Question

Discuss the relationships among the initial assessed control risk, test of controls, and substantive tests of transactions for cash disbursements, and the tests of details of cash balances. Provide one example in which the conclusions reached about internal controls in cash disbursements will affect the tests of cash balances.

Answer 1

RELATIONSHIP BETWEEN INITIAL ASSESSED CONTROL RISK , TEST OF CONTROLS & SUBSTANTIVE TESTS OF CASH DISBURSEMENTS & TEST OF DETAILS OF CASH BALANCE :

1. Control Risk :It is a risk that material misstatemnt will not be prevented / detected / corrected on timely basis by internal control system.

2. Test of Controls : Test of control are performed to obtain audit evidence that :

• Internal Control are suitably design to prevent , detect , correct material misstatement.
• Internal Control are operational through out the year.

3. Substantive test : These are the procedure which provide audit evidence about completeness , validity & accuracy of information contained in records

4. Test of Details. : Test of Details means tracing figures from source document . It includes testing by picking a sample of transactions to test to see if account balance is misstated

Relationship between above in case of Cash disburement & Cash Balances;

• If there is HIGH control risk in cash disbursement then MORE test of controls , substantive testing & test of details have to be performed on cash balances.
• If there is LOW control risk in cash disbursement then LESS test of controls , substantive testing & test of details have to be performed on cash balances.

EXAMPLE:

In a company Internal Control on Cash disburesement is weak i.e there is no proper approvals & permissions to be taken for cash disbursement ,hence the control risk is high & chances of misappropriation of cash is high. For Example the Credit Manager Mr A. himself approves payment & also make cash disbursement .

In the above case the test of cash balances has to be done in details so that each & every transaction is checked so that the risk created by weak internal control of cash disbursement on cash balances can be minimised.