Bus 426 - Chapter 9

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Business Administration
BUS 426
Michael Favere- Marchesi

Chapter 9 Internal Controls and Control Risk  Internal Control: The policies and procedures instituted and maintained by the management of an entity in order to provide reasonable assurance that management’s objectives are met   Three Objectives in Designing an Effective Internal Control System 1. Reliability of Financial Reporting 2. Efficiency and Effectiveness of Operations 3. Compliance with Laws and Regulations Management’s Objective in Designing Effective Internal Control 1. Maintaining reliable control systems 2. Safeguarding assets 3. Optimizing the use of resources 4. Preventing and detecting fraud and error What the Auditor is Interested in  Testing the controls related to the reliability of the financial reporting  Testing the control over the classes of transactions o Transaction-related Audit Objectives: Six audit objectives that must be met before the auditor can conclude that the total for any given class of transactions is fairly stated Transaction-Related Objectives Specific Sales Transaction Obj. Occurrence Sales are made to nonfictitious clients Completeness Existing sales transactions are recorded Accuracy Recorded sales are correctly recorded Classification Sales transactions are properly classified Posting and Summarization Sales transactions are included in the data files and summarized Timing Sales are recorded on the correct dates  Considering the whole picture of the client’s internal controls 3 Basic Concepts of an Internal Control System  Management must establish and maintain the entity’s controls  The internal controls should provide reasonable, but not absolute, assurance that the financial statements are fairly stated  Controls cannot be regarded as completely effective o For example, employees may engage in a collusion, where a bunch of employees defraud a business of its assets, they could manipulate the controls 5 Components Management should Design to Provide Reasonable Assurance for its Internal Controls Chapter 9 -Internal Controls and Control Risk   Control Environment: The actions, policies and procedures that reflect the overall attitudes of top management, directors, and owners of an entity about control and its importance to the entity  Active integrity and promotion of ethical values  Commitment to Competence  Board of Directors or Audit Committee Participation  Management Philosophy and Operating Style  Organizational Structure  Human Resource Policies and Practices  Methods of Assignment Authority and Responsibility  Management Control Methods: Methods management uses to supervise the entity’s activities  Systems Development Methodology  Management Reaction to External Influences  Internal Audit  Risk Assessment: Management’s identification and analysis of risks relevant to the preparation of financial statements in conformity with GAAP  Control Activities (Application Controls): Policies and procedures that help ensure that necessary actions are taken to address risks in the achievement of the entity’s objectives  Adequate segregation of duties i. Separation of Duties: Custody of assets, recording/data entry, systems development/acquisition and maintenance, computer operations, reconciliation and authorization  Proper authorization of transactions and activities Chapter 9 -Internal Controls and Control Risk i. General and Specific authorizations  Adequate documents and records i. Numbered consecutively ii. Prepared right when the transaction happens or asap iii. Simple yet detailed to understand iv. Forms designed for multiple use to minimize the use of different forms v. Constructed in a way that encourages correct preparation vi. Chart of Accounts: A listing of all the entity’s accounts which classifies transactions into individual balance sheet and income statement accounts vii. Accounting System (Application/Functional System): The set of manual and/or computerized procedures that collect, record and process data and report the resulting information viii. General Controls: Internal controls for automated information systems  Physical and logical control over assets and records  Independent checks of performance and recorded data i. Independent Checks: Internal control activities designed for the continuous internal verification of other controls  Information and Communication: Initiate, record, process and report the entity’s transactions and to maintain accountability for the related assets  To understand the design of the accounting information system, auditor must know: o The major classes of transactions of the entity o How those transactions are initiated and recorded o
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