Example Question #1 - Importance of internal control

Powersys is an electricity distribution company based in a large capital city. Its business is
to manage the electricity assets, including poles, wires, and other equipment, that are used
to deliver electricity to retail and business customers in the city. Pole, wire, and substation
maintenance and improvements are a large part of the company’s operations, and teams
of highly trained technicians are used for both planned work and emergency response
activities. Emergency response is required when storms or fires bring down power lines,
the power must be turned off at the direction of police, or the electricity supply fails for any
reason.

Each team has several vehicles (vans and trucks) and uses additional heavy equipment,
such as cherry pickers, cranes, and diggers, as required. Each vehicle carries a core set of
specialized parts and tools, and additional items are obtained as required from storage,
which is located in a large warehouse in the northern suburbs. The warehouse is staffed on
a 24-hour basis to assist night maintenance (designed to minimize disruption to business
customers) and emergency response.

Required:
a) Make a list of the potential problems that could occur in Powersys’s maintenance
and improvements program.
b) Suggest ways that good internal control over parts, equipment, and labour could
help Powersys avoid these problems.

Example Question #2 - Objectives of internal control

Carmel Harrison runs Emerald Spa, a business providing women-only hairdressing, beauty,
relaxation massage, and counselling services in a small tourist town. Ninety percent of the
clients using the beauty and massage services at Emerald Spa are weekend visitors to the
town, but 80 percent of the hairdressing and counselling clients are locals. The massage
therapist and counsellor have formal qualifications and are registered with the medical
authorities, allowing clients to claim the cost of the service with their private health insurer
if an appropriate receipt is provided when the client pays.

Emerald Spa has just opened another branch of the business in a town 100 kilometres
away, and there are plans for a third branch to be opened next year. Carmel has been very
busy establishing the new branches and relies on staff in each office to run the day-to-day
operations, including ordering supplies and banking receipts. In addition, the branch
manager organizes the staff and authorizes their time sheets. Carmel makes the payments
for rent, power, salaries, and large items of expenditure, such as furniture purchases.

Required:
a) Give examples of transactions that would occur at Emerald Spa.
b) Explain what could go wrong with these transactions if the system of internal
controls
Example Question #3 - Preventive controls
Alabama Industries manufactures and wholesales small tools. It sells the tools to a large
group of regular customers and makes most sales by telephone to this group. Additionally,
it receives orders online from its sales team, who sign up new customers within the sales
area. In the past, Alabama Industries has had trouble with customers who do not pay their
accounts on time. Despite instructing the sales team not to make sales to customers before
their creditworthiness has been assessed, sales are still being made to new customers
before their limits have been set and to existing customers beyond their credit limit. Also,
the economic situation has started to impact Alabama’s customers, and management is
concerned about the possibility of increasing bad debts.

a) What sort of preventive control could be used to deal with the problems faced by
Alabama Industries? Explain how the control would work.

b) Assume the preventive control is implemented, and during this year there have
been no sales to customers that have taken any customer beyond its credit limit.
What are two possible explanations for this that the auditor must consider?

c) If an auditor finds two sales transactions during the year that are in excess of a
customer’s credit limit at the time of the sale, what conclusion would the auditor
draw from this evidence? What other evidence could the auditor consider before
concluding that the preventive control has failed?

Example Question #4 – Assessing Internal Controls

Featherbed Surf & Leisure Holidays Ltd. is a resort company based on Vancouver Island. Its
operations include boating, surfing, fishing, and other leisure activities; a backpackers’
hostel; a family hotel; and a five-star resort. Justin and Sarah Morris own the majority of the
shares in the Morris Group, which controls Featherbed. Justin is the chair of the board of
directors of both Featherbed and the Morris Group, and Sarah is a director of both
companies as well as the CFO of Featherbed.

Justin and Sarah have a fairly laid-back management style. They trust their workers to work
hard for the company and they reward them well. The accounting staff, in particular, are
very loyal to the company. Justin tells you that some accounting staff enjoy their jobs so
much they have never taken holidays, and they rarely take sick leave. Justin and Sarah have
not bothered much in the past with formal procedures and policies, but they have
requested that the accounting staff start documenting the more common procedures.
Justin and Sarah do not conduct formal performance reviews; they rely on their staff to tell
them when there is a problem.

There are three people currently employed as accountants, the most senior of whom is
Peter Pinn. Peter heads the accounting department and reports directly to Sarah. He is in
his fifties and plans to retire in two or three years. Peter prides himself on his ability to
delegate most of his work to his two accounting staff, Kristen and Julie. He claims he has to
do this because he is very busy developing a policy and procedures manual for the
accounting department. The delegated work includes opening mail, processing payments
and receipts, banking funds received, performing reconciliations, posting journals, and
performing the payroll function. Julie is a recently graduated Chartered Professional
Accountant. Kristen works part-time—coming into the office on Mondays, Wednesdays,
and Fridays. Kristen is responsible for posting all journal entries into the accounting system
and the payroll function. Julie does the balance of the work, but they often help each other
out in busy periods. Kristen authorizes Julie’s transactions, and Julie returns the favour by
authorizing Kristen’s transactions. Together, they usually make the accounts balance.

Required: Assess the internal controls at Featherbed. What changes would you
recommend? (Use the W/I/R format)

Example Question #5 – PART 1 - Preventive and detective controls

Fellowes and Associates Chartered Professional Accountants is a successful mid-tier

accounting firm with a large range of clients across Canada. In April 2023, Fellowes and
Associates gained a new client, Health Care Holdings Group (HCHG), which owns 100
percent of the following entities:

• Shady Oaks Centre, a private treatment centre

• Gardens Nursing Home Ltd., a private nursing home
• Total Laser Care Limited, a private clinic that specializes in the laser treatment of
skin defects
•
The year end for all HCHG entities is June 30.

You are an audit senior on the Shady Oaks engagement. Your initial review of the business
has highlighted the following significant risks.

1) Payroll expense—Shady Oaks employs, in addition to its full-time staff, a significant

number of casual nursing, cleaning, and administrative staff. Overtime is often
worked on weekends and night shifts due to a shortage of staff. Payment at
overtime rates for standard weekend and night shifts has been a common
occurrence.

2) Accounts payable—Shady Oaks also has a large number of suppliers for various
medical supplies and drugs. Paying the supplier twice for the same purchase has
been a continuing problem.
In addition, your business risk assessment procedures indicate there is a risk that
payments to suppliers are made prior to goods being received. As part of your evaluation
of the potential mitigating internal controls, you note that accounting staff perform the
following procedures:

1) A pre-numbered cheque requisition is prepared for all payments.

2) The details on the supplier’s invoice are matched to the appropriate receiving
report.
3) The details on the supplier’s invoice and receiving report are matched to an
authorized purchase order.
4) The cheque requisition is stapled to the authorized purchase order, receiving report,
and supplier’s invoice and forwarded to the appropriate senior staff member for
review and authorization.
5) The authorized cheque requisition, together with the supporting documents, is
passed to accounts payable for payment.

Required: For each of the accounts for Shady Oaks (payroll expense and accounts payable
in items 1 and 2 above) identified to be a significant risk:

a) Determine the relevant assertions.

b) Describe a practical preventive internal control that would directly address the risk.
c) Describe a practical detective internal control that Shady Oaks could implement in
relation to the risk

Example Question #5 – PART 2 - Preventive and detective controls

Using the data from Example Question #5 Part 1 above,

a) Identify the relevant assertions at risk for payables in relation to payments made
prior to receipt of goods.

b) For the control procedures (1) to (5) above for payables:

i. Identify the key preventive internal control that directly addresses the risk of
payments being made by Shady Oaks to its suppliers before the goods are
received.
ii. Outline how your choice of the internal control in (i) will prevent payment to
suppliers prior to receipt of goods.
iii. Design and describe in detail an appropriate test of control that you would
use to satisfy yourself about the effectiveness of this internal control