Subject (SQ): Audit and Assurance

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  • 35 Marks

AA – L2 – Q30 – Internal Control Systems

Describe normal controls expected in a wages system and their purposes. Describe how to verify employees are not paid before commencing work. Describe audit procedures for attending a cash wages pay-out to manufacturing employees. Describe substantive procedures for the unclaimed wages system. Describe evidence to verify existence of employees paid via bank, including those at sales offices.

Apex Engineering
Your firm is the external auditor of Apex Engineering, a listed company, which has revenue of $75 million. The head office site includes the manufacturing unit, the accounting functions, and main administration. There are a number of sales offices in different parts of the country. Apex Engineering does not have an internal audit function.
At the interim audit, you have been assigned to the audit of the wages system. This will involve obtaining an understanding of the wages system, testing the controls, and performing substantive procedures in order to verify wages transactions.
The wages records are maintained on a computer, and all the wages information is processed at the head office. Some of the employees in the manufacturing unit are paid in cash, and all other employees have their wages paid directly into their bank account.
Manufacturing employees are paid their wages a week in arrears. All other employees are paid at the end of each week or month.
There is a personnel department which is independent of the wages department. The personnel department maintains records of the employees, including their starting date, grade, current wage rate, and leaving date (if appropriate).
Previous years’ audits have revealed frauds by wages department staff which have been facilitated by deficiencies in controls in the wages system. These frauds have included:

  • paying employees after appointment but before they commenced work;
  • paying employees after they have left; and
  • paying fictitious employees.
    A check of current controls in the wages system has revealed that the company has failed to instigate controls to prevent these types of fraud recurring. So the audit programme requires extensive substantive procedures to be carried out to ensure that recorded wages transactions have not been misstated by similar frauds taking place in the current year.
    The existence of employees at the head office site can be verified by physical inspection. From a cost-effectiveness point of view, only a small sample of sales offices will be visited. The audit manager has asked you to consider the audit procedures you would carry out to obtain sufficient appropriate evidence of the existence of employees at sales offices not visited by the audit staff.
    The audit manager has explained that ‘unclaimed wages’ (in part (c) below) arise when manufacturing employees are not present to collect their wages (when they are paid out in part (b)). The unclaimed wage packets are given to the cashier who records their details in the unclaimed wages book and is responsible for their custody. Any employee who has not received his/her wage packet at the pay-out can obtain it from the cashier. You have ascertained that there is no system of checking the operation of the unclaimed wages system by a person independent of the cashier and the wages department.
    Required:
  • (a) Describe the normal controls you would expect to see in a wages system and explain their purpose.
  • (b) Describe how you would verify that employees are not paid before they commenced work for the company.
  • (c) Describe the audit procedures you would carry out in connection with attending a pay-out of wages in cash to manufacturing employees.
  • (d) Describe the substantive procedures on transactions you would carry out on the unclaimed wages system.
  • (e) Describe the evidence you would obtain to verify the existence of employees whose wages are paid directly into their bank account, including those at sales offices.

 

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  • 30 Marks

AA – L2 – Q29 – Auditing in a Computerized Environment

List procedures for setting up customer files, price lists, and sales ledger balances in a new computerized system. Describe controls for transaction data input, customer file amendments, and product price changes in a computerized system. Describe procedures to ensure accuracy of transaction file data in a computerized sales ledger system.

Thompson Tools
Mr. Thompson, a client of your firm, is the managing director of Thompson Tools, which buys tools from large manufacturers and sells them to small retailers.
As the firm has been expanding, Mr. Thompson has recently purchased a computer. He has asked your advice about the controls which should be exercised over the computer when processing accounting data. Initially, Mr. Thompson is proposing to use the computer for producing sales invoices and maintaining the sales ledger.
The sales system data files will comprise:

  • a standing data file containing customer names, addresses, and credit limits and a price file containing the part numbers, descriptions, and selling prices of the company’s products
  • transaction files containing the outstanding transactions for each customer’s account, the values of individual invoices, credit notes, cash, discounts, and adjustments posted to the sales ledger in the month and the ageing and the total balance on each customer’s account.
    The system will operate as follows:
    The customer details, and the part numbers and quantities of the goods dispatched are input into the computer, which calculates the invoice value by accessing the standing data file. When the operator confirms that the invoice details have been input correctly, the computer prints the invoice and posts it to the sales ledger.
    Cash received and discounts are input into the system from the cash book, and they are matched to the invoices which are being paid.
    Credit notes and adjustments can be input directly into the sales ledger.
    At the end of the month, the computer prints:
  • a summary of the invoices, credit notes, adjustments, cash, and discounts posted to the sales ledger in the month;
  • an aged list of receivables; and
  • customer statements, which show the outstanding transactions at the end of the month.
    The computer has the facility to print out during the month the summaries as described above, and the details of any customer account.
    Required
    (a) List and describe the procedures which should be carried out in setting up the files containing:
    (i) the customer names, addresses, and credit limits;
    (ii) the price list of the products the company sells; and
    (iii) sales ledger balances which are to be transferred from the manual system to the new computer system.

(b) List and describe the controls which should be exercised over:
(i) the input of transaction data, to ensure the risk of misstatements is minimised and that there is no unauthorised input of transactions;
(ii) the amendment of standing data files containing customer names, addresses, and credit limits; AND
(iii) the amendment of the prices of the products the company sells.

(c) List and describe the procedures which should be carried out to ensure the accuracy of the transaction file data, which contains balances on customers’ accounts and the outstanding transactions making up those balances.

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  • 10 Marks

AA – L2 – Q28 – Internal Control Systems

Draft questions for an internal control questionnaire for a weekly cash wages system at a healthcare company.

28 Horizon Health Services
Horizon Health Services (HHS) has the following wages and salaries system for its 40 nurses who are paid weekly in cash.
Each employee fills in a record of nursing hours worked which is signed by one of two supervisors before being passed to the accounts department. The payroll clerk takes these details, and prepares the payroll, referring to the personnel records kept by the company secretary. The payroll clerk then requests a cheque for the weekly cash wages and prepares the pay packets which are distributed by the supervisors.
Required
Draft questions to be included in an internal control questionnaire for weekly wages paid in cash.

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  • 20 Marks

AA – L2 – Q27 – Risk Assessment and Internal Control

Identify five audit risks for Unity Football Club and explain auditor responses. Describe proof in total calculations for UFC’s ticket sales, loan interest, and payroll expenses. Explain three internal controls for UFC’s club shop or snack bars and their objectives.

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.

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  • 20 Marks

AA – L2 – Q26 – Audit of Public Sector Entities

Explain the purpose of a value for money audit in a public sector hospital context. Identify four strengths in Akunka hospital's operations and suggest improvements for value for money. Describe substantive procedures for verifying valuation, completeness, and rights and obligations of PPE at Akunka hospital.

(a) Explain the purpose of value for money audit.

(b) Akunka hospital is located in a country where healthcare is free, as the taxpayers funds are used to finance state owned hospitals. Two years ago, management reviewed all aspects of the hospital’s operations and instigated a number of measures aimed at improving overall “value for money” for the local community. Management have asked you, an audit manager in the hospital’s internal audit function, to perform a review over the measures which have been implemented.
Akunka has one centralized procurement department through which all purchase requisition forms are forwarded to. Upon receipt, the procurement team embarks on market research for the lowest price from suppliers after which a purchase order is raised. The purchased order is then submitted to the procurement director, who authorises all orders. The small procurement team receive in excess of 200 forms a day. The human resource department has had difficulties with recruiting suitably trained staff. Overtime rates have been increased to incentivise permanent staff to fill staffing gaps, this has been popular, and reliance on expensive temporary staff has been reduced. Monitoring of staff hours had been difficult but the hospital has implemented time card clocking in and out procedures and these hours are used for overtime payments as well.
The hospital has invested heavily in new surgical equipment, which although very expensive, has meant that more operations could be performed to ensure faster patient recovery. However, there is shortage of well-trained medical staff. A capital expenditure committee has been established, made up of senior managers, and they plan and authorise significant capital expenditure items.

Required:
(i) Identify and explain FOUR strengths within Akunka’s operating environment; and
(ii) For each strength identified, describe how Akunka might make further improvements to provide best value for money.

(c) Describe TWO substantive procedures the external auditor of Akunka should adopt to verify EACH of the following assertion in relation to an entity’s property, plant and equipment:

(i) Valuation;

(ii) Completeness; and

(iii) Rights and obligations.

(Note: Assume that the hospital adopts International Financial Reporting Standards).

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  • 20 Marks

AA – L2 – Q25 – Internal vs External Auditors

Contrast the roles of internal and external auditors, focusing on objectives, reporting, scope, and relationship with the company. Discuss the benefits of forming an audit committee for Apex Ltd, a private company with financial reporting and control challenges.

(a) Contrast the role of internal and external auditors.

(b) Apex Ltd designs and manufactures luxury motor vehicles. The company employs 2,500 staff and consistently makes a net profit of between 10% and 15% of revenue. Apex Ltd is not listed; its shares are held by 15 individuals, most of them from the same family. The maximum shareholding is 15% of the share capital.

The executive directors are drawn mainly from the shareholders. There are no non-executive directors because the company legislation in Apex Ltd’s jurisdiction does not require any. The executive directors are very successful in running Apex Ltd, partly from their training in production and management techniques, and partly from their ‘hands-on’ approach providing motivation to employees.

The board are considering a significant expansion of the company. However, the company’s bankers are concerned with the standard of financial reporting as the financial director (FD) has recently left Apex Ltd. The board are delaying provision of additional financial information until a new FD is appointed.

Apex Ltd does have an internal audit function, although the chief internal auditor frequently comments that the board of Apex Ltd do not understand his reports or provide sufficient support for his department or the system of internal control within Apex Ltd. The board of Apex Ltd concur with this view. Barnes & Co, the external auditors, have also expressed concern in this area and the fact that the internal audit function focuses work on systems of internal control, not financial reporting. Barnes & Co are appointed by and report to the board of Apex Ltd.

The board of Apex Ltd are considering a proposal from the chief internal auditor to establish an audit committee. The committee would consist of one executive director, the chief internal auditor as well as three new appointees. One appointee would have a non-executive seat on the board of directors.

Required:
Discuss the benefits to Apex Ltd of forming an audit committee.

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  • 30 Marks

AA – L2 – Q24 – Planning an Audit

Describe matters to consider in planning the audit of Rylan Products and actions for specific issues. Explain why auditors must understand the client’s legal framework per ISA 250 and actions for non-compliance. Explain the importance of planning an audit per ISA 300.

Your firm has been the auditor of Rylan Products, a listed company, for a number of years. The engagement partner has asked you to describe the matters you would consider when planning the audit for the year ended 31 January 20X5.
During a recent visit to the company you obtained the following information:
(i) The management accounts for the 10 months to 30 November 20X8 show revenue of €13 million and a profit before tax of €400,000. Assume revenue and profits accrue evenly throughout the year. In the year ended 31 January 20X5, Rylan Products had revenue of €11 million and a profit before tax of €800,000.
(ii) The company installed a new computerised control system which has operated from 1 June 20X8. As the control system records inventory movements and current inventory quantities, the company is proposing:

  • to use the quantities on the computer to value the inventory at the year-end; and
  • not to carry out a physical inventory count at the year end.
    (iii) You are aware there have been reliability problems with the company’s products, which have resulted in legal claims being brought against the company by customers, and customers refusing to pay for the products.
    (iv) The revenue increase in the 10 months to 30 November 20X8 over the previous year has been achieved by attracting new customers and by offering extended credit. The new credit arrangements allow customers three months credit before their debt becomes overdue, rather than the one month credit period allowed previously. As a result of this change, the age of receivables has increased from 1.6 to 4.1 months.
    (v) The financial director and purchasing manager were dismissed on 15 August. A replacement purchasing manager has been appointed but it is not expected that a new financial director will be appointed before the year end of 31 January 20X5. The chief accountant will be responsible for preparing the financial statements for audit.

Required

(a)  Describe the reasons why it is important that auditors should plan their audit work.

(b)  Explain why ISA 250 Consideration of Laws and Regulations in an Audit of Financial Statements requires auditors to obtain a general understanding of the legal and regulatory framework applicable to their client and how their client is complying with that framework. Set out the action auditors should take if they suspect material areas of non-compliance.

(c)  Describe the matters you will consider in planning the audit and the further action you will take concerning the matters listed in (i) to (v) above.

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  • 30 Marks

AA – L2 – Q23 – Analytical Procedures

Explain when and how analytical procedures are applied per ISA 520. Comment on Zenith Technologies' financial performance for two years using provided data. Identify audit risks from Zenith Technologies' performance and describe audit procedures to address them.

You have been presented with the following draft financial information about Fresca Solutions, a very successful company that develops and licenses specialist computer software and hardware. Its non-current assets mainly consist of property, computer hardware and investments, and there have been additions to these during the year. The company is experiencing increasing competition from rival companies, most of which specialise in hardware or software, but not both. There is pressure to advertise and cut prices.
You are the audit manager. You are planning the audit and are conducting a preliminary analytical review and associated risk analysis for this client for the year ended 31 May 20X8. You have been provided with a summarised draft statement of comprehensive income which has been produced very quickly and certain accounting ratios and percentages. You have been informed that the company accounts for research and development costs in accordance with IAS 38 Intangible Assets.

Statement of comprehensive income

Year ended 31 May
20X7 20X8
€’000 €’000
Revenue 15,206 13,524
Cost of sales 3,009 3,007
Gross profit 12,197 10,517
Distribution costs 3,006 1,996
Administration expenses 994 1,768
Selling expenses 3,002 274
Profit from operations 5,195 6,479
Net interest receivable 995 395
Profit before tax 6,190 6,874
Income tax expense 3,104 1,452
Net profit 3,086 5,422
Retained profits 1,617 3,983
Dividends paid €1,469,000 €1,439,000

Accounting ratios and percentages

Year ended 31 May
20X7 20X8
Earnings per share 0.43 1.04
Performance ratios include the following:
Gross margin 0.80 0.78
Expenses as a percentage of revenue:
Distribution costs 0.20 0.15
Administrative expenses 0.07 0.13
Selling expenses 0.20 0.02
Operating profit 0.34 0.48

Required

(a)  In accordance with ISA 520 Analytical Procedures explain when analytical procedures shall or may be carried out and the nature of such procedures.

(b) Using the information above, comment briefly on the performance of the company for the two years.

(c) Use your answer for part (b) to identify the areas that are subject to increased audit risk and describe the further audit work you would perform in response to those risks.

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  • 20 Marks

AA – L2 – Q22 – Risk Assessment

Explain the purpose of risk assessment procedures and outline sources of audit evidence for risk assessment. Identify and describe issues to consider in the risk assessment for the audit of Vantage Communications LLC.

(a) ISA 315 (Revised 2019) Identifying and Assessing the Risks of Material Misstatement deals with the auditor’s responsibility to identify and assess the risks of material misstatement in the financial statements.

Required:

(i) Explain the purpose of risk assessment procedures. (3 marks)

(ii) Outline the sources of audit evidence the auditor can use as part of risk assessment procedures. (3 marks)

 

(b) Roberts & Co, an audit firm, has seven partners. The firm has a number of audit clients in different industrial sectors, with a wide range of fee income.
An audit partner of Roberts & Co has just delegated to you the planning work for the audit of Vantage Communications LLC. This company provides a range of mobile communication facilities and this will be the second year your firm has provided audit services.
You have just met with the financial controller of Vantage prior to agreeing the engagement letter for this year.
The controller has informed you that Vantage has continued to grow quickly, with financial accounting systems changing rapidly and appropriate systems of internal control being difficult to maintain. Additional services in terms of review and implementation of a system of internal control have been requested. An internal audit function has recently been established and the controller wants you to ensure that external audit work is limited by using this function.
You have also learnt that Vantage is to market a new type of mobile telephone, which is able to intercept messages from law enforcement agencies. The legal status of this telephone is unclear at present and development is not being publicised.
The granting of the licence to market the mobile telephone is dependent on the financial stability of Vantage. The financial controller has indicated that Roberts & Co may be asked to provide a report to the mobile telephone licensing authority regarding Vantage’s cash flow forecast for the year ending December 20X5 to support the licence application.

Required:
As part of your risk assessment procedures for the audit of Vantage Communications LLC for the year ending 31 December 20X8, identify and describe the issues to be considered when providing services to this client.

(c) When reporting on a cash flow forecast, explain the term ‘negative assurance’ (4 marks) and why this is used.

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  • 15 Marks

AA – L2 – Q21 – Risk Assessment and Internal Control

Explain the meaning of audit risk and its importance to the auditor. Identify risks in auditing Aurum LLC and explain why they need consideration.

21 Golden LLC

Golden LLC designs, manufactures and retails traditional Ghanaian jewellery. Inventory is held at the design warehouse and at three shops. Inventory is also sometimes sent to customers for approval prior to a sale being made. Your firm has been re-appointed as auditors for the year ended 31st December 20X8.

Golden LLC has had a difficult year. A recession has caused a fall in revenue and the future is uncertain. A fourth shop was closed during the year and the premises are still up for sale. The financial director was dismissed half way through the year and is pursuing a claim for unfair dismissal. A replacement has not yet been found.

The managing director is due to retire next year and is likely to require loans he has made to the business to be repaid. Negotiations with the bank in respect of loans to cover these repayments have started.

Required

(a) State what you understand by audit risk and why it is important to the auditor.

(b) Identify the risks arising from the above that will need to be considered when planning the audit of Golden LLC. Explain why these risks need to be considered.

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