AnswersApplied Skills, AA ‘Audit and Assurance (AA) Section B Petra Co (2) Control objectives ofa sales system MarchiJune 2023 Sample Answers — To ensure that orders are only accepted it goods are availabe to be processed for customers. — Toensure that all orders are recorded completely and accurately = _Toensure that goods are not supplied to customers who are poor credit risks. = Tpensure that goods are dispatched for all orders on a timely basi. = To ensure that only genuine sales supported by a valid order are recognised in revenue. — Toensure that the correct quantity of goods are dispatched and they are of an adequate quality. = Toensure that all goods dispatched are correctly invoiced at authorised prices. = Toensure that all invoices raised are recorded as revenue in the correct accounting period, — Toensute that sales discounts are only provided up to an agreed limit = Toensure that all sales and related revelvables are recorded al an appropriate amount In he cortect accounts, — Toensure that cash recelved is allocated against the correct customer and invoices to prevent disputes. = Toensure that overdue receivables ae followed up on a timely basis = Toensure that imecoverable receivables are identified and written off appropriately. (©) Direct controls and tests of contr Direct contro! Factory staff ae issued with clock cards which they are ‘equited fo swipe to enter and ext the factory and this process is supervised by securly staf This ensures that genuine employees are only paid for the work actually done and reduces the risk of employees Doing ald but not completing thetr required hours. In addition, due tothe supervision it is unlikely that one employee could ‘raudulenty clock-in on behalf of otner employees. The paytll supervisor selects a sample of payslips, recalculates the gross to net pay calculations and compares their tesults tothe output ftom the paytol system and investigates any discrepancies. This reduces the risk that the automated system generates ferrrs during the payrall processing, Ary eros would be identifed on a timely basis to prevent wages being over of underpaid, Revised pay rates for factory staff are input by a clerk into the payrall system. Each ently Is checked by a senior Cletk for Input erors prior to processing and their review is evidenced via signature ofthe listing ‘This reduces the risk of input errors resulting in cover/underpayment of wages and salaries to employees. ‘The pay packets are prepated by two staff members using system generated payslips with one staf! member preparing {and one checking the pay packets. This is evidenced by each staff member signing the weekly listing, This ensures there is segregation of duties and reduces the ‘ikenood of errors or sta members fraudulently increasing the pay packes for friends and family member without being identified, ‘Test of contro! Observe the use of clock cards by employees when entering and exiting the factory and confirm that security staf are supervising the process. Review the weekly payslips sampled by the payroll supervisor ‘or his signature for evidence the review of calculations has been undertaken. For a sample of weekly payrolls, reperfir the gross to net pay calculation and compare to the payroll system. Discuss any discrepancies with the payroll supervisor. Enquire of the payroll supervisor whether any discrepancies hhave been noted during the year between the gross to net pay calculations and the figures generated by the payroll system and how these were resolved. Obtain the Apri paytl isting forthe factory staff used forthe pay rate increase and review for evigence of signature by te senior clerk who checks for input errors, CObsetve the preparation ofthe pay packets, ensuring that ‘one member prepares the wages using the system generated payslips and thal the second member checks pay packets for accuracy, Fora sample of weeks throughout the year, inspect the Weekly payroll listing for evidence of signature by two ‘members of staf involved in the preparation of the pay packets.(©) Control deficiencies and recommendations Control deficiency ‘credit check is performed on all new customers, after Which a credit limit is set by he finance director, and these limits temain unchanged unless the customer requests an I credit limits are not reviewed regulary, they could be out of date, resulting in limits being too high and thetefore sales ‘being made to poor credit rsks or, altematively, to low and therefore Petra Co losing potential revenuo. Customer orders are recorded on a pre-printed three-part form. No copy ofthe order form is sent tothe sales department of Pea Co and hence they would not be able ormonitor if orders are being fuliled on a timely basis. I orders are not fulfilled on a timely basis, this would reduce customer goodwil. Sales staff have discretion to grant sales discounts 10 customers of up to 8% but discounts granted are not reviewed, ‘This could result in unauthorised discounts In excess of 82% boing allowed and a loss of revenue as they may award unrealistic discounts simply to meet sales targets Access to the master lle data for suppliers is avalable to all those in the purchasing department who are able to make changes. As all members of the purchasing deoartment can make Changes to data and therefore add new suppliers to the ‘payables ledger systom, this increases the risk of rau. GGRNs and orders are matched and fled in the warehouse {and the finance department does not receive a copy. Therefore, on teceipt of putchase invoices, they are not ‘being agreed tothe relevant GRINs and orders porto input into the payables ledger. This could result in invoices being paid for goods which were not received or ordered. |A payables ledger clerk only utilises document count controls when inputting invoices into the payables ledger. Document count controls can confirm the completeness of input. However, they do not verity the accuracy or validity of input. If the invoices are not input corecty, suppliers may not be paid on time or may be paid incorrect amounts. This could lead to 2 loss of supplier goodwill or suppliers withdrawing credit facilities, Control recommendation Credit limits should continue to be set by the finance director, hhowover, these limits should be reviewed on a regular basis and amended as appropriate by a responsible offical “The sales order form should be amended to become four-part, with the fourth copy being sent to the sales department Upon dispatch, the goods dispatch note should be matched to the order. A regular review of unmatched orders should be Undertaken by the sales department to identity any unfuliled otdors. All discounts to be granted to customers should be authorised in advance by a responsible official, such as the sales director. I this is not practical, then the supervisor ofthe sales staf should undertake this role. A copy of the authorisation should be sent to the sales department and the customer's master file data amended for discounts allowed by 2 responsibe official, The master file data system should be amended to prohibit aiscounts in excess of 83% being entered. On a regular basis, the sales ditector should undertake a feview of ciscount levels granted on sales orders and ensure ‘they aro in line with authorised levels. ‘Amendments to master fle data should be restricted so that only authorised! members ofthe department ate able to make changes. In adation, a tog of changes to master te data, including details of which staff member made the change, should be produced and reviewed by a responsible oficial on a regular basis and signed as evidence oftheir review. ‘A copy of the GRN should be provided on a timely basis to the finance department. On receipt, all purchase Invoices should be matched tothe related GRN and purchase order and this should be undertaken prior tothe invoice being logged in the payables ledge. “The payables ledger clerk should instead input the invoices in batches and apply information processing controls, such as contol totals, rather than just completeness checks to ensure bth completeness and accuracy over the input of purchase ‘invoices. In addition, sequence checks should be buit into the system to ensure completeness of input@ © Control deficiency The total on the payables ledger isnot compared to the {general ledger on a monthly basis, hence payables ledger contol account reconelitions are nat being undertaken, Control recommendation (On a monthly basi, payables ledger control account reconciliations should be undertaken with all reconciling Items fully investigated. The account reconciliation should be reviewed by a tesponsible official who should evidence this Fi f a ang to undertake these reconciliations means that enors_fEvewen £¥ 8 Tonsnie in the payables ledger may not be identified promptly, resulting in suppliers being under oF overpaid. In addition, errors may be present in the general ledger resulting in the payables balance in the financial statements boing under or overstated ‘Substantive procedures for purchases and other expenses. ~ Calculate the operating profit and gross proft margin and compare tothe prior year anid ta budget and investigate any signfiesnt aifferences, — Review monthly purchases and other expenses to identify any significant fluctuations and discuss with management. — Review the annual purchases and other expenses on a line-by-line basis, compare to the prior year and investigate any significant afferonces. — Recalculate the accuracy of a sample of purchase invoice totals and related taxes and confirm that the expense has been correctly included in the general ledger. = Recalculate the year-end prepayments and accruals to ensure the accuracy ofthe expense charge Included in the proft or loss. — Selecta sample of post year-end expense invoices and ensure that any expenses relating tothe current year have been accrud. — Select a sample of expense payments from the cash book and trace to the relevant expense account in the general lodge to ensure the expense has been included and classified correctly ~ Select a sample of aoods received notes (GRNs) from throughout the year. Agree them to purchase invoices and the purchase day book to ensure the completeness of purchases. ~ Selecta sample of GRNs immediately before and after the year end. Agree to the purchase day book to ensure the expense is recorded in the correct aocounting period Corporate governance deficiencies and recommendations Deficiency Itis proposed that the current marketing director be appointed as the Chair of the company when the current Chair retires. [As a former executive dltecto, this director has been previously recently employed by the company and so will ‘not be independent on appointment as advised by corporat sovernance principle. A lack of independence may result in the Chair not bringing the necessary level of independence {and objective judgement to the role. Annually atthe company’s general meeting, two directors ate subject to re-election ‘The shareholders should review on a regular basis thatthe ‘composition ofthe board of directors is appropriate, and they do this by regular re-election of al directors. All members ofthe audit committee were previously involved in sales or purchasing related roles. Atleast one member of te aut committe should have recent and relevant financial experience. None ofthe non-executive directors (NEDs) appears to have held a financial role and so it is unlikely they possess the ‘required financial experience to be able to understand the financial statements. ‘The NEDs' remuneration is inthe form of an annual bonus. However, remuneration paid to NEDs should reflect the time ‘and responsibilities atached to the role, as the inclusion Of performance related elements, especially those ted ta short-term performance targets, can affect the independence Of NEDs, Recommendation The Chair of Petra Co should be independent on appointment and hence the marketing ditector should not be appointed 2s Chair, as they have been an employee within the last five Yeats and therefore not considered independent {An individual who fs fully Independent of Petra Co should be ‘appointed to the role of Chair when the current Chait retires. All ditectors should be subject to annual re-election by the shareholders. At the cutrent year’s general meeting, it should be proposed that all directors should be subject to re-election, “The company should consider recruiting a new independent NED who has the requited recent and relevant financial experience. This prooess may be undertaken as part of the te-election process for director. ‘The remuneration of the NEDs should be revised so they ate paid an annual fe for tlt services, which is unrelated ‘to now Petra Co performs, and should reflect the time commitment and responsibilities attached to the role, The board as a whole should determine an aporopriate level of remuneration for the NEDS.Lapis co @ @ ‘quality management (Overall, the audit engagement partner is requlted to take responsibly for overall supervision ofthe aucit and reviews performe however, this work is often performed by other senior members of the audit team. Supervision During the audit of Lapis Co, the auctor should keep track of the progress of the audit engagement, which includes monitoring progress against tne auait plan, assessing whether the objective of work performed has been achieved anc considering the ongoing adequacy of assigned resources. ‘The competence and capabilities of individual members of the engagement team should be considered, with on-the-job training and coaching provided to develop skils and competencies whete necessary Supervision also Includes creating an envitonment whete engagement team members can raise any concers without feat of repercussion. In addition, part ofthe supervision process involves taking appropriate action to address any significant matters arising during the uct of Lapis Co and modifying the planned approach appropriately “The supervising auditor Is also responsible for identying matters for consultation or consideration by more exoerlenced engagement team members such as the audit manager or audit engagement partner Review The auditor would be required to review the work completed by the team and consider whether this work has been performed in accordance withthe audit fms policies, Intemational Standards on Auditing and other regulatory requirements, The auctor should also consider whether al significant matters have been ralsed for aut engagement partner attetion of fr further consideration and, where appropriate consultations have taken place, whether appropriate conclusions have been documented, The auditor should consider if there Is a need to revise the nature, timing and extent of work performed. The auctor should also consider ifthe objectives of the engagement procedures have been achieved and if the work performed Supports the conclusions reached and has been propetly documented yeral, consideration should be given as to whether sufficient and appropriate evidence has been obtained to provide a basis for the auditors opinion, ‘Audit risks and auditor's response Aualt risk Lapis Co purchases its raw materials ftom overseas suppliers {and has responsibilly for goods at the point of aispatcn, with materials in transit for upto six weeks, Atthe year end, there is a risk that cutoff may not be accurate and inventory, purchases and payables may be Understated as the company may not correc recognise the ‘aw materials from the point of dispatch Indigo & Co may place reliance on the controls testing work undertaken by the intemal audit (1A) departiment, If reliance is placed on work which is inadequate fr the Durposes of tne audit, then tne extemal auait team may form an incorrect conclusion on the strength of the Internal controls at Lapis Co. This could resut in indian & Co performing insufficient levels of substantive testing, thereby increasing detection risk A significant wholesale customer has informed Lapis Co that itis experiencing financial dificutties. Lapis Co's finance director does not believe an allowance for receivables is required in the draft financial statements forthe year ending 20 September 20X8. ‘There Is a risk that trade recelvables will be overvalued, This customer balance may not be recoverable and so trade receivables will bo overstated and the allowance for receivables understated If an allowance is not recognised, Auditor's response The audit team should undertake detailed cut-off testing of purchases of raw materials at the year end. The sample of shipping documentation immediately before and after the. year end relating to goods from overseas suppliers should be Increased to ensure that cutoff is complete and accurate, The external audit team should meet with IA staf, read their reports and review their ls relating to conttls testing performed atthe factories to ascertain the nature ofthe work Undertaken, Before using the work of IA, the audit team will need to evaluate and perform audit procedures on the entirety of the work which they plan to use, in oder to determine its ‘adequacy forthe purposes ofthe audit. In adlition, the tearm Will need to re-perform some of the testing carted out by 1A ‘0 assess its adequacy, Roview and test the contils surrounding the way in which ‘the finance cirector identifies old or potentially recoverable receivables balances and other credit control pracesses to ensure that they are operating effectively. Review correspondence with this customer and discuss with the finance director the ratonate for not maintaining an allowance for receivables, despite the financial dificutties, ‘experienced by this custorner. Extend post year-end cash receipts testing, in particular for ‘his significant customer, in order to assess valuation and the ‘need for an allowance for receivables.Audit tsk ‘The company changed one of is television speaker suppliers in December 204 to a cheaper alterative and this has Jed to an increase in warranty claims for television speaker deficiencies. Inte overall number of customers claiming on the warranty has increased, then the warranty provision should possibly be higher. As the nance director i anticinating that the overall level ofthe provision wil be similat tothe prior year, there isa risk the provision and expenses are understated, In May 20X5, a payroll clerk was dismissed as they had cartied out fraudulent transactions at Lapis Co. Controls have since been implemented to prevent this reoccurring, There is a tsk thatthe clerk may have undertaken a significant number of fraudulent transactions which have not yet been identified The oss as a result ofthe fraudulent transactions would ‘need to be writen off tothe statement of profit or less. If these have not been discovered, profit may be misstated Control risk is also increased as the controls previously in ‘lace didnot prevert the fraud, The directors only disclosed the amount of remuneration payable to each director, which does not comply with local legsation which also requires the names ofthe dtectors to be alsclosed, ‘The directors’ remuneration disciosure will not be complet {and accurate if the names and individual total payments {ate not disclosed and hence the financial statements will be ‘misstated 2s a result ofthe non-compliance. Lapis Co is planning to include a $0-8m receivable relating toa Supplier rebate based on purchases for the year. The receivable should only be recognised ifthe company has purchased the required volume levels and the amount Claimed Is virtually certain to be recelved. Ifthe annual volumes are overstated, then the value of the ecelvable recognised may be overstated and cost of sales may be understated Lapis Co intends to capitalise within intangible asets all costs incurred of $1 6m in tespect ofthe development of a ‘new smart television made. IAS® 38 Intangible Assets requires esearch costs to be expensed to profit or ass and only development costs which ‘meet specticclteria to be capitalised as an intangible asset. All of this expenditure nas been included as an intangible asset, If esearch costs have been incorectly classified as, development expenditure, there is a risk that intangible assets ate oversiated and expenses understated ‘A $2-5m interest beating loan was obtained in April 20X5 ‘and will be repaid in quarterly instalments over four years. If the lan is not allocated conectly between non-current and current lables, this would ead to a classification enor with current and non-curent lables being misstated, In ‘dition, the company may fail to accrue fr the intrest, resulting in finance casts and accruals being understated, ‘Auditor's response Discuss with management their procedures for estimating the Warranty provision and specifically if they have identified the ‘reason for the increase in claims and the effect ofthis on the estimate, Review ine level o claims received during the year and post year end and compare this to the provision made at the year tend to assess the adequacy ofthe provision Discuss with the finance director the details of the fraud perpetrated by the payroll clek and what procedures have ‘been adopted to date to identify any adjustments which are ‘neodod inthe financial statements, In adaition, discuss with the finance altector what additional corrals have been put in place ta identify any similar frauds. Additional substantive testing should be conducted over te afected areas of the accounting records, particularly ‘payroll, to establish if there have been any further fraudulent ‘transactions. In adtion, the team should maintain their professional scepticism and be alert tothe risk of further fraud and errors, Discuss this matter with management and review the requiterents ofthe local legislation to determine if the disclosure in the financial statements is included aporopriatey It aisclosue Is inadequate, then request ‘management to amend the directors’ remuneration disclosures and review for compliance with local legislation. Discuss with management the basis ofthe rebate calculation and agree the calculations back to supporting documentation, Including the contract withthe supplier. Review post year-end correspondence with the supplier for evidence ofthe rebate being apolied or post year-end bank statements for evidence of receipt Obtain a breakdown ofthe expenditure capitalised and agree to supporting documentation as to whether the costs relate to the research or development stage. Discuss the accounting treatment with the finance director to assess whether the Criteria for capitalisation under IAS 38 are being met. Review the loan agreement to confirm the details and re-perform the company’s calculations to confirm thatthe loan has been correctly split between non-current and current liable, Rocaloulate the interest accrual and agree the amount to finance costs and the accruals schedule.Auait risk The directors are intending to propose a final dividend once the nancial statoments are finalised, In ine with |AS LO Events after the Reporting Period, the dividend is a nor-adjusting event and should not be recognised 2s a liability in the 20XS financial statements. ‘The obligation only atses once the dividend is declared, and Auditor's response Discuss the issue with management and confiem thatthe dividend will not be recognised within lialiies in the 20%5 financial statements. “The financial statements need to be reviewed to ensure that adequate disclosure of the proposed dividend is included in compliance with IAS 10. this occurs post year end. The dividends should, however, ‘be disclosed in the notes to the financial statoments assuming they are declared before the financial statements are authorised for issue Iv the dividend is recognised, it wll result in an overstatement of liabiltes. Falling to disclose the proposed dividend will result in a lack of completeness of cisclosur. Heron Co @ 3) ‘Substantive procedures for additions to plant and equipment — Obtain the detailed breaksiown ofthe cnsts incurred forthe new manufacturing line, cast the breakdown and confirm that its Included in the non-curtent assets rezister in order to confirm completeness of the addition, — Confirm the purchase price of $2:7m and delivery and installation costs of $0:3m to supplier Invoices and thatthe involoes ae in the name of Heron Co inorder to canfirm valuation and rights and obligations = Discuss the treatment ofthe refundable purchases tax of $0:5m with the nance director as this should be excluded from cost. ‘Agree to inclusion inthe tax control account. — Request that management expenses the $0-1m training costs and to profit o loss as they ate not eligible for capitalisation. Conf fo journal entry thatthe adjustment nas been made. — Review the breakdovin of the costs of $0:2m incurted when testing the new line. Discuss with management and agree to supporting documentation to confirm the nature ofthese costs to ensure they are eligible for capitalisation, — Select a sample from the non-current assets register and physically vely the new manufacturing line on the factory floor to confirm existence, — Discuss with management the basis ofthe eight-year useful fe and how it was derved and agree to supporting documentation such as the replacement policy. — Recalculate the depreciation charge to confirm that the calculations have been appropriataly time apportioned and that depreciation only commenced from December 20X4 when the asset was baught inta use, ‘Substantive procedures for provision for bank balances = Obtain a bank confirmation letter tom Heron Co's bankers fr all four of is accounts — Agree all balances listed on the bank confirmation letter to the company’s bank reconciliations or the tial balanoe/general ledger in order to ensure completeness of bank balances. — For the current account, obtain Heron Co's bank reconciliation and cast it to check the additions in order to ensure arithmetical accuracy, — Aajee the balance per the bank reconcliation to an original year-end bank statement and to the bank confirmation letter. — Aaree the reconctation’s balance per the cash book tothe year-end cash book. — Trace all the outstanding lodgements to the pre year-end cash book, post year-end bank statement and also to the paying-in ook pre year end. = Trace all unpresented cheques through to a pre year-end cash book and post year-end bank statement. For any unusual ‘amounts or significant delays, obtain explanations from management. = Examine any old unpresented cheques to assess whether they need to be writen back — Review the cash book and bank statements for any unusual items or large transfers around the year end, as this could be evidence of window dressing — Examine the bank confirmation letter for details of any security provided by Heron Co, with regards to the bank overdraft or any legal ight of set-off as these may require disclesure — For the savings accounts, review any reconciling items on the yearend bank reconciliations and agree to supporting ‘documentation© @ — Review the financial statements to ensure thatthe disclosure of bank balances is complete and accurate, an that the overdraft 's within current liabilities and the savings accounts within current assets ‘Substantive procedures re provision for legal claim = Discuss with management the facts of the case to determine the nature of the claim and why only $0-6m provided. — Review correspondence with Heron Co's lawyers or, with the client's permission, obtain confirmation from the client's lawyer about the likely outcome and possibility of payment. = Inspect correspondence received from the customer regarding the claim in order to assess whether 2 provision should be recognised and, if so, whether the amount ofthe provision is reasonable, ~ _lnspect the post year-end cash Book and bank statements to identify whether any payments have been made and compate ary ‘actual payments to the amounts provided inthe financial statements. — Inspect relevant board minutes and discuss withthe flnance director to ascertain whether payment is probable and the basis for the provision — Review the expense accounts in the statement of profit or loss fo inclusion of legal costs and agree to correspondence from the legal advisers. — Obtain a written representation from management that they believe the provision is valued appropriately and is complete. — Review the financial statement disclosures relating to the provision to ensure they are in compliance with IAS 37 Provisions, Contingent Lables and Contingent Assets. Subsequent event (The information regarding Spartow Co's cash flow difficulties was received on 14 July 205, after the year end, but provides further evidence of the recoverability of the receivable balance at the year end. If Sparrow Co is experiencing cash flow aificuties just a few months after the year end, itis highly unlikely thatthe $692,000 was recoverable as at 31 May 20X5 and hence this is an adjusting event in accordance with IAS 10 Events after the Reporting Period. The receivables balance is overstated and consideration should be given to adjusting this balance, if material ether through the use of an allowance for receivables or by writing off the balance relating to Spartow Co depending on the assessment ofthe recoverability ofthe balance ‘The total amount outstanding at the year end was $692,000 and is material as it represents 7-8% (0-692n/8-9m) of profit before tax and 1-1% (0°692nv65-4m) of total assets. Hence the directors should amend the 20X5 financial statements by ‘making an allowance or by writing off the receivable balance relating to Sparrow Co, depending on their assessment. (ii) The following audit procedures should be applied to form a conciusion as tothe adjustment: ~The correspondence with the customer should be reviewed to assess whether there ls any likelihood of payment. — Discuss with management and review board minutes to obtain an understanding as to why they feel an adjustment isnot required. — Review the post year-end cash book and bank statements to see if any payments Nave been recelved from the custome.Applied Skills, AA ‘Audit and Assurance (AA) Section B Petra Co @ o © @ © Control objectives of a sales system 11 mark per well-explaned point Restricted to Direct controls and tests of control Supervision clock care Gross to net checks Revisod rates Segregation of duties Other ‘Maximum 3 issues, 2 marks each Control deficiencies and recommendations Creait mits No copy of sales order Discounts not reviewed Access master data [No GRN to fnance Document count controls ‘No PLCA roc other ‘Maximum 5 issues, 2 marks each ‘Substantive procedures for purchases and other expenses, 1 mark per well-desctbed procedure Restricted to Corporate governance deficiencies and recommendations, Marketing ditector Chair Frequeney of director re-election NNEDs no financial experience ‘Annual bonus NEDS other ‘Maximum 3 Issues, 2 marks each ‘Total marks: MarchJune 2023 Sample Marking Scheme Marks avaliable Marks awarded * [Bis soronais anoniLapis co (2) Quality management | mark per welLexplained point Restricted to (©) Audit risks and auditor's response Goods in transit Reliance on 1A No allowance for recelvables Warranty provision Fraud Directors’ remuneration Rebate receivable Development expenditure ‘Now loan Dividend Other ‘Maximum 8 issues, 2 marks each Total marks Heron Co (2) Substantive procedures for plant and equipment 1 mark per well-described procedure Restricted to (©) Substantive procedures for provision for bank balances 1 mark per wel-descibed procedure Restricted to (©) Substantive procedures re provision for legal claim | mark per well-described procedure Restricted to (@) Subsequent event (Discussion of issue (i) Procedures |L mark per well described procedure Restricted to Total marks Marks avaliable Marks awarded12