Evaluation of internal control

1. Evaluation of internal control • Ascertaining the system • In the ascertaining the system cost auditor has to make himself familier with the system of internal control to know the flow of transaction and specific control procedure • Testing the system Cost auditor after reviewing the system has to test the system to determine the extent of reliance to be placed on it. Therefore he has to do the following: • Evolve his own techniques of gaining the knowledge on narrative, check list, questionnaire or flow chart. • Apply the compliance audit test to test the system of the organisation as a whole. • Apply substantive audit test the accuracy, completeness and validity of the transaction of the system of the organisation. • Suggest a better control if he thinks so.

2. Contd… • Evaluation of the system • Cost auditor after reviewing and testing the system has to evaluate it so as to ascertain whether a system is capable of detecting the materials errors and irregularities in the system to place reliance on it. Cost auditor therefore has to find out the following: • Ascertain the impact of the material errors and irregularities in the transaction on the related transactions. • Report on the weakness of the internal control system to the management of the company.

5. Inventory Control • Objectives • Avoidance of out of stock danger • Service to consumers • Economy in purchasing • Information about the inventory

6. Evaluation of inventory control • He should check whether the inventory is properly stored and protected from getting deteriorated. • Auditor should check whether material has been issued from stores only on valid requisition. • He should also confirm the authorized person to sign the requisition. • Auditor should check the records maintained at stores location. • He should check whether continuous stock records have been maintained for raw materials, consumable stores, finished goods and stocks held on behalf of third parties. • Auditor has to check whether records are maintained as per quantity, or as per value or both in quantity and value. • Auditor should check whether separate records are maintained for each category of raw materials. • He should confirm that the cost accounting system is fully integrated with financial records.

7. Budgetory Control • Budgetary control was defined can be defined as the establishment of budgets relating to the responsibilities of the executives to the requirements of a policy and a continuous comparison of the actual result’s with the budgeted result so as to provide a basis of revision of the activities.

8. Objectives of Budgetory Control • To plan • To coordinate • To communicate • To control

9. Evaluation of Budgetory Control • Whether the budgetary control system is serving any useful purpose. • Whether the standards are set in consultation with those who are responsible for their fulfillment. • Whether the budgetary control systems is used for the purpose of price quotation or is only used as an internal control device. • Whether flexibility is provided in the budgets. • Whether the budgets proposals are periodically reviewed. • Whether the budgeted figures are compared with actual in order to ascertain the variance. • Whether variances reports are timely prepared and corrective action are taken by the management in order to improve the planned result to avoid the negative variance in the future. • Whether the purpose of the budgetary control system is clear to all the levels management. • Whether budgets are prepared by taking the previous years budgets as a base year or zero base.

10. Management Information System (MIS) • MIS is a comprehensive and co-ordinated system of providing right information to the right person at a right time and in a right format to the various levels of management in the organisation for providing support to the decision making activities.

11. Evaluation of Management Information System • Content and source of information • A cost auditor should check whether the information collected is relevant to decision making or requires any improvement in the decision making process. • He should check whether the reporting of MIS is regular and uniform for financial and non-financial information. • Auditor should check the reliability of source of information and should see that unwanted information has been deleted.

12. Evaluation of Management Information System • Flow of information • A cost auditor has to check the system of organisation of information whether it is centralized or decentralized, flow of information from various units to control section, estimating the volume of data, transaction time and cost involved. • He should check the methods used in data collection and management. He should confirm that the data is classified properly and matched with decision making process.

13. Evaluation of Management Information System • Correlation of MIS with decision areas Cost auditor should examine whether input-output analysis is attempted. He should also check whether the MIS is helpful in reducing the effects of uncertainity.

14. Capacity Utilisation • Capacity can be defined as rate of output at which there is no incentive to alter the size of the plant if that rate of output is expected to the permanent the cost. • Capacity planning and production planning and control are the pre-requisites to capacity utilisation control mechanism for capacity planning

15. Evaluation of Capacity Utilisation • Method of measuring base machine capacity.Clear guidelines should be available regarding the assessment of capacity.In some industries a capacity is influenced by a number of factors and determining a single base figure requires adjustment of various variables. • Whether the system provides for a comparative study of the rated output, actual output and normal output. • Determined whether a capacity utilisation report is been prepared by the person other than the person who is responsible for the production activity. • Check whether the capacity measurement is based on capital output ratio or an any other factor.

16. Statistical sampling • Statistical sampling involves the random selection of a number of items for inspection and is endorsed by the accountancy bodies. • statistical sampling is that it removes the need for the use of the professional judgement. uses statistical methods to determine the sample size and to select and evaluate audit samples • it is the responsibility of the auditor to consider and specify in advance factors such as, the expected error rate or amount, standard deviation and population size, before the sample size can be determined. • Types of sampling are Random, Systematic, Stratified etc

17. Judgemental Sampling • It involves a subjective selection of items for testing and a subjective evaluation of the results. Judgemental sampling is accepted by the accounting professions as a means of gathering evidence concerning the truth and fairness of the financial statements. • It could be criticized on the grounds that it is not scientific and may be rendered inconsistent and unreliable because of: • Differences in individual auditor’s ability, knowledge, experience and prejudices. • Auditor’s state of physical and mental health. • It relies on intuition and non-quantitative methods in the evaluation process. It has also been criticized on the basis that the extent of audit testing is not consistent between auditors or across audits.

18. Assessment of the adequacy of the Internal Audit Function • Review of the accounting system and the related internal control • Examination of financial and operating information for the management • Compliance with established policies and procedures • Safeguarding of assets