Process for Understanding Internal Control & Assessing Control Risk

Rutgers Accounting Web

15 Jul 201501:46

Summary

TLDRThe script discusses the five components of internal controls, with a focus on control activities. It outlines the audit process in four phases: understanding internal controls during planning, assessing control risk, testing controls' reliability, and determining the extent of substantive procedures based on control assessment. The auditor evaluates the control environment and tests transactions to ensure they align with client descriptions.

Takeaways

🔍 The discussion revolves around the five components of internal controls, emphasizing the importance of control activities.
🔑 Auditors use the Closer framework to assess the five components of internal controls during an audit.
📈 The first phase of the audit involves the auditor obtaining an understanding of the internal control design and operation.
🗂️ Phase two is focused on assessing control risk, which may include walkthroughs and testing the effectiveness of controls.
🔎 In phase three, auditors determine if they can rely on internal controls by performing tests on a sample of transactions.
📊 Phase four involves the auditor deciding the nature and extent of substantive testing based on their understanding and reliance on internal controls.
🤝 Auditors engage with clients during the planning phase to gather information about the internal control environment.
📉 Control risk assessment is a critical part of the audit process, influencing the auditor's approach to substantive testing.
📋 The auditor's reliance on internal controls can reduce the extent of substantive testing required.
🔑 The effectiveness of internal controls is a key factor in the overall audit strategy and approach.
📝 The script highlights the iterative nature of audits, with ongoing activities to maintain and assess internal controls.

Q & A

What are the five components of internal controls?
-The five components of internal controls are not explicitly mentioned in the script, but they generally include control environment, risk assessment, control activities, information and communication, and monitoring.
What does the Closer framework refer to in the context of internal controls?
-The Closer framework is not explicitly defined in the script, but it is likely referring to a framework used by auditors to evaluate internal controls, possibly an acronym or a mnemonic for the five components.
What is the focus of the auditor when considering internal controls?
-The focus of the auditor is on the control activities component of internal controls, which involves assessing the effectiveness of the controls in place.
What are the phases of the audit process as described in the script?
-The phases of the audit process described are: obtaining an understanding of internal control design and operation (Phase one), assessing control risk (Phase two), testing controls and transactions if relying on internal controls (Phase three), and determining the nature and extent of substantive procedures based on the understanding and reliance on internal controls (Phase four).
What does the auditor do during the planning phase of the audit?
-During the planning phase, the auditor talks to the client, gathers information about the internal control environment, and plans the audit strategy.
How does the auditor assess control risk?
-The auditor assesses control risk by performing walkthroughs, testing to see if the controls are operating as designed or described by the client, and evaluating the effectiveness of the controls.
What happens in Phase three of the audit if the auditor determines they can rely on internal controls?
-In Phase three, if the auditor determines they can rely on internal controls, they perform tests on a sample of transactions to audit the controls around those transactions.
What is the purpose of substantive procedures in the audit process?
-The purpose of substantive procedures is to provide direct evidence about the fairness of the financial statement amounts, which is done after considering the understanding and reliance on internal controls.
Why is it important for auditors to understand the internal control environment?
-Understanding the internal control environment is important for auditors because it helps them assess the risk of material misstatement and plan their audit procedures accordingly.
What is the relationship between control activities and the overall effectiveness of internal controls?
-Control activities are a critical component of internal controls, as they directly influence the effectiveness of the controls by ensuring that they are operating as intended to prevent or detect errors and fraud.

Outlines

00:00

🔍 Understanding Internal Controls and Audit Phases

The paragraph discusses the concept of internal controls and their five components. It emphasizes the importance of control activities within these components. The auditor's role in evaluating these controls is outlined through a four-phase process. Initially, the auditor gains an understanding of the internal control environment during the planning phase. This involves gathering information from the client. In the second phase, the auditor assesses control risk by conducting walkthroughs and testing the controls' operation as designed. If the auditor determines that internal controls are reliable, they proceed to the third phase, where they perform tests on a sample of transactions to audit the controls. The final phase involves determining the nature and extent of substantive testing based on the auditor's understanding and reliance on internal controls.

Mindmap

Keywords

💡Internal Controls

Internal controls refer to the policies and procedures adopted by an organization to ensure the accuracy of financial reporting, compliance with applicable laws, and operational efficiency. In the video, internal controls are discussed as a critical component of an audit process, where auditors evaluate these controls to assess their effectiveness in mitigating risks and ensuring reliable financial data.

💡Control Activities

Control activities are the actions taken by an organization to ensure that its policies and procedures are being followed. They are a subset of internal controls and include tasks like authorizations, reviews, approvals, and reconciliations. The video emphasizes control activities as a focal point for auditors when they are evaluating the effectiveness of an organization's internal controls.

💡Auditor

An auditor is a professional who conducts audits to verify the accuracy of financial statements and assess the effectiveness of internal controls. In the context of the video, the auditor plays a key role in evaluating the five components of internal controls, ensuring that the organization's financial reporting is reliable and that its controls are functioning as intended.

💡Five Components of Internal Controls

The five components of internal controls are a framework for understanding and evaluating the effectiveness of an organization's internal control system. These components include control environment, risk assessment, control activities, information and communication, and monitoring. The video discusses these components as part of the auditor's evaluation process.

💡Control Risk

Control risk is the possibility that a material misstatement will not be prevented or detected on a timely basis by the organization's internal controls. In the video, auditors assess control risk during the second phase of the audit process by testing the effectiveness of the controls in place.

💡Walkthroughs

Walkthroughs are a procedure where auditors follow a transaction from its origin through the information system to observe the effectiveness of the controls in practice. The script mentions walkthroughs as a method auditors use to assess whether controls are operating as designed.

💡Substantive Procedures

Substantive procedures are audit procedures applied to the financial statement elements to detect material misstatements. In the video, it is mentioned that after evaluating the effectiveness of internal controls, auditors may perform substantive procedures to further test the accuracy and completeness of the financial data.

💡Phases of an Audit

The phases of an audit refer to the different stages an auditor goes through during an audit. These phases include planning, assessing control risk, testing controls, and performing substantive procedures. The video script outlines these phases and how they relate to the evaluation of internal controls.

💡Planning Phase

The planning phase is the initial stage of an audit where the auditor gathers information about the client's business and internal control environment to plan the audit approach. The video mentions that during this phase, auditors talk to the client and get information about the internal control environment.

💡Reliance on Internal Controls

Reliance on internal controls refers to the auditor's decision to depend on the effectiveness of an organization's internal controls to reduce the extent of substantive testing. In the script, it is discussed that if auditors determine they can rely on internal controls, they perform tests on a sample of transactions to assess control activities.

💡Transaction Sampling

Transaction sampling is a statistical method used by auditors to select a subset of transactions for testing to determine if the controls around those transactions are effective. The video script refers to transaction sampling as a method used in phase three of the audit process when auditors assess the effectiveness of internal controls.

Highlights

Internal controls have five components.

The focus is on control activities within internal controls.

Auditors use the Closer framework to evaluate internal controls.

Auditors test control activities as part of the Closer framework.

The first phase of the audit involves understanding internal control design and operation.

During the planning phase, auditors gather information about the internal control environment.

In Phase two, auditors assess control risk through walkthroughs and testing.

Control risk assessment involves verifying if controls operate as designed.

If auditors can rely on internal controls, they proceed to Phase three.

In Phase three, auditors perform tests on a sample of transactions to audit controls.

Phase four involves determining the nature and extent of substantive testing based on reliance on internal controls.

Auditors evaluate the effectiveness of internal controls throughout the audit process.

The audit process is iterative, with each phase building on the understanding of internal controls.

The Closer framework is a standard approach for auditors to test internal controls.

Control activities are a critical component of the internal control framework.

Auditors must understand how internal controls are designed and operate in practice.

Reliance on internal controls can reduce the extent of substantive testing required.

The audit process is designed to ensure the accuracy and reliability of financial reporting.

Internal control assessments help identify potential weaknesses in a company's control environment.

The auditor's role is to provide an independent evaluation of internal controls.