Auditing Theory and Practice: Internal Control and Recommendations

This report provides a detailed analysis of auditing theory and practice, with a specific focus on internal control mechanisms within business entities, particularly small businesses. It explores how internal control components are adjusted by management to prevent fraud and errors, highlighting the advantages and disadvantages of these adjustments. The report includes a case study of "Hello World," offering recommendations for internal control solutions across various departments, such as accounting and cash management, emphasizing the importance of segregation of duties and regular reconciliation. Furthermore, a management letter is presented, underscoring the significance of internal control policies in safeguarding business assets, promoting better management, and ensuring accurate financial reporting.

Running head: AUDITING THEORY AND PRACTICE
Auditing Theory and Practice
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Table of Contents
Answer to question A:................................................................................................................2
Answer to Question B:...............................................................................................................4
Answer to question C:................................................................................................................6
References:.................................................................................................................................8

2AUDITING THEORY AND PRACTICE
Answer to question A:
Regardless of the business size, all the business entities are vulnerable to frauds
particularly the small business entities are victimized in the larger percentage of situations.
As stated by Stewart and Shamdasani (2014) the components of internal control mainly
consists of the inter-related components that are treated as the criteria in determining and
attaining the effective internal control system. The components of internal control are derived
by the corresponding management style and philosophy that are different from the entities
and are attached with the process of management. The components of internal control are
adjusted by the management in most often situations to meet the needs of the small entities
(Chan and Vasarhelyi 2018). This includes undertaking a directive approach towards
attaining the desired outcome with the clear direction and strong drive by the management of
small entities to achieve their objective. The components of internal control are adjusted in a
manner that it is related to the higher level directions with positive arrangement of
encouraging the employees.
The management of companies often direct the internal control components that are
designed to make an attempt towards preventing the undesirable violations or situations that
leads to the irregular activities and occurrence of fraud (Hayes, Gortemaker and Wallage
2014). In other words, the management of small entities designs the internal control policies
in order to avoid the loss or damage with an attempt of minimizing the risk. Management
often applies the preventive control in their regular work of employees in compliance with
the differences in the functions and accountabilities such that the division of responsibilities
and obligations with mutual supervision and validity of work is maintained (De Paula 2016).
The internal control components are adjusted by the small entities in manner that it is able to
identify and recognize the errors that may occur in the daily business activities.

3AUDITING THEORY AND PRACTICE
Adjusting the components of internal control results in positive consequences and also
advantageous in keeping a positive flow of internal controls (Louwers et al. 2015). The
advantages are as follows;
a. Better communication: The documents that are well written not only helps in getting
the message across the organization but also helps in building the picture of the
culture and procedure that are created to assure that the small entities meet their aims
and objectives.
b. Reduction in Error: Adjusting the internal control according to the needs of the
small entities helps in minimizing the errors and saves time and resources for small
entities (Kumar and Sharma 2015). The internal control helps in making sure that the
information of business is correct and the employees are responsible for their
activities.
c. Protection and Authorisation: Adjusting the internal control components as per the
needs of the small entities helps in providing comfort to the work force provided that
they act in a manner that is prescribed by the internal controls and inside the limits of
authorization (Cook, Van Bommel and Turnhout 2016). The business would not be
able to blame its staff given that they have discharged their responsibilities in good
faith and inside the specified guidelines.
Apart from the advantages of the internal control there are certain disadvantages that
are related with internal control;
a. Error in Judgement: All the business genuinely remain dependent on the number of
procedure and honesty. There may instances where small business are faced with dis-
honest people. Owners must be thorough in scrutinizing the probable employees the
records of employments and holding conversation with the previous employees

4AUDITING THEORY AND PRACTICE
(Vovchenko et al. 2017). Financial stress, dissatisfaction can result people in
perverting the rules.
b. Management Override: Management and workforce might in certain situations
consider internal control as the red tape, needless and wastage of time (Li et al. 2015).
In small business, staffs are regularly found in tight budgets and would be tempted to
cut the corners. As a result, people may override the internal control for their personal
benefit and make an attempt of defrauding the business.
c. Collusion: Adjusting the internal control according to the needs of small business
may result in collusion (Lisic et al. 2016). This generally happens when two or more
people come together in an attempt to defraud. Collusion is treated as difficult to
defeat in small business.
Findings from the studies have suggested that poor internal control and override of
internal control might result in business frauds. Therefore, strong internal control system
would act as the best policy in protecting the small business from every type of fraud.
Answer to Question B:
Findings from the case study suggest that the current accounting practice of Hello
World initially involves recognition of importance of proper and adequate accounting system
for the company. The accountants are found to be taking information depending upon the
accounting records and documents or the summary of accounts voucher so that the
accountants can enter data into the computer system. Based on the understanding of the
current accounting practice at Hello World several suggestion can be made for the internal
control solutions based on the major functions of departments.
Recommendations for Accounting Department:

5AUDITING THEORY AND PRACTICE
Segregation of duties can be regarded as the most preferred and effective process of
implementing control activities at the Hello World. This activity can be treated of
fundamental importance at Hello World because financial fraudulent subject is increasingly
turning out to be serious issue. If Hello World takes the advantage and implement the
preventive activity control in their computer accounting system then they prevent in advance
several misappropriate management of cash and asset. Based on the principle of segregation
of duties the related financial activities should be conducted by different people.
Figure 1: Figure representing Segregation of Duties to be conducted at Hello World
(Source: As Created by Author)
Cash Accounting: Findings suggest that the cash management and numerous accounting
data is only managed by one person who later delegates the duty to sub-ordinates. It is
necessary that segregation of duties must be done where one person cannot be held
responsible for accounting records (Clinton, Pinello and Skaife 2014). A review and
oversight on cash account should be made. Furthermore, it is recommended that each
transaction with cash must be documented by the appropriate form and signature of the cash
manager.

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Accounts receivable: The segregation of duties must be made at Hello World as accounts
receivable significantly vulnerable to fraud. The board of directors and the accounting
managers must review the reports relating to the collection, billings and writing offs. Such
activities would empower the manager to keep a check on the cash flow and forewarn the
directors regarding any unofficial write offs. The system of order must be control correctly
under the approval of the accounting manager.
Accounting reconciliation and analysis: Following the access control and description of
job, accounting reconciliation and analysis is regarded as the third most vital group of the
basic controls. One of the vital ingredients of successful frauds is the successful concealment.
It is recommended that the regular, corrective accounting reconciliation and analysis would
make the concealment difficult or impossible (Demirakos 2018). Performing of accounting
reconciliation on the monthly basis should be carried out by the board of directors in the areas
of bank reconciliation for the accounts.
The board of directors should also review and oversight the accounts receivable
reconciliation from month to month and the general ledger to sub-ledger. A review should
also be conducted by the board of directors in the areas of accounts payable reconciliation for
both month to month and the general ledger to sub-ledger. Therefore, such procedure can be
helpful in highlighting the discrepancies that results in misappropriate of accounts and cash.
Answer to question C:
Management Letter
To Tim and Abi Scott
From ABC Consultants
Date: 16-10-2018

7AUDITING THEORY AND PRACTICE
Dear Tim and Abi
We wish seek your valuation attention towards our letter relating to the
importance of having internal control at Hello World. The internal control acts as the filter
throughout the entire business. The internal control policies are helpful in aligning with the
objectives of business and helps in making sure that the process of reporting that are carried
out at Hello World are in accordance with the objective of business. Having internal control
policies at Hello World would help in safeguarding the business assets as the system makes
sure that physical and monetary assets are safeguarded from fraud and errors of
misjudgement.
The internal control policies not only detect frauds and error but also helps in
promoting better management. Having internal control policies at Hello World would ensure
that systems recognize any error quickly as and when they occur. Apart from this, the internal
control policies would allow the managers to receive the appropriate information in the
timely manner regarding the performance of any target along with the vital figure than reflect
variations from the target.
The internal control policies helps in minimising the chances of unanticipated errors
at Hello World. Implementing the internal control at Hello World would ensure segregation
of duties and appropriate financial reporting. As understood maintenance of accurate and
complete reports is usually required by the legislation and management. Therefore, the
application of internal control policy would help the management in minimising the lost time
of correcting the errors and making sure that the resources of the business are effectively
managed.
We anticipate that the letter has served your purpose of implementing the internal
control policies and look forward to hear from you soon.

8AUDITING THEORY AND PRACTICE
Thank You

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References:
Chan, D.Y. and Vasarhelyi, M.A., 2018. Innovation and practice of continuous auditing.
In Continuous Auditing: Theory and Application (pp. 271-283). Emerald Publishing Limited.
Clinton, S.B., Pinello, A.S. and Skaife, H.A., 2014. The implications of ineffective internal
control and SOX 404 reporting for financial analysts. Journal of Accounting and Public
Policy, 33(4), pp.303-327.
Cook, W., Van Bommel, S. and Turnhout, E., 2016. Inside environmental auditing:
effectiveness, objectivity, and transparency. Current Opinion in Environmental
Sustainability, 18, pp.33-39.
De Paula, F.R.M., 2016. The principles of auditing a practical manual for students and
practitioners. Isaac Pitman & Sons, Ltd (1919).
Demirakos, E., 2018. Internal Auditing: Assurance and Advisory Services, UL Anderson, MJ
Head, S. Ramamoorti, C. Riddle, M. Salamasick, PJ Sobel, The Internal Audit Foundation
(2017), 627 pages, $199.99, ISBN: 978-0-89413-987-1.
Hayes, R.S., Gortemaker, H. and Wallage, P., 2014. Principles of auditing: an introduction
to international standards on auditing. Prentice Hall, Financial Times.
Kumar, R. and Sharma, V., 2015. Auditing: Principles and practice. PHI Learning Pvt. Ltd..
Li, C., Raman, K.K., Sun, L. and Wu, D., 2015. The SOX 404 internal control audit: Key
regulatory events. Research in Accounting Regulation, 27(2), pp.160-164.
Lisic, L.L., Neal, T.L., Zhang, I.X. and Zhang, Y., 2016. CEO power, internal control quality,
and audit committee effectiveness in substance versus in form. Contemporary Accounting
Research, 33(3), pp.1199-1237.

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Louwers, T.J., Ramsay, R.J., Sinason, D.H., Strawser, J.R. and Thibodeau, J.C.,
2015. Auditing & assurance services. McGraw-Hill Education.
Stewart, D.W. and Shamdasani, P.N., 2014. Focus groups: Theory and practice (Vol. 20).
Sage publications.
Vovchenko, G.N., Holina, G.M., Orobinskiy, S.A. and Sichev, A.R., 2017. Ensuring financial
stability of companies on the basis of international experience in construction of risks maps,
internal control and audit. European Research Studies Journal, 20(1), pp.350-368.