COLEGIO DE LA PURISIMA CONCEPCION

School of the Archdiocese of Capiz

Roxas City

COLLEGE OF BUSINESS, MANAGEMENT AND ACCOUNTANCY

1st Semester A.Y. 2020-2021

Auditing and Assurance Principles (Pr E 1)

Module 7
Internal Control/
Accounting Transaction Cycles

Auditor’s Consideration of Internal Control

The primary purpose of the auditor’s study and evaluation of internal control is to provide an auditor with the
knowledge necessary to (1) plan the audit and (2) assess control risk (which leads to the auditor’s determination of the
nature, timing and extent of tests to be performed).

Its secondary purpose is to inform the management concerning significant deficiencies in internal control (reportable
conditions).

STEPS IN ACCOUNTING AND INTERNAL CONTROL ASSESSMENT

1. Obtain understanding of internal control.

2. Make a preliminary assessment of the risk of material misstatement (inherent and control risks).
3. Determine the procedures to perform in response to assessed risks.
4. Revise the preliminary risk assessment, if necessary.
5. Finalize the audit strategy, audit plan and audit program.

Obtain Understanding of Internal Control

In the audit of financial statements, the auditor is only concerned with those policies and procedures within the
accounting and internal control systems that are relevant to the financial statement assertions. The understanding of
such systems will enable the auditor to

1. Identify the types of potential material misstatements that could occur in the financial statements.
2. Consider the factors that affect the risk of material misstatements.
3. Design the nature, timing and extent of further audit procedures.

Obtaining an understanding of internal control involves evaluating the design of a control and determining whether it
has been implemented or placed in operation.

Procedures in obtaining an understanding of an entity’s internal control:

1. Inquiries of appropriate company personnel,
2. Inspection of documents and records.
3. Observation of company activities and operations.
4. Walk-through – tracing a transaction from the first step to the last step of the cycle, the objective of which is to test
the accuracy and completeness of the auditor’s working papers regarding internal control documentation.

Documenting the Understanding

1. Narrative Memorandum (Description)
2. Flowchart.
3. Internal Control Questionnaires.
4. Checklists.
5. Decision Tables.

Make a Preliminary Assessment of the Risk of Material Misstatement

The preliminary assessment of control risk is the process of evaluating the effectiveness of an entity’s accounting and
internal control systems in preventing or detecting and correcting material misstatements. The auditor should make
preliminary assessment of control risk, at the assertion level, for each material account balance or class of transactions.

An auditor may assess control risk at a high (maximum) level or less than high (below maximum) level:

1. The auditor normally assesses control risk at a high level for some or all assertions when:
a. The entity’s internal control are ineffective. Wala na sang test control

Course Facilitator: Alberth Justine de la Cruz Balgos, CPA

 COLEGIO DE LA PURISIMA CONCEPCION
School of the Archdiocese of Capiz
Roxas City

b. Evaluating the effectiveness of the entity’s internal controls would not be efficient.

2. The auditor may assess control risk at a less than high level when the auditor:
a. Is able to identify internal controls relevant to the assertion which are likely to prevent or detect.
b. Plans to perform tests of control to support the assessment. Combination of test contro and substantive
procedures - DIRECT RELATIONSHIP

Determine the Procedures to Perform in Response to Assessed Risks

After making a preliminary assessment of the risk of material misstatement, the auditor should determine the following:
1. Overall Response. To address the risks of material misstatement at the financial statement level.
2. Audit Procedures Response to Risks of Material Misstatements at the Assertion Level. Design and perform further
audit procedures to address the risks of material misstatements at the assertion level.

Preliminary Control Risk

Response
Assessment
High  No test of controls will be performed.
 The auditor should instead rely entirely on substantive procedures.
Less than High  Performing combination of test of controls and a decreased scope of substantive
procedures is likely to be more effective than performing extensive substantive
procedures.

As mentioned earlier, the auditor should document his understanding of the entity’s internal controls. In addition, the
auditor should also consider the following documentation:
Control Risk Assessment of Control Risk Basis for the Assessment
High Yes No
Less than high Yes Yes

Tests of controls consist of audit procedures performed to obtain evidence about the effectiveness of the:

1. Design of the accounting and internal control systems, that is, whether they are suitably designed or not.
2. Operation of the internal controls throughout the period.

Tests of controls usually include

1. Inquiries of the client personnel
2. Inspection of documents and reports
3. Observation of employees performing the policy and procedures
4. Reperformance of policies and procedures performed previously by the client
5. Walk-through test

Inquiries and observation are usually performed on controls which leave no audit trail. An audit trail is a chain of
evidence provided through coding, cross references, and documentation connecting account balances and other
summary results with original transactions and calculations.

Revise the Preliminary Risk Assessment, if Necessary

Based on the results of tests of controls, the auditor should evaluate whether the internal control are designed and
operating as contemplated in the preliminary assessment of the control risk. The evaluation of deviations may result in
the auditor concluding that the assessed level of control risk needs to be revised. In such cases, the auditor would
modify the nature, timing and extent of planned substantive procedures. LESS THAN HIGH LEVEL

Management letter- secondary product

Finalize the Audit Strategy, Audit Plan and Audit Program

This stage involves the determination of the nature, timing and extent of substantive procedures to be performed by the
auditor.
 Nature – the purpose and type of audit procedures to be performed.
 Timing – when audit procedures are performed or the period or date to which the audit evidence applies.
 Extent – the extent of a specific audit procedure to be performed.

Communicating with those Charged with Governance and Management

Course Facilitator: Alberth Justine de la Cruz Balgos, CPA

 COLEGIO DE LA PURISIMA CONCEPCION
School of the Archdiocese of Capiz
Roxas City

The auditor is required to obtain an understanding of internal control relevant to the audit when identifying and
assessing the risks of material misstatement. In making those risk assessments, the auditor considers internal control in
order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of internal control. The auditor may identify deficiencies in the internal control not only
during this risk assessment but also at any other stage of the audit.

The objective of the auditor is to communicate appropriately to those charged with governance and management the
deficiencies in internal control that the auditor has identified during the audit and that, in the auditor’s professional
judgement, are of sufficient importance to merit their respective attentions.

Deficiency in internal control – This exists when

a. A control is designed, implemented or operated in such a way that is unable to prevent, or detect and correct,
misstatements in the financial
b. A control necessary to prevent, or detect and correct, misstatements in the financial statements on a timely basis is
missing.

Significant deficiency in internal control – A deficiency or combination of deficiencies in internal control, that in the
auditor’s professional judgement, is of sufficient importance to merit the attention of those charged with governance.

The auditor shall communicate in writing significant deficiencies in internal control identified during the audit to those
charged with governance on a timely basis.

The auditor should also communicate to management at an appropriate level of responsibility on a timely basis:

a. In writing, significant deficiencies in internal control that the auditor has communicated or intends to communicate to
those charged with governance, unless it would be inappropriate to communicate directly to the management in the
circumstances; and
b. Other deficiencies in internal control identified during the audit that have not been communicated to management by
other parties and that, in auditor’s professional judgement, are of sufficient importance to merit management’s
attention.

The auditor shall include in the written communication of significant deficiencies in internal control:

a. A description of the deficiencies ad an explanation of their potential effects: and

b. Sufficient information to enable those charged with governance and management to understand the context of the
communication. In particular, the auditor shall explain that:
 The purpose of the audit was for the auditor to express an opinion on the financial statements.
 The audit included consideration of internal control relevant to the preparation of the financial statements in
order to design audit procedures that are appropriate in the circumstances, but not for the purpose of
expressing an opinion on the effectiveness of internal control; and
 The matters being reported are limited to those deficiencies that the auditor has identified during the audit and
that the auditor has concluded are of sufficient importance to merit being reported to those charged with
governance.

Accounting/ Transaction Cycles

The accounting/transaction cycles are classified into the: 1.revenue cycle, (2) expenditure cycle; (3) personnel and
payroll cycle; (4) conversion cycle; (5) investing cycle, and (6) financing cycle

Revenue/Receipt Cycle
The revenue/receipt cycle encompasses both the sale of goods or services to customer (revenue) and the collection of
cash (receipt).

 A firm’s customer order department personnel prepares sales orders for potential sales (the customer filling out
the sales order is also a common practice).
 The sale is approved by the credit department.
 The goods are released by the inventory control department.(review kung may stocks ang gin order)
 The goods are then shipped by the shipping department.
Dapat gin approved ang sales order before e release

Course Facilitator: Alberth Justine de la Cruz Balgos, CPA

 COLEGIO DE LA PURISIMA CONCEPCION
School of the Archdiocese of Capiz
Roxas City

Documents: bill of and ship of document

Sulod sang packing slip: amount,recipient,shipment control number

 The billing department (a part of accounting) prepares a sales invoice (a copy of which becomes the customer’s
“bill”).
-Numbering sang sales invoice if na void should be retained, then may tatak nga voided,deficiency sang internal
control if gina hmboy mo.
-check regular yang account sang customer
-pasunoron then summary
-before mag prepare,sales order e reconcile sa shipping document before mag prepare sales invoice.

 The sales journal, general ledger, and accounts receivable subsidiary ledger are posted.(accounting dept)
 The customer pays the account with a check, and a remittance advice is enclosed to describe which invoice the
check is paying.
 An individual in the mailroom (receptionist) will open the mail which includes these customer remittances.
 -dpat gabukas sya
 Wala sya ga prepare bank deposit
 One copy kay cashier ..remittance advice and collection,one copy kay accounting

 The checks are listed and sent to the cashier who daily deposits them in the bank.

- Wala access sa records

- Separated from cash disbursement
- Recorded and deposited daily
- Dapat may contract
- Deposit slip should be prepared by cashier
- Cash summary should be forwarded to accounting dept.
- Test control is bank recon
 Another copy of the list of checks and the remittance advices sent to accounting to be used to post the cash
receipts journal, which is subsequently posted to the general and accounts receivable subsidiary ledgers …sales
order: accounting,credit,customer and shipping order.

Sales journal
Cash receipts journal
Purchase journal
Cash disbursement
General journal

Expenditure/Disbursement Cycle
The expenditure/disbursement cycle encompasses both the acquisition f goods and services (expenditure) and the
payment of cash (disbursement) for the goods and services acquired.

 The department in need of the supplies sends a purchase requisition to the purchasing department.
-three copy
 The purchasing department determines the proper quantity and vendor for the purchase and prepares a purchase
order. One copy of the purchase order is sent to the vendor. Another copy is sent to the receiving department to
allow the receiving personnel to know that items received have been ordered.
-5 copies
 When goods are received, a receiving report is prepared by the receiving department and forwarded to the
accounting department.
-4 copies, purchasisng,acct,inventory dept 2
 A vendor’s invoice or “bill” is received by the accounting department from the vendor.
 When the accounts payable department has the purchase requisition, purchase order, receiving report and
vendor’s invoice, the payment is approved (a voucher may be prepared), and a daily summary of the vouchers is
forwarded to the general accounting.
 A check is subsequently prepared and sent by the treasurer to the vendor in accordance with the terms of the sale.
 The purchase requisition, purchase order, receiving report and vendor’s invoice are stamped paid to prevent
duplicate payments.
Assertion
-valuation

Course Facilitator: Alberth Justine de la Cruz Balgos, CPA

 COLEGIO DE LA PURISIMA CONCEPCION
School of the Archdiocese of Capiz
Roxas City

Personnel and Payroll Cycle

The payroll and personnel cycle involves the employment and payment of employees regardless of classification or
method of determining compensation.

 A separate personnel department/hr department maintains complete, up-to-date records for each employee.
 The firm’s factory direct labor personnel use a time clock to punch in each morning and out each evening. Their
employee clock card shows the total hours worked each day. These direct labor personnel fill out job time ticket
for each job they work on each day. At the end of each week. Their supervisor compares job time tickets with
employee clock card which have already been signed by the employees.
 All of the above information is sent to the payroll department whose responsibility is to prepare payroll journal
and to prepare the unsigned payroll checks.
 The checks are then signed by the treasurer and distributed by an independent paymaster who has no other payroll
functions.
 Employees with cash handling and recordkeeping responsibilities should be covered by fidelity bonds, a form of
insurance which protects and employer against losses caused by dishonest employees.

Conversion/Production Cycle
The conversion/production cycle encompasses the production of finished goods for sale. It relates to both inventory and
to fixed assets.

 Responsibility for physically controlling the assets should be segregated from the accounting responsibility.
 Fixed asset additions, disposals and retirement should be authorized by the board of directors or senior
management.
 Fixed asset depreciation computation should be updated for asset additions, disposals and retirement.
 Written policies exist for capitalization vs expensing decisions.
 Periodic physical inspection of plant and equipment by individuals who are otherwise independent of PPE (e.g.,
internal auditors).

Investing Cycle
The investing cycle processes transactions that convert internal resources into external investment, liquidating when
necessary to convert investments into cash either for internal working capital needs or for alternative investments.

 All securities should be in the name of the company.

 Use of an independent agent such as a stockbroker, bank or trust company to maintain custody of securities.
 Securities not in the custody of an independent agent should be maintained in a bank safe deposit box under the
joint control of at least two officials (the treasurer and one other company official); both individuals must be
present to gain access.
 Persons having access to securities should be bonded.

Financing Cycle
The financing cycle processes transactions and events that generate capital funds.

 Debt and equity transactions are properly approved by the company’s board of directors.
 An independent trustee handles bond transactions.
 A stock registrar and a stock transfer agent handle capital stock transactions.
 Cancelled stock certificates are defaced to prevent their reissuance.

References:
Chen, Harvey S. (2018) Auditing Theory vol. 1
Iloilo City, Philippines.

…End of topic…

Course Facilitator: Alberth Justine de la Cruz Balgos, CPA