Chapter 7 Compliance Testing

Compliance Testing Compliance testing follows on from the preliminary evaluation stage. These tests examine the existence, effectiveness and continuity of controls in each sub system. Tests include: Enquiry Inspection Observation Reperformance

Designing Compliance Test Programs A judgemental or statistical approach or a mix of the two can be taken. A sample size needs to be determined. Audit Sampling Is a selection of less than 100% of the population and the evaluation of this sample, such that the auditor expects this sample to be representative of the whole population and upon which a reasonable conclusion can be drawn.

Designing Compliance Test Programs Attribute Sampling – most common Attribute sampling means that an item being sampled either will or won’t possess certain qualities, or attributes. An auditor selects a certain number of records to estimate how many times a certain feature will show up in a population. When using attribute sampling, the sampling unit is a single record or document. An example of an attribute sampling feature may be that per the client’s internal control procedures, all purchases over $50 are supposed to be authorized by a purchase order. So every purchase over $50 either will or won’t be authorized by a purchase order — attribute sampling has no gray area.

Designing Compliance Test Programs Once you have decided on the attribute, a sample size and selection method can be determined. Factors that influence the sample size are: The tolerable error rate (TER) The expected error rate (EER) The population size Sampling Risk may also be involved. It’s the risk that the sample selected does not draw the same auditors conclusion as what would have been reached if the tests were applied to the whole population

Implementing Compliance Test Programs Sales Program: 1. Testing controls: accounts receivable and sales Select representative sample of dispatch documents Trace to sales invoice Trace to entries in the sales journal Trace posting to accounts receivable subsidiary ledger

Implementing Compliance Test Programs Sales Program: 2. Testing controls: accounts receivable and sales Select a representative sample of sales invoices from the sales journal: Perform recalculations to check for mathematical accuracy Vouch prices to approved price list Vouch despatch documents

Implementing Compliance Test Programs Sales Program: 3. Testing controls: accounts receivable and sales Inspect storage of debtors records Review segregation of duties You can do the same sort of testing for the Accounts payable, Cash Receipts and Cash Payments subsystem

Example of Compliance Program Background Information Your sales sample is based on the following: Approx Sales $5,000,000 Tolerable error rate is 4% Expected error rate is 3% 80% sales on credit = $4,000,000 Average credit sale is $1,000 4,000,000 = 4,000 Population of sales invoices 1,000 is 4,000

Example of Compliance Program 10% will be examined – 400 Select 200 from November and 200 from February Inspect MYOB journals and related documentation for sales items

Example of Compliance Program Test Program Step 1 : Review despatch slips (200 Nov, 200 Feb) Signed? Invoice number on each docket? Details of despatch slip = sales invoice? Findings 50 invoices did not have corresponding despatch slips. Error rate = 50 x 100 = 12.5% Well above TER 400 WEAKNESS - ACTION REQUIRED

Example of Compliance Program Test Program Step 2 : Review Invoices (200 Nov, 200 Feb) Sales authorised? Despatch slip signed? Invoice price = current price lists (at date on invoice)? Accuracy of invoice checked? Findings 60 sales not authorised Error rate = 60 x 100 = 15% Above TER 400 WEAKNESS – ACTION REQUIRED

Example of Compliance Program Test Program Step 3 : Review Invoices (200 Nov, 200 Feb) Authorised credit limit exceeded? Credit checking process performed? All details correct in sales journal? Transaction in debtors ledger? Sales journal – correct sequence of invoice numbers? Scan invoices, all there? Findings 40 invoices had no credit checks. Error Rate = 10%. Above TER WEAKNESS - ACTION REQUIRED

Example of Compliance Program Final Step : Prepare report to management outlining weaknesses. Note: This level of error rate may indicate the need to increase the control risk in the subsystem

Report on Findings Management will be interested in this, as to others such as directors, shareholders or regulators Report would indicate weakness found and corrective action required Include scope of work and procedures undertaken

Report on Findings Recommended layout: Executive Summary Objective and Scope Specific findings and recommendations