records should be kept by persons independent of the receiving of
goods, invoice
authorization and payment routines.
(iii) Statements from
suppliers should be checked against the ledger account.
TESTS OF CONTROL
As already noted, tests
of control should be drawn up so as to check that control procedures are being
applied and to achieve
control objectives. One suggested way to design tests of control for a
particular
situation is to list the
documents in a transaction cycle and generate appropriate tests of control for
each
document. We shall
illustrate this approach here in connection with the purchases cycle (Note that
a similar
technique could be applied
to other transaction cycles!)
Post a Comment
Don't Forget To Join My FB Group VU Vicky
THANK YOU :)