PAA 3 – 2

41. Introduction and client background

You are the audit senior of choir & Co and your team has just completed the interim audit of

Chalk Industries Co, whose year-end is 31 January 20X2. You are in the process of reviewing the systems testing completed on the payroll cycle, as well as preparing the audit programs for the final audit.

Chalk Industries Co manufactures lights and the manufacturing process is predominantly automated; however, there is a workforce of 85 employees who monitor the machines, as well as approximately 50 employees who work in sales and administration. The company manufactures 24 hours a day, 7 days a week. The payroll system operates as follows.

Factory workforce

The company operates three shifts every day with employees working eight hours each. They are required to clock in and out using an employee swipe card, which identifies the employee number and links into the hours worked report produced by the computerised payroll system. Employees are paid on an hourly basis for each hour worked. There is no monitoring/supervision of the clocking in/out process.

On a weekly basis, the payroll department calculates the cash wages to be paid to the workforce.

This is calculated based on the hours worked report multiplied by the hourly wage rate, with appropriate tax deductions. These calculations are not checked by anyone as they are generated by the payroll system. During the year the hourly wage was increased by the human resources (HR) department and this was notified to the payroll department verbally.

Each Friday, the payroll department prepares the pay packets and physically hands these out to the workforce, who operate the morning and late afternoon shifts, upon production of identification. The pay packets for night shift workers are given to the factory supervisor to distribute. If any night shift employees are absent on pay day then the factory supervisor keeps these wages and returns them to the payroll department on Monday.

Sales and administration staff

The sales and administration staff are paid monthly by bank transfer. Employee numbers do fluctuate and during July two administration staff joined; however, due to staff holidays in the HR department, they delayed informing the payroll department, resulting in incorrect salaries being paid out.

Required:

(a) Identify and explain SIX DEFICIENCIES of Chalk Industries Co’s payroll system and provide a recommendation to address each of these deficiencies.

Note. Prepare your answer using two columns headed Control deficiency and Control recommendation respectively.

42. Glasscom Co manufactures and distributes car tyres to a wide customer base both in its country and across the rest of the continent. Its year end was 30 April 20X5. It is 1 July 20X5.

You are an audit manager of fish & Co and you are reviewing extracts of the documentation describing Glasscom Co’s sales and dispatch system following completion of the interim audit.

Glasscom Co has grown in size over the previous 18 months. All new customers undergo credit checks prior to being accepted and credit limits are subsequently set by the receivables ledger clerks who record the new customer details, assign a unique customer number and set credit limits in the master data file. The company’s credit controller is currently on secondment to the internal audit department for six months and no replacement has been appointed.

Customers wishing to order goods, telephone the company’s sales order department and provide their unique account details. Sequentially numbered four‐part sales orders are generated for all orders, after checking available inventory levels. One copy is retained by the sales ordering team to enable them to monitor progress of the sales orders, one copy is sent to the customer, one copy is sent to one of the company’s warehouses for dispatch and the final copy is sent to the finance department. Upon dispatch, a three‐part goods dispatch note (GDN) is completed which is assigned the same sequential number as the order number; one copy is sent with the goods, one remains with the warehouse and one is sent to the finance department.

Due to the recent growth of the company, and as there are a large number of sales invoices, additional temporary staff members have been appointed to help the sales clerks to produce the sales invoices. The sales invoices are prepared using quantities from the GDNs and prices from the authorized sales prices list, which is updated every six months. This year, in line with its main competitors, the company offered a 10% discount on all orders placed during one weekend in late November. Where a discount has been given, this has to be manually entered by the sales clerks onto the sequentially numbered invoice.

Customer statements are no longer being generated and sent out. The company only reconciles the receivables ledger control account at the end of April in order to verify the year‐end balance.

Required:

(a) List FOUR control objectives of Glasscom Co’s sales and dispatch system.

(b) As the external auditor of Glasscom Co, write a report to management in respect of the sales and dispatch system described which:

Identifies and explains SEVEN deficiencies in the sales and dispatch system and recommends a control to address each of these deficiencies; and

Note: Prepare your answer using two columns headed Control deficiency and Control recommendation respectively. The total marks will be split equally between each part.

43. Mountain Co operates six restaurant and bar venues which are open seven days a week. The company’s year end is 31 December 20X8. You are the audit supervisor reviewing the internal controls documentation in relation to the cash receipts and payments system in preparation for the interim audit, which will involve visiting a number of the venues as well as the head office. The company has a small internal audit (IA) department based at head office.

The purchasing department based at the company’s head office is responsible for ordering food and beverages for all six venues. In addition, each venue has a petty cash float of $400, held in the safe, which is used for the purchase of sundry items. When making purchases of sundries, employees are required to obtain the funds from the restaurant manager, purchase the sundries and return any excess money and the receipt to the manager. At any time the petty cash sum held and receipts should equal the float of $400 but it has been noted by the company’s IA department that on some occasions this has not been the case.

Each venue has five cash tills (cash registers) to take payments from customers. Three are located in the bar area and two in the restaurant area. Customers can pay using either cash or a credit card and for any transaction either the credit card vouchers or cash are placed in the till by the employee operating the till. To speed up the payment process, each venue has a specific log on code which can be used to access all five tills and is changed every two weeks.

At each venue at the end of the day, the tills are closed down by the restaurant manager who counts the total cash in all five tills and the sum of the credit card vouchers and these totals are reconciled with the aggregated daily readings of sales taken from each till. Any discrepancies are noted on the daily sales sheet. The daily sales sheet records the sales per the tills, the cash counted and the total credit card vouchers as well as any discrepancies. These sheets are scanned and emailed to the cashier at head office at the end of each week.

Approximately 30% of Mountain Co’s customers pay in cash for their restaurant or bar bills. Cash is stored in the safe at each venue on a daily basis after the sales reconciliation has been undertaken. Each safe is accessed via a key which the restaurant manager has responsibility for. Each key is stored in a drawer of the manager’s desk when not being used. Cash is transferred to the bank via daily collection by a security company. The security company provides a receipt for the sums collected, and these receipts are immediately forwarded to head office. The credit card company remits the amounts due directly into Mountain Co’s bank account within two days of the transaction.

At head office, on receipt of the daily sales sheets and security company receipts, the cashier agrees the cash transferred by the security company has been banked for all venues. She agrees the cash per the daily sales sheets to bank deposit slips and to the bank statements. The cashier updates the cash book with the cash banked and details of the credit card vouchers from the daily sales sheets. On a monthly basis, the credit card company sends a statement of all credit card receipts from the six venues which is filed by the cashier.

Every two months, the cashier reconciles the bank statements to the cash book. The reconciliations are reviewed by the financial controller who evidences her review by signature and these are filed in the accounts department. All purchases of food and beverages for the venues are paid by bank transfer. At the relevant payment dates, the finance director is given the total amount of the payments list which he authorizes.

Required:

Identify and explain EIGHT DEFICIENCIES in Mountain Co’s cash receipts and payments system and provide a recommendation to address each of these deficiencies.

Note: Prepare your answer using two columns headed Control deficiencies and Control recommendation respectively.

44. Bluewater Co is a retailer of ladies’ clothing and accessories. It operates in many countries around the world and has expanded steadily from its base in Europe. Its main market is aimed at 15 to 35 year olds and its prices are mid to low range. The company’s year-end was 30 September 20X0.

In the past the company has bulk ordered its clothing and accessories twice a year. However, if their goods failed to meet the key fashion trends then this resulted in significant inventory write downs. As a result of this the company has recently introduced a just–in-time ordering system. The fashion buyers make an assessment nine months in advance as to what the key trends are likely to be; these goods are sourced from their suppliers but only limited numbers are initially ordered.

Bluewater Co has an internal audit department but at present their only role is to perform regular inventory counts at the stores.

Ordering process

Each country has a purchasing manager who decides on the initial inventory levels for each store; this is not done in conjunction with store or sales managers. These quantities are communicated to the central buying department at the head office in Europe. An ordering clerk amalgamates all country orders by specified regions of countries, such as Central Europe and North America, and passes them to the purchasing director to review and authorize. As the goods are sold, it is the store manager’s responsibility to reorder the goods through the purchasing manager; they are prompted weekly to review inventory levels as although the goods are just-in-time, it can still take up to four weeks for goods to be received in store.

It is not possible to order goods from other branches of stores as all ordering must be undertaken through the purchasing manager. If a customer requests an item of clothing, which is unavailable in a particular store, then the customer is provided with other branch telephone numbers or recommended to try the company website.

Goods received and invoicing

To speed up the ordering to receipt of goods cycle, the goods are delivered directly from the suppliers to the individual stores. On receipt of goods the quantities received are checked by a sales assistant against the supplier’s delivery note, and then the assistant produces a goods received note (GRN). This is done at quiet times of the day so as to maximize sales. The checked GRNs are sent to head office for matching with purchase invoices.

As purchase invoices are received they are manually matched to GRNs from the stores; this can be a very time-consuming process as some suppliers may have delivered to over 500 stores. Once the invoice has been agreed then it is sent to the purchasing director for authorization. It is at this stage that the invoice is entered onto the purchase ledger.

(a) Auditors have a responsibility under ISA 265 Communicating Deficiencies in Internal Control to those Charged with Governance and Management to communicate deficiencies in internal controls. In particular, significant deficiencies in internal controls must be communicated in writing to those charged with governance.

Required:

As the external auditors of Bluewater Co, write a report to management in respect of the purchasing system which:

(i) Identifies and explains FOUR deficiencies;

(ii) Provides a recommendation to address each of these deficiencies; and

(iii) Describe a test of control Bluewater’s internal audit department could perform to

assess whether each of these controls, if implemented, is operating effectively.

45. Grace Co is a company listed on a stock exchange. It manufactures furniture which it supplies to a wide range of retailers across the region. The company has an internal audit (IA) department and the company’s year end is 30 June 20X9. You are an audit supervisor with Zain & Co, preparing the draft audit programs and reviewing extracts from the internal controls documentation in preparation for the interim audit.

Sales

Grace Co generates revenue through visits by its sales staff to customers’ premises. Sales ledger clerks, who work at head office, carry out credit checks on new customers prior to being accepted and then set their credit limits. Sales staff visit retail customers’ sites personally and orders are completed using a four‐part pre‐printed order form. One copy is left with the customer, a second copy is returned to the sales ordering department, the third is sent to the warehouse and the fourth to the finance department at head office. Each sales order number is based on the sales person’s own identification number in order to facilitate monitoring of sales staff performance.

Retail customers are given payment terms of 30 days and most customers choose to pay their invoices by bank transfer. Each day Lilla Shan, a finance clerk, posts the bank transfer receipts from the bank statements to the cash book and updates the sales ledger. On a monthly basis, she performs the bank reconciliation.

Purchases and inventory

Receipts of raw materials and goods from suppliers are processed by the warehouse team at head office, who agree the delivery to the purchase order, check the quantity and quality of goods and complete a sequentially numbered goods received note (GRN). The GRNs are sent to the finance department daily. On receipt of the purchase invoice from the supplier, Shami Green, the purchase ledger clerk, matches it to the GRN and order and the three documents are sent for authorization by the appropriate individual. Once authorized, the purchase invoices are logged into the purchase ledger by Camilla, who utilizes document count controls to ensure the correct number of invoices has been input.

The company values its inventory using standard costs, both for internal management reporting and for inclusion in the year‐end financial statements. The basis of the standard costs was reviewed approximately 18 months ago.

Payroll

Grace Co employs a mixture of factory staff, who work a standard shift of eight hours a day, and administration and sales staff who are salaried. All staff are paid monthly by bank transfer. Occasionally, overtime is required of factory staff. Where this occurs, details of overtime worked per employee is collated and submitted to the payroll department by a production clerk. The payroll department pays this overtime in the month it occurs. At the end of each quarter, the company’s payroll department sends overtime reports which detail the amount of overtime worked to the production director for their review.

Grace Co’s payroll package produces a list of payments per employee which links into the bank system to produce a list of automatic bank transfer payments. The finance director reviews the total to be paid on the list of automatic payments and compares this to the total payroll amount to be paid for the month per the payroll records. If any issues arise, then the automatic bank transfer can be manually changed by the finance director.

Required:

(a) In respect of the internal controls of Grace Co:

(i) Identify and explain SIX deficiencies

(ii) Recommend a control to address each of these deficiencies, and

(iii) Describe a TEST OF CONTROL the external auditors should perform to assess if

each of these controls, if implemented, is operating effectively to reduce the identified deficiency.

Note: Prepare your answer using three columns headed Control deficiency, Control recommendation and Test of control respectively. The total marks will be split equally between each part.

46. Blackpark Co operates an electric power station, which produces electricity 24 hours a day, seven days a week. The company’s year-end is 30 June 20X8. You are an audit manager of Grapefruit & Co, the auditor of Blackpark Co. The interim audit has been completed and you are reviewing the documentation describing Blackpark Co’s payroll system.

Systems notes – payroll

Blackpark Co employs over 250 people and approximately 70% of the employees work in production at the power station. There are three shifts every day with employees working eight hours each. The production employees are paid weekly in cash. The remaining 30% of employees work at the head office in non-production roles and are paid monthly by bank transfer.

The company has a human resources (HR) department, responsible for setting up all new joiners. Pre-printed forms are completed by HR for all new employees and, once verified, a copy is sent to the payroll department for the employee to be set up for payment. This form includes the staff member’s employee number and payroll cannot set up new joiners without this information. To encourage staff to attend work on time for all shifts, Blackpark Co introduced a discretionary bonus, paid every three months, for production staff. The production supervisors determine the amounts to be paid and notify the payroll department. This quarterly bonus is entered into the system by a clerk and each entry is checked by a senior clerk for input errors prior to processing. The senior clerk signs the bonus listing as evidence of undertaking this review.

Production employees are issued with clock cards and are required to swipe their cards at the beginning and end of their shift. This process is supervised by security staff 24 hours a day. Each card identifies the employee number and links into the hours worked report produced by the payroll system, which automatically calculates the gross and net pay along with relevant deductions. These calculations are not checked.

In addition to tax deductions from pay, some employees’ wages are reduced for such items as repayments of student loans owed to the central government. All employers have a statutory obligation to remit funds on a timely basis and to maintain accounting records which reconcile with annual loan statements sent by the government to employers.

At Blackpark Co student loan deduction forms are completed by the relevant employee and payments are made directly to the government until the employee notifies HR that the loan has been repaid in full. On a quarterly basis, exception reports relating to changes to the payroll standing data are produced and reviewed by the payroll director. No overtime is worked by employees. Employees are entitled to take 28 holiday days annually. Holiday request forms are required to be completed and authorised by relevant line managers, however, this does not always occur.

On a monthly basis, for employees paid by bank transfer, the senior payroll manager reviews the list of bank payments and agrees this to the payroll records prior to authorising the payment. If any errors are noted, the payroll senior manager amends the records.

For production employees paid in cash, the necessary amount of cash is delivered weekly from the bank by a security company. Two members of the payroll department produce the pay packets, one is responsible for preparing them and the other checks the finished pay packets. Both members of staff are required to sign the weekly payroll listing on completion of this task. The pay packets are then delivered to the production supervisors, who distribute them to employees at the end of the employees’ shift, as they know each member of their production team.

Monthly management accounts are produced which detail variances between budgeted amounts and actual. Revenue and key production costs are detailed, however, as there are no overtime costs, wages and salaries are not analysed.

Required:

(a) In respect of the payroll system for Blackpark Co:

(i) Identify and explain FIVE KEY CONTROLS which the auditor may seek to place reliance on; and

(ii) Describe a TEST OF CONTROL the auditor should perform to assess if each of these key controls is operating effectively.

Note: Prepare your answer using two columns headed Key control and Test of control respectively. The total marks will be split equally between each part.

(b) Identify and explain FIVE DEFICIENCIES in Blackpark Co’s payroll system and provide a recommendation to address each of these deficiencies.

 Note: Prepare your answer using two columns headed Control deficiency and Control recommendation respectively.

47. You are an audit senior of Smart & Co and are in the process of reviewing the inventory system documentation for your audit client, Lemon Shape Co (Shape) which manufactures computer equipment. The company’s factory and warehouse are based on one large site, and their year-end is 30 June 2016. Shape is planning to undertake a full inventory count at the year-end of its raw materials, work in progress and finished goods and you will be attending this count. In preparation you have been reviewing the inventory count instructions for finished goods provided by Shape.

The count will be undertaken by 15 teams of two counters from the warehouse department with Shape’s financial controller providing overall supervision. Each team of two is allocated a number of bays within the warehouse to count and they are provided with sequentially numbered inventory sheets which contain product codes and quantities extracted from the inventory records. The counters move through each allocated bay counting the inventory and confirming that it agrees with the inventory sheets. Where a discrepancy is found, they note this on the sheet.

The warehouse is large and approximately 10% of the bays have been rented out to third parties with similar operations; these are scattered throughout the warehouse. For completeness, the counters have been asked to count the inventory for all bays noting the third party inventories on separate blank inventory sheets, and the finance department will make any necessary adjustments. Some of Shape’s finished goods are high in value and are stored in a locked area of the warehouse and all the counting teams will be given the code to access this area. There will be no despatches of inventory during the count and it is not anticipated that there will be any deliveries from suppliers. Each area is counted once by the allocated team; the sheets are completed in ink, signed by the team and returned after each bay is counted. As no two teams are allocated the same bays, there will be no need to flag that an area has been counted. On completion of the count, the financial controller will confirm with each team that they have returned their inventory sheets.

Required:

(a) In respect of the inventory count procedures for Lemon Shape Co:

(i) Identify and explain FIVE deficiencies;

(ii) Recommend a control to address each of these deficiencies; and

(iii) Describe a TEST OF CONTROL the external auditors would perform to assess if each of these controls, if implemented, is operating effectively.

Note: The total marks will be split equally between each part.

49. Introduction

Lion Industries Co manufactures engineering parts. It has one operating site and a customer base spread across Europe. The company’s year-end was 31 March 20X6. Below is a description of the purchasing and payments system.

Purchasing system

Whenever production materials are required, the relevant department sends a requisition form to the ordering department. An order clerk raises a purchase order and contacts a number of suppliers to see which can dispatch the goods first. This supplier is then chosen. The order clerk sends out the purchase order. This is not sequentially numbered and only orders above $5,000 require authorisation.

Purchase invoices are input daily by the purchase ledger clerk, who has been in the role for many years and, as an experienced team member, does not apply any application controls over the input process. Every week the purchase day book automatically updates the purchase ledger; the purchase ledger is then posted manually to the general ledger by the purchase ledger clerk.

Payments system

Lion Industries Co maintains a current account and a number of saving (deposit) accounts. The current account is reconciled weekly but the saving (deposit) accounts are only reconciled every two months.

In order to maximize their cash and bank balance, Lion has a policy of delaying payments to all suppliers for as long as possible. Suppliers are paid by a bank transfer. The finance director is given the total amount of the payments list, which he authorizes and then processes the bank payments.

(a) ISA 260 Communication with Those Charged with Governance provides guidance to auditors in relation to communicating with those charged with governance on matters arising from the audit of an entity’s financial statements.

Required:

Identifies and explains SIX deficiencies in the system and recommends a control to address each of these deficiencies;

48. Night Co manufactures smartphones and tablets. Its main customers are retailers who then sell to the general public. The company’s manufacturing is spread across five sites and goods are stored in its nine warehouses located across the country. You are an audit supervisor of Ball & Co and in preparation for the forthcoming audit for the year ending 30 June 20X7, you are reviewing the following notes your audit manager has provided you with in relation to the company’s internal controls.

Night Co has a small internal audit (IA) department. During the year, IA started a programme of physically verifying the company’s assets and comparing the results to the non-current assets register, as this type of reconciliation had not occurred for some time. To date only 15% of assets have had their existence confirmed as IA has experienced significant staff shortages and several members of the current IA team are new to Night Co.

During the year, Night Co conducted an extensive reorganization of its manufacturing process to improve efficiency. Due to the significant number of employee changes required, the human resources department (HR) has been very busy and to ease their workload during this period, the payroll department has assisted by setting up any new employees who have joined the company. In January 20X7, the wage rate paid to employees was increased by the HR director and he notified payroll by emailing the payroll supervisor.

A new sales ledger system was introduced in May 20X6 and will continue to be run in parallel with the old system until IA has completed its checks between the two systems. New customers obtained by the sales team are required to undergo a full credit check; on the basis of this, a credit limit is proposed by sales staff and approved by the sales director and these credit limits remain static in the sales system.

Monthly perpetual inventory counts are undertaken at each of the nine warehouses, as a full year-end inventory count is too disruptive for the company. High value items are stored in a secure area in each warehouse. Access is via a four digit code, which for convenience is the same across all sites. Due to the company’s reorganization programme, some of the monthly inventory counts were not performed.

Bank reconciliations are undertaken monthly by an accounts clerk and details of all reconciling items are included. Where the sum of the reconciling items is significant, the reconciliation is sent to the financial controller for review. In order to maximize cash balances, the finance director approves all purchase invoices for payment 75 days after receipt of the invoice.

Required:

(a) Identify and explain EIGHT deficiencies in Night Co’s internal controls and provide a recommendation to address each of these deficiencies.

Note: Prepare your answer using two columns headed Control deficiency and Control recommendation respectively.

50. Bee Co is a clothing retailer which operates 45 stores throughout the country. The company’s year-end is 31 March 20X7. Bee Co has an internal audit department which has undertaken a number of internal control reviews specifically focusing on cash controls at stores during the year. The reviews have taken place in the largest 20 stores as this is where most issues arise. You are an audit supervisor of Woodlouse & Co and are reviewing the internal controls documentation in relation to the cash receipts system in preparation for the interim audit which will involve visiting a number of stores and the head office.

Each of Bee Co’s stores has on average three or four cash tills to take customer payments. All employees based at the store are able to use each till and individuals do not have their own log on codes, although employees tend to use the same till each day. Customers can pay using either cash or a credit card and for any transaction either the credit card payment slips or cash are placed in the till by the cashier. Where employees’ friends or family members purchase clothes in store, the employee is able to serve them at the till point.

At the end of each day, the tills are closed down with daily readings of sales taken from each till. These are reconciled to the total of the cash in the tills and the credit card payment slips and any discrepancies are noted. To save time, this reconciliation is done by the store’s assistant manager in aggregate for all of the store tills together. Once this reconciliation has taken place, the cash is stored in the shop’s small safe overnight and in the morning it is transferred to the bank via collection by a security company. If the store is low on change for cash payments, a junior sales clerk is sent by a till operator to the bank with money from the till and asked to change it into smaller denominations.

The daily sales readings from the tills along with the cash data and credit card payment data are transferred daily to head office through an interface with the sales and cash receipts records. A clerk oversees that this transfer has occurred for all stores. On a daily basis, he also agrees the cash transferred by the security company has been banked in full by agreeing the cash deposit slips to the bank statements, and that the credit card receipts have been received from the credit card company. On a monthly basis, the same clerk reconciles the bank statements to the cash book. The reconciliations are reviewed by the financial controller if there are any unreconciled amounts.

Required:

(a) State TWO control objectives of Bee Co’s cash receipts system.

(b) Identify and explain THREE KEY CONTROLS in Bee Co’s cash receipts system which the auditor may seek to place reliance on and describe a TEST OF CONTROL the auditor should perform to assess if each of these controls is operating effectively.

Note: Prepare your answer using two columns headed Key control and Test of control respectively.

(c) Identify and explain SIX DEFICIENCIES in Bee Co’s cash receipts system and provide a recommendation to address each of these deficiencies.

Note: Prepare your answer using two columns headed Control deficiency and Control recommendation respectively.