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2 See the Willis & Adams Policy Statement on Evaluating Control Deficiencies (messier9e) for more detailed guidance on evaluating deficiencies. Risk Factors That Affect Whether There Is a Reasonable Possibility That a Control Deficiency (or a Combination of Control Deficiencies) Will Result in a Misstatement of an Account Balance or Disclosure• The nature of the financial statement accounts, disclosures, and assertions involved.• The susceptibility of the related asset or liability to loss or fraud.• The subjectivity, complexity, or extent of judgment required to determine the amount involved.• The interaction or relationship of the control with other controls, including whether they are interdependent or redundant.• The interaction of the deficiencies.• The possible future consequences of the deficiency.Source:AS5, ¶65.T A B L E 7 – 6Indicators of Material Weaknesses• Identification of fraud, whether or not material, committed by senior management.• Restatement of previously issued financial statements to reflect the correction of a material misstatement.• Identification by the auditor of a material misstatement of financial statements in the current period in circumstances that indicate that the misstatement would not have been detected by the entity’s ICFR.• Ineffective oversight of the entity’s external financial reporting and ICFR by the entity’s audit committee.Source:AS5, ¶69.T A B L E 7 – 7
Chapter 7 Auditing Internal Control over Financial Reporting243Scenario 2 Ragunandan Company processes a significant number of inter-company 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 no 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. Man-agement does not perform any alternative controls to investigate significant inter-company account differences.An Example of an Auditor’s Tests of a Daily Information Technology–Dependent Manual ControlBill Boyd is manager for Emets & Shinn, the independent registered public accounting firm for Petheridge Packing Company (PPC). Based on discussions with PPC personnel and review of entity documentation, the auditor learns that PPC had the following procedures in place over the entire period to account for cash received in the bank lockbox:• The entity receives from the bank an electronic file listing cash received from customers.