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

First of all, understand these terms:

Control risk: The entity / individual have the objective of producing accurate and effective reports by establishing internal controls. Some examples of control activities and specific procedures that should exist in an appropriate control environment:

• Segregation of functions

• Appropriate documents and records

• Physical control of assets and records

Tests of Control: If an entity is small and has a limited segregation of functions, it is unlikely that an auditor will plan to rely on controls and test them as a verification procedure. If a control relevant to the audit is identified, testing must be performed to confirm that the control is effective. This is demonstrated through control documentation and appropriate verification tests. Like observations, research and walkthroughs.

Substantive procedures: Substantive procedures must be performed if the control tests establish that:

• Controls do not work effectively

• They do not exist

• The auditor has established that a substantial approach is more effective or efficient.

Tests of detail: Tests of detail involve checking the source documentation of the elements.

The appropriate tests for the ending balance in cash accounts largely depend on the initial assessment of control risk, tests of controls and substantive tests of transactions for cash receipts. The corporate checks over cash receipts help the auditor to establish that the cash received quickly deposited, the registered receipts are adequate, that the customer accounts are updated quickly and cut off cash at the end of the year is correct.

If the results of the internal control evaluation, the test of controls and substantive tests of transactions are appropriate, it is appropriate to reduce the tests of details of cash balances, in particular for the detailed evidence of bank reconciliations.

 On the other hand, if the test indicates that the customer's checks are weak, it may require extensive year-end examinations.

An example in which the conclusions reached with regard to checks on cash outflows affect cash balances could be:

If controls on the issue of blank checks, review of beneficiaries, amounts and supporting documentation, signing checks and reconciliation bank statements and supplier statements are adequate, the review by the auditor of outstanding checks on bank reconciliation at the end of year can be significantly reduced. Checks issued at the end of the year can be verified by analyzing a check sample returned with the bank statement, instead of tracing all outstanding paid checks and the final monthly checks in the cash disbursements journal to the last month’s cleared checks and bank reconciliation.