What is meant by the auditors understanding of a clients internal control?
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This is the very first step of any audit. Remember that audits are customised to the unique characteristics of the client at that point in time. ISA/ASA315 is the first step – you’ll often do this at a high level in the early planning stages. Show
As part of understanding the client, you also need to understand the internal controls. Interviewing the client and then documenting that work in a flowchart is essential. It is highly advisable to ask your client to go on a tour of their business – this way you can match up what staff tell you with what they actually do. Here is an example of me visiting a retailer and identifying internal controls. Peer Review results indicate that some auditors believe they can default control risk assessments to "maximum" without any consideration of their client's controls. But is this the right approach? Many will be shocked to learn that the answer is "no." Auditors should not default to any level of control risk. An auditor should have a reasonable basis for his or her assessment of control risk, regardless of the assessment level. Defaulting to a control risk assessment of "maximum" without evaluating the design and implementation of relevant controls could lead an auditor to failing to identify risks that are relevant to the audit. The evaluation of the design of controls and the determination of whether the controls are implemented provide the basis for designing an effective response to the risk of material misstatement. The auditor's strategy may or may not include testing the operating effectiveness of controls. In other words, a substantive audit approach may be implemented as long as your audit procedures are responsive (and linked) to the assessed risks of material misstatement. Peer Review results also indicate that some auditors believe they can lower their control risk assessment without testing whether the controls are operating as designed, but that's not true. If the auditor's response (i.e., substantive procedures) to the assessed risk of material misstatement is based on an expectation that controls are operating effectively, then the auditor is required to perform tests of the controls upon which reliance is placed. Evaluating control design and implementation is not the same thing as testing the operating effectiveness of those controls. Many auditors confuse the terms "implementation" and "operating effectiveness," but as paragraph .A77 of AU-C Section 315 states, "obtaining audit evidence about the implementation of a manual control at a point in time does not provide audit evidence about the operating effectiveness of the control at other times during the period under audit." Misstep No. 5: Failing to link further procedures to control-related risksOnce the auditor has assessed the risks of material misstatement including risk associated with the client's internal control, his or her next step will be to design and perform further audit procedures that are responsive to the client's risks. The auditor should not simply perform the same procedures that were required for another client in the same industry or even those audit procedures performed in the prior year. To illustrate, consider two clients in the manufacturing industry. For both clients, the auditor has assessed the risks of material misstatement related to the rights and obligations assertion in the accounts payable balance as maximum. Client A's bookkeeper records all invoices in the accounting system once the invoice is received. Because the invoices are not matched to a purchase order or otherwise reviewed to confirm their validity, the auditor determines that Client A's controls over the recording of accounts payable are ineffectively designed. A specific concern is the risk of recording fictitious invoices. Alternatively, Client B's bookkeeper records all invoices for authorized purchase orders in the accounting system when the invoice is paid. Because recording of invoices is delayed until payment occurs, the auditor determines that Client B's controls are ineffectively designed because a risk of unrecorded liabilities exists. While both clients are in the same industry and both have maximum risks of material misstatement related to the accounts payable rights and obligations assertion, they may require two very different audit responses. Client A's auditor may determine that the best way to lower detection risk would be to compare invoices received from vendors with a listing of approved vendors and purchase orders. Conversely, Client B's auditor may lower the threshold amount in performing a search for unrecorded liabilities. Tips to help comply with AU-C sections 315 and 330When performing future audit engagements, auditors should be sure to:
Following these tips will help drive high-quality, efficient audits that conform to the standards. For more help, visit aicpa.org/internalcontrol for free tools and resources on internal controls. About the authors Deana Thorps, CPA, is a manager; Hiram Hasty, CPA, CGMA, is a senior technical manager; and Bob Dohrer, CPA, CGMA, is chief auditor, all for the Association of International Certified Professional Accountants. To comment on this article or to suggest an idea for another article, contact Ken Tysiac, the JofA's editorial director, at [email protected] or 919-402-2112. AICPA resources Articles
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For more information or to make a purchase, go to aicpastore.com or call the Institute at 888-777-7077. What is meant by the auditor's understanding of a client's internal control?The understanding of internal controls assists the auditor in assessing the risks of material misstatement, which in turn assists in designing and implementing audit responses that are tailored to a client's assessed risks. This is true regardless of the size of the entity.
Why the auditors should understand the internal control components of the client?The auditor uses the understanding of internal control to identify types of potential misstatements, consider factors that affect the risks of material misstatement, and design the nature, timing, and extent of further audit procedures.
What are the methods auditors use to document their understanding of a client's internal controls?In addition to talking to company employees, the auditor must use additional procedures, such as inspections, observations, or tracing transactions through the information system, to understand the company's internal controls.
Why does an auditor need to understand a client's IT system?Obtaining an understanding of the IT environment relevant to the entity's information system is an integral part of identifying and assessing risks of material misstatement and of designing and implementing appropriate responses to those risks, including when applicable, performing tests of controls.
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