Test of Controls
Test of controls is an audit process designed to examine the effectiveness of an organization’s internal controls. As a CPA candidate, understanding this term is critical for scoring well on the AUD section of the exams. When auditors perform a test of controls, they are essentially checking to see if the company’s internal controls are designed well and operate effectively to prevent or detect errors or fraud.
There are different methods for executing these tests, such as:
1. Inquiry: Discuss procedures with the employees who perform them.
2. Observation: Watching a process or procedure being performed.
3. Inspection: Reviewing documentation to support a control.
4. Re-performance: Independently executing the controls to verify they are performed correctly.
Example: Let’s say you’re auditing a manufacturing company that has a control in place requiring three different managerial approvals for any expense over $10,000. You could test this control by selecting a sample of expense reports that crossed this threshold and verifying that all of them indeed have three managerial signatures. If you find that several do not, then the control is not effective, and this failure would affect your assessment of control risk.