Appendix 3 Tests of Controls The auditor may wish to test controls if they will be relied upon to reduce substantive

testing, or obtain information on which to base recommendations in the Management Letter. The following tables list some control procedures that a company might have in place for cash, accounts receivable, and inventories, along with tests that the auditor might perform to see if these controls are operating. Control Procedures or Activities that the Company Might Perform Cash: Authority to sign bank payment orders is restricted to selected individuals who do not have access to the accounting records (segregation of duties). Segregation of duties between personnel who have access to cash receipts and those who make entries into the accounts receivable records. Cash receipts are listed and deposited on a daily basis. Typical Tests of the Control that the Auditor Might Perform Observe and make inquiries about the performance of various functions and duties. Observe and make inquiries about the performance of various functions and duties. Select a sample of daily cash receipts listings. Compare information (date and amount) to bank deposit records, cash receipts journal and posting to accounts receivable. Compare the details of a sample of recorded disbursements in the cash disbursements journal to accounts payable postings, purchase orders, receiving reports, invoices and bank payment orders. Observe and make inquiries about the security procedures for cash on hand, including inquiries about access. Observe and make inquiries about the performance of this comparison. Select a sample of bank statements throughout the year and examine for indications that this comparison was performed and that any differences were promptly investigated and resolved.

Cash disbursements must be properly authorized.

Cash on hand is adequately safeguarded. Daily bank statements are compared with accounting records and any differences are investigated and resolved. The comparison is performed by a person who is restricted from making entries in the accounting records.

Control Procedures or Activities that the Company Might Perform Accounts Receivable and Sales: Segregate duties over sales from duties over collections of receivables. Match sales invoices with shipping documents, purchase orders, and sales orders. Review of the clerical accuracy of sales invoices by a second person. Obtain credit approval of sales prior to shipment. Mail monthly statements to customers and follow up on errors reported. Use listings to control and document cash collections. Use budgets and analyze variances from actual amounts. Use pre-numbered shipping and billing documents and account for the sequence. Use credit memoranda for authorization of adjustments to sales and receivables.

Typical Tests of the Control that the Auditor Might Perform Observe and make inquiries about the performance of various functions and duties. Select a sample of sales invoices and examine for evidence that the company compared details to shipping documents, purchase orders, and sales orders. Select a sample of sales invoices and examine them for evidence of secondperson review. Make inquiries about credit policies; select a sample of sales transactions and examine evidence of credit approval. Observe and make inquiries about the mailing of statements and review evidence of follow-up for a selected sample of statements. Observe, make inquiries about the process, and reconcile selected listings to the bank and accounting records. Examine budgets and evidence of followup on variances. Observe and make inquiries about the use of pre-numbered documents and inspect evidence of accounting for the sequence. Select a sample of credits to customers accounts and inspect credit memoranda and other supporting documents.

Control Procedures or Activities that the Company Might Perform Inventories: Segregation of duties over purchases and custody of inventories. Use pre-numbered requisitions, purchase orders, and receiving reports and account for the sequence of documents. Establish procedures for authorizing purchase transactions, reconciling purchase invoices to purchase orders and receiving reports, and verifying the clerical accuracy of purchase invoices. Establish general ledger control of inventories of raw materials, goods in process, and finished goods and periodically reconcile to production records. Establish controls for the cost accounting system that accumulates appropriate inventory costs on a job order or process cost basis, such as independent reviews of cost accumulations. Analyze variances from standard costs Use perpetual records to control inventories. Use appropriate procedures for taking the physical inventory counts. Establish appropriate physical controls over inventories.

Typical Tests of the Control that the Auditor Might Perform Observe and make inquiries about the performance of various functions. Observe and make inquiries about the use of pre-numbered documents and inspect evidence of accounting for the sequence. Observe and make inquiries about purchase procedures, and test a sample of purchase transactions by inspecting evidence of authorizations and reconciliations, comparing the details to authorized purchase orders and receiving reports, and recomputing the invoice amounts. Inspect accounting and production records and selected reconciliations.

Inspect evidence of independent reviews of cost accumulations, recompute material costs by reference to requisitions and purchase invoices, direct labor costs by reference to time and payroll records, and overhead application rates. Inspect inventory reports and examine evidence of follow-up on variances. Inquire about the perpetual inventory procedures, and test the records by reference to purchase invoices, receiving reports, and production records. Review the inventory instructions and observe the inventory-taking process. Observe and inquire about the physical control policies and procedures.