Modern
Modern Auditing:
Auditing:
Assurance
Assurance Services
Services and
and the
the Integrity
Integrity
of
of Financial Reporting, 8th Edition
Financial Reporting, 8 th
Edition
William C. Boynton
California Polytechnic State
University at San Luis Obispo
Raymond N. Johnson
Portland State University
Chapter 10 – Understanding Internal Control
Chapter
Chapter 10
10 Overview
Overview
Fundamental
Fundamental Concepts
Concepts of
of
Internal
Internal Controls
Controls
• Process integrated with an entity’s
infrastructure
• People implement internal control
• Can only provide reasonable assurance
• Achieve objectives in financial reporting,
compliance, and operations
Components
Components of
of Internal
Internal Control
Control
• Control Environment
• Risk Assessment
• Control Activities
• Information and Communication
• Monitoring
Entity
Entity Objectives
Objectives with
with Internal
Internal
Control
Control
• Reliability of financial information
• Compliance with applicable laws
and regulations
• Effectiveness and efficiency of
operations
Limitations
Limitations of
of Internal
Internal Control
Control
• Mistakes in Judgment
• Breakdowns
• Collusion
• Management Override
• Cost versus Benefits
Roles
Roles and
and Responsibilities
Responsibilities
• Management
• Board of Directors and Audit
Committee
• Internal Auditors
Roles
Roles and
and Responsibilities
Responsibilities (cont.)
(cont.)
• Other Entity Personnel
• Independent Auditors
• Other External Parties
Components
Components of
of Internal
Internal Control
Control
Control
Control Environment
Environment
• Integrity and Ethical Values
• Commitment to Competence
• Board of Directors and Audit
Committee
• Management’s Philosophy and
Operating Style
Control
Control Environment
Environment (cont.)
(cont.)
• Organizational Structure
• Assignment of Authority and
Responsibility
• Human Resource Policies and
Practices
Risk
Risk Assessment
Assessment Process
Process
Information
Information and
and Communication
Communication
• Information
– Transactions
– Audit Trail or Transaction Trail
– Documents
– Records
• Communication
Control
Control Activities
Activities
• Authorization Controls
• Segregation of Duties
– Transaction authorization
– Custody of assets
– Recorded accountability in accounting
records
Segregation
Segregation of
of Duties
Duties
Control
Control Activities
Activities (cont.)
(cont.)
• Information Processing Controls
– General Controls
– Computer Application Controls
– Controls over the Financial Reporting
Process
General
General Controls
Controls
• Organization and Operation Controls
• Systems Development and
Documentation Controls
• Hardware and Systems Software Controls
• Access Controls
• Data and Procedural Controls
Computer
Computer Application
Application Controls
Controls
• Input Controls
• Processing Controls
• Output Controls
Controls
Controls over
over the
the Financial
Financial
Reporting
Reporting Process
Process
Control
Control Activities
Activities (cont.)
(cont.)
• Physical Controls
• Performance Reviews
• Controls over Management
Discretion in Financial Reporting
Control
Control Activities
Activities (cont.)
(cont.)
• Monitoring
– Ongoing monitoring programs
– Separate evaluations
– Element of reporting deficiencies to
the audit committee
Antifraud
Antifraud Programs
Programs and
and Controls
Controls
Understanding
Understanding Internal
Internal Control
Control
Must perform procedures to:
• Understand design of policies and
procedures
• Determine whether the policies and
procedures are operating
Understanding
Understanding Internal
Internal Control
Control
Auditor uses the understanding to:
• Identify types of potential
misstatements
• Understand factors affecting risk of
material misstatement
• Design further audit procedures
Effects
Effects of
of Preliminary
Preliminary Audit
Audit
Strategies
Strategies
• Control Environment
• Risk Assessment
• Information and Communication
• Control Activities
• Monitoring
Procedures
Procedures to
to Obtain
Obtain an
an
Understanding
Understanding
• Review previous experience with the
client
• Inquire management, supervisory, and
staff personnel
• Inspect documents and records
• Observe activities and operations
• Trace transactions through system
Documenting
Documenting the
the Understanding
Understanding
• Questionnaires
• Flowcharts
• Decision Tables
• Narrative Memoranda
Questionnaire
Questionnaire
Decision
Decision Table
Table
Narrative
Narrative Memoranda
Memoranda
