What is a Test of Control?

A test of controls is a form of audit procedure that test on a company’s internal control. Typically, those controls are related to the company’s internal control over financial reporting. This is because the internal controls, particularly those controls over financial reporting, will have a substantial influence on the quality of the company’s financial statements. If the firm has strong controls, and the management has been implementing them efficiently, it has a relatively low risk of having material misstatements in its financial statements.

According to the requirement of the standards, auditors should complete the internal control testing at the stage of audit planning. However, in the real situation, auditors may perform it at the execution stage.

Both the substantive procedures audit approach and the system-based approach contains the tests of controls. Nonetheless, the substantive test is different from the tests of controls. The auditors may perform the latter to verify the effectiveness and efficiency of the controls over the financial reporting (Also see Distinguishing Financial Accounting and Management Accounting) of a company. This is to help the auditors to conclude whether they can rely on the controls or not. As an instance, the auditors may test if the company has prepared and reviewed its monthly bank statements properly.

Explanation

When the audit firms in Johor Bahru are conducting audit activities, it is a must for most of the audits of the financial statements to comply with the FRS (Also see FRS 1). This standard demands the auditors to conduct a risk assessment and acquire a good understanding of the internal controls and the business’s nature of their customer at the planning stage. Thus, generally, the auditor needs to understand their customer’s internal control associated with the operation and financial reporting, as well as the nature of the business.

However, the auditors do not have to test for all the internal controls. The main focus of the auditors will be on the internal controls over financial reporting since they play a crucial role in the preparation of financial reports which they have to audit. This explains why the auditors should understand the internal controls over financial reporting of their customers and assess whether the controls are reliable.

If the controls are reliable, they can detect most of the risks which may have a material impact on the financial statements. Besides, if the auditors want to assess the reliability of the controls, they have to design internal control testing on the crucial controls before making conclusions.

This step is crucial in enabling the auditors to do their work smoothly. As an instance, if the auditors conclude that their customer has a reliable and strong internal control over financial reporting, they will cut down the substantive testing. However, if the opposite happens, they will increase the substantive test according to their judgement, probably up to 95% with some reasonableness test.

The Procedures of the Test of Controls

The procedures involved in the tests of controls may be different as this depends on the type of control the auditors are testing. As an instance, the auditors may want to review the Capital Expenditure Authorisation (CEA) to determine if the management is implementing it according to the delegation which the board of directors has approved.

To deal with this type of control, the auditors may collect samples on the company’s capital expenditure which has happened throughout the period. Then, they need to examine the invoices as well as the relevant documents against the authorisation. The auditors will call this procedure as inspection.

Thus, the procedures that the auditors will use to conduct the tests of controls over financial reporting depends on the controls that the auditors intend to examine. Listed below are the procedures that the auditors will usually use:

• Observation: As an instance, the auditors will observe the inventories count of their customer at the end of the year to make sure that the count exists, and the workers are using the correct procedures during the count.
• Inspection: The auditors will inspect those documents which are associated with the controls. Some examples include the goods receive notes and the invoices.
• Reperformance: The auditors will reperform the controls that their customer has performed. For instance, they will reperform monthly bank reconciliation that the customer has done.
• Recalculation: For example, the customer will recalculate the monthly depreciation which the customers have performed.
• Confirmation: The auditors do this to test whether the accounts payables, accounts receivables, bank accounts or the loan balance exist.