## **Learning Outcomes**

After reading this article, you will be able to explain the purpose and nature of tests of controls and describe key control procedures for main transaction cycles. You will recognise typical control activities for sales, purchases, payroll, non-current assets, inventory, and cash. You will also be able to propose appropriate tests of control for each area, as required for the ACCA Foundations in Audit (FAU) exam.

## **ACCA Foundations in Audit (FAU) Syllabus**

For ACCA Foundations in Audit (FAU), you are required to understand the design and testing of controls for main business areas. This article focuses on:

- The purpose of tests of controls in the audit process
- Control objectives and procedures for key areas: sales, purchases, payroll, tangible non-current assets, inventory, and bank/cash
- Designing and describing tests of control for each accounting system
- Distinguishing between tests of control and substantive procedures

## **Test Your Knowledge**

_Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision._

1. Which of the following best describes a test of control?
   a) Reveals the year-end balance
   b) Checks the operation of an internal control
   c) Detects all fraud
   d) Confirms a transaction with a third party

2. State one key control and one corresponding test of control for the payroll system.

3. True or false? For the purchases cycle, testing that all invoices have been approved before payment is a test of control.

4. What is the main difference between a test of control and a substantive procedure?

## **Introduction**

Tests of controls are audit procedures designed to gather evidence on the operational effectiveness of internal controls in an entity’s systems. When auditors consider relying on controls to reduce substantive testing, they must determine whether these controls are not only well-designed but are also functioning as intended throughout the period. Each significant business cycle—such as sales, purchases, payroll, assets, inventory, and cash—has typical control procedures set up to achieve specific objectives.

> **Key Term: test of control**
> An audit procedure designed to evaluate the operating effectiveness of controls in preventing, or detecting and correcting, material misstatements at the assertion level.

## The Purpose of Tests of Controls

Tests of controls help the auditor determine whether specific internal controls are actually working as described. If controls are both well-designed and effective, auditors can place more reliance on them and can reduce the extent of substantive testing.

> **Key Term: control objective**
> The purpose or goal a control procedure is intended to achieve, such as ensuring completeness, accuracy, or authorisation of transactions.

## Common Control Procedures for Key Areas

Each accounting area has typical risks and relevant internal controls. Below are standard control objectives and procedures for main cycles, plus examples of tests of control.

### Sales and Receivables

#### Control Objectives — Sales and Receivables

- All goods despatched are invoiced and recorded.
- Only bona fide customers receive credit.
- Receipts are promptly recorded and matched to sales.

#### Typical Control Procedures — Sales and Receivables

- Credit approval required for new customers.
- Matching of sales invoices to despatch notes and orders.
- Sequential numbering and regular review of invoices.
- Separation of sales, cash receipt, and ledger functions.

### **Worked Example 1.1**

A business requires that all credit sales are authorised by a credit controller before goods are sent out. How can an auditor test if this control is working?

> **Answer:**
> The auditor selects a sample of sales orders and inspects for evidence of authorisation (e.g., signature or electronic approval) by the credit controller before the corresponding despatch.

### Purchases and Payables

#### Control Objectives — Purchases and Payables

- Only necessary and approved purchases are made.
- All goods received are checked and recorded.
- Payments are only made for goods actually received and invoiced.

#### Typical Control Procedures — Purchases and Payables

- Purchase orders authorised by a manager with pre-set limits.
- Verification and matching of purchase invoices to goods received notes and orders.
- Segregation of authorisation, receipt, and payment roles.
- Sequential numbering for orders, invoices, goods received notes.

### **Worked Example 1.2**

In a manufacturing company, all purchase invoices must be matched to both a purchase order and goods received note before payment is approved. Describe a suitable test of control.

> **Answer:**
> The auditor selects a sample of paid invoices and inspects for supporting, authorised purchase orders and goods received notes attached and dated before payment.

### Payroll

#### Control Objectives — Payroll

- Only valid employees are paid, at the correct rates.
- All payroll changes are properly authorised.
- Deductions are correctly calculated and remitted.

#### Typical Control Procedures — Payroll

- Written approval for hiring, termination, and pay changes.
- Overtime authorised in writing.
- Separation between personnel records and payroll processing.
- Payslips and payroll reconciliations reviewed by a responsible official.

### **Worked Example 1.3**

The company requires written authorisation for any changes to employee pay rates. How does an auditor test the effectiveness of this control?

> **Answer:**
> Select a sample of payroll amendments and inspect for evidence of written authorisation (e.g., signed change request or HR record) before the changes were processed in payroll.

### Tangible Non-Current Assets

#### Control Objectives — Tangible Non-Current Assets

- Only approved asset acquisitions/disposals are made.
- Assets are properly recorded and safeguarded.
- Depreciation is appropriately applied.

#### Typical Control Procedures — Tangible Non-Current Assets

- Board approval for significant asset purchases or disposals.
- Asset register maintained and regularly reconciled to general ledger.
- Physical verification of assets.
- All write-downs and impairments authorised.

### Inventory

#### Control Objectives — Inventory

- All inventory movements are recorded accurately.
- Inventory is safeguarded against loss or misappropriation.
- Valuation is correct and reflects reality.

#### Typical Control Procedures — Inventory

- Authorised requisitions for stock issues.
- Sequentially numbered goods received and issue notes.
- Regular full inventory counts supervised and reconciled to records.
- Restricted access to warehouse and stockrooms.

### Bank and Cash

#### Control Objectives — Bank and Cash

- All payments and receipts are authorised and recorded.
- Physical cash is safeguarded.
- Bank reconciliations are performed regularly.

#### Typical Control Procedures — Bank and Cash

- Cheques signed by two authorised individuals above set thresholds.
- Prompt banking of all receipts.
- Regular, independent bank reconciliations reviewed by management.
- Segregation of duties between cash handling and record keeping.

## Designing and Performing Tests of Controls

Tests of controls must provide direct evidence that the controls are applied consistently throughout the period. Typical audit procedures include:

- Inspecting documents for evidence of review or authorisation.
- Observing control activities (e.g., counting cash, inventory).
- Re-performing control processes (e.g., reconciling accounts).
- Inquiring of staff about how controls are implemented, then corroborating responses with tangible evidence.

> **Key Term: segregation of duties**
> Assigning different employees to authorise transactions, record entries, and handle assets, reducing risks of errors or fraud.

## Tests of Controls vs. Substantive Procedures

> **Key Term: substantive procedure**
> An audit procedure designed to detect material misstatements at the assertion level, including tests of details and analytical procedures.

Tests of controls are about HOW things are done (was the process followed?), while substantive procedures test WHAT the result is (is the balance correct?).

### **Exam Warning**

> Many students confuse testing for authorisation or sequence as a test of the balance itself. Remember: tests of controls are not about the amount—they are about checking that a specific control was properly performed.

## **Summary**

Systems of internal control must be effective and actually in use. Tests of controls are focused on key business cycles such as sales, purchases, payroll, assets, inventory, and cash. Auditors must check that these controls not only exist, but operate consistently and effectively, using appropriate tests of control tailored to the identified risks and control objectives.

## **Key Point Checklist**

_This article has covered the following key knowledge points:_

- Define and explain the purpose of tests of controls in audit
- Identify control objectives for sales, purchases, payroll, assets, inventory, and cash
- Describe typical control procedures for each key area
- Construct appropriate tests of control for specific procedures
- Distinguish between tests of controls and substantive procedures
- Recall the importance of segregation of duties as a control activity

## **Key Terms and Concepts**

- test of control
- control objective
- segregation of duties
- substantive procedure

Tests of controls - Control procedures for key areas