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