Modern Auditing: Assurance Services and the Integrity of Financial Reporting, 8 th Edition

1. Modern Auditing: Assurance Services and the Integrity of Financial Reporting, 8th Edition William C. Boynton California Polytechnic State University at San Luis Obispo Raymond N. Johnson Portland State University Chapter 10 – Understanding Internal Control

2. Chapter 10 Overview

3. Fundamental Concepts of Internal 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

4. Components of Internal Control • Control Environment • Risk Assessment • Control Activities • Information and Communication • Monitoring

5. Entity Objectives with Internal Control • Reliability of financial information • Compliance with applicable laws and regulations • Effectiveness and efficiency of operations

6. Limitations of Internal Control • Mistakes in Judgment • Breakdowns • Collusion • Management Override • Cost versus Benefits

7. Roles and Responsibilities • Management • Board of Directors and Audit Committee • Internal Auditors

8. Roles and Responsibilities (cont.) • Other Entity Personnel • Independent Auditors • Other External Parties

9. Study Break • _____ is a process that assesses the quality of internal control performance over time. • Control activities • Risk assessment • Information and communication • Monitoring D. Monitoring

10. Study Break 2. This limitation of an entity’s internal controls occurs when two or more individuals act together to perpetrate and conceal fraud. • Breakdowns • Collusion • Management override • Mistakes in judgment B. Collusion

11. Components of Internal Control

12. Control Environment • Integrity and Ethical Values • Commitment to Competence • Board of Directors and Audit Committee • Management’s Philosophy and Operating Style

13. Control Environment (cont.) • Organizational Structure • Assignment of Authority and Responsibility • Human Resource Policies and Practices

14. Risk Assessment Process

15. Information and Communication • Information • Transactions • Audit Trail or Transaction Trail • Documents • Records • Communication

16. Control Activities • Authorization Controls • Segregation of Duties • Transaction authorization • Custody of assets • Recorded accountability in accounting records

17. Segregation of Duties

18. Control Activities (cont.) • Information Processing Controls • General Controls • Computer Application Controls • Controls over the Financial Reporting Process

19. General Controls • Organization and Operation Controls • Systems Development and Documentation Controls • Hardware and Systems Software Controls • Access Controls • Data and Procedural Controls

20. Computer Application Controls • Input Controls • Processing Controls • Output Controls

21. Controls over the Financial Reporting Process

22. Control Activities (cont.) • Physical Controls • Performance Reviews • Controls over Management Discretion in Financial Reporting

23. Control Activities (cont.) • Monitoring • Ongoing monitoring programs • Separate evaluations • Element of reporting deficiencies to the audit committee

24. Antifraud Programs and Controls

25. Study Break 3. Which of the following does not influence the control environment? • Management’s Philosophy • Adequate Training • Hiring Processes • All of the above influence the control environment D. All of the above influence the control environment

26. Study Break 4. This component of control activities ensures that every transaction is authorized by management acting within the scope of their authority. • Authorization Controls • Segregation of Duties • Information Processing Controls • All of the above A. Authorization Controls

27. Study Break 5. This computer application control is designed to ensure that the processing results are correct and only authorized personnel receive the information. • Input Controls • Processing Controls • Output Controls • Data Controls C. Output Controls

28. Understanding Internal Control Must perform procedures to: • Understand design of policies and procedures • Determine whether the policies and procedures are operating

29. Understanding Internal Control Auditor uses the understanding to: • Identify types of potential misstatements • Understand factors affecting risk of material misstatement • Design further audit procedures

30. Effects of Preliminary Audit Strategies • Control Environment • Risk Assessment • Information and Communication • Control Activities • Monitoring

31. Procedures to Obtain an 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

32. Documenting the Understanding • Questionnaires • Flowcharts • Decision Tables • Narrative Memoranda

33. Questionnaire

34. Decision Table

35. Narrative Memoranda

36. Study Break 6. All of the following are procedures used to obtain an understanding of internal controls except: • Inspecting documents • Inquiries of client’s customers • Inquiries of management • All of the above procedures are used B. Inquiries of client’s customers

37. Study Break 7. This form of documentation is a diagram that uses symbols to identify the steps involved in processing information through the accounting system. • Questionnaire • Flowchart • Decision Table • Narrative Memoranda B. Flowchart