Audit & Internal Review

Lecture
Test of Control and Substantive Procedures
(In specific areas of business)

SERVICE EXCELLENCE
 Financial statement assertions
 Audit tests are designed to obtain evidence about the
financial statement assertions.
 Assertions relate to classes of transactions and events,
account balances at the period-end, and presentation
and disclosure.
 Financial statement assertions are the representations
by management, explicit or otherwise, that are embodied
in the financial statements being audited- i.e. the
statement the auditor is assessing the different types of
potential misstatements that may occur.

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 Financial statement assertions
ISA 315 states that the auditor must use
assertions for classes of transactions (i.e.
income statement), account balances (i.e.
SOFP), and presentation and disclosures in
sufficient detail to form the basis for the
assessment of risks of material misstatement
and the design and performance of further
audit procedures.

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 Assertions about classes of transactions
and events
 Occurrence: transactions and events that have been
recorded have occurred and pertain to the entity.
 Completeness: all transactions have been recorded.
 Accuracy: amounts and other data have been
recorded appropriately
 Cut-off: transactions have been recorded in the
correct accounting period
 Classification: transactions have been recorded in
the proper accounts

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 Assertions about account balances
 Existence: assets, liabilities and equity interests exist.
 Rights and obligations: entity holds or controls the
rights to assets and liabilities are the obligations of the
entity.
 Completeness: all assets, liabilities and equity (ALE)
that should have been recorded have been recorded.
 Valuation and allocation: all ALE are included in the
financial statements at appropriate amounts and any
resulting valuation or allocation adjustments are
appropriately recorded.

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 Assertions about presentation and
disclosure
 Occurrence and rights and obligation: disclosed
events, transactions and other matters have occurred and
pertain to the entity.
 Completeness: all disclosures that should have been
included in the financial statements have been included.
 Classification and understandability: financial
information is appropriately presented and described,
and disclosures are clearly expressed.
 Accuracy and valuation: information are disclosed
fairly and at appropriate amounts.

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 Cash sales and collections
Objectives:
To ensure that all cash to which the enterprise
is entitled is received.
To ensure that all such cash is properly
accounted for and entered in the records
To ensure that all cash is deposited promptly
and intact.

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 Cash sales and collections
Measures:
 Clearly defining and limiting the number of persons who
are authorized to receive cash. Sales assistants, cashiers
etc. must be clearly identified.
 Establishing a means of evidencing cash receipts. E.g.
receipt books should be numbered serially and should be
in triplicates, a responsible official other than the cashiers
should keep control of the cash receipt books and the
issues as well.
 Ensure that whoever pays cash, must receive a receipt.
And if a cash register is used, the amount rung up should
be visible to the customer.

SERVICE EXCELLENCE
 Cash sales and collections
Measures:
 Appointment of officials with responsibility for examining
cash register at prescribed intervals, and agreeing the amount
present with till roll totals. Such collections should be
evidenced in writing and be initialed by the assistant and the
supervisor.
 All cash and cheques must be banked intact and promptly.
 All cash shortages and excesses should be promptly
investigated.
 The cashier should not have access to other cash funds or
sales ledgers or even the purchases ledger.
 There should be occasional rotation of jobs.

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 Test of controls (compliance testing)
 As part of his overall plan the auditor must ascertain the
adequacy of the accounting system and the internal
controls system. He will decide which controls if any he
wishes to rely on and plan compliance tests to determine
whether such reliance can be warranted. The auditor will
almost certainly use the Internal Control Evaluation
Questionnaire (ICEQ) completed for each component
part of the system to draw up the compliance controls to
be tested and provide information as to their strength and
importance.
 Test of Controls are designed to check that the control
procedures are being applied and that control objectives
are being achieved.
SERVICE EXCELLENCE
 Sales System
The three separate elements into which
accounting controls may be divided clearly
appear in the consideration of sales
procedures. They are selling (authorization),
goods outwards (custody) and accounting
(recording).

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 Sales System- Control objectives
The control objectives include the following:
 Sales are made in accordance with the company objectives, with
agreement in place with all customers.
 Customer’s orders are authorized, controlled and recorded in
order to execute them promptly and determine any provision
required for losses arising from unfulfilled commitments.
 Goods shipped and work completed is controlled to ensure that
invoices are issued and revenue recorded for all sales
 Goods returned and claims by customers is controlled in order
to determine the liability for goods ordered and claims received
but not entered or recorded in the debtors’ records.
 Invoices and credit notes are appropriately checked as being
accurate and authorized before being entered in the debtors’
records.

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 Sales System-Control considerations
Selling: Considerations include the following:
 What arrangements are to be made to ensure that
goods are sold at their correct price and to deal with
cheque receipts, discounts and special reduction
including those in connection with cash sales?
 Who is responsible for and how control is to be
maintained over the granting of credit terms to
customers.
 Who is responsible for accepting customer’s orders
and what procedures are to be adopted for issuing
production orders and dispatch notes?

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 Sales System-Control considerations
Selling:
 Who is to be responsible for the preparation of invoice
and credit notes and what controls are to be instituted to
prevent errors and irregularities. For example, how
selling prices are to be ascertained and authorized, how
the issue of credit note is to be controlled and checked,
what checks should be on prices, quantities, extensions
and totals shown on invoices and credit notes and how
such documents in blank or completed form are to be
protected against loss or misuse.
 What special controls are to be exercised over the
dispatch of goods free of charge or on special terms?

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 Sales System-Control considerations
Goods Outwards: Factors to be considered include the
following:
 Who may authorize the dispatch of goods and how
such authority is evidenced.
 What arrangements are to be made to examine and
record goods outwards (preferably this should be
done by a person who has no access to stocks and
has no accounting or invoicing duties)
 The procedures to be instituted for agreeing goods
outwards records with customers’ orders, dispatch
notes and invoices.

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 Sales System-Control considerations
 Accounting: As far as possible sales ledger staff
should have no access to cash, cash books or
stocks and should not be responsible for invoicing
and other duties normally assigned to sales staff.
The following are amongst matters which should
be considered:
 Appoint separate persons as far as possible for:
Recording sales and sales returns
Maintaining customers’ accounts
Preparing debtors’ statements

SERVICE EXCELLENCE
 Sales System-Control considerations
 Arrangements to ensure that goods dispatched but not
invoiced (or vice versa) during an accounting period are
properly dealt with in the accounts of the periods
concerned.
 What procedures are to be adopted for the preparation,
checking and dispatch of debtors’ statements and for
ensuring that they are not subject to interference before
dispatch.
 How discounts granted and special terms are to be
authorized and evidenced.
 What procedure is to be adopted for reviewing and
following up overdue accounts.
 Who is to authorize the writing off of bad debts and how
such authority is to be evidenced.

SERVICE EXCELLENCE
 Substantive Tests (Sales)
Accounting Records:
 Check additions and cross-casts of the sales
daybook and sales returns day book.
 Check the posting of individual invoices to
the nominal ledger and the control accounts
 Check entries in the sales day book and sales
returns day book back to original invoices,
credit notes and dispatch notes and vice
versa.

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 Substantive Tests (Sales)
 Invoices and Credit Notes:
 Check the numerical sequence of invoices, enquiring into
missing numbers and inspecting all copies of cancelled
invoices.
 Check copy sales invoices and credit notes with sales day
books and debtors’ ledger accounts, checking analysis of
sales day books where appropriate and authorization of credit
notes.
 Compare invoice prices with authorized, up-to-date price
lists, quotations and correspondence.
 Check calculations and additions of invoices and credit notes
 Scrutinize credit notes for large or unusual items.

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 Substantive Tests (Sales)
Stock Records:
 Check goods dispatched notes or goods
outwards records to copy sales invoices.
 Trace good outwards from invoice or dispatch
note to stock record
 Trace goods returned from return
documentation to stock records and credit
notes.

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 Substantive Tests (Sales)
General: Where returns or allowances affect the
calculation of commissions, ensure that
adjustments have been made properly.
Control Accounts: Test the year-end control
account reconciliation, checking back to source
documentation such as sales invoices, cash and
returns records. Ensure that any reconciling items
are dealt with properly.

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 Substantive Tests (Sales)
Analytical Procedures:
 Fluctuations in sales levels. Compare levels of
sales throughout the year on a month-by-month
basis and also sales in the last month of the year
to sales in the first month of the next year.
 Investigate any large fluctuations. Consider
vouching larger individual sales.
 Compare current gross profit percentage to
previous year
 Compare stock turnover rate to previous year.

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 Substantive Tests (Sales)
 Cut Off Tests:
 Select items on both sides of the end date and
ensure that they have been properly treated in the
correct accounting period.
 Examine the file of unprocessed invoices and
dispatch notes and ensure that none belongs to the
period under review but has not been treated.
 Check that dispatch notes issued before the end of
the year but not matched by any invoices are
accrued and reported in the accounts under
review.
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 Substantive Tests (Sales)
Disclosure:
 Check the classification, description and
presentation of sales and sales return in the
financial statements.
 Check that amounts stated are in agreement
with the accounting records.

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 Note
 You may have noticed that the tests of controls and
substantive procedures noted above sometimes appear very
similar. One test can serve both as a test of control and as
substantive procedure. Where for example, an invoice is
checked for authorization (test of control) it can also be
checked for accuracy and pricing (substantive procedure).
This does not mean that tests of controls and substantive
procedures are interchangeable. It is vital that you understand
the conceptual difference between the two types of test.

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