PAA 3 – 1

The following scenario relates to questions 1 – 5

You are an audit manager in the internal audit department of SME Co, a listed retail company. The internal audit department is auditing the company’s procurement system. The system operates as follows:

Ordering

SME’s ordering department consists of six members of staff: one chief buyer and five purchasing clerks.

All orders are raised on pre-numbered purchase requisition forms, and are sent to the ordering department.

In the ordering department, each requisition form is approved and signed by the chief buyer. A purchasing clerk transfers the order information onto an order form and identifies the appropriate supplier for the goods.

Part one of the two-part order form is sent to the supplier and part two to the accounts department. The requisition is thrown away.

Goods received

When goods are received, the goods inwards department immediately raises a two-part pre numbered goods received note (GRN).

• Part one is sent to the ordering department, which then forwards the GRN to the accounts department.
• Part two is filed in order of the reference number for the goods being ordered (obtained from the supplier’s goods dispatched documentation), in the goods inwards department.

SME Co’s management is concerned that a number of inefficiencies in the procurement system may be having a negative financial impact on the company. As a result, they have requested the internal audit department to carry out a value for money audit focused on the company’s procurement practices.

1. Which of the following is NOT a likely effect of the deficiencies in the internal control system for ordering described above?

2. Which of the following statements are valid recommendations with regards to improving the internal controls for goods received described above?

1. The ordering department should match orders to GRNs and mark orders as closed once all goods have been received, to enable any outstanding orders to be chased up.
2. The first copy of the GRN should be sent directly to the accounts department, without first going through the ordering department, to prevent delays in recording the purchase.
3. The goods inwards department should review the goods for their condition, in order to identify and return any damaged goods.
4. GRNs should be filed in date order or by purchase order number, instead of by the supplier’s reference number, to ensure that they can be matched easily to orders.

3. As part of your audit of the procurement system, you have recommended that the goods inwards department should ensure that the goods received are valid business purchases, by matching all deliveries to an authorized order form before issuing a GRN.

Which of the following would be an appropriate test of control to confirm that the control is operating effectively?

4. SME Co’s management is keen to increase the range of assignments that the company’s internal audit undertake. Which of the following assignments could the internal audit department be asked to perform by management?

5. Which of the following best summarizes the meaning of ‘efficiency’ in the context of a Value for Money audit as requested by SME Co’s management?

The following scenario relates to questions 6 – 10

Curry Bloom Co (Curry) manufactures custom made furniture and its year end is 30 April. You are the audit supervisor of Poplar & Co and are developing the audit programs for Curry’s forthcoming interim audit.

You have ascertained that Curry purchases its raw materials from a wide range of approved suppliers. When production supervisors require raw materials, they complete a requisition form and this is submitted to the purchase ordering department. Requisition forms do not require authorization and no reference is made to the current inventory levels of the materials being requested.

Curry has an internal audit department which has provided you with details of the internal controls around the non-current assets cycle. One such control is that upon receipt of a new asset, each asset is assigned a unique serial number and this is recorded on the asset and in the non-current assets register.

6. As part of audit planning, the audit team needs to obtain an understanding of the company’s system of internal control. Peter, the audit junior, is unsure what a company’s internal control comprises.

Which of the following is NOT a component of an entity’s internal control?

7. Which of the following are the most likely consequences of the internal control deficiency described in the requisition system for raw materials?

1. Fraudulent purchases may be made, leading to funds being diverted to third parties for illegal purposes.
2. Stock-outs may occur, resulting in the company being unable to meet orders and lost revenue.
3. Unnecessary purchases may be made, resulting in excess obsolescent raw materials accumulating in inventory requiring to be written down.
4. Raw materials of poor quality may be purchased, resulting in low quality products being produced, customer goodwill being lost and going concern risks.

8. While reviewing Curry’s purchases cycle, you identified that goods received notes for raw material purchases are not sequentially numbered.

Which of the following areas would you consider to be most at risk of material misstatement, as a result of this internal control deficiency?

9. You now turn your attention to Curry’s non-current assets cycle.

Which of the following statements is correct regarding audit procedures concerning the non-current assets cycle?

10. In relation to the control relating to the receipt of a new asset, which TWO of the following describe the MOST RELIABLE audit procedures which enable the auditor to assess whether this control is operating effectively?

1. Select a sample of capital additions on site, agree that a serial number is recorded on the asset and confirm it is included in the non-current assets register
2. Select a sample of assets recorded on the non-current assets register, confirm that it includes a serial number for each asset and agree the number to the physical asset
3. Inspect the non-current asset register and verify that there are no duplicated serial numbers
4. Observe the receipt of assets to confirm that serial numbers are assigned and recorded

The following scenario relates to questions 11 – 15

You are the audit senior on the interim audit of Bird Co. The company introduced a new system at the beginning of this financial year. You have discussed the new system with the sales director, and have noted the following two points in particular:

(1) Existing and new customers input their orders into computerized order forms on Bird Co’s website. The order notes the items requested, the billing and sales addresses, and the customer number (if any). The system checks whether goods are in stock and approves the order instantly if so. The order is forwarded automatically to the sales department to be prepared.

(2) When an order is ready to send out, the sales department inputs the details into their system, and if it matches the order, a goods outward note is produced and the invoicing department is notified automatically. Staff have experienced multiple issues of goods outward notes not matching on the system, and have often resorted to simply printing the order and using it as a goods outward note. The printed order is then taken to the invoicing department for invoicing.

The partner has requested that you document the new system fully during the interim audit. She wants the system notes to be easy to update, and to contain an element of evaluation of the system.

11. In relation to orders received through the website which of the following control objectives is met?

12. Your audit junior has identified four possible risks arising from the use of the printed order as a goods outward note and subsequent hand delivery to the invoicing department.

Which TWO of the below risks arise from the identified system deficiency?

13. You are reviewing the audit plan for tests of controls over invoicing, which reads:

(1) Observe the invoicing clerk to ensure that prices are checked to the official price list.

(2) Review a sample of invoices to ensure their numerical sequence.

(3) Review a sample of goods out notes to ensure they have been matched to sales invoices.
(4) Review a sample of sales invoices to verify evidence that the calculations were checked before they were sent to customers.

Which TWO of the procedures relate to the completeness assertion?

14. Your audit junior is seeking to understand when deficiencies in internal control would be judged to be significant and therefore should be reported to those charged with governance.

Which TWO of the following factors would influence your judgment of whether the control deficiencies identified at Bird   are significant?

15. In the light of the partner’s request concerning documentation, you are considering different options for recording the system.

Which of the following recording methods most suits her requirements?

The following scenario relates to questions 16 – 20

North Cake Co, your audit client, is a large unlisted construction company (building houses, offices and hotels) employing a large number of workers on various construction sites.

As part of planning for the audit of the financial statements for the year ended 31 December 20X6, you are reviewing the cash wages systems within the company.

The following information is available concerning the wages systems:

(i) Hours worked are recorded using a clocking in/out system. On arriving for work and at the end of each day’s work, each worker enters their unique employee number on a keypad.

(ii) Workers on each site are controlled by a foreman. The foreman has a record of all employee numbers and can issue temporary numbers for new employees.

(iii) Any overtime is calculated by the computerised wages system and added to the standard pay.

(iv) The two staff in the wages department make amendments to the computerized wages system in respect of employee holidays and illness, as well as setting up and maintaining all employee records.

(v) The computerized wages system calculates deductions from gross pay, such as employee taxes, and net pay. Every month a wages clerk checks the gross pay and deductions for a sample of employees. Finally a list of net cash payments for each employee is produced.

(vi) Cash is delivered to the wages office by secure courier.

(vii) The two staff place cash into wages packets for each employee along with a handwritten note of gross pay, deductions and net pay. The packets are given to the foreman for distribution to the individual employees.

North Cake’s finance director has mentioned to you that an allegation of suspected fraud had been made against a member of the senior management team during the year. This is currently being investigated by the internal audit team and the finance director hopes that the audit may shed further light on the matter.

North Cake has an internal audit department of six staff. The chief internal auditor appoints staff within the internal audit department, although the chief executive officer is responsible for appointing the chief internal auditor. The chief internal auditor reports directly to the finance director. The chief internal auditor decides on the scope of work of the internal audit department. North Cake does not currently have an audit committee.

16. In preparation for the audit planning meeting, the audit junior has identified a number of areas requiring audit focus.

Based on the information regarding the wages system, which TWO of the following are likely to introduce the highest risk of material misstatement?

17. During the previous audit, the audit team had recommended North Cakes’s management to ensure that any amendments to standing data on the wages system are reviewed by an authorized manager.

Which of the following is a test of control designed to provide evidence that the recommended internal control is operating effectively?

18. Which of the following statements about the responsibilities of external and internal auditors with regards to fraud is NOT correct?

19. Which of the following recommendations are appropriate in increasing the independence of North Cake’s internal audit department?

(1) The chief internal auditor should be appointed by the board of directors.

(2) The chief internal auditor should report to the board of directors.

(3) The finance director should decide on the scope of the internal audit work.

20. You have been told by the finance director that the senior management team is looking to upgrade the company’s computerised accounting system in a year’s time. This is part because the senior management team believes that due to the increasing size and complexity of the business, the company will need more robust general IT controls in the future.

Which TWO of the following are general IT controls?

The following scenario relates to questions 21 – 25

You are an audit manager in Windy & Co and you are responsible for the audit of Coastal Co. The internal control systems in relation to purchases and payroll have recently been documented by the audit junior. Tests of controls have been performed to evaluate the effectiveness of the system.

The audit junior has used narrative notes and an internal control questionnaire to document the system. You are reviewing the work performed by the audit junior before assessing the impact on the audit approach to be taken in respect of purchases and payroll.

The following features of the purchases and payroll systems have been noted in the audit junior’s documentation:

1. Goods are counted and agreed to the supplier’s delivery note before signing the delivery note to accept the goods.
2. The purchase invoice is matched to, and filed with, the related goods received note and purchase order by the purchase ledger team in the finance department.
3. Payroll standing data files are sent to department managers on a monthly basis for review.
4. Hours worked are entered onto a pre‐printed payroll sheet by the wages clerk.
5. Before payroll payments are made, the finance director reviews the bank transfer list and signs to authorize the payments to be made.

21. Select whether the following advantages and disadvantages relate to narrative notes, internal control questionnaires or both.

Advantages:

A. Can be prepared in advance

B. Easy to understand

Disadvantages:

C. May overstate the controls

D. Some controls may be missed

22. Select whether the features of the purchases and payroll systems described are a strength or deficiency of the internal control system of Coastal Co.

1.

2.

3.

4.

23. Which of the following control objectives is addressed by feature number 5?

24. You have reviewed the work of the audit junior and concluded that reliance can be placed on the internal controls. What impact will this have on the nature and extent of substantive audit procedures to be performed at the final audit?

25. The payroll section of the audit plan of Coastal Co includes the following procedures. For each procedure select whether it is a test of control or a substantive procedure.

A. Inspect the bank transfer list for evidence of the finance director’s signature

B. Review the procedures to ensure payroll files and documents are kept secure and confidential

C. Recalculate the total of the bank transfer list

D. For a sample of employees, agree the salary details in the standing data files to the calculation of the employee’s monthly salary as per the pay slip

The following scenario relates to questions 26 – 30

Hologram Co manufactures snacks such as potato chips which are supplied to large and small food retailers. Hologram Co has experienced significant growth over recent years and in response to this growth, senior management has established an internal audit department to improve the control environment of the company. You are a member of the recently formed internal audit department. Senior management of Hologram Co has concerns about the effectiveness of the company’s sales and dispatch system and has instructed the internal audit department to perform a review of the system. Any deficiencies identified are to be reported to the finance director who will report the findings back to the board of directors at the next board meeting. Recommendations for improvements are also to be provided.

During the review the following deficiencies were identified:

(i) Availability of inventory is not checked until at the time of ordering

(ii) Telephone orders are initially noted on a piece of paper and then transferred to an order form after the call has ended

(iii) Order forms are not sequentially numbered

(iv) The online ordering system allows customers to place orders which exceed their credit limit.

26. Which of the following is NOT an objective of Hologram Co’s sales and dispatch system?

27. Match the control deficiencies to an appropriate explanation of the issue.

Deficiency
(1)
(2)
(3)
(4)

Explanation
A. Risk of incorrect orders being dispatched
B. Risk of irrecoverable debts
C. Risk of orders not being fulfilled on a timely basis
D. Orders may go missing leading to unfulfilled orders

28. Which TWO of the following are appropriate recommendations to address the credit limit system deficiency?

29. Which of the following recommendations should be made to address deficiencies (ii) and (iii)?

1) Order clerks should have online access to view real‐time inventory quantities at the time of ordering.

2) Order forms should be sequentially pre‐numbered and a regular sequence check should be performed.

3) All orders should be entered directly into the ordering system as the customer is placing the order

4) Customers should be instructed not to place orders by telephone

30. Which of the following statements is TRUE in respect of the review findings?

The following scenario relates to questions 31 – 35

Redpink Co has recently upgraded its computer system to enable greater automation of transaction processing. The new system has integrated the sales, inventory and purchasing systems resulting in minimal manual entry.

Sales orders are entered into the system manually. The inventory system is automatically updated to reflect that inventory has been allocated to an order. The system will flag if there is insufficient inventory to fulfil the order. The inventory system is linked to the purchasing system so that when inventory falls to a minimum level a purchase order is automatically created and sent to the purchasing manager for authorization. Once the manager clicks ‘authorized’ the order is automatically sent electronically to the approved supplier for that item. The system is backed up daily to ensure minimal loss of data in the event of a system failure.

Redpink Co’s internal auditors were present during the implementation of the new system and performed tests during the process to ensure the information transferred into the new system was free from error. The internal audit plan of work has been updated to include regular tests of the system throughout the year to ensure it is working effectively.

The external auditor of Redpink Co is planning to use automated tools and techniques during the audit for the first time this year as a result of the new system and is also planning to use the work of Redpink Co’s internal audit department if possible.

31. Which of the following is NOT a test of control in respect of Redpink Co’s system?

32. Select whether the following controls identified in Redpink Co’s systems are general or application controls?

A. Authorization of purchase orders

B. Automatic updating of inventory once goods are sold

C. Daily backups of the system

D. Minimum order quantities

33. Which of the following procedures provides the MOST reliable evidence that the inventory system updates automatically once an order has been received?

34. Which can be tested by placing a dummy sales order for a large quantity of goods into the system? Select all that apply.

Control

35. Which TWO of the following procedures should be performed by the external auditor of Redpink Co to identify whether the work of Redpink Co’s internal audit department can be relied upon?

The following scenario relates to questions 36 – 40

Prom Co is a manufacturer of vegetarian food including ready meals and plant‐based sausages and burgers which it supplies to large grocery chains across the country. The company has grown significantly over the last five years with revenue increasing by 50%. Its year end is 31 July 20X5.

You work in the internal audit department of Prom Co which performs periodic reviews of internal controls, assesses the risk management processes of the company and performs fraud investigations when applicable. The following areas have been reviewed by the internal audit department over the last three years:

20X5 Non‐current assets, revenue

20X4 Purchases, payroll

20X3 Inventory, cash

You are reviewing the internal controls over non‐current assets and capital expenditure of the company which were last reviewed in 20X2.

You have been provided with the following information relating to the non‐current assets cycle.

Prom Co prepares a rolling five‐year capital expenditure budget which is updated annually by the capital expenditure committee. The committee has three members. Each year the heads of department meet with the committee to discuss capital requirements for the budget period. All capital items purchased must be included in the budget, except in exceptional circumstances for which there is a contingency fund set aside.

When capital expenditure is required, the relevant department head must send a requisition to the committee with quotations from at least two suppliers. The requisition is approved by the committee if the items requested are included in the budget and the quotation is acceptable. The approval is noted in the minutes of the meeting. A copy of the approved requisition form is sent to the purchasing department where a purchase order is completed and a copy of the approved requisition is kept with the order. Before the order is placed, the purchasing director must agree the order details to the approved requisition and sign the purchase order as evidence of the check.

On receipt, a goods received note (GRN) is completed. Each asset is checked to the authorized purchase order and checked for condition and evidence of these checks is noted on the GRN. Each asset is assigned a unique serial number which is recorded on the asset and written on the GRN.

The GRN is forwarded to the finance team which maintains the non‐current asset register. The asset is added to the register.

The non‐current asset register contains a description of the asset, the serial number, the cost to be capitalized, the expected useful life, purchase date, department/location and estimated residual value. The non‐current asset register is password protected and only a small number of people in the finance department know the password.

On a quarterly basis the management accounts detail the total capital expenditure incurred and the amount budgeted for the period with explanations of any variances greater than 5%.

Once a year the internal audit department performs a reconciliation of physical assets to the asset register to ensure the register is complete.

36. Which TWO of the following control objectives are addressed by the work of the capital expenditure committee?

37. For each of the controls given below, select the type of control activity described.

A. Variances between actual and budgeted expenditure are analyzed in the quarterly management accounts

B. The internal audit department confirms the non‐current asset register is complete

C. The non‐current asset register is password protected

38. Which THREE of the following documents together provide persuasive evidence that capital items purchased during the year have been authorized?

1) Requisition

2) Order

3) Goods received note

4) Non‐current asset register

5) Minutes of capital expenditure committee meetings

39. Which of the following is NOT a test of control the external auditor of Prom Co may perform in relation to non‐current assets?

40. The external auditor has this year expressed an interest in using some individuals from Prom Co’s internal audit department to provide direct assistance with external audit procedures.

For which of the following areas would it be appropriate for internal audit to provide direct assistance?