Management Control Tools and Audit Procedures

Management Control Instruments

Planning

Establishes lines of action and responsibility within a company's organization to achieve goals. This is executed through programs and embodied in the budget applicable to each program.

Budget

Determines objectives more precisely, specifying amounts and responsible parties. The budget, when applied to the immediate future, is known as operational planning. It is typically performed for a period of days or weeks, using fully quantitative variables and involving the direct participation of each department.

Causes of Deviations

Deviation Definition

A deviation is the difference that arises when comparing expected (planned or budgeted) data with actual results.

Sources of Deviations

• Errors in environmental estimates: Inaccuracies in estimated sales, cost of sales, or overheads.
• Methodological errors: Issues such as insufficient decentralization, poor timing (lax temporary coordination), lack of coordination between accounting and budgets, etc.
• Errors in the ends-means relationship: Setting overly ambitious targets, incorrect use of resources, and other related issues.

Sufficient Audit Evidence

Refers to the measure of the quantity of audit evidence that the auditor must obtain through audit procedures to form reasonable conclusions on which to base the audit opinion on the financial statements.

Substantive Audit Evidence

Aims to obtain audit evidence to detect material misstatements in the annual accounts (financial statements). Substantive procedures relate to amounts and assertions and are of two main types: analytical procedures and tests of details of transactions and balances.

Types of Substantive Tests

• Physical Examination: Inventory observation and cash counts.
• Documentary Review: Examination of invoices, vouchers, purchase orders, contracts, and other relevant documents.
• Confirmations: Obtaining direct verification from third parties (e.g., bank confirmations, accounts receivable confirmations, public records checks).
• Testimonial Evidence (Inquiry): Using questionnaires, asking questions during informal meetings, and conducting formal interviews.
• Analytical Procedures: Performing arithmetic tests (e.g., recalculating depreciation and provisions), calculating and analyzing key financial ratios and trends.
• Record Review: Examination of accounting journals, general ledger, and subsidiary ledgers.
• Internal Control Evaluation: Assessing controls using internal control questionnaires, flowcharts, walkthroughs, etc. (Note: Often performed as tests of controls but can inform substantive testing).
• Representations: Obtaining written representations from management confirming certain matters.

Understanding Audit Risk Components

• Audit Risk (AR): The risk that the auditor expresses an inappropriate audit opinion when the financial statements are materially misstated.
• Control Risk (CR): The risk that a misstatement that could occur in an assertion about a class of transaction, account balance, or disclosure and that could be material, either individually or when aggregated with other misstatements, will not be prevented, or detected and corrected, on a timely basis by the entity's internal control.
• Detection Risk (DR): The risk that the procedures performed by the auditor to reduce audit risk to an acceptably low level will not detect a misstatement that exists and that could be material, either individually or when aggregated with other misstatements.
• Inherent Risk (IR): The susceptibility of an assertion about a class of transaction, account balance, or disclosure to a misstatement that could be material, either individually or when aggregated with other misstatements, before consideration of any related controls.

Materiality in Auditing

The magnitude or nature of a misstatement (including an omission) in financial information that, either individually or collectively, and in light of surrounding circumstances, makes it probable that the judgment of a reasonable person relying on the information would have been changed or influenced by the misstatement.