- 20 Marks
Question
You are the manager responsible for the audit of Seraphim Nigeria Limited, a manufacturing company which produces biscuits. The company’s financial year ended on December 31, 2018, and you are reviewing the audit work which was completed on a number of material balances and transactions: assets held for sale, capital expenditure, and payroll expenses.
A summary of the audit procedures carried out by the audit team is given below:
(i) Provision for Restructuring:
The board approved changes in the management structure of the company. The directors determined that the company was ‘top heavy’ and decided that 80% of the middle management staff should be laid off. The Finance Director had estimated the cost of the restructuring to be N180 million and a manual journal has been posted to record a provision for restructuring costs. The Finance Director has overridden the segregation of duties control by posting this journal and approving it himself. He told the team that he had done it because he wanted to preserve the confidentiality of the transaction. The audit team discussed the planned restructuring with the Managing Director (MD). The audit team relied on the discussions with the MD and the board resolution approving the restructuring as audit evidence.
(ii) Investments:
The company’s investments trading portfolio is outsourced to a fund manager – Hala Funds Management Limited, which processed all trades done by the company. The investments balance and income on investments recorded in the financial statements have been traced and agreed to year-end reports from the service organization. The audit team relied on the reports from the fund manager which was given to them by the Chief Financial Officer (CFO) of the company.
Based on discussions, the audit team determined that the CFO had not classified the investments in line with the requirements of IFRS 9, and the interest income on its bonds investment was computed using the contractual rate.
The company made some investments directly without passing them through the fund manager, which is not in line with the company’s policy. The audit team traced and agreed those transactions to the bank statement. The amounts of investments made directly without involving the fund manager were not considered material.
Required:
For each of the two matters described above:
(a) Comment on the sufficiency and appropriateness of the audit evidence obtained. (10 Marks)
(b) Recommend further audit procedures to be performed by the audit team. (8 Marks)
(c) Explain the matters which should be included in a report in accordance with ISA 265: Communicating Deficiencies in Internal Controls to Those Charged with Governance and Management. (2 Marks)
Answer
Part (i): Provision for Restructuring
(a) Sufficiency and Appropriateness of Audit Evidence Obtained
- Insufficiency of Evidence: The audit team relied only on discussions with the MD and the board resolution approving the restructuring. These are not sufficient or reliable audit evidence as they lack corroborative support.
- Inappropriate Evidence: The Finance Director’s override of segregation of duties weakens the reliability of the provision journal. A lack of independent review introduces a risk of misstatement.
(b) Recommended Further Audit Procedures
- Obtain Supporting Documents: Review calculations, estimates, and assumptions supporting the N180 million provision.
- Inspect Employee Communication: Verify communication sent to affected employees regarding the restructuring.
- Review Contractual Obligations: Examine termination agreements or contracts to validate the estimated costs.
- Subsequent Events Review: Verify whether the restructuring was implemented after year-end and compare actual costs incurred with the provision.
(c) Matters for Report in Line with ISA 265
- Segregation of Duties Override: Highlight that the Finance Director posted and approved the provision journal, bypassing controls.
- Lack of Supporting Evidence: Report the reliance on verbal evidence (discussions with the MD) without corroborative documentation.
Part (ii): Investments
(a) Sufficiency and Appropriateness of Audit Evidence Obtained
- Reliance on Fund Manager’s Reports: The reports from the fund manager were provided by the CFO without independent confirmation. This introduces a risk of misstatement if the reports were altered or incomplete.
- Improper Classification: The investments were not classified per IFRS 9, indicating non-compliance with accounting standards.
- Policy Non-Adherence: Direct investments outside the fund manager’s purview were not reviewed for compliance with company policy.
(b) Recommended Further Audit Procedures
- Obtain Direct Confirmation: Confirm balances and income directly from the fund manager to ensure accuracy and completeness.
- Verify IFRS 9 Compliance: Reassess the classification of investments to ensure compliance with the standard.
- Recompute Interest Income: Verify the accuracy of bond interest income calculations using the effective interest rate method.
- Inspect Direct Investments: Review the rationale and authorization for direct investments to ensure they align with company policies.
(c) Matters for Report in Line with ISA 265
- Policy Non-Adherence: Report the deviation from company policy regarding direct investments without the fund manager’s involvement.
- Accounting Non-Compliance: Highlight the CFO’s failure to classify investments in line with IFRS 9.
Conclusion
For both matters, the audit team should strengthen their evidence through independent confirmations and compliance reviews. Internal control deficiencies, including policy deviations and control overrides, should be promptly communicated to governance for corrective action.
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