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CS Professional · Internal and Forensic Audit · Internal Controls

At Narmada Foods Ltd., the auditor identifies a control deficiency in the month-end reconciliation of receivables. Management has a compensating control: the CFO independently reviews the receivables ageing monthly with precision to detect any misstatement above materiality. What should the auditor do in evaluating whether the deficiency is a material weakness?

The auditor should assess whether the CFO's review is precise enough to prevent or detect a material misstatement and should test that it actually operates. Only if it does can it mitigate the deficiency's severity; management representation alone or ignoring it is inappropriate.

  1. AIgnore the compensating control since it is not the primary control
  2. BTreat it as a material weakness automatically because any reconciliation failure is material
  3. CConsider whether the compensating control operates at a precision sufficient to prevent or detect a material misstatement, and test itCorrect
  4. DAccept the compensating control on management's representation without testing

Explanation

Compensating controls can reduce the severity of a deficiency only if they operate effectively and with enough precision, which the auditor must test. Automatic classification or untested acceptance is wrong.

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