Answers and Solutions

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Determine the extent and types of controls being used by the client. Determine which of these controls the auditor intends to rely upon. Based on the first two steps, determine which audit procedures should be expanded or reduced. Make recommendations to the client regarding how to improve its system of internal controls.

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An evaluation of internal control involves an examination of the effectiveness of an organization's system of internal controls. By engaging in this evaluation, an auditor can determine the extent of other tests that must be performed in order to arrive at an opinion regarding the fairness of the entity's financial statements. A robust system of internal controls reduces the risk of fraudulent activity, which moderates the need for additional audit procedures. The examination concentrates on such issues as:

• The separation of duties
• Checks and balances
• Safeguarding of records
• The training level and competence of employees
• The effectiveness of the entity's internal audit function

The steps involved in this evaluation process include the following:

Determine the extent and types of controls being used by the client. Determine which of these controls the auditor intends to rely upon. Based on the first two steps, determine which audit procedures should be expanded or reduced. Make recommendations to the client regarding how to improve its system of internal controls.

The last of the preceding steps is useful for improving the control environment for the auditor in the following year's audit.

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Interview Management

Management interviews allow auditors to understand the mindset of business owners and other managers in the company. Interview questions include why the owner created certain internal controls, what the controls are for, do managers understand the purpose of the controls and what corrective measures are taken when a control violation is found. These questions also help auditors determine how close business owners and managers are to the company’s frontline operations. Managers who are consistently absent from creating or reviewing internal controls can signal a lax environment where employees may abuse company operations.

Interview Employees

Employee interviews serve another important evaluation process. Auditors use employee interviews to determine how well individuals are trained for their jobs. The interviews can also shed more light on how well business owners and managers educate employees on the importance of safeguarding business operations. Auditors may ask employees what is their job responsibility, how do they protect the company’s business and financial information, have they been given a manual outlining the company’s standard operating procedures and who is responsible for reviewing the employee’s completed work.

Related Reading: What Are the Benefits of an External Audit?

Observe Processes

Auditors often observe or review business processes when evaluating internal controls. Auditors and business owners or managers generally select a few critical operations to observe. Selecting a sample is a common process in internal and external audits. Auditors focus attention on processes that are responsible for the majority of the company’s business production. These processes may also be subject to more fraud or abuse by employees. Observing internal controls in the actual environment help auditors determine the effectiveness of each control in the company.

Test Controls

Auditors often test a company’s internal controls by reviewing operational information. Testing internal controls relates to the company’s financial accounting department as a rule. Auditors select a sample of information and test it against the company’s standard operating procedures or national accounting standards. This process ensures employees are not abusing a company’s financial information by committing fraud or embezzlement. Small business owners may need an external audit to secure financing from banks, lenders or investors. Business owners can use external auditors' opinions to ensure lenders and investors that the company is properly safeguarding their financial information with internal controls.

Answer

There is a new guidanace note issued by Institute of Chartered Accountants of India for evaluation of the internal control effectiveness. Please refer the guidance note and study the Risk control matrix mentioned in the guidance note.