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PAA 3 – 2

Question 41-50
Question 41-50

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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.

(a)

Control deficiency Control recommendation
There are no monitoring/supervision procedures relating to the clocking in and clocking out of employees. This means that staff may ask colleagues to clock them in when they are not actually present resulting in a payroll cost in excess of that expected for the actual hours worked. Clocking in and out should be monitored by a supervisor of an appropriate level, or by CCTV cameras installed to deter employees from clocking in for one another. Furthermore, employees should be automatically clocked out at the end of their shift, and should be required to clock back in if they are completing pre-agreed overtime.
Payroll calculations are not reviewed and 100% reliance is placed on the accuracy of the payroll system. This means that any errors made, for example as a result of standing or underlying data being incorrect or errors occurring during payroll processing, then they would not be discovered. This may lead to overpayments or underpayments (and incorrect payroll costs) and may result and lead to losses or disgruntled employees. A payroll supervisor should periodically recalculate the net pay based on the gross pay and expected deductions, then compare the result with the computer generated figures for a sample of employees. The review should be evidenced by a signature and wages should not be paid until this signed review is completed.
The HR department has used verbal authorization to inform the payroll department of pay increases. This indicates a lack of authorization at board level and could lead to invalid increases in employee wages (eg for HR personnel’s friends or relatives). HR should be required to gain written board authorization for any proposed wage increase before passing this to payroll. Similarly, payroll should be informed only to action a wage increase or other change on receipt of written authorization approved by the board.
The factory supervisor is trusted with substantial cash sums in advance of the distribution of wages to the night shift. This cash is susceptible to theft and loss while not with employees or securely stored. Payroll officials should be available for certain hours during the night shift to distribute wages.

 

The night shift workers should also be required to produce identification before they are given their pay packets.

 

Alternatively Chalk may decide to pay the night shift via bank transfer.

The factory supervisor keeps absent employees’ wages over the weekend before handing back to payroll and this further increases the risk of loss or theft of cash wages. Any amounts not paid out on Fridays should be kept by payroll in a safe or other secure means until Monday when the employee can collect from payroll.
Staff holidays in the HR department have meant that payroll information relating to new joiners was not communicated on a timely basis, which in turn meant that joiners were not paid on time leading to disgruntled employees and inaccurate payroll records. HR staff duties and responsibilities should be reallocated when staff are ill or on holiday, including the responsibility of immediate communication of new joiners (and leavers) to payroll.

 

In addition, new joiner forms showing start date should be completed and authorized, and then passed to payroll so that they are aware of the need to update the payroll records.

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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.

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(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.

(b)

Control deficiency Control recommendation
Customer credit limits are set by receivables ledger clerks. Receivables ledger clerks are not sufficiently senior and so may set limits too high, leading to irrecoverable debts, or too low, leading to a loss of sales. Credit limits should be set by a senior member of the receivables ledger department and not by receivables ledger clerks. These limits should be regularly reviewed by a responsible official.
Receivables ledger clerks record new customer details and credit limits in the customer master data file and these changes are not reviewed.

 

There is a risk that customers could be set up incorrectly resulting in a loss of customer goodwill and sales revenue.

 

In addition, the receivables ledger clerks are not senior enough to be given access to making changes to master file data as this could increase the risk of fraud.

Receivables ledger clerks should not be able to access the master data file to add new customers or make amendments. Any such additions/amendments to master file data should be restricted so that only supervisors and above can make changes.

 

An exception report of changes made should be generated and reviewed by a responsible official.

Glasscom Co’s credit controller is currently on secondment for six months to the internal audit department and has not been replaced.

 

During this period, it does not appear that anyone else has been responsible for monitoring ageing receivables.

 

This could result in an increased risk of irrecoverable debts and lead to customers not paying their outstanding balances on time, or at all, leading to reduced cash flows.

During the period of the secondment, an alternative member of the finance department should be trained in the credit control role and assigned responsibility for reviewing the aged receivables listing and following up on any overdue customers.
Goods dispatch notes (GDN) are given the same number as the order number to which they relate.

 

The sales invoices are only raised on receipt of a GDN, and without separate sequential numbers, it is difficult for Glasscom  Co to identify if any GDNs are missing as they are not likely to be raised in the same sequence as the sales orders.

 

If GDNs are missing and the company fails to raise invoices in a timely manner, this could lead to a loss of revenue.

GDNs should all be sequentially numbered using a sequence which is different to the order number. On a regular basis, a sequence check of GDNs should be undertaken to identify any missing dispatch notes.
Once orders are processed, copies of GDNs are sent to the finance department, customer and remain in the warehouse.

 

However, the sales order department of Glasscom Co does not receive a copy of the GDN.

 

If the sales order department does not receive a copy of the completed GDNs, they are not able to monitor if orders are being fulfilled on a timely basis.

 

This could result in a loss of revenue and customer goodwill.

The GDN should be amended to be at least four‐part. One copy should be sent to the sales order department.

 

Once the copy of the GDN has been received by the order department, it should be matched to the order. A regular review of unmatched orders should be undertaken by the sales order department to identify any unfulfilled orders.

Additional staff has been drafted in to help the sales clerks produce the sales invoices. As the extra staff will not be as experienced as the sales clerks, there is an increased risk of mistakes being made in the sales invoices.

 

This could result in customers being under or overcharged leading to misstated revenue or dissatisfied customers.

Only the sales clerks should be able to raise sales invoices. As Glasscom Co is expanding, consideration should be given to recruiting and training more permanent sales clerks who can produce sales invoices.

 

If this is not currently possible, temporary staff should be adequately trained and additional input checks on invoices should be introduced.

Discounts given to customers who purchased goods during the 10% off weekend are manually entered onto the sales invoices by sales clerks.

 

This could result in unauthorized sales discounts being given as there does not seem to be any authorization required.

 

In addition, a clerk could forget to manually enter the discount or enter an incorrect level of discount for a customer, leading to the sales invoice being overstated and a loss of customer goodwill.

During the period of any special offers, such as the 10% off weekend, the authorized sales prices file should be updated by a responsible official. These changes should be reviewed for any input errors, this review should be evidenced.

 

The invoicing system should confirm that orders were placed during the discount weekend. Hence the sales invoices for these periods should automatically contain the reduced prices.

Unauthorized discounts in excess of 10% would result in a loss of revenue, either due to error or fraud. The invoicing system should be amended to prevent sales clerks from being able to manually enter sales discounts onto invoices.
Customer statements are no longer being generated and sent to customers.

 

If statements are not sent regularly, this increases the likelihood of errors and any disputed invoices not being quickly identified and resolved by Glasscom Co.

 

This could lead to cash flow issues.

Glasscom Co should produce monthly customer statements for all customers and send them out promptly.
The receivables ledger control account is only reconciled at the end of April in order to verify the year‐end balance.

 

If the receivables ledger is only reconciled annually, there is a risk that errors will not be spotted promptly. Receivables may be misstated.

The receivables ledger control account should be reconciled on a monthly basis to identify any errors which should be investigated and corrected. The reconciliations should be reviewed by a responsible official and they should evidence their review by way of signature.

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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.

Control deficiency Control recommendation
Each restaurant maintains a petty cash float of $400, and at any point in time the receipts and funds present should equal the float. It has been noted by the internal audit (IA) department that on occasions there are differences due to the fact that no log is maintained of petty cash requests.

 

This could be as a result of sundry items being purchased without the relevant receipt or voucher being returned.

 

There is also a possibility that the cash is being misappropriated by staff members, or being spent on non-business related items.

A petty cash log should be maintained so the purchase of sundry items is recorded in the log along with the sum borrowed, date and employee.

 

On purchase of the items, the relevant employee should return the relevant receipt or voucher and any funds not spent. The log should be updated to confirm return of funds and receipts.

 

On a weekly basis, the restaurant manager should reconcile the petty cash and if any receipts are missing, these should be followed up with the relevant employee. If it is cash which is missing, then this should be investigated further with the employees who made petty cash purchases during that period.

 

To speed up the cash payment by customers, for each venue the tills have the same log on code and these codes are changed fortnightly.

 

In the event of cash discrepancies arising in the tills, it would be difficult to ascertain which employees may be responsible as there is no way of tracking who used which till. This could lead to cash being easily misappropriated.

 

Each employee should be provided with a unique log on code and this is required to be entered when using the tills.

In order to facilitate the investigation of till differences, employees should be allocated to a specific till point for their shift.

 

Any discrepancies which arise should initially be double checked to ensure they are not arithmetical errors. If still present, the relevant employees who had access to the till can be identified and further investigations can be undertaken.

 

The reconciliations of the tills to the daily sales readings are performed in total for all five tills at each venue rather than for each till. This means that when exceptions arise, it will be difficult to identify which till caused the difference and therefore which employees may require further till training or may have undertaken fraudulent transactions.

 

The reconciliations should be undertaken on an individual till by till basis rather than in aggregate and any discrepancies noted should be investigated immediately.
The cashing up of tills along with the recording of any cash discrepancies is undertaken by just one individual, the restaurant manager. There is a fraud risk as the manager could remove some of the cash and then simply record that there was an exception on the daily sales list.

 

In addition, as there is no segregation of duties, the restaurant manager could, fraudulently or by error, record the total sales as per each till incorrectly leading to incorrect identification of discrepancies.

 

The cashing up process should be undertaken by two individuals together, ideally an assistant manager and the restaurant manager. One should count the cash and the other record it.

 

Any exceptions to the till reading should be double checked to confirm that they are not simply arithmetical errors. If still present, the relevant employees who had access to the till can be identified and further investigations can be undertaken.

Daily sales sheets are scanned and emailed to head office on a weekly basis.

 

There is a possibility that some sales sheets could be misplaced by the restaurant manager resulting in incomplete sales and cash receipts data being recorded into the accounting system.

Daily sales sheets for each venue should be sequentially numbered and remitted to head office on a daily basis.

 

At head office, a sequence check should be undertaken on a regular basis to identify any missing sheets and any gaps should be investigated further.

 

Once received, the cashier should post the sales and cash data for all six venues on a daily basis. Once processed, they should then be signed as posted by the cashier and filed away securely.

 

Cash is stored in a safe at each venue and the restaurant manager stores the safe key in a drawer of their desk when not in use. Although cash is banked on a daily basis, there could still be a significant sum of cash onsite each day.

 

There is a risk of significant cash losses due to theft if access to the safe key is not carefully controlled.

 

The current key lock safe should be replaced with a safe with a digital code. Only authorized personnel should have the code which should be updated on a regular basis.
The cashier is responsible for several elements of the cash receipts system. She receives the daily sales sheets from restaurants, agrees that cash has cleared into the bank statements, updates the cash book and undertakes the bank reconciliations.

 

There is a lack of segregation of duties and errors will not be identified on a timely basis.

 

These key roles should be split between different members of the finance team, with ideally the bank reconciliations being undertaken by another member of the team.
The cashier is not checking that payments made by credit card have resulted in cash being received by Mountain Co. The credit card statements are not reviewed or reconciled, they are just filed away.

 

There is a risk that receipts of cash by credit card may have been omitted and this would not be identified on a timely basis as the bank is only reconciled every two months and may result in difficulties in resolving any discrepancies with the credit card company.

 

The cashier should reconcile the credit card vouchers per restaurant to the monthly statement received from the card company. The daily amounts per the statement should be agreed to the bank statement to ensure that all funds have been received.

 

This reconciliation should be reviewed by a responsible official, such as the financial controller, who should evidence by signature that the review has been undertaken

The bank reconciliations are only carried out every two months.

 

For a cash-based business, the bank reconciliation is a key control which reduces the risk of fraud. If it is not reconciled regularly enough, then this reduces its effectiveness as fraud and errors may not be identified on a timely basis.

 

 

 

The bank reconciliations should be performed on a monthly basis rather than every two months. The financial controller should continue to review each reconciliation and evidence her review by way of signature on the bank reconciliation.
The finance director only views the total amount of payments to be made rather than the amounts to be paid to each supplier.

 

Without looking at the detail of the payments list, as well as supporting documentation, there is a risk that suppliers could be being paid an incorrect amount, or that sums are being paid to fictitious suppliers.

 

The finance director should review the whole payments list prior to authorising.

 

As part of this, he should agree the amounts to be paid to supporting documentation, as well as reviewing the supplier names to identify any duplicates or any unfamiliar names.  He should evidence his review by signing the bank transfer list.

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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.

Control deficiency Control recommendation Test of control
The purchasing manager determines store inventory levels without consulting those who are best placed to judge the local market; the store or sales managers.

 

Certain clothes and accessories may be initially over-ordered and may need to be sold at reduced prices. This may also result in overvalued inventory (if held at cost) in the management accounts and ultimately the financial statements. Also some inventory may not be ordered in enough colume to meet demand and the reputation of Bluewater may suffer.

The purchasing manager should consult (in a meeting or by conference call) the store managers and a joint decision should be made on the initial inventory levels to be ordered for clothes/accessories. Select a sample of the minutes of meetings held by the purchasing manager and store managers for evidence that the store managers have been consulted on inventory order levels.

 

Discuss with/email a sample of store managers to request confirmation that they have been consulted on inventory order levels.

Store managers are responsible for reordering through the purchases manager and it can take four weeks for goods to be received.

 

The reliance is on store managers to be proactive and order four weeks before a potential stock-out. Without prompting they may order too late and inventory may run out for a period of up to four weeks, resulting in lost revenue.

Realistic reorder levels should be established in the inventory system. When inventory is down to the predetermined level, the purchasing manager should be prompted to raise a purchase order (for example the system may generate an automatic reorder request which is emailed to the purchasing manager). Use test data to process sufficient sales so that the inventory levels of a sample of items fall below the reorder level. Determine whether an automatic reorder request is emailed to the purchasing manager.
Stores cannot transfer goods between each other to meet demand. Customers are directed to try other stores/the website when an item of clothing is sold out.

 

Revenue may be lost because the system is inconvenient for the customer, who may not follow up at other stores, but may have purchased if the goods were transferred to their local store. Additionally the perceived lack of customer service may damage the store’s reputation.

An internal ordering system should be set up which allows for the transfer of goods between stores. In particular, stores with very low inventory levels should be able to obtain excess inventories from those with high levels to meet demand while goods are reordered. Process a sample of orders between different stores in order to determine whether the internal ordering system operates as documented.
Goods received are not checked against purchase orders. Goods which were not ordered in the first place could be received.

 

Once received, it may be difficult to return these goods and they may need to be paid for. In any case there is a potential unnecessary administrative cost.

 

Additionally, some goods ordered may not be received leading to insufficient inventory levels and potential lost revenue.

A copy of authorized orders should be kept at the relevant store and checked against goods received notes (GRNs).

 

If all details are correct, the order should be marked completed and sent to head office. The purchasing clerk should review the purchase orders at regular intervals for incomplete items and investigate why these are not completed.

Inspect a sample of goods received notes (GRN) to confirm that they have been checked back to the original order, and that the GRN has been initialed to show that the check has been performed.

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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.

Control deficiency Control recommendation Test of control
Customer credit limits are set by sales ledger clerks.

 

Sales ledger clerks are not sufficiently senior.

 

Limits may be set which are too high, leading to irrecoverable debts, or too low, leading to a loss of sales.

Credit limits should be set by a senior member of the sales department and not by sales ledger clerks.

 

These limits should be regularly reviewed by a responsible official.

For a sample of new customers accepted in the year, review the authorization of the credit limit, and ensure that this was performed by a responsible official.

 

Enquire of sales ledger clerks as to who can set credit limits.

Customer orders are given a number based on the sales person’s own identification number.

 

These numbers are not sequential. Without sequential numbers, it is difficult for Grace Co to identify missing orders and to monitor if all orders are being dispatched in a timely manner.

 

If they are not, this could lead to a loss of customer goodwill.

Sales orders should be sequentially numbered. On a regular basis, a sequence check of orders should be undertaken to identify any missing orders. Re‐perform the control by undertaking a sequence check of sales orders. Discuss any gaps in the sequence with sales ordering staff.
Lilla Shan, a finance clerk, is responsible for several elements of the cash receipts system as she posts the bank transfer receipts from the bank statements to the cash book, updates the sales ledger and performs the bank reconciliations.

 

There is a lack of segregation of duties.

 

Errors will not be identified on a timely basis. There is also an increased risk of fraud.

The key roles of posting bank receipts, updating the sales ledger and performing bank reconciliations should be split between different individuals. If this is not practical, then as a minimum, the bank reconciliations should be undertaken by another member of the finance team. Review the file of completed bank reconciliations to identify who prepared them.

 

Review the log of IDs of individuals who have posted bank receipts and updated the sales ledger to assess whether these are different individuals.

 

Discuss with the financial controller which members of staff undertake the roles of processing of bank receipts and updating of the cash book and sales ledger.

GRNs are only sent to the finance department.

 

Failing to send a copy to the purchase ordering department means that it is not possible to monitor the level of unfulfilled orders.

 

This could result in a significant level of unfulfilled orders leading to stock‐outs and a consequent loss of sales.

 

In addition, if the GRN is lost, then it will not be possible for the finance department to match the invoice to proof of goods being received.

 

This could result in a delay to the invoice being paid and a loss of supplier goodwill.

The GRN should be created in three parts with one copy of the GRN being sent to the ordering department. The second copy should be held at the warehouse and the third sent to the finance department.

 

A purchase ordering clerk should agree their copy of the GRN to the purchase order and change the order status to complete. On a regular basis, a review should be undertaken for all unfulfilled orders and these should be followed up with the relevant supplier.

Review the file of copy GRNs held by the purchase ordering department and review for evidence that these are matched to orders and flagged as complete.

 

Review the file of unfulfilled purchase orders for any overdue items and discuss their status with an ordering clerk.

Shami Green, the purchase ledger clerk, only utilizes document count controls when inputting invoices into the purchase ledger.

 

Document count controls can confirm the completeness of input.

 

However, they do not verify the accuracy or validity of input.

 

If the invoices are not input correctly, suppliers may not be paid on time, or paid incorrect amounts leading to an overpayment or loss of supplier goodwill who may withdraw credit facilities.

The purchase ledger clerk should instead input the invoices in batches and apply application controls, such as control totals, rather than just completeness checks to ensure both completeness and accuracy over the input of purchase invoices.

 

In addition, sequence checks should be built into the system to ensure completeness of input.

The audit team should utilize test data procedures to assess whether data can be entered without the use of batch control totals and also whether sequence checks are built into the system.

 

Observe the inputting of purchase invoices and identify what application controls are utilized by the clerk.

The company values its inventory using standard costs, which are not being kept up‐to‐date.

 

If the standard costs were reviewed 18 months ago, there is the risk that the costs are misstated as changes in raw materials and wages inflation may not have been adjusted for.

 

This could result in inventory being under or overvalued and profits being misstated.

 

In addition for year‐end reporting, IAS 2 Inventories only allows standard costs to be used for valuation purposes if they are a close approximation to actual costs, which is unlikely if the standard costs remain unchanged for a long period of time.

 

Therefore the valuation may not be in line with IAS 2.

A review of all standard costs currently in use should be undertaken by a senior manager in the production department.

 

Actual costs for materials, labour and overheads should be ascertained and compared to the proposed standard costs to ensure they are a close approximation.

 

The revised standard costs should be reviewed by the production director who should evidence this review. At least annually, a review of the standard costs should be undertaken to ensure they are up‐to-date.

Obtain a copy of the standard costs used for inventory valuation, assess when the review was last undertaken and inspect for evidence of review by the production director
Overtime worked is not authorized prior to being paid.

 

The information per employee is collated and submitted to payroll by a production clerk, but not authorized. The production director is only informed about overtime levels via quarterly reports.

 

These reports are reviewed sometime after the payments have been made which could result in unauthorized overtime or amounts being paid incorrectly and Grace Co’s payroll cost increasing.

All overtime should be authorized by a responsible official prior to the payment being processed by the payroll department.

 

This authorization should be evidenced in writing.

Review the overtime report for evidence of authorization and note the date this occurred to ensure that this was undertaken prior to the payment of the overtime.
The finance director compares the total of the list of bank transfers with the total to be paid per the payroll records.

 

There could be employees omitted or fictitious employees added to the payment listing so that, although the total payments list agrees to payroll totals, there could be fraudulent or erroneous payments being made.

The finance director, when authorizing the payments, should on a sample basis perform checks from the human resource department’s staff records to payment list and vice versa to confirm that payments are complete and only made to bona fide employees.

 

The finance director should sign the payments list as evidence that these checks have been undertaken.

Obtain a sample of payments lists and review for signature by the finance director as evidence that the control is operating correctly.

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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.

(a)

Key control Test of control
Blackpark Co has a separate human resources (HR) department which is responsible for setting up all new employees.

 

Having a segregation of roles between human resources and payroll departments reduces the risk of fictitious employees being set up and also being paid.

Review the job descriptions of payroll and HR to confirm the split of responsibilities with regards to setting up new joiners.

 

Discuss with members of the payroll department the process for setting up new joiners and for confirmation that the process is initiated by HR.

 

Pre-printed forms are completed by HR for all new

employees, and includes assignment of a unique employee

number, and once verified, a copy is sent to the payroll department. Payroll is unable to set up new joiners without information from these forms.

 

Select a sample of new employees added to the payroll

during the year, review the joiner forms for evidence of completion of all parts and that the information was verified as accurate and was received by payroll prior to being added to the system.

The use of pre-printed forms ensures that all relevant information, such as tax IDs, is obtained about employees prior to set up. This minimises the risk of incorrect wage and tax payments. In addition, as payroll is unable to set up new joiners without the forms and employee number, it reduces the risk of fictitious employees being set up by payroll.

 

Select a sample of edit reports for changes to payroll during the year; agree a sample of new employees added to payroll to the joiners forms.
The quarterly production bonus is input by a clerk into the payroll system, each entry is checked by a senior clerk for input errors prior to processing, and they evidence their review via signature.

 

This reduces the risk of input errors resulting in

over/underpayment of the bonus to employees.

 

 

 

 

 

 

 

If attending Blackpark Co at the time of bonus processing, observe the clerk inputting and senior clerk checking the bonus payments into the payroll system.

 

In addition, obtain listings of quarterly bonus payments and review for evidence of signature by the senior clerk who checks for input errors.

 

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.

 

This ensures that genuine employees are only paid for the work actually done, and reduces the risk of employees being paid but not completing their eight-hour shift. In addition, due to the supervision it is unlikely that one employee could swipe in others.

 

Observe the use of clock cards by employees when entering the power station.

 

Confirm the security team is supervising the process and following up on discrepancies through discussions with the security staff.

The clock card information identifies the employee number and links into the hours worked report produced by the payroll system.

 

As the hours worked are automatically transferred into the payroll system, this reduces the risk of input errors in entering hours to be paid in calculating payroll, ensuring that employees are paid the correct amount.

 

Utilise test data procedures to input dummy clock card information, verify this has been updated into the payroll system.
On a quarterly basis, exception reports of changes to payroll standing data are produced and reviewed by the payroll director.

 

This ensures that any unauthorised amendments to standing data are identified and resolved on a timely basis.

 

Select a sample of quarterly exception reports and review for evidence of review and follow up of any unexpected changes by the payroll director.
For production employees paid in cash, cash is received weekly from the bank by a security company.

 

It is likely the sum of money required to pay over 175 employees would be considerable. It is important that cash is adequately safeguarded to reduce the risk of misappropriation.

Enquire of payroll clerks how cash is delivered to Blackpark Co for weekly pay packets.

 

Review a sample of invoices from the security company to Blackpark Co for delivery of cash.

The pay packets are prepared by two members of staff with one preparing and one checking the pay packets and this is evidenced by each staff member signing the weekly listing.

 

This ensures there is segregation of duties which prevents fraud and errors not being identified.

 

Observe the preparation of the pay packets ensuring that two members of staff are involved and that pay packets are checked for accuracy.

 

For a sample of weeks throughout the year, inspect the weekly payroll listing for evidence of signature by the two members of staff involved in the preparation of the pay packets.

 

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(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.

(b)

Control deficiency Control recommendation
Production supervisors determine the amount of the  discretionary bonus to be paid to employees.

 

Production supervisors should not determine this as they could pay extra bonuses to friends or family members, resulting in additional payroll costs.

 

The bonus should be determined by a responsible official, such as the production director and should be formulated based on a written policy. If significant in value, the bonus should be formally agreed by the board of directors.

 

The bonus should be communicated in writing to the payroll department.

 

The wages calculations are generated by the payroll system and there are no checks performed.

 

Therefore, if system errors occur during the payroll processing, this would not be identified. This could result in wages being over or under calculated, leading to an additional payroll cost or loss of employee goodwill.

 

A senior member of the payroll team should recalculate the gross to net pay workings for a sample of employees and compare their results to the output from the payroll system.

 

These calculations should be signed as approved before payments are made.

Student loan deduction forms are completed by relevant employees and payments are made directly to the third party until the employee notifies HR that the loan has been repaid in full.

 

As the payments continue until the employee notifies HR, and employees are unlikely to be closely monitoring payments, there is the risk that overpayments may be made, which then need to be reclaimed, leading to employee dissatisfaction.

 

In the case of underpayments, Blackpark Co has an obligation to remit funds on time and to reconcile to annual loan statements. If the company does not make payments in full and on time, this could result in non-compliance by both the company and employee, which could result in fines or penalties.

 

The payroll department should maintain a schedule, by

employee, of payments made to third parties, such as the central government as well as the cumulative balance owing. On a regular basis, at least annually, this statement should be reconciled to the loan statement received from the government and sent to the employee for agreement.

 

In accordance with the schedule, payments which are due to cease shortly should be confirmed in writing with the third party, prior to stopping.

Holiday request forms are required to be completed and

authorised by relevant line managers, however, this does not always occur.

 

This could result in employees taking unauthorised leave, resulting in production difficulties if an insufficient number of employees are present to operate the power plant. In addition, employees taking unauthorised leave could result in an overpayment of wages.

 

 

 

 

 

Employees should be informed that they will not be able to take holiday without completion of a holiday request form, with authorisation from the line manager.

 

Payroll clerks should not process holiday payments without agreement to the authorised holiday form.

The senior payroll manager reviews the bank transfer listing prior to authorising the payments and also amends the payroll records for any changes required.

 

There is a lack of segregation of duties as it is the payroll team which processes the amounts and the senior payroll manager who authorises payments. The senior manager could fraudulently increase the amounts to be paid to certain employees, process this payment as well as amend the records.

 

The senior payroll manager should not be able to process changes to the payroll system as well as authorise payments.

 

The authorisation of the bank transfer listing should be undertaken by an individual outside the payroll department, such as the finance director.

The pay packets are delivered to the production supervisors, who distribute them to employees at the end of their shift.

 

The supervisor is not sufficiently independent to pay wages out. They could adjust pay packets to increase those of close friends whilst reducing others.

 

In addition, although the production supervisors know their team members, payment of wages without proof of identity increases the risk that wages could be paid to incorrect employees.

 

 

 

 

All pay packets should be distributed by the payroll department, directly to employees, upon sight of the employee’s clock card and photographic identification as this confirms proof of identity.

 

Payroll should undertake a reconciliation of pay packets issued to production supervisors, wages distributed with employee signatures to confirm receipt and pay packets returned to payroll due to staff absences. Any differences should be investigated immediately.

 

As employees work eight-hour shifts over 24 hours, consideration should be given to operating a shift system for the payroll department on wages pay out day.

This will ensure that there are sufficient payroll employees to perform the wages pay out for each shift of employees, with the same level of controls in place.

 

Monthly management accounts do not analyse the variances between actual and budgeted wages and salaries; this is because there are no overtime costs.

 

However, wages and salaries are a significant expense and management needs to understand why variances may have arisen. These could occur due to extra employees being recruited which were not budgeted for, or an increase in wage pay out rates. The board would need to monitor the wages and salaries costs as if they are too high, then this would impact the profitability of the company.

 

The monthly management accounts should be amended to include an analysis of wages and salaries compared to the budgeted costs. These should be broken down to each relevant department and could also include an analysis of headcount numbers compared to budget.

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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.

Deficiencies Controls Test of controls
The count will be undertaken by teams of warehouse staff.

 

There should be a segregation of roles between those who have day-to-day responsibility for inventory and those who are checking it. If the same team are responsible for maintaining and checking inventory, then errors and fraud could be hidden.

 

The counting teams should be independent of the warehouse; hence members of alternative departments should undertake the counting rather than the warehouse staff. Attend the year-end count and enquire of the counting teams which department they normally work in.

 

Inspect the updated inventory count instructions to verify that they have been communicated to members of staff outside the warehouse department.

The inventory sheets contain quantities as per the inventory records. There is a risk that the counting teams may simply agree with the pre-printed quantities rather than counting the balances correctly, resulting in significant errors in inventory.

 

The count sheets should be sequentially numbered and contain product codes and descriptions but no quantities. Inspect a sample of the counting sheets being used by the counting teams to verify that only the inventory product codes and description are pre-printed on them.
There are 15 teams of counters, each team having two members of staff.

 

However, there is no clear division of responsibilities within the team.

 

Therefore, both members of staff could count together rather than checking each other’s count; and errors in their count may not be identified.

 

Each team should be informed that both members are required to count their assigned inventory separately.

 

Therefore, one member counts and the second member also undertakes a count and then records the inventory on the count sheets correctly.

 

In addition, the financial controller supervising the count should undertake some sample checks of inventory counted by each team.

 

Observe the counting teams to assess if they are counting together or if one counts and the other then double checks the quantities counted.

 

Review the records of the sample checks undertaken by the supervisor of the inventory count.

Inventory owned by third parties is also being counted by the teams with adjustments being made by the finance team to split these goods out later. There does not appear to be a method for counters to identify which items are third party inventory.

 

There is a risk that these goods may not be correctly removed from the inventory count sheets, resulting in inventory being overstated.

 

All inventories belonging to third parties should be moved to one location. This area should be clearly marked and excluded from the counting process. Enquire of the count supervisor where the third party inventory is to be stored, confirm through inspection of the counting sheets that these bays are not included on any pre-printed forms.
High value inventory which is normally stored in a secure location will be accessible by all team members as they will be given the access code. This significantly increases the risk of theft as any member of the counting team could subsequently access these goods.

 

 

 

 

 

 

The high value inventory should be kept in the locked area of the warehouse. Senior members of the team should be allocated to count these goods, and they should be given the access code to enter the area.

 

Upon completion of the count the access code should be changed.

 

Attempt to access the area where the high value inventory is stored; this should not be possible without the access code.

 

At the year-end visit attempt to access with the code which was supplied during the inventory count.

Each bay of the warehouse is counted once only. If inventory is only checked once, then counting errors may arise resulting in under or overstated inventory.

 

Once all inventories have been counted once, each area should be recounted by a different team. Any differences on the first count should be promptly notified to the count supervisor and a third count undertaken if necessary.

 

If a full second count would be too time-consuming for the company, then sample checks on the inventory counted should be undertaken by a different counting team.

 

Observe the counting team undertake second counts of all areas; confirm that different teams undertake this process.
Once areas are counted, the teams are not marking the bays as completed. Therefore there is the risk that some areas of the warehouse could be double counted or missed out.

 

All bays should be flagged as completed, once the inventory has been counted. In addition, the count

supervisor should check at the end of

the count that all of the bays with

Shape’s inventory have been flagged as completed.

 

Physically confirm that the completed bays of the warehouse have been flagged to indicate that the goods have been counted.

 

At the end of the count, review any bays containing Shape’s goods which have not been flagged.

 

The inventory sheets are sequentially numbered and at the end of the count they are given to the count supervisor who confirms with each team that they have returned all sheets.

 

However, no sequence check of the sheets is performed. If sheets are missing, then the inventory records could be understated.

 

After the counting has finished, each team should return all of their sequentially numbered sheets and the supervisor should check the sequence of all sheets at the end of the count. Review the sequence of the inventory sheets for any gaps in the sequence and obtain an explanation from the count supervisor.

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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;

Control deficiency Control recommendation
When raising purchase orders, the clerks choose whichever supplier can despatch the goods the fastest.

 

This could result in Lion Industries Co ordering goods at a much higher price or a lower quality than they would like, as the only factor considered was speed of delivery.

It is important that goods are despatched promptly, but this is just one of many criteria that should be used in deciding which supplier to use.

 

An approved supplier list should be compiled; this should take into account the price of goods, their quality and also the speed of delivery.

 

Once the list has been produced, all orders

should only be placed with suppliers on the

approved list

Purchase orders are not sequentially numbered.

 

Failing to sequentially number the orders means that Lion Industries Co’s ordering team are unable to monitor if all orders are being fulfilled in a timely manner; this could result in stock outs.

 

If the orders are numbered, then a sequence

check can be performed for any unfulfilled

orders

All purchase orders should be sequentially numbered and on a regular basis a sequence check of unfulfilled orders should be performed
Purchase orders below $5,000 are not authorised and are processed solely by an order clerk.

 

This can result in goods being purchased which are not required by Lion Industries Co.

 

In addition, there is an increased fraud risk as an order clerk could place orders for personal goods up to the value of $5,000, which is significant.

All purchase orders should be authorised by a responsible official.

 

Authorised signatories should be established with varying levels of purchase order authorisation.

Purchase invoices are input daily by the purchase ledger clerk and due to his experience, he does not utilise any application controls.

 

Without application controls there is a risk that invoices could be input into the system with inaccuracies or they may be missed out entirely. This could result in suppliers being paid incorrectly or not all, leading to a loss of supplier goodwill.

The purchase ledger clerk should input the invoices in batches and apply application controls, such as control totals, to ensure completeness and accuracy over the input of purchase invoices.
The purchase day book automatically updates with the purchase ledger but this ledger is manually posted to the general ledger.

 

Manually posting the amounts to the general ledger increases the risk of errors occurring.

 

This could result in the payables balance in the financial statements being under or overstated.

The process should be updated so that on a regular basis the purchase ledger automatically updates the general ledger.

 

A responsible official should then confirm through purchase ledger control account reconciliations that the update has occurred correctly.

Lion Industries Co’s saving (deposit) bank accounts are only reconciled every two months. If these accounts are only reconciled periodically, there is the risk that errors will not be spotted promptly.

 

Also, this increases the risk of employees committing fraud. If they are aware that these accounts are not regularly reviewed, then they could use these cash sums fraudulently.

All bank accounts should be reconciled on a regular basis, and at least monthly, to identify any unusual or missing items.

 

The reconciliations should be reviewed by a responsible official and they should evidence their review.

Lion Industries Co has a policy of delaying payments to their suppliers for as long as possible.

 

While this maximises Lion Industries Co’s bank balance, there is the risk that the company is missing out on early settlement discounts. Also, this can lead to a loss of supplier goodwill as well as the risk that suppliers may refuse to supply goods to Lion  Industries Co.

Lion Industries Co should undertake cash flow forecasting/budgeting to maximise bank balances. The policy of delaying

payment should be reviewed, and suppliers

should be paid in a systematic way, such

that supplier goodwill is not lost

The finance director authorises the bank transfer payment list for suppliers; however, he only views the total amount of payments to be made.

 

Without looking at the detail of the payments list, as well as supporting documentation, there is a risk that suppliers could be being paid an incorrect amount, or that sums are being paid to fictitious suppliers.

The finance director should review the whole payments list prior to authorising.

 

As part of this, he should agree the amounts to be paid to supporting documentation, as well as reviewing the supplier names to identify any duplicates or any unfamiliar names. He should evidence his review by signing the bank transfer list.

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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.

Control deficiency Control recommendation
Physical verification of assets within the non-current asset register has not been undertaken for some time. A current programme has started but is only 15% complete, due to staff shortages.

 

If non-current assets are not physically verified on a regular basis, there is an increased risk of assets being misappropriated or misplaced as there is no check that the assets still exist in their correct location.

 

Additional resources should be devoted to completing the physical verification of all assets within the register. If any assets cannot be located, they should be written off.

 

Following this full review, on a monthly basis a sample of assets at the sites should be agreed back to the register to confirm existence.

Night Co has experienced significant staff shortages within their internal audit (IA) department. In addition, several members of the current IA team are new to the company.

 

Maintaining an IA department is an important control as it enables senior management to test whether controls are operating effectively within the company. If the team has staff shortages or lack of experience, this reduces the effectiveness of this monitoring control.

 

Senior management should consider recruiting additional employees to join the IA department.

 

In the interim, employees from other departments, such as finance, could be seconded to IA to assist them with the internal audits, provided these reviews do not cover controls operating in the department where the employees normally work.

During the year, the human resources (HR) department has been busy; therefore the payroll department has set up new joiners to the company.

 

This is a lack of segregation of duties, as employees are able to set up new joiners in the payroll system and process their pay, this leads to an increased risk of fictitious/duplicate employees being set up.

The HR director should as a matter of urgency review the workloads of the department to assess whether other tasks can be reprioritised as payroll should cease to set up new joiners. This role must immediately revert back to HR to undertake.

 

Additionally, a review should be undertaken of all new joiners set up by payroll with agreement to employee files to confirm that all new employees are bona fide.

 

The wage rate has been increased by the HR director and notified to the payroll supervisor by email. As payroll can be a significant expense for a business, any decision to increase this should be made by the board as a whole and not just by the HR director.

 

In addition, the notification of the payroll increase was via email and the payroll supervisor was able to make changes to the payroll standing data without further authorisation. This increases the risk of fraud or errors arising within payroll.

 

All increases of pay should be proposed by the HR

department and then formally agreed by the board of directors.

 

Upon agreement of the pay rise, a written notification of the board decision should be sent to the payroll supervisor who enters the revised pay rate into the system. This change should trigger an exception report for the payroll director, and the new rate should not go live until the director has signed off the changes.

New customers undergo a credit check, after which a credit limit is proposed by the sales staff and approved by the sales director, these credit limits are not reviewed after this.

 

Over a period of time it may be that the customers’ credit limits have been set too high, leading to irrecoverable debts, or too low, leading to a loss of sales.

 

Credit limits should continue to be approved by the sales director; however, on a regular basis the sales director should review these limits based on order history and payment record.
High value inventory is stored in a secure location across all nine warehouses and access is via a four digit code, which is common to all sites.

 

As the code is the same across all sites, this significantly increases the risk of fraud. A considerable number of people will be aware of the codes and could access inventory at any of the nine sites.

 

The access codes for all of the sites should be changed. Each site should have a unique code, known to a small number of senior warehouse employees. These codes should be changed on a regular basis.
Monthly perpetual inventory counts are supposed to be undertaken at each of the nine warehouses, but some of these are outstanding.

 

In order to rely on inventory records for decision making and the year-end financial statements, all lines of inventory must be counted at least once a year, with high value or high turnover items counted more regularly. If the counts are outstanding, some goods may not be counted, and the inventory records may be incorrect.

 

The programme of perpetual inventory counts should be reviewed for omissions. Any lines which have been missed out should be included in the remaining counts.

 

At the year end, if any lines are identified as having not been counted, the company should organise an additional count to ensure that all items are confirmed to inventory records.

 

 

The bank reconciliations are only reviewed by the financial controller if the sum of reconciling items is significant; therefore some reconciliations are not being reviewed. The financial controller relies solely on the accounts clerk’s notification that the bank reconciliations require review.

 

The bank reconciliations could contain significant errors, but a low overall amount of reconciling items, as there could be compensating errors which cancel each other out.

 

Bank reconciliations are a key control which reduces the risk of fraud. If they are not reviewed, then this reduces its effectiveness and also results in a lack of assurance that bank reconciliations are being carried out at all or on a timely basis.

 

The bank reconciliations should be reviewed by the financial controller on a monthly basis, even if the reconciling items are not significant, and he should evidence his review by way of signature on the bank reconciliation.
Invoices are authorised by the finance director, but payment is only made 75 days after receipt of the invoice. There is the risk that Night Co is missing out on early settlement discounts.

 

Also, failing to pay in accordance with the supplier’s payment terms can lead to a loss of supplier goodwill as well as the risk that suppliers may refuse to supply goods to the company.

 

The policy of making payment after 75 days should be reviewed. Consideration should be given to earlier payment if the settlement discounts are sufficient. If not, invoices should be paid in accordance with the supplier’s payment terms.

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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.

13 / 14

(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.

Key control Test of Control
Bee  Co has an internal audit (IA) department which has undertaken a number of internal control reviews, which specifically focused on cash controls at stores during the year.

 

This is a strong monitoring control as stores will aim to ensure that company procedures are maintained as they would not wish IA to report any exceptions at their store.

Discuss with IA the programme of their visits to stores and the areas addressed on these visits. This will assess the strength of this monitoring control. In particular, enquire of IA whether over a rolling period all stores will be visited.

 

Review the IA department files for the results of the store visits, to confirm that the 20 stores programmed to be visited did all actually take place and for exceptions noted and actions taken.

At the end of each day, the tills are closed down with daily readings of sales taken; these are reconciled to the total of the cash in the tills and the credit card payment slips and any discrepancies are noted.

 

Daily cashing up procedures should ensure that the cash is controlled and reduces the risk of fraud as employees are aware that the assistant manager will be looking for cash discrepancies.

For a sample of stores visited, the auditor should review the file of daily reconciliations to ascertain if end of day till reconciliations have taken place on a daily basis.

 

For reconciliations with discrepancies, discuss with the store manager what actions were taken and how these differences were resolved.

Cash received from customers is taken to the bank daily via collection by a security company.

 

This ensures that cash is safeguarded and that the risk of theft when transferring to the bank is minimised.

During the store visits, enquire of staff how the cash is transferred to the bank.

 

A sample of invoices from the collection company should be reviewed and confirmed that they are charging Centipede Co on a daily basis.

 

In addition, during these visits observe the cash collection process carried out by the security company.

The daily sales readings from the tills along with the cash and credit card data are transferred to head office through a daily interface into the sales and cash receipts records.

 

This should ensure that sales and cash records are updated on a prompt basis and are complete and accurate.

During the interim audit at head office, compare the daily sales readings from individual stores, including some visited by the audit team, to the sales and cash receipt records within the general ledger.

 

Review the date on which the sales and cash receipt records were updated to ensure this occurred promptly. Any discrepancies should be discussed with the clerk responsible for overseeing this process.

On a daily basis the clerk agrees that the cash banked and the credit card receipts from the credit card company have been credited to the bank statements in full.

 

This should ensure the completeness of cash receipts, as they are transferred in from two sources, being the security company and the credit card operator.

Discuss with the clerk responsible for reconciling the cash and credit card receipts, the process he undertakes.

 

Review the daily reconciliations he has completed to confirm the process has been undertaken as described.

Bank reconciliations are undertaken on a monthly basis.

 

This should ensure that any discrepancies between the cash book and the bank statements are identified promptly.

Review the file of bank reconciliations to ascertain if there is one for each month and that they are either fully reconciled, or the financial controller has evidenced their review of any unreconciled amounts.

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(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.

Control deficiency Control recommendation
The IA department only undertakes cash control visits to the 20 largest stores as they feel this is where most issues arise. However, Bee  Co has 45 stores in total which means over half of the stores are not being checked.

 

This increases the likelihood of control errors, as these stores may not comply with company procedures.

 

As it is a cash business heightens the chance of frauds occurring.

Caterpillar’s IA department should have a rolling programme of visits to all 45 stores. This programme can have a bias to large and high risk stores, but it should ensure that all stores are visited on a cyclical basis.
All store employees are able to use each till and none have an individual log on code when using the tills.

 

Allowing all employees access to the till points increases the risk of fraud and error arising.

 

Also in the event of cash discrepancies arising in the tills, it would be difficult to ascertain which employees may be responsible as there is no way of tracking who used which till.

Only employees for whom criminal record/credit checks have been undertaken should be able to use the tills to take customer payments.

 

Each employee should have a designated till and a log on code, which is required for each payment transaction.

Where employees’ friends or family members purchase clothes in store, the employee is able to serve them at the till point.

 

There is a significant fraud risk as employees could fail to put the goods through the till, but retain the cash paid by the friend/family members.

 

Additionally, they could give the goods away for free or undercharge for goods sold, thereby granting unauthorised discounts.

Bee  Co should instigate a policy whereby employees are unable to serve friends or family members at the till points. They should be required to request that a manager or supervisor put these goods through the till.

 

In addition, CCTV cameras could be placed in the shops, near to the till points to record the daily till transactions. This would act as a deterrent to employees as well as provide evidence in the case of fraudulent transactions occurring.

 

Also Bee  Co should carry out regular inventory counts to identify if goods in the stores are below the levels in the inventory records, as this could identify goods being given away for free.

The daily reading of sales and reconciliations to the tills is performed in aggregate rather than for each till.

 

This means if exceptions arise, it will be difficult to identify which till caused the difference and therefore which employees may require further till training or have undertaken fraudulent transactions.

The reconciliations should be undertaken on an individual till by till basis rather than in aggregate.
The cashing up of tills along with the recording of any cash discrepancies is undertaken by just one individual, the assistant store manager.

 

There is a fraud risk as the store manager could remove some of the cash and then simply record that there was an exception on this till.

The cashing up process should be undertaken by two individuals together, ideally the assistant and the store manager. One should count the cash and the other record it. Any exceptions to the till reading should be double checked to confirm that they are not simply addition errors.
The cash is kept at the store overnight in a small safe. Although in a safe, this is not secure as it is likely that the cash sales for one day would be a significant sum.

 

This cash is at risk of being stolen overnight.

The cash should continue to be collected daily by the security company, but rather than in the morning it should be collected as the store closes in the evening so that cash does not have to be stored overnight.
If a store needs change, a junior sales clerk is sent to the bank by a till operator to change it into smaller denominations.

 

There is a risk of the cash being misplaced or stolen on the way to the bank or collusion between the junior clerk and till operator as no record appears to be kept of the money removed from the till in these instances and no confirmation of how much cash is returned is carried out.

Caterpillar’s head office should stipulate a float amount per till and how the note denominations should be comprised. When assigning the cash float in the morning, the store manager should ensure that this policy is adhered to.

 

If during the day, further smaller denomination notes are required, the store manager should authorise a member of staff to obtain cash from the bank and should fully record movements in and out of the till.

One clerk is responsible for several elements of the cash receipts system.

 

He oversees the daily interface from stores, agrees that cash has cleared into the bank statements and undertakes the bank reconciliations.

 

There is a lack of segregation of duties and errors will not be identified on a timely basis as well as increasing the risk of Fraud.

These key roles should be split between a few individuals, with ideally the bank reconciliations being undertaken by another member of the finance team.
The bank reconciliations are only reviewed by the financial controller if there are any unreconciled amounts.

 

The bank reconciliation could reconcile but still contain significant errors as there could be compensating errors which cancel each other out.

 

In addition, for a cash based business, the bank reconciliation is a key control which reduces the risk of fraud. If it is not reviewed, then this reduces its effectiveness.

The bank reconciliations should be reviewed by the financial controller on a monthly basis, even if there are no exceptions, and he should evidence his review by way of signature on the bank reconciliation.

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