Question

Question 7: Understanding & Testing Internal Controls
You are the manager on the audit of Pix Ltd for the year ended 30 September 2016. You are briefing your team to ensure that they have a proper understanding of the work to be done before they start.
Required:
a) Briefly explain the importance of internal controls to both the entity and the auditor?
b) Briefly explain any three limitations of internal controls?
c) Briefly explain how an ‘Integrated Test Facility’ is used and why it is only a test of controls not a substantive test?
d) Identify one method of documenting the auditors understanding of an internal control system? (1 mark)

Answer 1

IMPORTANCE OF THE INTERNAL CONTROL SYSTEM

1) Internal control system helps the entity to reduce the risk of error. In an internal control system the work of an employee is checked by the other and cross checking helps to reduce the frequency of errors.

2) it’s also helps of detection of fraud. As the work responsibility is segregated among employees, the chances of the fraud is reduced.

3) The strong internal control system create systematic working environment among employees so that smooth and hassle free activities can be carried out. Employees need to follow the protocol lay down for day to day activities.

For auditors it is extremely important to understand thoroughly the internal control system. AS much strong the internal control system , that much auditor can rely upon facts presented and need not to go deep in the matter.

Lack of strong internal control system ,auditor need to do his work in details. Inefficiency of internal control system does not reduce the responsibility of the auditor.

Limitation of internal control system

1. The basic concept of checking the work of one employee by the other creates the strong internal control system. But lack of segregation any of thea work can cause lack of internal control system.
2. It may possible the employees among whom responsibility is distributed join to do the fraud.
3. Limitation of human mind also weakens the internal control system. Employee need to understand how the internal control system works and how they can make it improved. Human errors can still be there formed to find the errors and fraud. Errors can be done be the person crosscheckin the work of the other person.

Integrated test facility:- ITF is the IT tool to check the integrity of the transaction processed in the system. A dummy entity is created in an application and data is taken from the live system entries. This Application is integrated with the actual system of real entries to validate its correct operations. ITF checks whether the actual process as per standard lay down is followed or not. Result of the dummy is crosschecked with the actual one reuslts. But all these test checking works on the level of entries in the system. Yet ITF cannot find the actual operation carried out or deviated at the operation level which has actual weightage.

‘4) internal control questionnaire:- it is important tool through which the auditor understand the limits and controls of the internal control system. This is structured approach through simple questions of the auditor to understand the internal control system of the entity. Questions are usually to be answerable through “yes” or “ No” answers. Auditors try to find the system gap, strength and weakness of the internal control System.