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MGMT 138 Study Guide - Final Guide: Engagement Letter, Quality Control, Kpmg

Course Code
MGMT 138
Patricia Wellmeyer
Study Guide

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Mgmt 138 Final review
o Effective internal control requires that:
o Each of the five components of internal control and relevant principles are present and
functioning together in an integrated manner
o Control environment - overall context of control process.
o Risk assessment - identification, sourcing and evaluation of threats.
o Control activities - policies and procedures to reduce likelihood that risk will exceed
acceptable limits.
o Information and communication - systematic transfer of information within and outside the
o Monitoring - analysis of functioning of other components of internal control.
o Steps for Evaluating Internal Control Design and Effectiveness
1. Plan/scope the evaluation
Consider the complexity of the system, determine materiality, assess control
2. Evaluate aageet’s docuetatio ad testig
Management documentation of control designed to prevent fraud
3. Obtain an understanding of internal controls:
Use narratives, flowcharts, questionnaires, walkthroughs to Identify significant
account balances and relevant assertions
Evaluate design of controls for effectiveness in preventing material misstatements.
Preventive controls: intended to prevent the occurrence of an activity that is
not consistent with control objectives (i.e. reduce risk).Examples: Separating
approval and payment to vendor; limiting access to IT systems.
Detective controls: intended to identify errors or unauthorized activities after
they have occurred so that corrections can be made in a timely
manner.Examples: Reconciliations; performance monitoring (budgets,
Identify entity-level and process level controls to test based on the above
Entity Controls: Controls set to advance effectiveness of organization and its
processes, promote synergies, and mitigate risks
Process Controls: Control activities that are performed as part of the various
processes within the organization.
o Processing controls (general and application)
o Physical controls
o Segregation of duties
o Compensation controls
4. Assess control risk for financial reporting assertions.
Identify Audit Objective/Assertion
Associate control risk with audit objective
Assess control risk
Design and execute audit process
5. Test effectiveness of internal control
Inquiry of client personnel
Inspection of documents and reports indicating performance of policies and
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Observation of application of controls
Reperformance by auditor of policies and procedures to a sample of transactions or
6. Evaluate results of control tests.
Classifications of deficiencies
Immaterial deficiency:
Significant deficiency: more than remote possibility controls would not
detect fraud or errors, but compensating controls exist and no material
misstatements are likely to occur
Material weakness: more than a remote likelihood that controls will fail to
prevent or detect material misstatement on financial statements
o The Fraud Triangle:
1. Pressure: when company management feels pressure from inside or outside the company
to meet earnings targets or a certain level of growth
2. Opportunity: when an individual believes that internal controls are weak or not designed to
prevent fraud and can be overridden
3. Rationalization: when an individual believes that their actions to commit fraud can be
o dual-purpose procedure: An audit procedure that simultaneously serves the substantive
purpose (obtain direct evidence about the dollar amounts in account balances) and the testof
controls purpose (obtain evidence about the company’s performance of its own control
o sales cutoff tests: The tests that ensure that sales are recorded in the proper period
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