Assessing and documenting the understanding of internal controls

To understand a process, the auditor combines enquiry, observation and inspection. A useful technique is a walkthrough: select one actual transaction and follow it from the point it began to its entry in the accounting records. For a credit sale, the auditor might follow a customer order through credit approval, dispatch, invoicing and posting to the sales ledger. A walkthrough gives evidence about design and implementation. Evidence of consistent operation throughout the year requires further work when the auditor intends to rely on the control. standards.xrb.govt.nz

Documentation method	What the auditor records	Example
Narrative description	A written account of who performs each step, which documents are used and how exceptions are resolved.	“Every Friday, the accounts supervisor compares the dispatch register with the invoice listing and follows up on deliveries that have no invoice number.”
Flowchart	The movement of transactions, documents and information between people or departments.	A sales flowchart shows where the warehouse sends delivery information to accounts and where the supervisor checks for unbilled deliveries.
Internal control questionnaire (ICQ)	Answers to questions about specific controls, with notes on the evidence examined.	“Who checks that every delivery has been invoiced?” The auditor records the supervisor’s name or role and the weekly report inspected.
Risk and control matrix	The link between a possible misstatement, the relevant assertion, the company’s control and the auditor’s assessment.	The auditor links unbilled deliveries to completeness of revenue, identifies the weekly review and records whether it has been implemented.

Worked examination example

During a walkthrough, the auditor finds that accounts staff check invoices for the correct selling price, but nobody checks whether every delivery has been invoiced. Identify the weakness, its effect, a recommended control and a test of that control.

Required point	Suggested answer
Weakness	No one reconciles completed deliveries to sales invoices. The price check covers only invoices that staff have already prepared.
Possible effect	Goods may be delivered without a sale being recorded. Revenue and trade receivables may be understated. The main assertion affected is completeness.
Recommended control	Each week, an accounts supervisor should match completed delivery notes to invoices, investigate unmatched deliveries and document how each exception was resolved.
Test of control	Once the control is in use, select weeks across the period, inspect evidence of the supervisor’s review, repeat selected matches and verify that the supervisor followed up on exceptions.