Question Of The Week

AUD: Reduced Control Risk

Which of the following procedures concerning accounts receivable would an auditor most likely perform to obtain evidence supporting an assessed control risk below the maximum level?

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A. Inspecting documents for proper review and approval of write-offs by the treasurer.
B. Asking principal customers to verify the amounts they owe the client.
C. Inspecting an analysis of accounts receivable for unusual balances.
D. Comparing credit loss expense with the history of accounts receivable written off.

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Explanation

Four procedures for testing controls (RIIO)
Reperformance	Performing the control procedures (eg, recalculations) Comparing test results with the client's results
Inspection	Examining documents and reports Obtaining evidence that control procedures are followed
Inquiry	Asking client personnel if they think control is effective Asking client how control is performed
Observation	Watching client's employees perform control procedures Evaluating whether policies are followed

Control risk (CR) The risk that a company's internal controls will neither prevent nor detect material misstatements. is the risk that an entity's internal control (I/C)Procedures put in place to ensure the integrity of financial information and to prevent or detect and correct fraud or errors. will not prevent or detect material misstatement(s). If an auditor intends to reduce the level of CR, control tests An audit procedure used to form a conclusion about the design and operating effectiveness of an internal control procedure used by the client to prevent or detect material misstatements. must be performed to evaluate the operating effectiveness of the entity's I/C over a specific financial assertion.

Inspecting documents can provide evidence that a control procedure (eg, segregation of duties) has been effectively followed. For example, an accounts receivable (AR) control test might determine whether an accountant recorded credit loss expense based on documented approval by another person (eg, treasurer). Control testing may lead to a reduction in assessed CR if the control is deemed effective.

In contrast, substantive procedures are used to detect material misstatements and are generally performed after tests of controls. For example:

Asking principal customers to verify the amounts they owe the client (ie, provide AR confirmations) or inspecting an AR analysis for unusual balances (an analytical procedure) are substantive procedures performed to verify the reported net AR balance is materially correct (Choices B and C). Control tests do not verify account balances.
Comparing an entity's history of AR write-offs with the current expense for credit losses is an analytical procedure to test the reasonableness of both that expense and the balance in the allowance for credit losses account. This procedure does not test the controls associated with AR (Choice D).

Things to remember:

An auditor performs tests to evaluate the operating effectiveness of internal control (I/C) over financial reporting. I/C is effective, control risk and substantive audit testing may be reduced.

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