## Methods of Evaluation of Internal Control

Before the auditor can rely on internal controls, they must evaluate those controls. Four methods are used:

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### i) Narrative Record

A complete and exhaustive written description of the internal control system as found in operation by the auditor.

Preparation: Requires prior testing and observation before the description can be written.
Best suited for: Entities where no formal control system exists; small businesses.

Disadvantages:

(a) Difficult to comprehend the system in operation.
(b) Hard to identify weaknesses or gaps in the system.
(c) Difficult to incorporate changes arising from reshuffling of manpower or reorganisation.

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### ii) Checklists

A series of instructions and questions that auditing staff must follow and/or answer.

Answers are recorded against each instruction: Yes / No / N/A
Initial space is provided against each instruction for staff to sign off.
This is an on-the-job requirement — completed while work is in progress.

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### iii) Internal Control Questionnaire (ICQ)

The most widely used method for assessing the existence of organisational internal controls.

Questions framed by: the Auditor
Answers given by: Management (Yes / No / N/A)
Questions are framed such that:
Yes → indicates adequacy of the control
No → highlights a weakness
N/A → irrelevant question (with space for explanation)

Process:

1. Client fills out the questionnaire.

2. Inconsistencies are discussed with the auditor's team.

3. Auditor then reports deficiencies and suggests improvements.

Scope: Covers existence, operation, and efficiency of controls.

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### iv) Flowchart

A graphic (diagrammatic) presentation of each part of the internal control system.

Most concise way to record the auditor's review of internal controls.
Minimises the need for narrative explanation.
Gives a bird's-eye view of the system.
The flow of transactions can be easily spotted and traced.

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### After Evaluation — Formulate the Audit Programme

Once the auditor evaluates internal controls, the Audit Programme must be formulated based on the findings.

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### Benefits of Evaluating Internal Controls to the Auditor

A review of IC helps the auditor determine:

#	Benefit
i	Whether an adequate IC system is in use and operating as planned
ii	Whether the effective internal audit department is operating
iii	Whether controls adequately safeguard assets
iv	Whether errors or fraud are likely to be located in the ordinary course of operations
v	Areas where control is weak or excessive
vi	Whether control suggestions can be given to improve the system
vii	Extent and depth of examination the auditor needs to carry out in different accounting areas

Worked example

### Example 1

Example — ICQ vs Checklist:

For a cash receipts cycle, an auditor uses an ICQ with the question: 'Are all cash receipts recorded on the same day as receipt?' Management answers 'No' → this highlights a weakness (delay in recording increases risk of misappropriation). Compare this with a checklist, where the audit staff member personally verifies and ticks off 'Cash receipt vouchers are pre-numbered' — this is an on-the-job verification, not a management response.

### Example 2

Example — Narrative Record for a Small Entity:

A sole proprietorship bakery has three employees. The auditor writes: 'The owner collects cash from customers, manually records sales in a cash book, and deposits cash weekly. No separation exists between cash handling and recording. Petty cash is kept in a drawer without formal vouchers.' This narrative captures the system but makes it difficult to identify gaps systematically — hence it is suitable only for small, simple entities.

### Example 3

Exam Question: Compare any two methods of evaluation of internal control.

Candidate answer structure:

Narrative Record: Written description; suitable for small businesses; disadvantage — hard to spot weaknesses systematically.
Flowchart: Diagrammatic; concise; gives bird's-eye view; easy to trace transaction flow; minimises narrative explanation.
ICQ: Most widely used; questions by auditor, answers by management; Yes = adequate, No = weakness; covers existence, operation, efficiency.

⚠️ Common exam mistakes

Confusing ICQ with Checklists — in ICQ, management answers questions framed by the auditor; in checklists, auditing staff follow instructions on the job.
Stating that 'Narrative Record is the most widely used method' — it is the ICQ (Internal Control Questionnaire) that is most widely used.
Forgetting that in an ICQ, a 'Yes' answer indicates adequacy (strength) while a 'No' answer highlights a weakness — students sometimes reverse this.
Omitting benefits of IC evaluation to the auditor when the question asks for them — seven specific benefits should be listed.
Not mentioning that the Audit Programme must be formulated after evaluating internal controls — this is a key conclusion step.

Reference:

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