1. Modern Auditing:
Assurance Services and the Integrity of Financial Reporting, 8th Edition
William C. Boynton
California Polytechnic State University at San Luis Obispo
Raymond N. Johnson
Portland State University
Chapter 10 – Understanding Internal Control

2. Chapter 10 Overview

3. Fundamental Concepts of Internal Controls
Process integrated with an entity’s infrastructure
People implement internal control
Can only provide reasonable assurance
Achieve objectives in financial reporting, compliance, and operations

4. Components of Internal Control
Control Environment
Risk Assessment
Control Activities
Information and Communication
Monitoring

5. Entity Objectives with Internal Control
Reliability of financial information
Compliance with applicable laws and regulations
Effectiveness and efficiency of operations

6. Limitations of Internal Control
Mistakes in Judgment
Breakdowns
Collusion
Management Override
Cost versus Benefits

7. Roles and Responsibilities
Management
Board of Directors and Audit Committee
Internal Auditors

8. Roles and Responsibilities (cont.)
Other Entity Personnel
Independent Auditors
Other External Parties

9. Study Break
_____ is a process that assesses the quality of internal control performance over time.
Control activities
Risk assessment
Information and communication
Monitoring
D. Monitoring

10. Study Break
2. This limitation of an entity’s internal controls occurs when two or more individuals act together to perpetrate and conceal fraud.
Breakdowns
Collusion
Management override
Mistakes in judgment
B. Collusion

11. Components of Internal Control

12. Control Environment Integrity and Ethical Values
Commitment to Competence
Board of Directors and Audit Committee
Management’s Philosophy and Operating Style

13. Control Environment (cont.)
Organizational Structure
Assignment of Authority and Responsibility
Human Resource Policies and Practices

14. Risk Assessment Process

15. Information and Communication
Transactions
Audit Trail or Transaction Trail
Documents
Records
Communication

16. Control Activities Authorization Controls Segregation of Duties
Transaction authorization
Custody of assets
Recorded accountability in accounting records

17. Segregation of Duties

18. Control Activities (cont.)
Information Processing Controls
General Controls
Computer Application Controls
Controls over the Financial Reporting Process

19. General Controls Organization and Operation Controls
Systems Development and Documentation Controls
Hardware and Systems Software Controls
Access Controls
Data and Procedural Controls

20. Computer Application Controls
Input Controls
Processing Controls
Output Controls

21. Controls over the Financial Reporting Process

22. Control Activities (cont.)
Physical Controls
Performance Reviews
Controls over Management Discretion in Financial Reporting

23. Control Activities (cont.)
Monitoring
Ongoing monitoring programs
Separate evaluations
Element of reporting deficiencies to the audit committee

24. Antifraud Programs and Controls

25. Study Break
3. Which of the following does not influence the control environment?
Management’s Philosophy
Adequate Training
Hiring Processes
All of the above influence the control environment
D. All of the above influence the control environment

26. Study Break
4. This component of control activities ensures that every transaction is authorized by management acting within the scope of their authority.
Authorization Controls
Segregation of Duties
Information Processing Controls
All of the above
A. Authorization Controls

27. Study Break
5. This computer application control is designed to ensure that the processing results are correct and only authorized personnel receive the information.
Input Controls
Processing Controls
Output Controls
Data Controls
C. Output Controls

28. Understanding Internal Control
Must perform procedures to:
Understand design of policies and procedures
Determine whether the policies and procedures are operating

29. Understanding Internal Control
Auditor uses the understanding to:
Identify types of potential misstatements
Understand factors affecting risk of material misstatement
Design further audit procedures

30. Effects of Preliminary Audit Strategies
Control Environment
Risk Assessment
Information and Communication
Control Activities
Monitoring

31. Procedures to Obtain an Understanding
Review previous experience with the client
Inquire management, supervisory, and staff personnel
Inspect documents and records
Observe activities and operations
Trace transactions through system

32. Documenting the Understanding
Questionnaires
Flowcharts
Decision Tables
Narrative Memoranda

33. Questionnaire

34. Decision Table

35. Narrative Memoranda

36. Study Break
6. All of the following are procedures used to obtain an understanding of internal controls except:
Inspecting documents
Inquiries of client’s customers
Inquiries of management
All of the above procedures are used
B. Inquiries of client’s customers

37. Study Break
7. This form of documentation is a diagram that uses symbols to identify the steps involved in processing information through the accounting system.
Questionnaire
Flowchart
Decision Table
Narrative Memoranda
B. Flowchart