Question

Discuss the importance of understanding internal control in developing an effective audit program. In that context, include in your discussion a general overall position and specifically the internal control questionnaires for either the Revenue and collection Cycle or Production (Inventory) Cycle, which also includes internal control over Inventory Transaction Processing. Matters such as seperation of duties should be part of your response.

Include in your answer several (3 would be enough) important considerations to satisfy sound internal control for each of the five assertions: OCCURRENCE, COMPLETENESS, ACCURACY, CUTOFF AND CLASSIFICATION.

Answer 1

IMPORTANCE OF UNDERSTANDING INTERNAL CONTROL IN DEVELOPING AUDIT PROGRAM

Internal control, as defined in accounting and auditing, is a process for assuring achievement of an organization's objectives in operational effectiveness and efficiency, reliable financial reporting, and compliance with laws, regulations and policies. A broad concept, internal control involves everything that controls risks to an organization.

An internal control questionnaire provides evidence that a document or financial database exists, For example, a questionnaire may ask whether the company keeps a chart of its accounts. The auditor can then ask where the chart of accounts is located if it exists, or design the audit to operate without it. If an employee mentions that the chart of accounts exists and does not know where it is located, that may provide evidence that the company does not keep good records so the auditor should perform a more thorough audit.

Auditors can define general areas of concern when creating an internal control questionnaire, so it can be used when auditing other departments or companies. For example, an auditor can create a document that assigns high risk to inventory records when a company controls valuable inventory which is not monitored frequently, or low risk when the inventory is not valuable or specialized.

An internal control questionnaire examines the effectiveness of a board of directors. The internal questionnaire asks questions such as whether the directors of the organization monitor accounts receivable records, or whether the directors receive financial reports from the organization and examine them.

Internal controls are broadly defined into one of two categories: preventative or detective. Preventative internal controls are policies and procedures that do not allow certain events to occur. Preventative internal controls are proactive and the first line of defense in a financial accounting system. Detective internal controls are the backup procedures that ensure the preventative internal controls are operating as intended. Items or events missed by the first line of defense have the potential to be caught by this second set of controls.