Lew Pherson and Vera Collier are friends who are employed by different CPA firms

Question

Lew Pherson and Vera Collier are friends who are employed by different CPA firms. One day during lunch they are discussing the importance of internal control in determining the amount of audit evidence required for an engagement. Pherson expresses the view that internal control must be evaluated carefully in all companies, regardless of their size or whether they are publicly held, in a similar manner. His CPA firm requires a standard internal control questionnaire on every audit as well as a flowchart of every transaction area. In addition, he says the firm requires a careful evaluation of the system and a modification in the evidence accumulated based on the controls and deficiencies in the system. Collier responds by saying she believes that internal control cannot be adequate in many of the small companies she audits; therefore, she simply ignores internal control and acts under the assumption of inadequate controls. She goes on to say, "Why should I spend a lot of time obtaining an understanding of internal control and assessing control risk when I know it has all kinds of weaknesses before I start? I would rather spend the time it takes to fill out all those forms in testing whether the statements are correct."

a.Express in general terms the most important difference between the nature of the potential controls available for large and small companies.

b. Criticize the positions taken by Pherson and Collier, and express your own opinion about the similarities and differences that should exist in understanding internal control and assessing control risk for different-sized companies.

c.Discuss whether Collier's approach is acceptable under existing auditing standards for either public or non-public companies.

Explanation / Answer

Part A)

A small company may not have an adequate internal control structure as compared to a big size company. It is because a lot of functions are performed by a limited number of executives available within the organization making it impossible to implement key internal control like segregation of duties. All the transactions are required to be authorized by the owner which is not the case in a large scale organization. A small scale organization may not have policy documents for expense reimbursements, leaves, maintenance of petty cash, etc. Such policies are usually found in big companies, which are frequently used as reference points for conducting audits and verifying the approval and authorization process. The control in a small scale company lies majorly in the hands of the owner and his/her active participation in all the business processes is required for preventing frauds/approval of unauthorized transactions.

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Part B)

It is important for an auditor to treat each organization as an independent unit and devise an appropriate audit program. Pherson's approach of conducting audit in a similar manner for all types of corporations regardless of their size and nature is not appropriate. Extenstive auditing may be required in small corporations where adquate controls are not in place. While significant deficiencies may not be observed in large businesses, an auditor may discover material deficiencies while reviewing the business processes of a small company. The approach of Collier to perform audit of a small corporation without obtaining an understanding of the control envoirnment and flow of transactions is also not correct and against auditing professional standards. It is very much possible that the small corporation may have enough controls in place to detect and prevent the occurence of fraudulent activities/transactions within the organization. In such a case, performing a detailed audit may result in unnecessary costs for a small business.

________

Part C)

Collier’s approach is not acceptable when it is engaged in the audit of a public company. Obtaining an understanding of internal controls over financial reporting and performing tests of key controls is essential to determine the effectiveness of such controls. A public company is required to comply with a lot of regulatory requirements in order to protect the interests of the investors. Therefore, it becomes important for the auditor of a public company to conduct audit in accordance with the established auditing standards and procedures irrespective of the size of the company. Personal opinions and assumptions should not form the basis for performing audit.

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