◄UNIT 10: INTERNAL CONTROL SYSTEMUNIT 12: PROCEDURES IN AUDIT OF FINANCIAL STATEMENTS►

UNIT 11: TEST OF CONTROL

  • UNIT 11: TEST OF CONTROL

    Key unit competence: To be able to describe the characteristics of 

    effective accounting systems.

    Introductory activity

    1. Explain the relationship between small circles and big circle

    In the last Unit we talked about controls and evaluating internal controls. We 
    have stated that in all audits, auditors must ascertain the accounting system and 
    internal control system used. If auditors decide to rely on controls, they must 
    test them. The next Unit describes the controls that may operate and the tests 

    auditors may carry out.

    It is best to examine controls in terms of the various components of the 
    accounting system. Most commonly, these will be: sales, purchases, wages 
    and other systems such as inventory, non-current assets and management 

    information.

    11.1. Sales system

    Learning activity 11.1

    Analyze the picture above, and answer the following questions: 
    1. What do you see in this picture? 

    2. Which elements do you see can be used in sales system?

    The tests of controls of the sales system will be based around: 

    • Selling (authorisation) 
    • Goods outwards (custody) 

    • Accounting (recording and valuation)

    11.1.1. Control objectives

    The most important objectives of internal control relating to receivables and 

    sales are as follows.

    11.1.2. Control activities 

    The following control activities relate to the ordering and credit control process; 
    note the importance of controls over credit terms, ensuring that goods are only 

    sent to customers who are likely to pay promptly.

    • Segregation of duties : credit control, invoicing and inventory despatch 

    • Authorisation of credit terms to customers involves: 

    – References/credit checks obtained 

    – Authorisation by senior staff 

    – Regular review

    • Authorisation for changes in other customer data

    – Change of address supported by letterhead 

    – Requests for deletion supported by evidence balances cleared/

    customer in liquidation 

    • Credit limits confirmed before new orders are accepted 

    • Sequential numbering of blank order documents 

    • Matching of customer orders with production orders and despatch 

    notes

    The following procedures relate to invoice preparation and despatches:

    • Authorisation of despatch of goods 

    – Despatch only on sales order 

    – Despatch only to authorised customers 

    – Special authorisation of despatches of goods free of charge or 

    on special terms

    • Examination of goods outwards as to quantity, quality and condition 

    • Recording of goods outwards on goods despatched notes 

    • Agreement of goods outwards records to customer orders, 

    despatch notes and invoices

    • Pre-numbering of despatch notes and delivery notes and regular 

    checks on sequence

    • Condition of returns reviewed 

    • Recording of goods returned on goods returned notes 

    • Signature of delivery notes by customers

    Procedures for the preparation of invoices and credit notes including the 

    following: 

    – Authorisation of selling prices/use of price lists 

    – Authorisation of credit notes 

    – Verification of prices, quantities, extensions and totals on invoices 

    and credit notes

    – Sequential numbering of blank invoices and credit notes, and 

    regular tests on sequence 

    • Inventory record updated on a timely basis 

    • Matching of sales invoices with despatch and delivery notes and 

    sales orders 

    • Regular review for orders which have not yet been delivered

    The following control activities relate to accounting and recording.

    • Segregation of duties: recording sales, maintaining customer accounts 

    and preparing statements 

    • Recording of sales invoices sequence and control over spoilt 

    invoices 

    • Matching of cash receipts with invoices

    • Retention of customer remittance advices 

    • Separate recording of sales returns, price adjustments etc. 

    • Cut-off procedures to ensure goods despatched and not invoiced (or 

    vice versa) are properly dealt with in the correct period 

    • Regular preparation of receivables statements 

    • Review of receivables’ statements to ensure they have been prepared 

    correctly 

    • Safeguarding of receivables statements so that they cannot be 

    altered before despatch

    • Review and follow-up of overdue accounts 

    • Authorisation of writing off of irrecoverable debts (bad debts)

    • Reconciliation of receivables ledger (sales ledger) control account 

    • Analytical review of receivables ledger (sales ledger) and profit 

    margins

    11.1.3. Tests of controls 

    The precise nature of the tests of controls performed by the auditor would 
    depend on the way in which the control is being operated by the audit client. 

    Procedures however would typically include the following.

    • Review the organisation chart and allocation of responsibilities and 

    assess whether segregation of duties is operating. 

    • Verify that references are being obtained for a sample of new 

    customers by reviewing customer files. 

    • Verify that a sample of new accounts on the sales ledger have been 

    authorised by senior staff. 

    • Examine computer application controls for credit limits. 

    • For a sample of customer orders obtain evidence that they have been 

    matched with production orders and despatch notes. 

    • Verify that price lists and terms of trade are properly documented, 

    authorised and communicated. 

    • Obtain evidence of authorisation of goods despatched e.g. signature 

    of despatch note.

    • Review and test the entity’s procedures for accounting for numerical 
    sequences     of despatch notes and inspect despatch notes to confirm 

    that they are sequentially numbered. 

    • Examine delivery notes for evidence of confirmation of receipt of 

    goods by customers e.g. customer signature.

    • Obtain evidence that procedures relating to the accuracy of invoices
    have been performed e.g. evidence that prices have been matched 
    to the price list, evidence that calculations have been reperformed, 

    evidence that discounts have been authorised. 

    • Review and test the entity’s procedures for accounting for numerical 
    sequences of invoices     and inspect invoices to confirm that they are 

    sequentially numbered. 

    • Review and observe procedures for matching of invoices to despatch 

    notes and reperform a sample.

    • Obtain evidence of authorisation of credit notes. 

    • Evaluate procedures for the preparation of customer statements. 

    • Review supplier statement reconciliations produced by the audit 

    client. 

    • Reperform a sample of supplier statement reconciliations produced 
    by the audit client to determine whether they have been performed 

    accurately. 

    • Review control account reconciliations to the receivables ledger 

    produced by the client.

    • Reperform a sample of control account reconciliations to the 
    receivables ledger to determine whether they have been performed 

    accurately. 

    • Confirm authorisation of irrecoverable receivables allowances/write 

    offs.

    Application activity 11.1
    1. What should auditors consider when reviewing sales invoices? 
    2. Which of the following controls identified when evaluating a sales 
    system would provide positive assurance to an auditor in respect of 
    the key question ‘can goods and services be supplied to a bad credit 
    risk?’ 
    a) References are obtained for new customers 
    b) Goods are verified to sales order prior to dispatch 
    c) Invoice prices prepared from authorized selling prices 

    d) Receivables statements are prepared

    11.2. The purchases system

    Learning activity 11.2

    Analyse the image above and answer the following questions: 

    1. Identify the elements can be used in purchase system

    The tests of controls of the purchases system will be around: 

    • Buying (authorisation) 

    • Goods inwards (custody) 

    • Accounting (recording and valuation)

    11.2.1. Control objectives

    The most important objectives of internal control relating to suppliers and 

    purchases are: 

    • Ordering

    To ensure that: 

    – All orders for, and expenditure on, goods and services are properly 
    authorised, and are for goods and services that are actually received 

    and are for the company. 

    – Orders are only made to authorised suppliers. 

    – Orders are made at competitive prices.

    • Receipt and invoices

    To ensure that: 

    – Goods and services received are used for the organisation’s 

    purposes and not private purposes. 

     Goods and services are only accepted if they have been ordered, 

    and the order has been authorised. 

    – All goods and services received are accurately recorded. 

    – Liabilities are recognised for all goods and services that have been 

    received. 

    – All credits to which the organisation is due are claimed. 

    – Receipt of goods and services is necessary to establish a liability.

    • Accounting

    To ensure that: 

    – All expenditure is authorised and is for goods that are actually 

    received. 

    – All expenditure that is made is recorded correctly in the general 

    (nominal) and payables (purchase) ledgers. 

    – All credit notes that are received are recorded in the general and 

    payables ledgers. 

    – All entries in the payables ledger are made to the correct payables 

    ledger accounts. 

    – Cut-off is applied correctly to the payables ledger.

    11.2.2. Control activities 

    The following control activities should be in place over ordering.

    – Central policy for choice of suppliers

    – Evidence required of requirements for purchase before purchase 

    authorised (re-order quantities and re-order levels) 

    – Order forms prepared only when a purchase requisition has been 

    received 

    – Authorisation of order forms by appropriate authorised personnel 

    – Prenumbered order forms 

    – Safeguarding of blank order forms 

    – Review of orders not received 

    – Monitoring of supplier terms and taking advantage of favourable 

    conditions (bulk order, discount)

    The client should carry out the following procedures on goods received and 

    invoices from suppliers.

    • Examination of goods inwards 

    – Quality 

    – Quantity 

    – Condition 

    • Recording arrival and acceptance of goods (pre-numbered goods 

    received notes)

    • Comparison of goods received notes with purchase orders

    • Referencing of supplier invoices; numerical sequence and supplier 

    reference 

    • Verification of suppliers’ invoices 

    – Prices, quantities, accuracy of calculation 

    – Comparison with order and goods received note 

    • Recording return of goods (pre-numbered goods returned notes) 

    • Procedures for obtaining credit notes from suppliers

    The following control activities should be in place over accounting procedures.

    • Segregation of duties: accounting and verification functions 

    • Prompt recording of purchases and purchase returns in day books and 

    ledgers 

    • Regular maintenance of payables ledger 

    • Comparison of supplier statements with payables ledger balances on 

    a regular basis

    • Authorisation of payments 

    – Authority limits 

    – Confirmation that goods have been received, accord with 

    purchase order, and are properly priced and invoiced 

    • Review of allocation of expenditure 

    • Reconciliation of payables ledger control account to total of payables 

    ledger balances on a regular basis 

    • Cut-off accrual of unmatched goods received notes at year end

    11.2.3. Tests of controls

    A most important test of controls is for auditors to confirm that all purchases have 
    been authorised. The officials who approve the invoices should be operating 
    within laid-down authority limits. The precise nature of the tests of controls 
    performed by the auditor would depend on the way in which the control is 
    being operated by the audit client. Procedures however would typically include 

    the following.

    • Observe the processing of purchase orders throughout the purchasing 

    cycle and evaluate whether proper segregation of duties is operating. 

    • Examine application controls for re-order levels. 
    • Verify that authorised supplier lists exist and have been communicated. 
    • Obtain evidence of regular management reviews of supplier terms. 
    • Examine a sample of purchase orders for evidence that they have been 
    authorised. 
    • Observe procedures for receipt of goods to verify that the goods 
    actually received are matched to the purchase order. 
    • Review entity’s procedures for accounting for pre-numbered documents 
    and inspect a sample of goods received notes for evidence of sequential 
    numbering. 
    • Review a sample of goods received notes for evidence of matching to 
    purchase orders.
    • Examine supporting documentation for evidence that purchase invoices 
    are matched to goods received notes and orders. 
    • Review a sample of purchase invoices for evidence that their accuracy 
    has been verified (e.g. signature or initials) and reperform the procedures. 
    • Review evidence of approval of invoice coding to relevant expenditure 
    account by responsible staff member. 
    • Test application controls relating to the input of purchase invoices 
    and credit notes. For example, perform a batch reconciliation to 
    determine whether purchase invoices have been entered accurately 
    and a sequence check to determine whether all credit notes have been 
    recorded. 
    • Review procedures for reconciling supplier statements to payables 
    ledger accounts and reperform a sample of reconciliations. 
    • Review reconciliations of the payables ledger accounts and payables 
    ledger control account.
    • Reperform a sample of reconciliations of the payables ledger accounts 
    and the payables ledger to ensure that they have been performed 

    accurately.

    Application activity 11.2

    1. Which of the following controls undertaken when evaluating a 
    purchases system would provide positive assurance to the auditor 
    in respect of the key question ‘Are goods only bought for business 

    purposes?’

    a) Orders should only be raised in response to an authorized 

    purchase requisition

    b) Goods inwards are examined for quality 

    c) Goods inwards are verified to purchase orders 

    d) Review of allocation of expenditure 

    2. What are the important objectives of internal control relating to 

    suppliers and purchases

    11.3. The payroll system

    Learning activity 11.3


    Analyse the image above and answer the following questions: 

    1. Explain the relationship between small circles and big circle.


    Key controls over payroll cover: 
    • Documentation and authorisation of staff changes 
    • Calculation of wages and salaries 
    • Payment of wages and salaries 

    • Authorisation of deductions

    11.3.1. Control objectives 

    The most important objectives of internal control relating to wages and salaries 

    are: 

    Setting of wages and salaries 

    To ensure that: 
    • Employees are only paid for work that they have done. 
    • Gross pay has been calculated correctly and authorised. 

    Recording of wages and salaries 

    To ensure that: 
    • Gross and net pay and deductions are accurately recorded on the 
    payroll. 
    • Wages and salaries paid are recorded correctly in the bank and cash 

    records. 

    • Wages and salaries are correctly recorded in the general ledger. 

    • Payment of wages and salaries 

    To ensure that: 
    • The correct employees are paid. 
    • Wages and salaries are only paid to valid employees. 

    Deductions 

    To ensure that: 
    • Statutory and non-statutory deductions have been calculated correctly 
    and are authorised.

    • The correct amounts paid to the taxation authorities.

    11.3.2. Control activities 

    While in practice separate arrangements are generally made for dealing with 
    wages and salaries, the considerations involved are broadly similar and for 

    convenience the two aspects are here treated together

    General arrangements 

    Responsibility for the preparation of pay sheets should be delegated to a suitable 
    person, and adequate staff appointed to assist him/her. The extent to which the 
    staff responsible for preparing wages and salaries may perform other duties 
    should be clearly defined. In this connection full advantage should be taken 
    where possible of the division of duties, and controls available where automatic 

    wage-accounting systems are in use.

    Setting of wages and salaries 

    • Staffing and segregation of duties 

    • Maintenance of personnel records and regular reconciliation of wages 

    and salaries to details in personnel records 

    • Authorisation 

    – Engagement and discharge of employees (new staff are added to 
    the payroll system correctly, and leavers are removed) 
    – Changes in pay rates 
    – Overtime 
    – Non-statutory deductions (for example pension contributions) 
    – Advances of pay 
    • Recording of changes in personnel and pay rates 
    • Recording of hours worked by timesheets, clocking in and out 
    arrangements
    • Review of hours worked 
    • Recording of advances of pay 
    • Holiday pay arrangements
    • Answering queries 

    • Review of wages against budget

    Recording of wages and salaries 

    • Bases for compilation of payroll 

    • Preparation, review and approval of payroll 

    • Dealing with non-routine matters

    Payment of cash wages 

    • Segregation of duties 

    – Cash sheet preparation 

    – Filling of pay packets 

    – Distribution of wages 

    • Authorisation of wage cheque 
    • Custody of cash 
    – Encashment of cheque 
    – Security of pay packets 
    – Security of transit arrangements 
    – Security and prompt banking of unclaimed wages
    • Verification of identity 

    • Recording of distribution

    Payment of salaries 
    • Preparation and signing of cheques and bank transfer lists 
    • Comparison of cheques and bank transfer list with payroll 

    • Maintenance and reconciliation of wages and salaries bank account

    Deductions from pay 
    • Maintenance of separate employees’ records, with which pay lists may 
    be compared as necessary 
    • Reconciliation of total pay and deductions between one pay day and 
    the next
    • Surprise cash counts 
    • Comparison of actual pay totals with budget estimates or standard 
    costs and the investigation of variances 
    • Agreement of gross earnings and total tax deducted with the returns 

    submitted to the taxation authorities

    Appropriate arrangements should be made for dealing with statutory and 
    other authorised deductions from pay, such as social insurance, tax, pension 
    fund contributions, and savings held in trust. A primary consideration is the 

    establishment of adequate controls over the records and authorising deductions. 

    For the payroll system, as with other systems, it is important that you appreciate 

    how the control activities we have identified relate to the control objectives.

    11.3.3. Tests of controls 

    Setting of wages and salaries 

    Auditors should confirm that the wages and salaries summary is approved for 
    payment. They should confirm that procedures are operating for authorising 

    changes in rates of pay, overtime, and holiday pay. 

    A particular concern will be joiners/new employees and leavers. Auditors will 
    need to obtain evidence that staff only start being paid when they join the 
    company, and are removed from the payroll when they leave the company. They 
    should test that the engagement of new employees and discharges have been 

    confirmed in writing. 

    Auditors will also wish to verify that the calculation of wages and salaries is 
    accurate. Tests of controls should be designed to obtain evidence that the 

    client is carrying out adequate checks on the calculations. 

    The precise nature of the tests of controls performed by the auditor would 
    depend on the specific control activities operated by the entity. However, they 

    would typically include the following:

    • Review payroll and HR job descriptions and company policies on the 
    payroll process, to evaluate whether proper segregation of duties is in 

    place. 

    • Review a sample of starters/new employees and leavers in the year and 
    verify that the correct documentation is in place e.g. personnel files. 
    • Review the entity’s procedures for reporting changes (e.g. wage 
    increases) to the payroll department. 
    • Obtain evidence of authorisation of standing data in payroll system. 
    • Review and test authorisation procedures for hiring staff, wage rates, 
    overtime etc. 
    • Observe employees’ use of clocking-in and out procedures.
    • Inspect a sample of clock-cards/timesheets for evidence of approval by 
    the appropriate level of management. 
    • Review documentary evidence that a sample of payroll calculations 
    have been independently reperformed by entity staff e.g. review of 
    spreadsheet printout. 
    • Test operation of computerised controls e.g. range checks. 
    • Inspect documentary evidence of management’s review of agreement 
    of gross earnings and total tax deducted to taxation returns. 
    • Examine paid cheques or a certified copy of the bank list for evidence 
    of proper authorisation.
    • Where wages are paid in cash attend the pay-out and observe 
    procedures. 
    • Review payroll budgeting procedures adopted by the client. 
    • Review reconciliation of the payroll master file to the wages and salaries 
    account in the general ledger. 
    • Review procedures for classifying payroll costs to ensure that costs are 

    not incorrectly capitalised.

    Application activity 11.3

    1. Which of the following controls would not provide assurance that the 
    correct amounts are paid to employees, in a system where employees 

    are paid by the hour? 

    a) Recording of hours worked 
    b) Reperformance of payroll calculations 
    c) Comparing bank transfer list with payroll 

    d) Comparing payroll and income tax returns 

    2. How should auditors confirm that wages have been paid at the 

    correct rate to individual employees?

    11.4. The inventory system

    Learning activity 11.4


    Analyse the picture above and answer the following questions: 

    1. Which activities are carried out there?
    2. What elements do you see on the picture can be used in inventory 

    system? 

    Inventory controls are designed to ensure safe custody, and appropriate 

    valuation. These include:

    • Restriction of access to inventory 
    • Documentation and authorisation of movements 

    • Regular inventory counting/checking and review of inventory condition

    11.4.1. Control objectives 

    The most important objectives of internal control relating to inventory are: 

    Recording 

    To ensure that: 
    • All inventory movements are authorised and recorded. 
    • Inventory records only include items that belong to the client. 
    • Inventory records include inventory that exists and is held by the client. 
    • Inventory quantities have been recorded correctly. 

    • Cut-off procedures are properly applied to inventory. 

    Protection of inventory 
    To ensure that: 

    • Inventory is safeguarded against loss, pilferage/theft or damage. 

    Valuation of inventory 

    To ensure that: 
    • The costing system values inventory correctly. 

    • Allowance is made for slow-moving, obsolete or damaged inventory. 

    Inventory-holding 

    To ensure that: 

    • Levels of inventory held are reasonable.

    11.4.2. Control activities 

    Key control activities are as follows. 

    Recording of inventory:
    • Segregation of duties : custody and recording of inventories 
    • Receipt, review and recording of goods inwards 
    • Inventory issues supported by appropriate documentation 
    • Maintenance of inventory records: 
    – Inventory ledgers 
    – Bin cards 

    – Transfer records

    Protection of inventory:
    • Precautions against theft, misuse and deterioration by: 
    – Restriction of access to stores 
    – Controls on stores environment (right temperature, precautions 
    against damp etc.) 
    • Security over inventory held by third parties, and third party inventory 
    held by entity
    • Inventory counting: 
    – Regular inventory counting/checking 
    – Fair coverage so that all inventory is counted at least once a 
    year 
    – Counts by independent persons 
    – Recording 
    – Cut-off for goods in transit and time differences 
    – Reconciliation of inventory counting to book records and 

    control accounts

    Valuation of inventory:
    • Computation of inventory valuation 
    – Accords with IAS 2 Inventories 
    – Review of calculations 
    • Review of condition of inventory 
    – Treatment of slow-moving, damaged and obsolete inventory 

    – Authorisation of write-offs

    Inventory holding:
    • Control of inventory levels by: 
    – Maximum inventory limits 
    – Minimum inventory limits 
    – Re-order quantities and levels 

    • Arrangements for dealing with returnable containers

    11.4.3. Tests of controls 

    Most of the testing relating to inventory has been covered in the purchase and 

    sales testing outlined. 

    Auditors will primarily be concerned at this stage with ensuring that the business 
    keeps track of inventory. To confirm this, tests must be carried out on how 

    inventory movements are recorded and how inventory is secured.

    • Select a sample of inventory movement’s records and reperform 

    matching to goods received and goods despatched notes. 

    • Confirm that movements have been authorised as appropriate. 

    • Select a sample of goods received and goods despatched notes and 

    agree to inventory movement records. 

    • Reperform a sample of reconciliations of inventory records with the 

    general ledger to confirm that they are performed and reviewed. 

    • Examine evidence of sequence of inventory records. 

    • If the company uses perpetual inventory counting (i.e. it counts inventory 
    on a regular basis throughout the year, rather than at the year-end 
    alone), reperform a sample of the inventory counts and review evidence 

    to confirm that:

    – All discrepancies between book and actual figures have been 
    fully investigated All discrepancies have been signed off by a 

    senior manager 

    – Obsolete, damaged or slow-moving goods have been marked 

    accordingly and written down to net realisable value

    • Observe security arrangements for inventories. 

    • Consider environment in which inventories are held. 

    • Review procedures for counting inventory and attend the count.

    Application activity 11.4

    1. What controls should businesses exercise over inventory levels? 

    2. Which of the following would be appropriate test of controls in the 

    audit of inventory :

    a) Agree a sample of inventory items to purchase invoices 

    b) Obtain details of last goods out at the inventory count 

    c) Review the system for safeguarding inventory 

    d) Review the overhead allocation system

    11.5. Non-current assets

    Learning activity 11.5


    Analyse the image above and answer the following questions: 

    1. Which kind of an assets observed on the picture? 

    Important controls over tangible non-current assets include physical custody 

    and authorisation of purchases and disposals.

    These systems tend to be of lesser importance, although this depends on the 

    nature of the business.

    11.5.1. Control objectives

     The most important objectives of internal control relating to non-current assets 

    are to ensure that:

    • Non-current assets are properly accounted for and recorded. 

    • Security arrangements over non-current assets are sufficient. 

    • Non-current assets are maintained properly. 

    • Non-current assets acquisitions are authorised. 

    • Non-current assets disposals are authorised and proceeds of disposals 

    are accounted for.

    • Depreciation rates are reasonable. 

    • All income from income-yielding non-current assets is collected.

    11.5.2 Control activities 
    Key control activities are as follows. 
    • Segregation of duties : authorisation, custody and recording 
    • Maintenance of appropriate accounting records (including distinction 

    between capital and revenue expenditure) 

    Security and maintenance: 
    • Maintenance of plant and property registers which are regularly 
    reviewed for: 
    – Agreement with general ledger 
    – Inspection of assets recorded 
    • Inspection of non-current assets to ensure properly maintaining and 

    using 

    Acquisition and disposal:
    • Authorisation of capital expenditure 

    • Authorisation of sales, scrapping or transfer of non-current assets 

    Depreciation:
    • Authorisation of depreciation rates: 
    – Calculation and confirmation of depreciation rates 

    – Arithmetical accuracy Assessment of asset lives

    Income from non-current assets: 
    • Identification of income-producing assets 
    • Monitoring of income 
    • Receipt of cash

    • Adequate insurance cover 

    Asset register 

    Maintenance of a non-current asset register is a key control activity. The register 
    should contain details of all the company’s tangible non-current assets. It is an 
    important control over the completeness of recording and safe custody of those 
    assets. To preserve segregation of duties, it should be maintained by someone 

    who does not use, and is not responsible for the custody of non-current assets. 

    The non-current asset register acts as a point of comparison against which the 
    non-current assets that physically exist can be compared, and also the non-
    current asset accounts in the general ledger. It is of most use for assets that
    can easily be stolen. Information that should be included within the register for 

    individual assets includes the following. 

    • Cost 
    • Additions or alterations to the assets 
    • Total depreciation charged over the asset’s life 
    • The serial number or other means of identification 
    • Description of the asset 
    • The location of the asset 
    • The manufacturer and supplier 
    • Insurance details 

    • Maintenance record 

    As well as knowing the control objectives and control activities that could be 
    used in relation to non-current assets, it is important that you appreciate how 

    the different control activities relate to the control objectives.

    11.5.3. Tests of controls 

    The precise nature of the tests of controls performed by the auditor would 
    depend on the way in which the control is being operated by the audit client. 
    Procedures, however, would typically include those listed below. 
    A key concern of auditors will be proper controls over movements (acquisitions 

    and disposals) during the year.

    • Confirm maintenance of a non-current asset register 
    • Review annual capital budgets produced by the board and confirm that 
    they are authorised
    • For a sample of acquisitions and disposals recorded in the non-current 
    asset register confirm authorisation (and board approval if necessary). 
    • Inspect invoices to confirm that they have been appropriately approved. 
    • Review reconciliations of the non-current assets register to the general 
    ledger accounts and confirm that discrepancies are followed up. 
    • Reperform a sample of reconciliations. 
    • Verify that depreciation rates are authorised and are in line with company 
    policy. 
    • Review evidence of arithmetical accuracy of depreciation and reperform 
    a sample of calculations. 
    • Review evidence of calculations of profits or losses on disposal and 
    reperform a sample of calculations. 
    • Review adequacy of physical security measures.
    Auditors should also carry out some testing on security and maintenance of 
    non-current assets.

    For a sample of non-current assets from the non-current asset register: 
    • Review procedures used to ensure assets are in good condition eg 
    inspection procedures.
    • Ascertain for a sample of assets when they were last reviewed for 
    maintenance and whether this is in line with company’s policy. 
    • Observe for a sample of newly acquired assets the procedures for 
    ensuring they are labelled and stored. 
    • Review procedures for insuring new assets and renewal of insurance 

    for existing assets.

    Application activity 11.5

    1. What tests would auditors normally carry out on controls over noncurrent asset purchases?
    2. Which of the following is not a test of controls over non-current 
    assets? 
    a) Review the system of authorizing capital expenditure 
    b) Review whether a non-current asset register exists 
    c) Review the system of authorizing non-current asset disposal 

    d) Review the condition of non-current assets in use.

    11.6. Non-current liabilities

    Learning activity 11.6


    Analyse the picture above and answer the following question: 
    1. Among the elements above, which ones are non- current liabilities?
    2. Why for the auditor, is auditing the liabilities of the client very 

    important?

    Non-current liabilities may comprise payables due more than one year after the 
    year end, as well as capital lease obligations, mortgages, debentures, and other 
    loans repayable at a date more than one year after the year end. 
    The most important objectives of internal control relating to non-current liabilities 

    are to ensure:

    • Authorisation: that loans and any other long-term borrowings are 
    properly authorised
    • Completeness: that all non-current liabilities have been recognised 
    and disclosed 
    • Accuracy: that the value of the liability has been correctly recorded, 
    and that interest payable has been calculated correctly and included in 
    the correct accounting period
    • Classification and understandability: that long-term loans and interest 

    on loans have been correctly disclosed in the financial statements.

    A major complication for the auditors is that debenture and loan agreements 
    frequently contain conditions with which the company must comply. These may 
    include restrictions on the company’s total borrowings, and requirements to 

    adhere to specific borrowing ratios. 

    In this respect, it is important that internal controls ensure that borrowing limits 

    imposed by agreements are not exceeded. 

    New loans should be approved by the Board, and documented in signed Board 

    minutes. 

    In the financial statements themselves, it will also be important to ensure 
    non-current liabilities are correctly disclosed, in accordance with accounting 
    standards. In particular, the capital element of any loans repayable within one 
    year should be classified under current liabilities, rather than under non-current 

    liabilities.

    Application activity 11.6

    What will be the control activities if non-current liabilities have been properly 

    recorded? 

    11.7. Management information

    Learning activity 11.7

    Analyse the image above and answer the following questions: 

    1. Explain the relationship between small circles and big circle
    The management information system is an important aspect of the control 
    environment, since timely and accurate information helps management supervise 
    operations. There should be controls in place to ensure budgets are regularly 
    set, and reports and information are provided on time to the specified degree of 

    accuracy and detail. 

    As well as the control aspects, auditors will be concerned with the management 

    information system’s ability to provide useful data for analytical procedures. 

    Auditors will also be particularly concerned of course with the accounting records, 
    with the procedures that ensure transactions are completely posted, and journal 

    adjustments are authorised and backed up by appropriate documentation. 

    11.7.1. Management information procedures 

    Auditors will review the contents of internal management accounting reports, 
    and confirm in particular that budgets are being set and that actual results are 

    being compared with budgeted figures. 

    As well as testing based on individual components of the accounting system, 
    the auditor will also perform some general tests, including the following. 
    • Test postings from books of prime entry to the general ledger. 
    • Confirm that the general ledger is regularly balanced. 

    • Test vouch a sample of journal entries to original documentation.

    Application activity 11.7

    What test of control of management information helps the management 

    operations?

    Skills lab activity 11

    Under guidance of the teacher, students in their learning teams act as 
    auditor of school and test how purchase system, payroll system, inventory 

    system are recorded, maintained and reported in accounting systems. 

    End unit 11assessment

    1. How can a company ensure that quantities of goods ordered do not 
    exceed those that are required? 
    2. What are the important verification procedures that should be made 
    on invoices received from suppliers? 
    3. Which of the following controls helps to ensure that non-current 

    assets are depreciated in line with company policy? 

    a) Limiting access to non-current assets 

    b) Periodically verifying that assets listed in the non-current asset 

    register exist 

    c) Review of records that show significant profits on disposal 

    d) Obtaining authorization for capital purchases 

    4. Mpundu Ltd, a limited liability company, manufactures high fashion 
    jeans for distribution to wholesalers and retailers. 
    You have been assigned to the audit of inventory in the company’s 
    financial statements for the year ended 31 July 2019. 

    The following points are relevant to the audit. 

    i. The company has raw materials, consumables and work in 
    progress inventory at its factory base. Finished goods are 
    stored in a separate warehouse located five miles away. The 

    company does not hold inventory owned by third parties. 

    ii. On 31 July 2019 employees of the company will physically count 
    the inventory at both of the company’s sites and members of 

    your audit team will attend.

    iii. The company has significant quantities of finished goods 
    inventory held by independent retail stores under its sale 
    or return system. Under this system, inventory is displayed 
    for sale at retail shop premises but remains the property of 
    Mpundu until it is sold by retailers. Any garments not sold 
    within three months are returned to Mpundu for bulk sale at 

    heavily discounted prices. 

    iv. Some quantities of finished goods inventory were stated at net 
    realisable value in the financial statements of the company for 

    the previous year. 

    Required 

    a) With explanations, discuss why the inherent risk associated with 
    inventory in the financial statements of Mpundu would be assessed 

    as ‘high’. 

    b) Identify five tasks that members of your audit team should carry out 
    when attending the company’s physical inventory count on 31 July 

    2019.

    ◄UNIT 10: INTERNAL CONTROL SYSTEMUNIT 12: PROCEDURES IN AUDIT OF FINANCIAL STATEMENTS►