Overview

Tests of controls are audit procedures designed to evaluate whether internal controls are operating effectively to mitigate the risks of material misstatement (RMM) in the acquisition and expenditure cycle. These tests assess whether controls over significant accounts (e.g., accounts payable, expenses) are functioning as intended across relevant assertions (completeness, cutoff, existence, presentation, valuation, accuracy, classification). The document implies these tests through descriptions of control activities and audit approaches, particularly in the context of fraud detection and control evaluation.

Examples of Tests of Controls

Below are examples of tests of controls derived from the document, linked to the internal control activities from LO 8-4 (Exhibit 8.5, Page 11) and supplemented by the audit approach in Case 8.1 (Pages 27-28):

1. Accounts Payable

• Completeness (Control: Prenumbered receiving reports used sequentially and accounted for):

  • Test: Select a sample of receiving reports from the period and verify that they are prenumbered, issued in sequence, and matched to corresponding accounts payable entries by period-end. Inspect the receiving report log to ensure no gaps exist in the sequence, confirming all received goods are recorded as liabilities.

  • Purpose: Verifies that the control prevents unrecorded liabilities by ensuring all receiving reports are accounted for.

• Cutoff (Control: Compare payables recorded early in the period to receiving reports and invoices):

  • Test: Examine a sample of accounts payable entries from the first weeks of the new period and trace them back to receiving reports and invoices dated before year-end to confirm they were recorded in the correct period.

  • Purpose: Ensures the control correctly identifies and assigns liabilities to the appropriate period, preventing cutoff errors.

• Existence (Control: Voucher packages include purchase orders and receiving reports; three-way match performed):

  • Test: Select a sample of voucher packages from paid invoices and verify that each includes a purchase order, receiving report, and vendor invoice, with evidence of a three-way match (e.g., initials or system approval). Confirm that vendors are on the approved vendor list by cross-referencing to the list.

  • Purpose: Confirms that the control ensures only legitimate obligations are recorded, reducing fictitious liabilities.

• Presentation (Control: Chart of accounts used for classifying transactions):

  • Test: Review a sample of accounts payable entries and trace the account codes to the company’s chart of accounts, ensuring they align with the nature of the transaction (e.g., inventory vs. expense).

  • Purpose: Verifies that the control ensures proper classification and disclosure of liabilities.

• Valuation (Control: Prices on invoices agreed to approved price list; invoices tested for accuracy):

  • Test: Select a sample of vendor invoices, compare prices to the approved price list or purchase order terms, and recalculate totals to confirm mathematical accuracy.

  • Purpose: Ensures the control maintains accurate valuation of payables by validating amounts against agreed terms.

2. Various Expenses

• Completeness (Control: Prenumbered vouchers, purchase orders, checks verified sequentially):

  • Test: Obtain a sequence of prenumbered vouchers or checks from the period, select a sample, and verify that each is present, properly authorized, and recorded in the expense ledger, checking for missing numbers.

  • Purpose: Confirms that the control captures all expense transactions, preventing omissions.

• Cutoff (Control: Managers compare actual expenses to budgeted amounts):

  • Test: Inspect a sample of management’s budget-to-actual comparison reports from period-end, verifying that variances are investigated and expenses are recorded in the correct period based on supporting documents (e.g., invoices dated before year-end).

  • Purpose: Ensures the control detects and corrects expenses recorded in the wrong period.

• Accuracy (Control: Expenses matched to vendor invoices or work orders):

  • Test: Select a sample of expense entries, trace them to corresponding vendor invoices or work orders, and verify that the recorded amounts match the documented costs.

  • Purpose: Confirms that the control ensures expenses are recorded accurately based on source documents.

• Classification (Control: Expenses reviewed for proper account recording):

  • Test: Examine a sample of expense transactions, review evidence of supervisory or system checks (e.g., approval initials, system logs), and confirm that expenses are recorded in the correct accounts per the chart of accounts.

  • Purpose: Verifies that the control prevents misclassification by ensuring review processes are effective.

Additional Insights from Case 8.1 (Printing Money, Pages 27-28)

The fraud case provides practical examples of tests of controls in a weak control environment, which can be adapted to verify operating effectiveness:

• Test: Select a sample of project files and vouch costs (e.g., copying expenses) to supporting documents like purchase orders and receiving reports (occurrence direction).

  • Purpose: Tests the control that costs are only charged to authorized, active projects, ensuring existence and proper classification.

• Test: Select a sample of expenditures (e.g., payments to Quickprint) and trace them to project cost records to verify coding accuracy (completeness direction).

  • Purpose: Confirms that the control ensures all expenditures are recorded in the appropriate project accounts, testing completeness and classification.

• Observation: In the case, weak controls (e.g., Welby approving and coding bills) were tested minimally, but the approach suggests observing whether segregation of duties is enforced (e.g., different individuals authorize and record).

Key Considerations

• Segregation of Duties (Page 12): Tests may include observing or inquiring about who performs authorization, custody, recording, and reconciliation tasks to ensure separation, reducing fraud risk.

• Automation (Page 12): For automated controls like the three-way match, test effectiveness by reviewing exception reports (e.g., unmatched receiving reports) and confirming management follow-up.

• Dual-Purpose Tests: As noted in Case 8.1, some tests (e.g., vouching project costs) serve both control and substantive purposes when performed at year-end, enhancing efficiency.

Key Takeaways

• Tests of controls involve inspecting documents (e.g., voucher packages, receiving reports), tracing transactions, recalculating amounts, and observing processes to verify that controls operate as designed.

• Examples are tailored to each assertion, ensuring completeness (sequential checks), cutoff (period-end reviews), existence (three-way match), presentation/classification (account coding), and valuation/accuracy (price and math checks).

• The document’s fraud case illustrates how these tests can detect control failures, reinforcing their importance in verifying effectiveness.