Consideration of Internal Control in a Financial Statements Audit
9.The documentation of the auditor’s understanding must provide clear evidenceof support for the auditor’s conclusions regarding the assessed level of controlrisk. This is especially necessary if control risk is assessed below the maximumlevel. The documentation at this point typically consists of some combination of narrative memoranda, questionnaires or checklists, and internal controlflowcharts, as well as documentation of the auditor’s conclusions, and thereason(s) for assessing control risk below maximum, if applicable.10.Testing of internal financial controls may permit the auditor to further reduce theassessed level of control risk. This, in turn, should lead to a decrease in thenature, timing, and/or extent of substantive audit testing in the circumstances.11.The following factors may cause the auditor to decide not to test the client’sinternal financial controls beyond obtaining an initial understanding:a.Controls may already have been evaluated as ineffective; b.Further testing is not cost effective (i.e., the cost of further testing isgreater than the cost savings resulting from reduced substantive testing)12.Some combination of the following means is typically utilized by the auditor intesting a client’s internal financial controls:a.Reprocessing transactions through the client’s system; b.Observation of controls; andc.Document examination and testing.13.
is a form of financial statement misstatement caused byintentional efforts by management to distort reported financial position and/or results of operations.
is a form of fraud whereby one or moreemployees effect a transfer of assets from employer to employee, accompanied by concealment in the form of account or substance alteration.14.The following are some examples of internal control weaknesses and suggestedexpanded substantive testing, given the weaknesses:a.Perpetual inventory records not maintained: Expand test counts duringinventory observation b.Bank accounts not reconciled: Expand year-end audit of cash accountsc.Customer exceptions to monthly statements not investigated andcleared: Expand accounts receivable confirmation at year-end.15.Reportable conditions are matters coming to the auditor’s attention, as a result of his/her study and evaluation of the client’s internal financial controls, relating tosignificant deficiencies in the design or operation or of the internal controls thatcould adversely affect the organization’s ability to record, process, summarize,and report financial data consistent with the assertions of management in thefinancial statements. The purpose of the reportable conditions letter is to inform