Case 1

During the pre-audit conference for Quicky, IncThe senior auditor described for the new staff
people assigned to this year’s audit the essential characteristics of Quicky’s internal control
system. In the payroll cycle, controls have been found to be severely lacking; however, the
auditors have been reasonably satisfied with the controls within the other cycles. In the past, the
controls over cash receipts have been evaluated as excellent.

Within the payroll area, material errors and irregularities can occur readily. Supervisors do not
review time cards prepared by employees; pay rates, hours, extensions, and withholdings are not
reviewed independently. Paychecks, after being signed, are returned to department supervisors
for distribution.

Required:
a. What alternatives are available to auditors for dealing with weak financial controls subsets?
What possible effects might the absence of payroll controls have on the financial statements in
this case?

When a company has weak internal control or the assessed level for control risk is high the
auditor needs to rely primarily on substantive tests. The deficiencies found in the payroll area
also need to be communicated to those charged with governance or to an appropriate level of
management so that they can make timely remedies and minimize the risk of material
misstatement.

In the absence of control in the payroll area, there will be a significant effect on the financial
statement. The amount shown in the fs would be erroneous since there is no one reviewing the
time cards of the employees so the amount of salaries expense recognized is likely to be wrong.
This will may result in the understatement or overstatement of expenses which would affect the
net income and also the equity of the company

b. What steps should the auditor take if, based on the initial review, controls are thought to be
adequate?

If the internal controls are found to be adequate then the auditor can rely on the entity's internal
controls but the auditors still need to do a test of controls. They need to identify the specific
internal control policies or procedures that are likely to prevent or detect material misstatements
relevant to financial statement assertion and perform tests of controls to determine if the policies
and procedures are really effective. They should also document the conclusion that the assessed
level of internal control is less than the high level or low level, their understanding of the internal
control, and the basis for reaching such an assessment.
c. Although the control procedures relating to cash receipts have been excellent in the past, they
should be reevaluated again this year.
1. Why is it necessary for the auditor’s to study and evaluate internal control each year?

It is necessary to review the internal control every year because of inherent limitations such as
changes in the environments or conditions. There may be changes every year so we need to
review it every time. We should always have professional skepticism because having excellent
internal control in the past may not equate to having excellent internal control in the present
because as previously said internal control has many inherent limitations and may be easily
affected by changes in the organization. Because in one year there are many events or changes
that may happen like changes in the person assigned to a certain task that's why it is essential to
review or assess it every year.

2. Why is a minimum audit necessary notwithstanding excellent controls?

We should maintain professional skepticism even if the assessed internal control is excellent
because there may still be a chance that there are things that were overlooked like collusion and
management override, Especially those since it is hard to detect them because the ones involved
or are at the top are the ones who do this. Also no matter how effective internal control
procedures are, auditors must first test the controls to obtain evidence of whether these controls
are working effectively before the auditor uses or relies on them. They should test the control
regarding the design and operation of the internal control procedures.
Case 2
David Tiongzon, CPA, has been engaged to audit the financial statements of the Islander Drug
Store, Inc. Islander is a medium-sized retail outlet that sells a wide variety of consumer goods.
All sales are for cash or check. Cashiers use cash registers to process these transactions. There
are no receipts by mail and there are no credit card or charge sales.

Required:
Construct the “Processing Cash Collections” segment of the internal control questionnaire on
“Cash Receipts” to be used as a basis for understanding the internal control system for the
Islander Drug Store, Inc. Each question should elicit either a yes or no response. Do not discuss
the internal controls relating to cash sales.

Islander Drug Store Inc.

Internal Control Questionnaire
Audit Period:
Prepared by/date: Reviewed by/date:

Questions Ye No Remarks
s

Receiving of Cash

1. Is it Islander Drug Shop Inc.'s policy to identify

clients who pay by check with a store identification
card?

2. Does the cash register generate and issue receipts to

every customer?

3. Is the individual preparing a summary of cash register

readings independent from the physical handling of
cash receipts?

Cash Depositing

4. Is the employee to whom receipts are forwarded an

independent employee who makes bank deposits?

Cash Reconciliation

5. Is the deposit slip prepared by an independent

employee reconciled to the individual who prepared
the summary of the cash register to ensure all
 collected funds are deposited?

Other Areas of Handling Cash

6. When cashiers return their drawers, is the cash

counted and verified (i.e., balanced)?

7. Is stored money kept in a secure or double-locked

location until it is deposited?

8. Are receipt books regularly reviewed for missing

receipts by someone other than the cashier?

9. Does an independent employee count and document

the change funds periodically?

10. Does management investigate variations such as

voids, no sales, refunds, errors, etc.?