Business Processes

Learning Outcomes:

At the end of the session, students should be able to.

1. Understand the different types of audit tests performed by the auditor in gathering sufficient and
appropriate audit evidence

2. Understand how tests of controls might be applied in practice.

3. Identify different business processes involved

4. Apply the knowledge in the scenarios given.

1. Audit tests
Test of controls

Tests of control are tests performed to obtain audit evidence about the effectiveness of the:

i. Design of the accounting and internal control systems, ie whether they are suitably designed to
prevent, or detect and correct, material misstatement at the assertion level; and

ii. Operation of the internal controls throughout the period.

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Tests of control are distinguished from substantive tests which are designed to detect material mis-
statements in financial statements.

Tests of control may include the following.

(a) Inspection of documents supporting controls or events to gain audit evidence that internal
controls have operated properly, eg verifying that a transaction has been authorised

(b) Inquiries about internal controls which leave no audit trail, eg determining who actually per-
forms each function, not merely who is supposed to perform it

(c) Re-performance of control procedures, eg reconciliation of bank accounts, to ensure they

were correctly performed by the entity

(d) Examination of evidence of management views, eg minutes of management meetings

(e) Testing of internal controls operating on computerised systems or over the overall IT func-
tion, eg access controls

(f) Observation of controls to consider the manner in which the control is being operated

Auditors should consider:

• How controls were applied

• The consistency with which they were applied during the period

• By whom they were applied

Deviations in the operation of controls (caused by change of staff etc) may increase control risk and
tests of control may need to be modified to confirm effective operation during and after any change.
In a continuing engagement, the auditor will be aware of the accounting and internal control systems
through which work was carried out previously but will need to update the knowledge gained and
consider the need to obtain further audit evidence of any changes in control.

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Test your knowledge

1. Which of the following is not a test of control?

A. Inspection of documents

B. Re-performance of control procedures

C. Observation of controls

D. Verification of value to invoice

2. After the controls have been assessed, if there control risk is high, the audit plan may be modi-
fied.

A. True

B. False

Summary

• The auditors must understand the accounting system and control environment in order to de-
termine their audit approach.

• The auditors shall assess the adequacy of the systems as a basis for the financial statements
and shall identify risks of material misstatements to provide a basis for designing and per-
forming further audit procedures.

• The auditors must keep a record of the client's systems which must be updated each year.
This can be done through the use of narrative notes, flowcharts, questionnaires or checklists.

• If the auditors believe the system of controls is strong, they may choose to test controls to
assess whether they can rely on the controls having operated effectively.

• There are special considerations for auditors when a system is computerised. IT controls
comprise general and application controls.

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Business processes
1. The sales system / Revenue System

2. The purchases system / Payment system

3. The inventory system

4. The bank and cash system / Treasury system

5. The payroll system

6. Revenue and capital expenditure / PPE

Here we will see how tests of controls might be applied in practice. Therefore students need to be
familiar with the major transaction cycles.

1. The sales system / Revenue System

The tests of controls in the sales system will be based around:

• Selling (authorisation)
• Goods outwards (custody)
• Accounting (recording)
The following diagram illustrates the sales system.
(https://www.youtube.com/watch?v=Slfh50J_vF8)

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1. Sales system: Control objectives, controls and tests of controls

Audit Assertions are the implicit or explicit claims and representations made by the management
responsible for the preparation of financial statements regarding the appropriateness of the various
elements of financial statements and disclosures. (ACUCOVER)
• Accuracy
• Completeness
• Understandability
• Classification and Cut-off
• Occurrence
• Valuation
• Existence
• Rights and obligations

As noted above, there are three general categories of assertions:

• Account Balances – They are generally balance sheet accounts (at the period end)
• Classes of Transactions – They are generally income statement accounts (for the period)
• Presentation and Disclosure – How different accounts are presented in the financial state-
ments (long-term asset vs current asset or long-term liability vs current liability)

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Page 6 of 15
Test Your Knowledge

Type of As- Specific As-

Statement
sertion sertion

Uncollectible receivables have been allowed for

All leases have been fully included in capital assets

Inventory is physically present in the warehouse

Sales revenue transactions include actual shipments made to real

customers

Investment income has been properly excluded from sales revenue

Obtain the last 5 receiving reports for 2021 and the first 5 receiving
reports for 2022 to ensure that the shipment has been recorded in
the proper period

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Control objectives, controls and tests of controls

Assertion Control Objectives Controls Test of controls

Occurrence and ex- 1. To ensure that The tasks of taking Observe the pro-
istence recorded sales trans- orders, recording cessing of orders
actions represent sales and receiving through the sales cy-
goods or services payment are allo- cle and inspect sign-
provided. cated to three differ- offs to evaluate
ent staff members. whether proper seg-
regation of duties is
operating.

Sales are only rec- For a sample of

orded if there is an sales invoices, en-
approved sales order sure there is a re-
form and ship- lated sales order
ping/despatch docu- form that has been
mentation. authorised and ship-
ping documentation.

Examine application
controls for authori-
sation.

Accounting for nu- Inspect invoices to

merical sequences confirm whether
of invoices. they are sequentially
numbered.

Monthly customer Review entity's pro-

statements sent out cedures for sending
and customer que- out monthly state-
ries and complaints ments and dealing
handled inde- with customer que-
pendently. ries and complaints.

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 Assertion Control Objectives Controls Test of controls

2. To ensure that Authorisation of Review entity's pro-

goods and services credit terms to cus- cedures for granting
are only supplied to tomers (senior staff credit to customers.
customers with good authorisation, refer-
credit ratings. ences/credit checks Examine a sample
for new customers, of sales orders for
regular review of evidence of proper
credit limits). credit approval by
the appropriate sen-
Authorisation by ior staff member.
senior staff required
for changes in other Examine application
customer data such controls for credit
as address etc. limits.

Orders not accepted Review all new cus-

unless credit limits tomer files to ensure
reviewed first. satisfactory credit
references have
been obtained.

3. To ensure that Authorised price Verify that price

goods and services lists and specified lists and terms of
are provided at au- terms of trade in trade are properly
thorised prices and place. documented, author-
on authorised terms. ised and Communi-
cated.
To ensure that cus-
tomers are encour- Examine application
aged to pay controls for author-
promptly. ised price;s and
terms.

Completeness 1. Toensure that all Accounting for nu-
revenue relating to merical sequences
goods despatched is of invoices.
recorded.
Review and test entity's
procedures for account-
ing for numerical se-
quences of invoices, and
inspect invoices to con-
firm whether they are se-
quentially numbered.

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 Assertion Control Objectives Controls Test of controls

2. Toensure that all Shipping/despatch For a sample of

goods and services documentation is shipping/despatch
sold are correctly in- matched to sales in- documents, ensure
voiced. voices. each has been
matched to a related
sales invoice that
was subsequently
recorded.

Sales invoices are Review a sample of

reconciled to the reconciliations per-
daily sales report. formed. Reperform
a sample of recon-
An open-order file ciliations.
is maintained and
reviewed regularly. Inspect the open-or-
der file for unfilled
orders.

Accuracy To ensure that all Sales invoices and Review supporting

sales and adjust- matching documents documents for a
ments are correctly required for all en- sample of sales en-
journalised, summa- tries and the date tries to ensure they
rised and posted to and reference of the contain the written
the correct accounts. entry are written on details that indicate
each document. they were referred
to when entered.

Cut-off To ensure that trans- All shipping docu- Compare dates on

actions have been mentation is for- sales invoices with
recorded in the cor- warded to the in- dates of correspond-
rect period. voicing section on a ing shipping docu-
daily basis. mentation.

Daily invoicing of Compare dates on

goods shipped. sales invoices with
dates recorded in the
sales ledger.

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 Assertion Control Objectives Controls Test of controls

Classification To ensure that all Chart of accounts Inspect any docu-

transactions are (COA) in place and mentary evidence of
properly classified is regularly re- review (such as
in accounts. viewed for appropri- emails requesting
ateness and updated update to COA as a
where necessary. result of review).

Codes in place for Test application

different types of controls for proper
products or services. codes.

Test Your Knowledge:

You are the auditor of ABC Stationery, and you have been asked to suggest how audit
work should be carried out on the sales system.

ABC Stationery Ltd sells stationery to shops. Most sales are to small customers who do
not have a sales ledger account. They can collect their purchases and pay by cash. For
cash sales:

I. The customer orders the stationery from the sales department, which raises a pre-
numbered multi- copy order form.

II. The dispatch department makes up the order and gives it to the customer with a
copy of the order form.

III. The customer gives the order form to the cashier who prepares a handwritten sales
invoice.

IV. The customer pays the cashier for the goods by cheque or in cash.

V. The cashier records and banks the cash.

Required,

A. State the deficiencies in the cash sales system.

B. Describe the systems-based tests you would carry out to audit the controls over the
system.

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2. The purchases system
The tests of controls in the purchases system will be based around:

• Buying (authorisation)

• Goods inwards (custody)

• Accounting (recording)

The following diagram illustrates the purchases system.

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Control objectives, controls and tests of controls

Assertion Control Ob-

Controls Test of controls
jectives
Occurrence To ensure Authorisation procedures and Inspect policies and procedures
and existence that recorded policies in place for ordering and enquire about them.
purchases goods and services.
represent Observe the processing of pur-
goods and chase orders throughout the pur-
services re- chasing cycle and evaluate
ceived. whether proper segregation of
duties is operating.

The responsibility for placing Examine a sample of purchase

the orders, recording the pur- orders to ensure they have been
chase order and making the appropriately authorised.
payment is carried out by three
different staff members.

Purchase orders raised for each

purchase and authorised by ap- Review the delegated list of au-
propriate senior personnel. thority for purchases.

For a sample of goods received

Approved purchase order for notes (GRNs), ensure there is a
each receipt of goods. related purchase order that has
been properly approved.

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 Assertion Control Objectives Controls Test of controls

Staff receiving goods Observe receipt of

check them to the pur- goods by staff to con-
chase order. firm whether the check
is done.

Stores clerks sign for Inspect a sample to

goods received. confirm whether stores
staff undertake this
check.

Examine supporting
Purchase orders and
GRNs are matched documentation to en-
with the suppliers' in- sure it has been
voices. matched for a sample
of invoices.

Supplier statements in- Review procedures for

dependently reviewed reconciling supplier
and reconciled to trade statements and reper-
payable records. form a sample of rec-
onciliations.

Completeness To ensure that all pur- Purchase orders and For a sample of pur-
chase transactions that GRNs are matched chase orders in the year
occurred have been with the suppliers' in- ensure each has been
recorded. voices. matched to a related in-
voice that was subse-
quently recorded.

Periodic accounting for Review entity's proce-

pre-numbered GRNs dures for accounting
and purchase orders. for pre- numbered doc-
uments and inspect a
sample of GRNs for se-
quential numbering.
Examine application
controls.
Independent check of
amount recorded in the Examine documenta-
purchase journal. tion for evidence of
this check.

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Additional Supporting: (https://www.youtube.com/watch?v=LOWj0ZSEHus)

Test your Knowledge

Derek, a limited liability company, operates a computerised purchase system. Invoices

and credit notes are posted to the purchases ledger by the purchases ledger department.
The computer subsequently raises a cheque when the invoice has to be paid.

Required:

List the controls that should be in operation:

1. Over the addition, amendment and deletion of suppliers, ensuring that the standing
data only includes suppliers from the company's list of authorised suppliers

2. Over purchase invoices and credit notes, to ensure only authorised purchase in-
voices and credit notes are posted to the purchase ledger

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