1. Chapter 7
Compliance Testing

2. 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

3. 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.

4. 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.

5. 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

6. 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

7. 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

8. 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

9. 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, is 4,000

10. 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

11. 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 = 12.5% Well above TER
400
WEAKNESS - ACTION REQUIRED

12. 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 = x = 15% Above TER
400
WEAKNESS – ACTION REQUIRED

13. 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

14. 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

15. 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

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