Lecturer:

Auditing I
Chapter 6 (Internal Control in a Financial Statement Audit) Mr. Freddy Loing

Group 4 (Telolet) Accounting Class 4 (Monday 07.30 – 10.00):

Amellia Samantha / 008201500036
Fajar Widya Kusumah / 008201400035
Ginsi Trianesti / 008201500117
Lyra Raisa / 008201500122
Muhammad Ihsan / 008201500124
 Problems 6-13

An auditor should obtain sufficient understanding of each component

of an entity’s internal control system to plan the audit of the entity’s
financial statements and to asses control risk for the assertions embodied in
the transaction class, account balance and disclosure elements of the
financial statements.
Required:
a. Define internal control.
b. For what purpose should an auditor’s understanding of the internal control components
be used in planning an audit?
c. What are an auditor’s documentation requirements concerning an entity’s internal
control system and the assessed level of control risk?
Answers

a. Internal control is designed and affected by those charged with

governance (e.g. an entity’s board of directors), management, and
other personnel that is designed to provide reasonable assurance about
the achievement of the entity’s objectives in the following categories:
(1) reliability of financial reporting, (2) effectiveness and efficiency of
operations, and (3) compliance with applicable laws and regulations.

b. In planning an audit, the auditor should obtain an understanding of

each of the components of internal control that is sufficient to plan
the audit by performing procedures to understand the design of
controls relevant to the preparation of financial statements and
whether they have been placed in operation.
c. An auditor should document the understanding of the internal
control components obtained to plan the audit. The auditor
should document the identified and assessed risks of material
misstatements related to internal controls. When the auditor
has tested the controls, the auditor documents the linkage of
the tests with the assessed risks at the assertion level. The
manner in which these matters are documented is based on the
auditor’s professional judgment.
Problems 6-17

Cook, independent auditor, has been engaged to audit the financial statements of
General Department Stores, a continuing audit client, which is a chain of medium-size
retail stores. General's fiscal year will end on 30 June 2009, and General's management
has asked Cook to issue the auditor's report by 1 August 2009. Cook will not have
sufficient time to perform all the necessary fieldwork in July 2009, but will have time to
perform most of the fieldwork as of an interim date, 30 April 2009.
After the accounts are tested at the interim date, Cook will also perform
substantive procedures covering the transactions of the final two months of the year. This
will be necessary to extend Cook's conclusions to the balance sheet date.

Required:
a. Describe the factors Cook should consider before applying substantive procedures to
General's balance sheet accounts at 30 April 2009.
b. For accounts tested at 30 April 2009, describe how Cook should design the substantive
procedures covering the balances as of 30 June 2009, and the transactions of the final
two months of the year.
Answers

a. Before applying principal substantive procedures to balance sheet accounts at

30 April 2005, the interim date, Cook should assess the difficulty in controlling
incremental audit risk. Cook should consider whether:
• Cook’s experience with the reliability of the accounting records and management’s
integrity has been good.
• Rapidly changing business conditions or circumstances may predispose General’s
management to misstate the financial statements in the remaining period.
• The year-end balances of accounts selected for interim testing will be predictable.
• General’s procedures for analyzing and adjusting its interim balances and for
establishing proper accounting cutoffs will be appropriate.
• General’s accounting system will provide sufficient information about year-end balances
and transactions in the final two months of the year to permit investigation of unusual
transactions, significant fluctuations, and changes in balance compositions that may
occur between the interim and balance sheet dates.
 • The cost of the substantive tests necessary to cover the final two months of the year
and provide the appropriate audit assurance at year-end is substantial.
• Assessing control risk at below the maximum would not be required to extend the
audit conclusions from the interim date to year-end. However, if Cook assesses
control risk at the maximum during the final two months, Cook should consider
whether the effectiveness of the substantive tests to cover that period will be
impaired.
b. Cook should design the substantive procedures so that the assurance from
those tests and the tests to be applied as of the interim date, and any
assurance provided from the assessed level of control risk, will achieve the
audit objectives at year-end. Such tests should include the comparison of
year-end information with comparable interim information to identify and
investigate unusual amounts. Other analytical procedures and/or
substantive procedures should be performed to extend Cook’s conclusions
relative to the assertions tested at the interim date to the balance sheet
date.
Problems 6-20

Brown, independent auditor, is auditing the financial statements of

Big Z Wholesaling, a continuing audit client, for the year ended 31 January
2009. On 5 January 2009, Brown observed the tagging and counting of Big
Z’s physical inventory and made appropriate test counts. These test counts
have been recorded on a computer file. As in prior years, Big Z gave Brown
two computer files. One file represents the perpetual inventory (first-in,
first-out) records for the year ended 31 January 2009. The other file
represents the January 5 physical inventory count.
Assume:

1. Brown issued an unqualified opinion on the prior year’s financial statements.

2. All inventory is purchased for resale and located in a single warehouse.
3. Brown has appropriate computerized audit software.
4. The perpetual inventory file contains the following information in item number sequence:
a) Beginning balances at 1 February 2008: Item number, item description, total quantity and price.
b) For each item purchased during the year: date received, receiving report number, vendor item
number, item description, quantity and total euro amount.
c) For each item sold during the year: date shipped, invoice number, item number, item description,
quantity and euro amount.
d) For each item adjusted for physical inventory count differences: date, item number, item description,
quantity and euro amount.
5. The physical inventory file contains the following information in item number sequence:
tag number, item number, item description and count quantity.
Required:

Describe the substantive auditing procedures Brown may consider performing

with computerized audit software using Big Z’s two computer files and Brown’s computer
file of test counts. The substantive auditing procedures described may indicate the
reports to be printed out for Brown’s follow-up by subsequent application of manual
procedures. Do not describe subsequent manual auditing procedures. (Group the
procedures by those using (1) the perpetual inventory file and (10 answers) (2) the
physical inventory and test count files (7 answers).)
Answers

The substantive auditing procedures Brown may consider performing

include the following:

Using the perpetual inventory file

• Recalculate the beginning and ending balances (Prices x Quantities), foot, and
print out a report to be used to reconcile the totals with the general ledger (or
to agree beginning balance with the prior year’s working papers).
• Calculate the quantity balances as of the physical inventory date for
comparison to the physical inventory file. (Alternatively, update the physical
inventory file for purchases and sales from January 6 to 31 January 2009, for
comparison to the perpetual inventory at 31 January 2009).
• Select and print out a sample of items received and shipped for the periods (a)
before and after January 5 and 31, 2009, for cutoff testing, (b) between January
5 and January 31, 2009, for vouching or analytical procedures, and (c) prior to 5
January 2009, for tests of details or analytical procedures.
• Compare quantities sold during the year to quantities on hand at year-end. Print
out a report of items for which turnover is less than expected. (Alternatively,
calculate the number of days’ sales in inventory for selected items.)
• Select items noted as possibly unsalable or obsolete during the physical inventory
observation and print out information about purchases and sales for further
consideration.
• Recalculate the prices used to value the year-end FIFO inventory by
matching prices and quantities to the most recent purchases.
• Select a sample of items for comparison to current sales prices.
• Identify and print out unusual transactions. (These are transactions
other than purchases or sales for the year, or physical inventory
adjustments as of 5 January 2009).
• Recalculate the ending inventory (or selected items) by taking the
beginning balances plus purchases less sales, (quantities and/or
amounts) and print out the differences.
• Recalculate the cost of sales for selected items sold during the year.
Using physical inventory and test count files

• Account for all inventory tag numbers used and print out a report of
missing or duplicate numbers for follow-up.
• Search for tag numbers noted during the physical inventory observation
as being voided or not used.
• Compare the physical inventory file to the file of test counts and print
out a report of differences for auditor follow-up.
• Combine the quantities for each item appearing on more than one
inventory tag number for comparison to the perpetual file.
• Compare the quantities on the file to the calculated quantity balances on the
perpetual inventory file as of 5 January 2009. (Alternatively, compare the
physical inventory file updated to year-end to the perpetual inventory file.)
• Calculate the quantities and euro amounts of the book-to-physical adjustments
for each item and the total adjustment. Print out a report to reconcile the total
adjustment to the adjustment recorded in the general ledger before year-end.
• Using the calculated book-to-physical adjustments for each item, compare the
quantities and euro amounts of each adjustment to the perpetual inventory file
as of 5 January 2009, and print out a report of differences for follow-up.