Auditing and Assurance revision question and answer

Auditing and Assurance Revision Questions and Answers

Based on study and evaluation of internal control system, auditor concludes that internal controls are well designed and functioning effectively. Still auditor performs appropriate substantive audit procedures to form an opinion on the financial statements before issuance of audit report. Explain why auditor has to perform appropriate substantive audit procedures in such an ideal situation also.
Answer
An internal control system can provide only reasonable assurance that the management‟s objectives in establishing the system are achieved. This is due to the fact that internal control system has the following inherent limitations:
i) Controls have to be cost effective. So, some controls may not be instituted because they are not cost effective.
ii) Most controls are directed at transactions of usual or routine nature. Therefore transactions of unusual nature may escape from ambit of internal control.
iii) The potential of human error remains in any system of control.
iv) Controls may not prevent frauds through collusion between two or more persons.
v) Management may override controls.
vi) Controls may not keep pace with changing circumstances.
vii) Management itself may manipulate transactions or accounting estimates.

Above inherent limitations of internal control system makes it necessary for the auditor to perform substantive procedures to express an appropriate opinion on the financial statements. But if the “Test of Control” conducted the auditor concludes that internal control system is in existence, operated throughout the period and functioning effectively, the auditor may not consider necessary to perform substantive audit procedure for that particular area. Substantive procedures though cannot be fully eliminated and the auditor determines the area where substantive procedures should be used.



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