- 20 Marks
AA – L2 – Q27 – Risk Assessment and Internal Control
Question
You are the senior responsible for planning the audit of Unity Football Club Limited (UFC) for the year ended May 31, 2008.
UFC runs a football club which was promoted to the top division in the league this season. The football season starts on September 1 and ends on May 31 so that the players get a break over the summer months.
UFC own their football stadium which now has the capacity to seat 25,000 people. Of the 25,000 seats, 19,000 are allocated to UFC supporters (home supporters) and are sold to season ticket holders only. The remaining 6,000 tickets are for away supporters and cannot be sold to UFC supporters.
Season tickets cost GH¢260 for adults and GH¢175 for children. Following their recent promotion all the season tickets have been sold this year with 70% of season tickets sold to adults and the remaining 30% to children. Tickets for away supporters are always sold at GH¢20 per ticket regardless of whether the ticket is sold to an adult or a child. On average 50% of away supporter tickets have been sold for each of the 14 home games played at UFC’s stadium during the football season.
UFC’s other revenue streams include the sale of football kits and other memorabilia from the club shop, and food and drink sales from the club snack bars.
Following promotion to the top division, the club added an extra stand to the stadium to increase the seating capacity to the current level of 25,000. Other existing areas of the stadium also underwent maintenance in order to restore them to their original condition. The work was carried out during June and July, 2007 and cost a total of GH¢3,360,000. To finance this UFC took out a GH¢2,900,000 loan on June 1, 2007.
The loan carries an interest rate of 7% and is repayable over the next five years. The loan is secured on the stadium.
The directors feel that the club’s greatest assets (other than the stadium) are the football players themselves. The players have performed so well this year that some of the other football clubs in the same division have made preliminary offers to buy three of UFC’s players. UFC is particularly pleased about this as these players joined the club through their youth academy programme. Consequently the directors would like to value these three players as intangible non-current assets in UFC’s financial statements. The players will be valued at the offer price received from the other clubs. The directors feel this is a prudent valuation because they are confident that the eventual selling price would be much higher than the preliminary offer.
One of the major drawbacks of the club’s promotion has been that the club has had to increase the level of players’ salaries. The total salary expense for the year is estimated to be in the region of GH¢2,800,000. This is a particularly surprising figure as it is higher than the other operating costs for the year which are estimated at GH¢2,400,000.
UFC has just appointed a team of internal auditors. They have not been in position long enough to help you with your audit work but the directors are keen for the internal auditors to improve the company’s internal controls in relation to the club shop and snack bars.
Required:
(a) Using the information provided, describe FIVE (5) audit risks and explain the auditor’s response to each risk in planning the audit of UFC.
(b) Describe how the auditor could perform a proof in total calculation to confirm each of UFC’s revenue from ticket sales, loan interest and payroll expense for players’ salaries.
(c) Explain THREE (3) internal controls the internal auditors of UFC should implement relating to the club shop or snack bars, and state the objective of each of the three controls.
Answer
(a)
| Audit risk | Auditor’s response |
|---|---|
| The expenditure of GH¢3,360,000 on the stadium includes costs for both the addition of a new stand and maintenance work. There is a risk that maintenance costs, which should be expensed, are incorrectly capitalized as part of the stadium’s carrying amount, leading to an overstatement of non-current assets and profit. | The auditor should obtain a breakdown of the GH¢3,360,000 spent on the stadium and establish which costs relate to the addition of the new stand and which relate to maintenance. These amounts should then be traced through to the nominal ledger accounts to ensure that expenditure is appropriately classified. |
| The directors intend to value three players as intangible non-current assets based on preliminary offers from other clubs. This valuation may not comply with IFRS, as players are not typically recognized as assets unless specific criteria (e.g., transfer fees paid) are met, leading to a risk of misstatement in the financial statements. | The auditor should review the accounting policy for intangible assets and assess whether the valuation of players complies with IFRS (e.g., IAS 38). Discussions with management should be held to understand the basis of valuation, and external evidence (e.g., offer letters) should be inspected to verify the amounts. |
| The high level of players’ salaries (GH¢2,800,000) compared to other operating costs (GH¢2,400,000) suggests a risk of misstatement due to errors in payroll processing or unauthorized salary increases, especially following the club’s promotion. | The auditor should perform substantive testing on payroll costs, including vouching a sample of salary payments to contracts and payroll records. Analytical procedures, such as comparing current year salaries to prior years and industry benchmarks, should be conducted to identify anomalies. |
| Revenue from ticket sales (approximately GH¢5.3m) is material and depends on accurate recording of season ticket and away supporter ticket sales. There is a risk of incomplete or inaccurate revenue recognition due to manual processes or errors in ticket sales recording. | The auditor should perform a proof in total calculation for ticket sales revenue (as described in part (b)) and compare it to recorded revenue. A sample of ticket sales transactions should be traced to cash receipts and ticket stubs to verify completeness and accuracy. |
| The loan of GH¢2,900,000 with a 7% interest rate may not be accurately accounted for, leading to a risk of misstatement in interest expense (GH¢203,000 expected) or loan liability balances, particularly as it is secured on the stadium. | The auditor should obtain the loan agreement and confirm the terms (e.g., interest rate, repayment schedule). A proof in total calculation for interest expense should be performed and compared to the recorded amount. The loan balance should be confirmed with the lender, and security details should be verified. |
(b) Revenue
The auditor should perform a proof in total calculation as follows:
Season ticket sales Adults (19,000 × 70% × GH¢260) = 3,458,000
Children (19,000 × 30% × GH¢175) = 997,500
Away supporter sales
6,000 seats × 50% capacity × GH¢20 × 14 games = 840,000
Expected revenue = 5,295,500
The expected revenue of GH¢5,295,500 should be compared to the actual revenue from ticket sales and any significant differences investigated and discussed with management.
Loan interest
Again the auditor should perform a proof in total calculation as follows:
Loan value = 2,900,000
Interest rate = 7%
Expected revenue (GH¢2,900,000 × 7%) = 203,000
The expected loan interest expense GH¢203,000 should be compared to the actual interest expense charged and any significant differences investigated and discussed with management.
Payroll costs
Here the auditor could obtain information about the players’ salaries last year and calculate the average salary per player for the prior period.
He would then need to determine from management the average percentages increase in salary and calculate the average salary for the current year.
Multiplying the average salary for the current year by the number of players would give an expected payroll cost for the current year.
This should then be compared to the actual payroll charge and any significant differences investigated.
(c)
| Internal control | Control objective |
|---|---|
| Each season UFC should invite suppliers of the different products sold by the club to tender for the contract to supply goods. Each supplier’s products should be inspected/tasted to ensure they are of the quality required by UFC. | To ensure that all goods (products to be sold in the club shop and food and drinks for the snack bars) are purchased at the most competitive prices and represent the best value for money. |
| After each game, the snack bar manager should complete a schedule of quantities of drinks and food sold for each product. This information should then be reviewed by management to determine which games generate the most activity in the snack bars. This information should then be used to project the demand for food and drink at similar games in order to assist with the quantity of perishable food and drink ordered. | To ensure there is minimum food wastage which in turn will maximise the profits generated by the snack bars. |
| At the end of each game, the money in the tills at the club shop and snack bars should be counted. The sales revenue taken per the till receipt roll should also be reconciled to the amount in the till and any differences investigated. A float should be left in the till drawer and kept in a locked safe. Additional monies should be banked promptly. | To prevent and detect fraud and misappropriation of cash in the club shop and snack bar |
- Tags: Audit Risk, Auditor Response, Capital Expenditure, Financial Reporting, Internal controls
- Level: Level 2
- Uploader: Samuel Duah