- 15 Marks
AAA – L3 – Q36 – Internal audit
Question
You are the audit manager in charge of the audit of Coral Bites, a company which runs a chain of snack bars operating in a number of beach holiday resorts. Your firm has been the auditor for a number of years and has always had to substantively test cash sales because of a lack of control over the recording of takings. The auditor’s reports to date have been unmodified.
You have recently been informed that the company has taken on a newly qualified chartered accountant as chief internal auditor and an unqualified assistant internal auditor. Since their appointment half way through the year ended 31 December 20X8 the two have spent most of their time carrying out substantive procedures on cash sales.
The directors are hopeful that your audit fee this year will decrease because you will be able to use the work carried out by the internal auditors.
Required:
(a) Explain the issues that will be relevant to your firm in deciding whether you can use the work performed by the internal auditors.
(b) Explain how much reliance to place on that work.
Answer
(A)
The decision to use the work performed by the internal auditors of Coral Bites is governed by ISA 610, Using the Work of Internal Auditors. The following issues are relevant:
- Objectivity of the Internal Audit Function:
- Assess whether the internal auditors are sufficiently independent from management. Since the chief internal auditor is newly qualified and the assistant is unqualified, their objectivity may be compromised if they report directly to management or lack authority.
- Review the organizational structure to determine if the internal audit function is free from management influence.
- Competence of the Internal Auditors:
- Evaluate the qualifications and experience of the internal auditors. The chief internal auditor is a newly qualified chartered accountant, which suggests some competence, but the unqualified assistant may lack technical expertise, potentially reducing the reliability of their work.
- Review their training, certifications, and prior audit experience.
- Systematic and Disciplined Approach:
- Determine whether the internal audit function follows a systematic approach, including planning, documentation, and quality control. The focus on substantive procedures for cash sales suggests limited scope, which may not align with a comprehensive audit approach.
- Review internal audit work plans, working papers, and quality review processes.
- Scope and Relevance of Work Performed:
- Assess whether the internal auditors’ substantive procedures on cash sales are relevant to the external audit objectives. Since cash sales have historically required substantive testing due to weak controls, their work may align with audit needs.
- Verify that the procedures address key assertions (e.g., completeness, occurrence) and are adequately documented.
- Communication and Coordination:
- Establish whether there is effective communication between the external and internal auditors. The internal auditors’ mid-year appointment may limit coordination for the full year.
- Review any reports or findings shared by the internal auditors.
- Impact of Weak Controls:
- The lack of control over cash sales recording increases audit risk. The internal auditors’ work may not address underlying control deficiencies, limiting its usefulness.
- Assess whether their procedures compensate for these weaknesses or merely replicate substantive testing.
- Extent of Reliance:
- Even if the work is usable, ISA 610 requires the external auditor to perform some procedures directly. The unqualified assistant’s involvement may reduce reliance, requiring additional external audit work.
- Determine the extent to which the internal auditors’ work can reduce, but not eliminate, substantive testing.
- Documentation and Review:
- Ensure the internal auditors’ work is properly documented and can be reviewed. Poor documentation or inadequate procedures may prevent reliance.
- Plan to reperform a sample of their procedures to confirm reliability.
These issues will guide the decision on whether the internal auditors’ work can be used, balancing their contribution with the need for sufficient external audit evidence.
(B) The extent of reliance on the internal auditors’ work for the Coral Bites audit depends on the evaluation of their objectivity, competence, and the quality of their work, as per ISA 610. The following factors determine how much reliance can be placed:
- Limited Objectivity:
- The internal auditors’ objectivity may be limited if they report to management or lack independence. Their mid-year appointment suggests potential influence from management, reducing reliance.
- Reliance is lower unless evidence confirms their independence (e.g., reporting to an audit committee).
- Mixed Competence:
- The chief internal auditor’s qualification as a chartered accountant suggests some competence, but the unqualified assistant’s involvement raises concerns about the overall reliability of their work.
- Reliance is limited, particularly for complex procedures, due to the assistant’s lack of qualifications.
- Scope of Work:
- The internal auditors’ focus on substantive procedures for cash sales aligns with the external audit’s needs, given the historical lack of controls. However, their work may not address control deficiencies or other assertions (e.g., cut-off).
- Reliance is moderate if their procedures are relevant and well-executed but limited if they only cover part of the audit scope.
- Quality of Work:
- The quality of the internal auditors’ work depends on their documentation, testing methodology, and adherence to standards. Poor documentation or inadequate testing (e.g., due to the unqualified assistant) reduces reliance.
- Review their working papers to assess quality; reliance is higher if work is robust and lower if deficiencies are found.
- Need for External Procedures:
- ISA 610 prohibits full reliance on internal auditors. The external auditor must perform direct procedures on cash sales, especially given the weak controls. The internal auditors’ work can reduce, but not eliminate, substantive testing.
- Reliance is limited to supplementing, not replacing, external audit work.
- Reperformance and Testing:
- The external auditor should reperform a sample of the internal auditors’ procedures to confirm reliability. If errors or inconsistencies are found, reliance decreases significantly.
- Plan additional substantive tests if the internal auditors’ work is deemed unreliable.
- Impact on Audit Fee:
- The directors’ expectation of a reduced audit fee is unlikely to be met if significant external audit work is still required. Limited reliance due to the unqualified assistant or weak controls may maintain or increase audit effort.
- Communicate to directors that reliance depends on the quality and extent of internal audit work.
In conclusion, reliance on the internal auditors’ work is likely to be limited due to the unqualified assistant, potential objectivity issues, and the need for direct external audit procedures. The external auditor should use their work to supplement testing but perform significant substantive procedures to ensure sufficient audit evidence.
- Tags: Audit Evidence, Auditor Reliance, Cash sales, Internal Audit, Substantive testing
- Level: Level 3
- Uploader: Salamat Hamid