Tests of Controls

Summary

This video lecture discusses tests of controls, also known as compliance tests, used in auditing to evaluate the effectiveness of internal controls in preventing, detecting, and correcting material misstatements. The lecture covers the purpose, timing, and extent of these tests, and explains when auditors use them alongside substantive procedures. It also details scenarios where auditors may rely on previous audit evidence, and highlights the process of testing internal controls, including inquiries, inspections, and observations. The importance of identifying deviations and potential deficiencies in internal controls is emphasized.

Takeaways

• 📝 Test of controls (also known as compliance tests) are audit procedures designed to evaluate the effectiveness of internal controls in preventing, detecting, and correcting material misstatements.
• ⚙️ These tests assess both the design and operational effectiveness of controls throughout the audit period.
• 🔍 Tests of controls are performed when auditors believe internal controls are effective, which can reduce the extent of substantive procedures needed.
• 📊 If internal controls are deemed ineffective, the auditor assesses control risk as high, and tests of controls may no longer be necessary.
• 🛠️ Tests of controls are necessary when substantive procedures alone cannot provide sufficient audit evidence, especially in IT environments with limited documentation.
• 🔄 Auditors may perform dual-purpose tests, assessing both control effectiveness and substantive accuracy on the same transaction.
• 👀 Inquiries, inspections, observations, and walkthroughs are common methods used in tests of controls to evaluate the implementation and operation of internal controls.
• 📅 Tests of controls may be performed at interim dates if controls are effective, but further testing might be required for the remaining audit period based on several risk factors.
• 📈 The extent of tests of controls depends on factors like the frequency of control performance, the expected rate of deviation, and the reliability of evidence obtained.
• ⚠️ If deviations are detected, auditors need to evaluate their significance and may increase substantive procedures or perform additional tests of controls.

Q & A

What is the purpose of a test of controls in an audit?

A test of controls, also known as a compliance test, is performed to evaluate the operating effectiveness of internal controls in preventing, detecting, and correcting material misstatements at the assertion level.

When are tests of controls typically performed by an auditor?

Tests of controls are typically performed when the auditor's risk assessment includes the expectation that internal controls are suitably designed and operating effectively. They are also conducted when substantive procedures alone are not sufficient to provide appropriate audit evidence.

What is the difference between a test of controls and substantive procedures?

Tests of controls focus on evaluating the effectiveness of internal controls in preventing and detecting errors, while substantive procedures aim to gather evidence about the completeness, accuracy, and validity of financial information.

What should an auditor do if they find internal controls to be ineffective?

If internal controls are found to be ineffective, the auditor assesses the control risk as high or maximum. In such cases, tests of controls are not necessary, and the auditor will increase substantive procedures to gather sufficient evidence.

What is a dual-purpose test in auditing?

A dual-purpose test is when the auditor performs both tests of controls and substantive procedures on the same transaction. This allows the auditor to evaluate control effectiveness and detect material misstatements simultaneously.

What factors influence the timing of tests of controls?

The timing of tests of controls depends on the auditor's risk assessment, the significance of risks, the specific controls tested during the interim period, and any significant changes to those controls during the period.

What happens if deviations from controls are found during the test of controls?

If deviations from controls are detected, the auditor should investigate further to understand the causes and assess the consequences. They must determine whether the controls can still be relied upon or if additional tests or substantive procedures are necessary.

Why might an auditor perform additional tests of controls during the audit period?

An auditor may perform additional tests of controls to gather more evidence if the initial test results are inconclusive or if the internal controls show signs of weakness, particularly over high-risk areas.

What is the importance of an audit trail in the context of tests of controls?

An audit trail provides a chain of evidence connecting account balances and summary results to the original transactions and supporting documentation, allowing the auditor to trace the entire process and assess internal control effectiveness.

How often should controls be tested if the auditor relies on prior audit evidence?

If the auditor relies on prior audit evidence, controls should be tested at least once every three audits, and some controls should be tested in each audit to ensure continued reliability without testing all controls in a single period.