Question

1. Explain the what is meant by internal controls.

2. Explain the process the audit team uses to assess control risk; understand its impact on the risk of material misstatement; and ultimately know how it affects the nature, timing, and extent of further audit procedures to be performed on the audit.

3. Describe additional responsibilities for management and auditors of public companies required by Sarbanes-Oxley and PCAOB auditing standard #2201.

I need the answer in like 200 o 250 words. Thank you

Answer 1

1. Internal controls refer to the plan, policies and procedures which the company has implemented to detect, prevent and correct material misstatements or to ensure that the financial statements are free from material misstatements. It can also be defined as policies put in place by the management of the company to safeguard its assets and resources and to prevent employees from committing frauds. Since the accounting scandals and frauds in the early 2000s like Enron case, there has been an  increasing importance placed on internal controls. In 2002, Sarbanes-Oxley act was introduced and PCAOB was established to regulate the public listed companies and to make such companies implement and have a strong control framework.

2. Control risk refers to the risk that internal controls fail to detect, prevent and correct material misstatements in financial statements. It is evaluated by the audit team in 2 stages. First the auditor evaluates the internal controls at the preliminary stage by performing walkthroughs which lets the auditor know whether he can rely on such controls or not and whether they have been designed appropriately. At the next stage auditor performs test of controls to check the whether the internal controls have been operating effectively throughout the year or not. If internal control fails to meet the requirement at any stage and it is material, auditor is required to qualify his report.

3. Additional responsibilities for management and auditors of public companies required by Sarbanes-Oxley and PCAOB auditing standard #2201 :

i) Audit committee has been given wide power in overseeing the management's accounting decisions.

ii) It now requires the top officials of the management such as the CFO to personally certify the financial statements. If any fraud is later found, they will be personally held liable.

iii) Sarbanes-Oxley act has especially strengthened the disclosure requirements such as disclosure of any material non-balance sheet arranagement or discosure of pro forma statements etc.

iv) PCAOB requires the auditors of public listed companies in US to perform an integrated audit wherein auditor is required to provide an integrated opinion on both internal control testing as well as the substantive testing.

v) PCAOB has made the auditor's responsibilities regarding testing of internal controls much more stringent.