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Sarbanes Oxley Act -
Auditing Standards |
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Public
Company Accounting Oversight
Board
Bylaws
and Rules – Standards – AS2
Auditing
Standard No. 2: An Audit of Internal Control
Over Financial Reporting Performed in
Conjunction With an Audit of Financial
Statements
APPENDIX
D
Examples of
Significant Deficiencies and Material
Weaknesses
D1. Paragraph 8 of
this standard defines a control deficiency.
Paragraphs 9 and 10
go on to define a
significant deficiency and a material weakness,
respectively.
Paragraphs 22
through 23 of this standard discuss materiality
in an audit of internal
control over
financial reporting, and paragraphs 130 through
140 provide additional
direction on
evaluating deficiencies in internal control over
financial reporting.
The following
examples illustrate how to evaluate the
significance of internal
control
deficiencies in
various situations. These examples are for
illustrative purposes only.
Example D-1—
Reconciliations of
Intercompany Accounts Are Not Performed on
a
Timely
Basis
Scenario A –
Significant Deficiency. The company processes a
significant number of
routine
intercompany transactions on a monthly basis.
Individual intercompany
transactions are
not material and primarily relate to balance
sheet activity, for
example,
cash transfers
between business units to finance normal
operations.
A formal
management policy requires monthly
reconciliation of intercompany
accounts
and confirmation
of balances between business units. However,
there is not a process
in place to ensure
performance of these procedures. As a result,
detailed
reconciliations of
intercompany accounts are not performed on a
timely basis.
Management does
perform monthly procedures to investigate
selected large-dollar
intercompany
account differences. In addition, management
prepares a detailed
monthly variance
analysis of operating expenses to assess their
reasonableness.
Based only on
these facts, the auditor should determine that
this deficiency represents
a significant
deficiency for the following reasons: The
magnitude of a financial
statement
misstatement resulting from this deficiency
would reasonably be expected
to
be more than
inconsequential, but less than material, because
individual intercompany
transactions are
not material, and the compensating controls
operating monthly should
detect a material
misstatement. Furthermore, the transactions are
primarily restricted to
balance sheet
accounts. However, the compensating detective
controls are designed
only to detect
material misstatements. The controls do not
address the detection of
misstatements that
are more than inconsequential but less than
material. Therefore,
the likelihood
that a misstatement that was more than
inconsequential, but less
than
material, could
occur is more than remote.
Scenario B -
Material Weakness. The company processes a
significant number of
intercompany
transactions on a monthly basis. Intercompany
transactions relate to a
wide range of
activities, including transfers of inventory
with intercompany profit
between business
units, allocation of research and development
costs to business units
and corporate
charges. Individual intercompany transactions
are frequently material.
A formal
management policy requires monthly
reconciliation of intercompany
accounts
and confirmation
of balances between business units. However,
there is not a process
in place to ensure
that these procedures are performed on a
consistent basis. As a
result,
reconciliations of intercompany accounts are not
performed on a timely
basis,
and differences in
intercompany accounts are frequent and
significant. Management
does not perform
any alternative controls to investigate
significant intercompany
account
differences.
Based only on
these facts, the auditor should determine that
this deficiency represents
a material
weakness for the following reasons: The
magnitude of a financial
statement
misstatement
resulting from this deficiency would reasonably
be expected to be
material, because
individual intercompany transactions are
frequently material and
relate to a wide
range of activities. Additionally, actual
unreconciled differences in
intercompany
accounts have been, and are, material.
The
likelihood of such a misstatement is more than
remote because such misstatements have
frequently occurred and compensating controls
are not effective, either because they are not
properly designed
or not operating effectively. Taken together,
the magnitude and
likelihood of
misstatement of the financial statements
resulting from this internal
control
deficiency meet
the definition of a material
weakness.
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