Lecture 2 Basic of Audit – Internal Control system, compliance procedures and substantive procedures…………………

Lecture 2 Basic of Audit – Internal Control system, compliance procedures and substantive procedures…………………

Good Morning friends once again…

In the last lecture we have come to know about the concept of audit now today we are going to know further more about audit. In the last lecture we have also learned that, what the limitations of audit are?

In today’s lecture we will understand about the Internal control system, Compliance procedures and substantive procedures.

Lets understand this

One day CA Abhishek received one notice from R K oil Limited about to make audit of that particular company. It was very well established manufacturing company containing very huge amount of transactions.

Now as being an auditor which point should be thought ?

According to me following points I will think first…..

What is company doing?

How will I do audit? Within how much time will it take? What will be audit programme?

In the company………………

• What are the policies of accounting transactions?
• What are the flows of transactions?
• Who is authorized to make, which kinds of transactions?
• What is system of accounting communication?
• Organizational structure
• Computer Technology used for accounting.
• Management’s efforts to control and detect frauds – errors.
• Allocation of authority and responsibility.

From the above points it should be cleared that it is management’s duty to prepare and implement well system to prevent and detect frauds and errors.

Now what management can do to prevent and detect frauds and errors?

Some examples are……..

• C. C. TV cameras
• Allocation of authority and responsibility
• Data access as per the authority and responsibility
• Password protected system
• Periodical verification of transactions (means internal audit)
• Internal check
• Change the job of employee so that one employee’s work is checked by the other employee. For example one employee should collect cash and other should make the entry in to the system by using his ID and Password. This password and ID should not be accessible to Cash collecting employee.
• Budget preparation and periodical comparison.

Dear friends this entire system design to prevent and detect frauds and errors is known as Internal Control System where work of one person is checked by the other person.

 

Here the chances of making frauds and errors automatically reduces.

Ok……..

 Then what is Internal check???

• When work of one person is checked by the other person is known as internal check. This entire process and system is known as the internal control system.

Preventing and detecting the frauds and errors is the duty of management and not of the auditor.

Then

What is the duty of auditor??

• auditor’s duty is to check whether such internal control system is 

–         established

–         Implemented

–         And was in operation through out the year or not

How can auditor perform his such duty?

• By using compliance procedures

What is Compliance procedure?

• Assessment of internal control by auditor is known as compliance procedure.
• The extent of substantive is known by such compliance procedure.

What techniques are used by the auditor in application of compliance procedure?

• First technique is known as flow chart analysis of organization.
• When flow chart is not prepared by the management then Internal control questionnaire is used by the Auditor.
• Surprise check made by the auditor.
• Main objective of such techniques is to know the transaction process system and flow of transactions of organization.

Now lets discuss points one by one

• Flow chart

–         In the company where the transactions are in the huge amount, it becomes necessary for the management to allocate the authority and responsibility.

–         Not only that it is also specified that which employee will be responsible to which officer?

–         By whose authority the transaction will be approved and at which authority the reporting will be made.

–         Entire such flow is drawn as diagram by the organization which is known as the flow chart.

• Internal control questionnaire

–         Some company does not prepare the flow charts.

–         So auditor send questionnaire to the various responsible officers, mentioning sequential questions of the organization about internal control.

–         By this way also auditor come to know about the internal control. Not only to that auditor can know also that at where he should pay more concentration. Auditor can know about his substantive procedures.

You will have question that what this substantive procedure is?

But dear wait for some more time I will discuss it at later on in some paras.

• surprise check

–         Surprise check is one of the most effective technique to know about the organization’s internal control

–         Auditor should visit client place without informing client and should make surprise checking.

–         Auditor can make surprise checking of the following particulars

• cash on hand
• Investment on hand
• Bank balance on hand
• Stock and inventory on hand
• Assets verification
• Salary payment on the payment date

Now question arises that what is the substantive procedure……….

Thanks for waiting………….

• Substantive procedure

 

Just assume that during the surprise check, auditor found major variance in to the inventory by showing more inventories on hand in book, but actually it was not there.

Inventory has been shown excessively. What may be the reasons?????

–         Error in recording

–         Sales has been made but not recorded

–         Excess purchase has been shown

–         There is misappropriation of inventory by some employees.

–         There may be some accident or destruction

There may be lots of reasons BUT……… reason to believe is available thereat.

So auditor will pay more concentration on such area. Means he will make his verification strict by

–         Vouching,

–         verification,

–         total check,

–         analytical review,

–         comparison,

–         reconciliation,

–         re computation,

–         confirmation

–         Erithmatical accuracy checking

–         brought / carry forward verification

With the help of above, auditor will try to clear his dought and if there is any kind of error or fraud is lying in the transactions, chances of detection will be increased.

This process of audit is known as the substantive procedures. Means process other than compliance procedure.

Vouching is generally made for items of profit and loss account when verification is made for the items mentioned in balance sheet………..

Hope you are aware about profit and loss account and balance sheet.

Understand????????????

I hope yes………….

So now u should be clear in the compliance procedures and substantive procedure

Now question is what is the relation between these two things?????

Lets understand………. If management has implemented very strong internal control system, there will be less chances to have frauds and errors in the system and if still they are available, they will be detected by the compliance procedures and be resolved.

If there are less chances of having frauds and errors, means auditor can rely on the financial statement prepared by the organization and he will use less vouching and verification means substantive procedures.

So if internal control system is strong more compliance procedures will be used than substantive procedures

If internal control is weak then more substantive procedures will be used than compliance procedures.

Means we can say that compliance procedure is filter of system when substantive procedure is scanner of transactions. If error is not found by filter then use scanner.

Still remember that auditor will be solely responsible for his audit………

Dear students here we have just completed the concept clarity of internal control and its main procedures in the next lecture we will discuss about……….basics of audit and Auditor………………….in  which we will discuss following points…………..

–         what is audit?

–         Objective of audits

–         What are the financial statements?

–         What is auditor?

–         Scope of audit

–         Independence of auditor

–         Importance of evidences

–         Explanation of some terminologies

Thank you take care………………………

We will meet soon………………….