Question Tag: Internal Control

ABC Limited was incorporated on 1 November, 2015 as a limited liability company
to carry out general merchandise business. It commenced business on 1 January,
2016. Your firm was appointed as external auditors on 5 February, 2017 with a
mandate to audit the company‟s accounts for the year ended 31 December, 2016.
Following receipt of the signed copy of the engagement letter from the managing
director, your team went to the company to commence the audit assignment.
Consequently, the audit manager in-charge assigned members of the audit team to
the various job schedules as stated in the Audit Planning Memorandum. The audit
which was concluded within the budgeted time-frame of two weeks was done with
a review of the accounting system and internal controls of the company. The
following were the accounting systems recorded at the commencement of the audit
exercise:
(a) Income Recognition
Income is recognised by the client on the basis of the amounts in the sales
invoices issued for the goods supplied and the amounts of the sales orders
are recognised as income for all the pending supplies as at 31 December of
each year. Commissions are paid to the sales executives in the first week of
January following the year end on the basis of the turnover figure in the
management accounts prepared by the chief accountant before the year-end
audit is done by the external auditors.
(b) Salary Payment
Staff salaries are prepared in a register maintained by the accountant from
where the salary summary sheet is prepared for submission to the chief
accountant for approval. The cashier consequently withdraws cash needed
for the salary payment and the salary due to each staff is put in an envelope.
On the pay day, payment of salaries is done by the cashier and staff
members are not made to sign for the payment because management
believes that the payment process is witnessed by another staff from the
sales department. At the end of the payment, the cashier stamps the salary
summary sheets with “Paid Stamp” which is regarded as evidence of the
salary payment.

(c) Directors‟ Drawings
The chief accountant gives approval for personal drawings requested by the
directors on the basis of the telephone discussion such a director had with
him. No separate drawings account is maintained for each of the directors in
the general ledger. The accountant only has the consolidated outstanding
balance in the Directors‟ Drawings account without showing the amount
drawn by each of the directors.
The engagement partner discovered during his review of the audit file that
the following adjustments were passed by the audit manager which made
some of the figures in the draft accounts to be different from those of the
management accounts prepared by the client.
(i) The turnover figure was adjusted by N250 million which made the
figure of N1 billion in the management accounts drop to N750 million
in the draft copy of the audited financial statements.
(ii) Part of the staff salaries, N12 million included in the cost of sales in
the management accounts was reclassified to increase staff salary
figure to N27 million in the draft copy of the audited financial
statements.
(iii) The directors‟ personal drawings totalling N50 million included in the
cost of sales in the management accounts was adjusted and taken to
directors‟ current account which consequently reduced the cost of
sales in the management accounts to N600 million.
(d) The managing director disagreed with the firm on the above audit journals
passed and gave the following reasons to support his argument.
(i) The turnover of N250 million that was adjusted represented the sales
orders received on 30 December, 2016 for new supplies to be made in
the following year. He said that their decision to recognise the amount
as income in the year 2016 was to help the company reach a turnover
benchmark of N1 billion required to competitively bid for government
contracts. He also said that commission on sales has been paid to the
sales executives on the basis of the turnover of N1 billion disclosed in
the management accounts.
(ii) Staff salaries of N12 million was included in the cost of sales so as to
reduce the PAYE tax to be paid by the company.
(iii) The directors‟ personal drawing of N50 million was included in the cost
of sales so that the amount could be hidden from the company‟s
shareholders.
The board of directors refused to sign the audited financial statements
because of the disagreement that occurred on the above audit
adjustments

As the audit senior in charge, you are required to:
a. Highlight FIVE major contents to be included in the engagement letter.
(10 Marks)
b. Identify FIVE major weaknesses in the internal control system of ABC
Limited. (10 Marks)
c. Advise by recommending suggestions that would address the identified
weaknesses. 10 Marks)
(Total 30 Marks)