Please refer to problem H.43 in your textbook. Mark Company\'s audit team is eva

Question

Please refer to problem H.43 in your textbook.

Mark Company's audit team is evaluating the controls that Mark has implemented over the automated processing of payroll transactions. During the understanding and assessment stages of the audit, the following processing and output controls have been identified as being important in this processing:

To detect unauthorized access to payroll programs and processing, a system log is generated and reviewed on a weekly basis. This log identifies the programs that have been accessed during the past week, the individual(s) who have accessed those programs, and the time(s) during which the programs have been accessed. This log is reviewed, and any unexpected or unauthorized access is investigated immediately.

Control totals are determined prior to the input of data and compared to computer-generated totals following transaction processing.

Any gross pay calculations in excess of $25,000 per month are identified and written to a rejected transaction file for separate investigation because Mark's highest paid employee whose salary is processed through the system earns $300,000 per year.

The system generates a report of any errors or unusual situations identified during transaction processing. This report is reviewed, and any items are resolved in a timely manner, and the resolution is documented by notations made on the report.

Any changes to employee master file information since the last payroll period are evaluated to ensure that they have been properly authorized by the appropriate personnel.

The output is reviewed for reasonableness prior to distribution to users.

Required:

Consider the four methods of testing the operating effectiveness of controls (inquiry, observation, document examination, and re-performance). For each of the preceding controls, provide an example of how Mark's audit team might choose to test the operating effectiveness of the control using the four methods of test of controls (e.g., how would the audit team use inquiry, observation, document examination, and re-performance to test control #1, the generation and review of the system log?). [Note: Not all types of tests of controls will be appropriate for testing all the controls.]

Imagine that you will be presenting to your audit partner on how you will conduct the audit of this section of controls. Prepare the following deliverables:

a PowerPoint presentation summarizing your testing methods for each of the controls listed above and high-level advantages or limitations to such tests for that particular control, and

a Word document with your talking points to support the PowerPoint slides.

Explanation / Answer

control is a process for assuring achievement of an organization's objectives in operational effectiveness and efficiency, reliable financial reporting, and compliance with laws, regulations, and policies.

There are four main methods that can be adopted by Mark's audit team to test the operating effectiveness of the control and test each control in place at the service organization. These methods include (listed in order of complexity from lowest to highest): inquiry, observation, examination or inspection of evidence, re-performance.

1. Inquiry: In this method of control, the mark company’s auditor will ask for the appropriate management and staff about the controls of the company to determine some relevant information. This method is often used in conjunction with other, more reliable methods. For example, an auditor may inquire of management if visitors to the data center are escorted at all times if the auditor is not able to observe this activity while on site. No control objective or criteria should ever be supported by controls only tested through inquiry procedures.

2. Observation: In this method, Activities and operations of mark company’s are tested using observation by the auditor and his team. This method is useful when there is no documentation of the operation of a control, such as observing that a security camera is in place or observing that a fire suppression system is installed.

3. Examination or Inspection of Evidence:-In this method, the auditor examines the documents and inspect the place, data, records, books of accounts. This method is used to determine whether or not manual controls are being performed. For instance, are backups scheduled to run on a regular basis? Are forms being filled out appropriately? This method often includes reviewing written documentation and records such as employee manuals, visitor logs, and system databases.

4. Re-performance:- This method is used when the other three above methods combined fail to provide sufficient assurance that a control is operating effectively or this method can be used to prove and automated controls it operating effectively. This method of testing (as well as a CAAT) is the strongest type of testing to show the operating effectiveness of a control. Re-performance requires the auditor to manually execute the control, such as re-performing a calculation that a system automatically calculates.

After completion of audit procedure and audit control the auditor give his opinion as below whether the company is complying with the applicable laws, rules, regulation and accounting standards or not.

Advantages of the above 4 test :( Inquiry, Observation, Document Examination, and Re-performance):-

1. EFFECTIVE CONTROL: The audit control is helpful to have effective control over the business activities. Control is a function of management that relates to supervision and direction of ongoing activities. The manager concerned can remove the difficulties for smooth working. Internal audit alerts the management for effective control.

2. BETTER MANAGEMENT:- The benefits of internal audit is that there better management of the business concern. The internal auditor can point out the weak areas of management. The goals can be achieved if there is proper internal control, internal check, and internal audit. It should be noted that management could rely on internal audit for best results.

3. PROGRESS REVIEW: The internal audit is beneficial to review the progress of business concern. The figures for the previous year are compared with this year. Moreover, the performance results of similar companies can be compared to determine the progress made by the entity.

4. PROPER ACCOUNTING SYSTEM: The benefits of an audit is that proper accounting system is introduced, the Accounting system is a chain of activities in an entity by which transactions are processed for financial records.

5. ASSETS PROTECTION: The assets safeguard is achievable through an internal audit. The management can use the asset for the benefit of business only. The assets cannot be used for private purpose.

6. NO ERRORS:- The audit is used to protect the accounting records from errors. The accounting and auditing go side by side. When the accounting work is over the auditing work starts. There is no time gap. In such a situation the accounting staff is not in a position to commit errors.

Disadvantages of the above 4 test :( Inquiry, Observation, Document Examination, and Re-performance):-

1. Inherent Limitations:- Due to the inherent limitations of an audit, auditors are only able to offer 'reasonable assurance' over the truth and fairness of the financial statements rather than absolute assurance. Inherent limitations of an audit are discussed below.

2. Use of professional judgment:- An audit involves the use of judgment in the identification of audit risks, selection of appropriate auditing procedures and the interpretation of audit evidence. Although auditing standards provide guidelines to assist auditors in forming sound professional judgments, it is inevitable that an auditor may at times misjudge a situation which may cause the auditor to overlook a misstatement in the financial statement.

3. Management Representations:- Although auditors collect audit evidence from a range of sources, too often they have to rely on the representations of management in order to assess the reasonableness of the matters concerning financial statements.

4. Risk of Fraud:- By their very nature, frauds are intended to be concealed by the perpetrators and therefore pose a very high risk of remaining undetected by the auditors even in spite of the application of sound audit methodology and procedures.

5. Time Constraints:- In practice, auditors face strict time constraints within which they have to provide their opinion on the financial statements. Auditors tend to prioritize tasks that are essential for the effective performance of the audit. In some cases, particularly where there is a legal requirement for companies to publish their financial reports within a certain time frame, the auditors may, in a bid to meet the assignment deadlines, fail to consider an important matter in the finalization of the audit report.

6. Scope:- Audit procedures are designed to detect material misstatements in the financial statements and focus on the financial aspects of transactions and events. Non-financial matters are generally not considered in the performance of the audit unless they have relevance to the financial statements. Stakeholders often misinterpret the role and scope of an external audit.

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