Question

1. Explain what “internal controls” are and how they relate to the audit. What effect do internal controls have on the job of the independentauditor?Your answer should discuss the relationship between internal controls and the financial statements. In answering your questions, consider whether good internal controls contribute to the accuracy of financial statements. On the other hand, explore the possibility that financial statements can be accurate even if internal controls are poor. You may give an example of an internal control procedure.

2. Commonly misunderstood facts about a corporate audit of financial statements:

Terrible internal controls will result in a bad audit opinion.

A client that violates the law will result in a bad audit opinion.

A client that has a terrible business will result in a bad audit opinion.

In one or two sentences, explain why each of the following statements areuntrue.

Terrible internal controls will result in a bad audit opinion.

A client that violates the law will result in a bad audit opinion.

A client that has a terrible business will result in a bad audit opinion.

In addition to the textbook, you may want to take the multiple-choice quiz first. After you submit your answers I will provide you with the answer key. Then read the explanations to the answers, particularly on internal controls, to gain further insight.

Answer 1

1. Internal Controls: The Turnbull Report defines Internal control as the "policies, processes, tasks, behaviours and other aspects of an organisation is taken together."

The purpose of internal control is to facilitate effective and efficient operation of an organisation by enforcing compliance to the daily operations of the business and help the organisation achieve its objectives.It also ensures quality of internal and external reporting, by maintaining proper records and processes which enables smooth flow of reliable information from both internal and external sources.

Internal Control is set up in the organisation to ensure that the records are maintained as per compliancce with the standards. Make sure that each transactions are supported by legitimate documentary evidences, It reviews accounting and internal control system, examine financial and operating information. Hence the external auditor's job is made easy, because it already checks for the accuracy and reliability of financial records. It reduces the burden of the independent auditor by filtering the irrelevant information.Highlighting the redflags.

Even if the internal control is poor, the financial statements can be accurate, but there stands possibility that the management may try to somehow manipulate the financial statements within the norms of the accounting standards and regulations. With proper internal controls, the possibility reduces to very low. Also a weak internal control may not highlight the area of concern, or say red flags, which may be very useful for the independent auditor to make a valid judgement on the reliability of the financial statements. It has happened in the case of Enron, where poor internal control system kept on deceiving the independent auditor for years.

2. Terrible internal controls will result in a bad audit opinion.

Terrible internal controls may result to manipulative financial statements, but the job of an auditor is to make sure that the financial statements are accurate, as per the compliance to regulations and accounting standards, and in the interest of the stakeholders. Even if the internal control is not in place, its no excuse for the auditor to publish a bad audit report. The auditor's job is to make wise judgement, based on the financial records and not on the basis of internal control system. Internal controls may help the auditor, but its not the only base on the basis of which the auditor will pass the judgement.

A client that violates the law will result in a bad audit opinion:

If the client violates the law, it will be a legal matter, and will be dealt in the court of law. Its the task of the auditor to investigate and find out the flaws and violations, and publish a valid audit opinion.

A client that has a terrible business will result in a bad audit opinion.

A client may have a terrible business, and it may increase the burden of auditor, but it can in no way hamper the audit opinion. Business has nothing to do with the authenticity and accuracy of the financial statements. The auditor is to pass judgement on accuracy of the financial statements and not on the nature of business.

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