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Preliminary Audit Plan Assessing Internal Control Risk

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The engagement partner has requested a meeting tomorrow to discuss audit plan for MTI She has requested several documents for that meeting.

1.  A preliminary audit plan assessing internal control risk and providing preliminary judgment for detection risk.

2.  A description of specific substantive procedures that could be conducted for the WIP inventory.

You are required to justify the audit plan by referring to theoretical grounds learnt from this unit.



Preliminary audit plan assessing internal control risk:

The control risk is the risk that there is a misstatement in the balances of the accounts or in the classes of the transactions. The material misstatement could be so material that it is incapable of being detected and corrected within the time period. The accounting and the internal control systems are incapable of detecting the misstatements.

The internal control system is the system of the control wherein the management has to make sure that there is no misstatement in the financial statements whatsoever.  Further, the system of internal control aims at ensuring that the business is conducted in an orderly and an efficient manner.

The objective of an audit is to ensure that the internal control system is in place in the organization and it is capable of detecting the material misstatements and ensure that the financial statements represent a true and a fair picture of the financial position of the organization. The responsibility of the maintenance of the internal control system is of the management and the responsibility of commenting on the same is of the auditor.

The internal control is way beyond the matters that are directly related with the function of the accounting system and consist of the following:

1. Preliminary assessment of the control risk: it is the process through which the accounting and the internal control systems effectiveness is evaluated with regard to the detecting and correcting the material misstatements. There is some degree of the control risk that is always attached due to the presence of the inherent limitation of the accounting and the internal control systems.

2. After an understanding of the accounting and the internal controls has been obtained, an auditors makes the preliminary assessment of control risk at the assertion level for each of the balance of the account or the class of the transactions.

3. An auditor must assess the access the control risk at the higher levels for the few of the assertions when the following exists:

4. When the accounting and the internal control systems are not at all effective

5. When the evaluation of the accounting and the internal control system have been found to be ineffective and inefficient

6. The preliminary assessment of the risk of the control would be regarded as to be high till the time an auditor is able to:

7. Identify the internal controls that must be carried out and are relevant for the prevention and the detection of the material misstatement.

8. The tests of controls must be so planned that they support the assessment, as per SAS 300.7

9. Even when the preliminary assessment of the control risk has been found to be successful, an auditor must not place his reliance on the same till the time, he has obtained a reasonable assurance that the internal controls are capable of detecting the material misstatement and rather had been functioning properly and within the entire period. The understanding of the control risk must be adequately documented

10. The auditor is duty bound to documents all of the following:

11. His understanding of the accounting and the internal control system

12. The assessment of the control risk

When an auditor is of the opinion that the control risk is very high, then he must document each and every thing in his working papers as to why he concluded that the control risk was high. And when he has concluded it, he must extend the different techniques that would help him in documenting the information with regard to the accounting and the internal controls systems. The identification and the selection of the techniques would entirely depend upon the judgement and the experience of the auditor. An auditor must use the combination or two or more techniques and must ensure that the techniques include the narrative descriptions, questionnaires, checklists and the flow charts. The types of the documentation would be dependent upon the size and the complexity of the organization and the nature and the timing of the accounting and the internal controls system of the organization. When the accounting and the internal control system is complex, then the auditor procedures to be performed will be more complex and then the documentation would be more extensive than otherwise.

According to the assessments and the internal controls, when auditor has gained the evidences with regard to the procedures that could be performed in order to gain an understanding of the accounting and the system of internal control and concludes that the accounting and the internal controls systems are in place, then an auditor must assess the control risk at lesser than the high level.

In the computerized environment, the tests of the internal controls will be very different from the procedures that will be performed in the manual environment. Some of the procedures of the audit will change though. An auditor would find it relevant to use the Computer Assisted Auditing techniques. The use of such techniques will include the techniques like file interrogation or the audit test data that may be appropriate when the accounting and the internal control system provides no evidence with regard to documenting the performance of the internal controls that are programmed into the computerized system of accounting. On the basis of the tests of the controls, an auditor must assess the internal controls that have been designed and have bene operating as the contemplated in the preliminary assessment of the control risk. The conclusion of the assessed level of the control risk may be revised when an auditor has evaluated the deviations. In such of the cases, an auditor will modify the nature, timing and the extent of the substantiative procedures that have been planned to be performed.

The tests of control could include the following:

1. All the documents must be supported by the relevant transactions and the other such events so as to gain an understanding of the knowledge regarding whether the internal controls operate effectively and efficiently

2. Inquiring about the observation of the internal controls that have no audit trail

3. Re-performing the internal controls.

Detection risk is the risk that the auditor will not be able to detect the material misstatements during the course of his audit term.

An auditor must assess the detection risk and then use the substantitative procedures in order to minimize the risk of detection. He reduces the detection risk by deciding the nature, timing and the extent of the substantive procedures.


Audit plan for the work in progress inventory:

The following are the substantive tests that could be performed in respect of the inventories and the same must be compared with that of the last year and the industry averages. The following must be looked into:

1. Whether the ending inventory has been overstated

2. Whether the sales have been overstated

3. Whether the ending inventory have been understated

4. Whether the variable selling costs have been overstated.

The following are some of the factors that must be considered:

1. Book to physical adjustment: this refers to the cumulative effects of the errors in the perpetual system as well as the shrinkage and the loss that is caused due to theft. This amount of loss must and only be accepted when the internal control system of the client is reliable.

2. Turnover: the problem of obsolescence can be detected primarily through the slower amounts of the inventory.

3. Individual reasonableness tests: the prices and the quantities of the individual items of the inventory must be assessed and must be compared with that of the last years.

The physical observation of the inventory:

1. SAS 1 requires the inventory to be valued at the lower of the market value or the purchase price.

2. There must be a presence of the tags in the work in progress inventory. This is due to the following reasons:

3. It will indicate the inventory that has been counted

4. It will provide the written indication of the internal verification of the inventory and that too with accuracy

5. It will provide the pre-numbered document for the tests to be conducted later for the existence of the compilation of the inventory.

6. Test counts: this is done to ensure that the client knows as to what has been counted by the auditor so that no subsequent alteration could be made

7. The pricing could be tested by ascertaining the quantities, description and the unit if measurement

Monitoring the tag sequences: an auditor must use the tags so as to ensure that all the tags have been accounted for. This comes into play and this comes into play when the inventory of the client has to be determined that contains only the valid tags.

1. The account balances in the accounts of the purchases, inventories and the cost of the goods sold must be compared with that of the previous years. The significant changes must be investigated. When the following ratios are computed, the figures are compared with that of the previous years so as to calculate the reasonableness of all the assertions:

2. The classification of the inventory (raw materials, work in process, finished goods) as the % of the total inventory

3. The gross margin at the level of the financial statements and by the product line

4. The turnover of the inventory at the financial statement level and by the product line.

The following plan must be followed in respect of the work in progress:

1. The dates of the inventory observations must be taken in the record

2. The location and the methods that have been adopted by the division so as to test the existence of each of the category of the inventory, such as the raw materials, work in progress, finished goods and consignments.

3. The extent to which the physical inventory taking has been observed must be taken into record

4. The written instructions in respect of the inventory must be taken down and went through in detail and its clarity and adequacy must be assessed. The documents must be assessed and any suggestions must be incorporated in the same, whenever deemed necessary.

5. Obtain the lists of the teams involved in the inventory count and ascertain as to whether the employees that are involved are capable of identifying the nature and the quality of the items and whether the persons from the various departments do not have any responsibility with regard to the movement, recording or the custody of the inventory. In case, the both 2 stated points are absent, then it will be necessary to revise the extent of the work that has been performed and ensure that the complete and the accurate inventory count is achieved

6. Determine as to whether the lists of the inventory differentiates between the various stages of the work in progress. It must be ascertained that the information exists for the proper identification of the inventory and the test counts of the inventory.

7. Ascertain whether the procedures that are being performed are adequate to control the use of the tags of the inventory or the sheets are adequate and if not found adequate, then the division of the duties must be considered and the persons must be made responsible for the tag and the count sheet control, for the counting of the inventory and for inputting the tags and the count sheets into the records of inventory.

8. Ascertain as to whether the procedures that have been established ensure a proper cut off.

9. Evaluate the procedures to be performed during the time when the goods are received, when they are entered for production and when they are shipped.

10. Ascertain whether any goods are there that are owned by the divisions in the custody of the others of the inventories that are owned by the premises of the other divisions.

The following points must be clearly spelt out:

1. Whether the control procedure of the client is adequate?

2. The control procedures that are used by an auditor is the blend of the physical examination of the goods, observation and inquiry.

3. Whether the timing of the count is adequate?

4. What all the locations where the inventory is kept?

5. Whether an expert is needed to assist the count? When an auditor uses the services of the expert, he would consider the materiality of the inventory and the nature and the complexity of the items and the other such evidences that would be available to him.

6. There must be a written plan that must be communicated to all the member of the staff

7. There must be a proper arrangement of the items of the inventory

8. The physical counting must be supervised by the internal auditors or the supervisory personnel that would re-count the inventory on the test basis

9. The auditor must observe the procedures that are followed by the employees of the client

10. Reconcile all the work in progress with the records that have bene maintained by the client

11. The documentation of the inventory must be inspected and the external confirmation must be obtained from the third party such as the inventory that has been pledged as collateral.

12. Ensure that all the work in progress actually exists and are in fact in the stage of production

13. All the work in progress inventories are counted and are included in the balance of the work in progress and no other amounts have been included in the inventory of work in progress

14. All the listings of the work in progress have been accurately compiled, extended, footed and summarized and the totals are correctly reflected in the accounts

15. The cost of the inventory and the selling prices have been adequately valued

16. The defective inventory has been properly removed from the work in progress inventory quantity in hand.



Accountingweb.com, (2014). Auditing Special Purpose Frameworks: Auditing Inventories “Part 2 | Accounting WEB. [Online] Available at: https://www.accountingweb.com/article/auditing-special-purpose-frameworks-auditing-inventories%E2%80%94part-2/223797 [Accessed 7 Feb. 2015].

All.net, (2015). [Online] Available at: https://all.net/books/audit/ASAP/invntry.txt [Accessed 7 Feb. 2015].

Business.baylor.edu, (2015). Audit plan for WIP. [Online] Available at: https://business.baylor.edu/charles_davis/courses/acc5317/.../wipplan.doc [Accessed 7 Feb. 2015].

Myweb.whitman.syr.edu, (2015). Physical inventory. [Online] Available at: https://myweb.whitman.syr.edu/rjelder/Acc476/Notes/CH21.doc [Accessed 7 Feb. 2015].

Nba.nl, (2015). Risk Assessments and Internal Control. [Online] Available at: https://www.nba.nl/hraweb/richtlijnen/2002/Bundel1/Eng/sectie_400_21-39.htm [Accessed 7 Feb. 2015].

novellaqalive2.mhhe.com, (2015). Substantive Tests of Transactions and Balances. [Online] Available at: https://novellaqalive2.mhhe.com/sites/dl/free/0074711709/90089/sample_ch10.pdf [Accessed 7 Feb. 2015].

Pcaobus.org, (2015). Auditing Standard No. 8. [Online] Available at: https://pcaobus.org/Standards/Auditing/pages/auditing_standard_8.aspx [Accessed 7 Feb. 2015].

Prasad, M. (2012). The components of audit risk. [Online] The Hindu Business Line. Available at: https://www.thehindubusinessline.com/features/mentor/the-components-of-audit-risk/article2910361.ece [Accessed 7 Feb. 2015].

www.frc.org.uk, (2015). www.frc.org.uk. [online] Available at: https://www.frc.org.uk/Our-Work/Publications/APB/SAS-300-Accounting-and-Internal-Control-Systems-an.pdf [Accessed 7 Feb. 2015].

www.hkicpa.org.hk, (2015). STATEMENT OF AUDITING STANDARDS 300 AUDIT RISK ASSESSMENTS AND ACCOUNTING AND INTERNAL CONTROL SYSTEMS. [Online] Available at: https://www.hkicpa.org.hk/file/media/section6_standards/standards/sas300.pdf [Accessed 7 Feb. 2015].

www.icisa.cag.gov.in, (2015). INTERNATIONAL STANDARD ON AUDITING 400 RISK ASSESSMENTS AND INTERNAL CONTROL. [Online] Available at: https://www.icisa.cag.gov.in/Background%20Material/RISK%20ASSt%20AND%20INTNL%20CONTROL%20ISA_400.pdf [Accessed 7 Feb. 2015].


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