• Audit evidence (recap)

Chapter 10
• Tests of controls
Tests of controls
• Systems
• Communication of deficiencies
in internal control
• ISA 260 (Revised)

BPP LEARNING MEDIA

 Syllabus learning outcomes 1

• Describe control objectives, control procedures, activities, direct

controls, indirect controls and tests of control in relation to:
o The sales system
o The purchases system
o The payroll system
o The inventory system
o The bank and cash system
o Non-current assets
• Discuss the requirements and methods of how reporting significant
deficiencies in internal control are provided to management and those
charged with governance.

BPP LEARNING MEDIA

 Syllabus learning outcomes 2

• Explain, in a format suitable for inclusion in a management letter,

significant deficiencies within a system of internal control and provide
control recommendations for overcoming these deficiencies to
management.
• Discuss the need for auditors to communicate with those charged with
governance.
• Describe the format and content of internal audit review reports and
make appropriate recommendations to management and those
charged with governance.

BPP LEARNING MEDIA

 Chapter summary diagram

Audit evidence Internal audit reports

Tests of controls

Sales Purchases Payroll

Revenue and
Bank and cash Inventory
capital expenditure

BPP LEARNING MEDIA

 Chronology of an audit

BPP LEARNING MEDIA

 Audit evidence (recap)

From Chapter 8:
There are two main ways in which an auditor can gather audit evidence:
• Tests of controls
• Substantive procedures (tests of detail and analytical procedures)

The mnemonic AEIOU can help generate different audit procedures.

• Analytical procedures
• Enquiry/confirmation
• Inspection
• Observation
• RecalcUlation/re-performance

BPP LEARNING MEDIA

 Tests of controls 1

The auditor must have an understanding of an entity’s accounting and

internal control systems but will only ever carry out tests of controls if
their initial risk assessment suggests that the entity’s internal controls
operate effectively.
If this is the case, the auditor will perform tests of controls to gather
audit evidence about relevant financial statement assertions.
The auditor must test that the control:
• Is properly designed;
• Exists; and
• Has operated throughout the period.

BPP LEARNING MEDIA

 Tests of controls 2
Tests of controls include enquiry in combination with other audit
procedures, for example:
• Inspection of documents supporting controls or events to gain
audit evidence that controls have operated effectively, for example
verifying that a transaction has been authorised
• Observation of the entity’s control procedures, for example
observing an inventory count to ensure it is being conducted in
accordance with the inventory count instructions
• Re-performance of the application of a control to ensure it was
performed correctly, for example re-performing a bank reconciliation
to verify that it has been done properly
• Examination of evidence of management reviews, for example
minutes of board meetings
• Testing of the control activities performed by a computer, using,
for example, computer assisted audit techniques (CAATs)
BPP LEARNING MEDIA
 Systems

There are six systems detailed in the syllabus:

BPP LEARNING MEDIA

 The sales system 1

BPP LEARNING MEDIA

 The sales system 2

Assertions: Occurrence and existence

Control objectives
To ensure that one person is not responsible for taking orders,
recording sales and receiving payment

Controls
Segregation of duties

Tests of controls
Observe and evaluate whether proper segregation of duties is operating

BPP LEARNING MEDIA

 The sales system 3

Assertions: Occurrence and existence

Control objectives
To ensure that recorded sales transactions represent goods or services
provided

Controls
• Sales are only recorded if there is an approved sales order form and
shipping/dispatch documentation
• Accounting for numerical sequences of invoices
• Monthly customer statements sent out and customer queries and
complaints handled independently

BPP LEARNING MEDIA

 The sales system 4

Tests of controls
• For a sample of sales invoices ensure there is a related sales order
form that has been authorised and shipping documentation
• Examine information processing controls for authorisation
• Review and test entity's procedures for accounting for
numerical sequences of invoices
• Review entity's procedures for sending out monthly statements
and dealing with customer queries and complaints

BPP LEARNING MEDIA

 The sales system 5

Assertions: Occurrence and existence

Control objectives
To ensure that goods and services are only supplied to customers with
good credit ratings.

Controls
• Authorisation of credit terms to customers (senior staff authorisation,
references/credit checks for new customers, regular review of credit
limits)
• Authorisation by senior staff required for changes in other customer
data such as address
• Orders not accepted unless credit limits reviewed first

BPP LEARNING MEDIA

 The sales system 6

Assertions: Occurrence and existence

Tests of controls
• Review entity's procedures for granting credit to customers.
• Examine a sample of sales orders for evidence of proper credit
approval by the appropriate senior staff member.
• Examine information processing controls for credit limits.
• Review all new customer files to ensure satisfactory credit references
have been obtained.

BPP LEARNING MEDIA

 The sales system 7

Assertions: Occurrence and existence

Control objectives
To ensure that goods and services are provided at authorised prices and
on authorised terms.

Controls
Authorised price lists and specified terms of trade in place.

Tests of controls
Verify that price lists and terms of trade are properly documented,
authorised and communicated.
Examine information processing controls for authorised prices and terms.

BPP LEARNING MEDIA

 The sales system 8

Assertion: Completeness
Control objectives
To ensure that all revenue relating to goods dispatched is recorded.

Controls
Accounting for numerical sequences of invoices.

Tests of controls
Review and test entity's procedures for accounting for
numerical sequences of invoices.

BPP LEARNING MEDIA

 The sales system 9

Assertion: Completeness
Control objectives
To ensure that all goods and services sold are correctly invoiced.

Controls
(i) Shipping/dispatch documentation is matched to sales invoices.
(ii) Sales invoices are reconciled to the daily sales report.
(iii) An open-order file is maintained and reviewed regularly.

BPP LEARNING MEDIA

 The sales system 10

Assertion: Completeness
Tests of controls
(i) For a sample of shipping/dispatch documents, inspect to ensure
each has been matched to a related sales invoice that was
subsequently recorded.
(ii) Review a sample of reconciliations performed.
(iii) Inspect the open-order file for unfilled orders.

BPP LEARNING MEDIA

 The sales system 11

Assertion: Accuracy
Control objectives
To ensure that all sales and adjustments are correctly journalised,
summarised and posted to the correct accounts.

Controls
Sales invoices and matching documents required for all entries and the
date and reference of the entry are written on each document.

Tests of controls
Review supporting documents for a sample of sales entries to ensure
they contain the written details that indicate they were referred to when
entered.

BPP LEARNING MEDIA

 The sales system 12

Assertion: Cut-off
Control objectives
To ensure that transactions have been recorded in the correct period.
Controls
(i) All shipping documentation is forwarded to the invoicing section on a
daily basis.
(ii) Daily invoicing of goods shipped.
Tests of controls
(i) Compare dates on sales invoices with dates of corresponding
shipping documentation.
(ii) Compare dates on sales invoices with dates recorded in the sales
ledger.

BPP LEARNING MEDIA

 The sales system 13

Assertion: Classification assertions

Control objectives
To ensure that all transactions are properly classified in accounts.
Controls
(i) Chart of accounts in place which is regularly reviewed and updated.
(ii) Codes in place for different types of products or services.
Tests of controls
(i) Inspect any documentary evidence of review (such as emails
requesting update to chart of accounts as a result of review).
(ii) Test information processing controls for proper codes.

BPP LEARNING MEDIA

 Tackling the exam: the sales system

• Deficiencies in the sales system were examined in the

2016 Specimen Exam (Section B, Question 17) and in the
September 2016 exam (Section B, Question 16).
• The most typical requirement you will get is to explain the
deficiencies in internal control and describe recommendations to
overcome them. Sometimes you are also required to suggest
associated tests of controls.
• Make use of the table format given in the exam – this allows you
to link the deficiencies with the recommendations and any
associated tests of controls. It also gives your answer structure
and is an approach which is recommended by the examining
team.

BPP LEARNING MEDIA

 Tackling the exam

• Tests of controls are very likely to be examined as the examining

team will want to see that students understand the difference
between tests of controls and substantive tests.
• Another area of confusion is the difference between control
objectives, controls and tests of controls.
• Control objectives tell you what the control is trying to achieve and
will always start 'To ensure that…'
• Controls are the processes in place to achieve the control
objectives, eg monthly bank reconciliations.
• Tests of controls are carried out by the auditor and are procedures
to gain evidence about whether controls are working, so to test the
control of monthly bank reconciliations, the auditor would inspect
all the bank reconciliations for the year to see if they had been
done every month.

BPP LEARNING MEDIA

 The purchases system 1

BPP LEARNING MEDIA

 The purchases system 2

Assertions: Occurrence and existence

Control objective
To ensure that recorded purchases represent goods and services
received

BPP LEARNING MEDIA

 The purchases system 3

Assertions: Occurrence and existence

Controls
(i) Authorisation procedures and policies in place for ordering goods
and services
(ii) Segregation of duties
(iii) Purchase orders raised for each purchase and authorised by
appropriate senior personnel
(iv) Approved purchase order for each receipt of goods
(v) Staff receiving goods check them to the purchase order
(vi) Stores clerks sign for goods received
(vii) Purchase orders and GRNs are matched with the suppliers' invoices

BPP LEARNING MEDIA

 The purchases system 4

Assertions: Occurrence and existence

Tests of controls
(i) Inspect policies and procedures in place.
(ii) Observe and evaluate segregation of duties.
(iii) Examine a sample of purchase orders to ensure they have been
appropriately authorised.
(iv) Review the delegated list of authority for purchases.
(v) For a sample of GRNs, ensure there is a related purchase order that has
been properly approved.
(vi) Observe receipts of goods by staff to confirm whether the check is done.
(vii) Inspect a sample to confirm whether stores staff undertake this check.
(viii) Examine supporting documentation to ensure it has been matched for a
sample of invoices.

BPP LEARNING MEDIA

 The purchases system 5

Assertions: Completeness

Control objectives
To ensure that all purchase transactions that occurred have been
recorded

Controls
(i) Purchase orders and GRNs are matched with the suppliers' invoices
(ii) Periodic accounting for pre-numbered GRNs and purchase orders
(iii) Independent check of amount recorded in the purchase journal

BPP LEARNING MEDIA

 The purchases system 6

Assertions: Completeness

Tests of controls
(i) For a sample of purchase orders in the year ensure each has been
matched to a related invoice that was subsequently recorded.
(ii) Review entity's procedures for accounting for pre-numbered
documents.
(iii) Examine information processing controls.
(iv) Examine documentation for evidence of this check.

BPP LEARNING MEDIA

 The purchases system 7

Assertions: Rights and obligations

Control objectives
To ensure that recorded purchases represent the liabilities of the entity

Controls
Purchase orders and GRNs are matched with the suppliers' invoices

Tests of controls
Examine supporting documentation to ensure it has been matched for a
sample of invoices

BPP LEARNING MEDIA

 The purchases system 8

Assertions: Accuracy, classification and valuation

Control objectives
To ensure that purchase transactions are correctly recorded in the
accounting system

Controls
(i) Purchase orders and GRNs are matched with the suppliers' invoices
(ii) Mathematical accuracy of the supplier's invoice is verified
(iii) Amount posted to general ledger is reconciled to the purchases
ledger
(iv) Chart of accounts in place

BPP LEARNING MEDIA

 The purchases system 9

Assertions: Accuracy, classification and valuation

Tests of controls
(i) Examine supporting documentation for a sample of invoices.
(ii) Review a sample of invoices for evidence the accuracy has been
verified (eg signature or initials) and re-perform the check.
(iii) Review reconciliations for evidence of this check.
(iv) Review purchases journal and general ledger for reasonableness.

BPP LEARNING MEDIA

 The purchases system 10

Assertion: Cut-off
Control objectives
To ensure that purchase transactions are recorded in the correct
accounting period
Controls
(i) All goods received reports forwarded to accounts payable department
daily
(ii) Procedures in place that require recording of purchases as soon as
possible after goods/services received
Tests of controls
(i) Compare dates on reports to dates on relevant vouchers
(ii) Compare dates on vouchers with dates they were recorded in the
purchases journal

BPP LEARNING MEDIA

 Tackling the exam: The purchases system

• Deficiencies in the purchases system were examined in the June

2015 exam and September/December 2017 exam (Section B,
Q16).
• In the June 2015 exam the requirement was to explain the
deficiencies, followed by recommendations to overcome them.
• Do not produce a covering letter unless it is specifically asked for
as you won't get any credit for doing so.
• We will work through the June 2015 question in the next few
slides.

BPP LEARNING MEDIA

 Question: June 2015 Sec B Question 4 1

Cherry Blossom Co (Cherry) manufactures custom-made furniture

and its year end is 30 April. The company purchases its raw materials
from a wide range of suppliers. Below is a description of Cherry’s
purchasing system.
When production supervisors require raw materials, they complete a
requisition form and this is submitted to the purchase ordering
department. Requisition forms do not require authorisation and no
reference is made to the current inventory levels of the materials
being requested. Staff in the purchase ordering department use the
requisitions to raise sequentially numbered purchase orders based
on the approved suppliers list, which was last updated 24 months
ago. The purchasing director authorises the orders prior to these
being sent to the suppliers.

BPP LEARNING MEDIA

 Question: June 2015 Sec B Question 4 2

When the goods are received, the warehouse department verifies the
quantity to the supplier’s dispatch note and checks that the quality of
the goods received is satisfactory. They complete a sequentially
numbered goods received note (GRN) and send a copy of the GRN
to the finance department.
Purchase invoices are sent directly to the purchase ledger clerk, who
stores them in a manual file until the end of each week. He then
inputs them into the purchase ledger using batch controls and gives
each invoice a unique number based on the supplier code. The
invoices are reviewed and authorised for payment by the finance
director, but the actual payment is only made 60 days after the
invoice is input into the system.

BPP LEARNING MEDIA

 Question: June 2015 Sec B Question 4 3

Required:
In respect of the purchasing system of Cherry Blossom Co:
(i) Identify and explain FIVE deficiencies; and
(ii) Recommend a control to address each of these deficiencies.
Note. The total marks will be split equally between each part.
(10 marks)

BPP LEARNING MEDIA

 Approach: June 2015 Sec B Question 4

Firstly, look at the requirement carefully: there are ten marks

available, split between the requirements equally, so five marks each
for deficiencies and recommended controls.
Note the requirement for five deficiencies so make sure you have five
but no more as you won't get credit for more than five.
The deficiencies and recommendations should be presented in a
tabular format.
You will see from the model answer that follows that there are more
than five deficiencies that you can choose to include in your answer.

BPP LEARNING MEDIA

 Answer: June 2015 Sec B Question 4 1
Deficiencies
Requisition forms are completed by
production supervisors but are not
authorised. This increases the risk of
fraudulent purchases, or of goods being
ordered which are not required, leading to
unnecessary cash outflows.
Orders are being placed for goods without
the inventory levels being checked first. This
could result in goods being ordered which
are not required, leading to unnecessary
cash outflows.
In addition, as the company does not
currently monitor inventory levels, it could
experience stock-outs resulting in the
company being unable to meet customer
orders.
BPP LEARNING MEDIA
Controls
Requisition forms should be authorised by the
production manager or director prior to being
sent to the purchase ordering department.
This department should not process any
unauthorised requisitions.
The inventory system should be updated to
record minimum/maximum required levels of
raw materials. When completing the purchase
order, the ordering clerk should check the
current level of inventory on the system and
only order if the quantity is within the set
parameters.
The company should set minimum authorised
reorder levels for inventory items.
 Answer: June 2015 Sec B Question 4 2
Deficiencies Controls
The purchase ordering department maintains an The approved supplier list should be reviewed
approved supplier list; however, this has not and updated as necessary. Going forward, it
been updated for 24 months. should be updated regularly, at least on an
As this list has not been recently updated, the annual basis.
suppliers being used may not be ideal with
regards to price, quality and delivery times. This
could result in Cherry paying increased costs for
raw materials or receiving poorer quality goods.
Goods are being received without any checks A copy of the authorised order form should be
being made against purchase orders. This could sent to the warehouse department. This should
result in Cherry receiving and subsequently then be checked to the goods when received.
paying for goods it did not order.
In addition, if no check is made against the Once checked, the order should be sent to the
purchase order, then the company may have purchase ordering department and logged as
significant purchase orders which are completed. On a regular basis, an ordering clerk
outstanding, leading to loss of sales. should review the order file for any outstanding
items.

BPP LEARNING MEDIA

 Answer: June 2015 Sec B Question 4 3
Deficiencies
Purchase invoices are manually filed by the
purchase ledger clerk and only updated to
the ledger on a weekly basis. Until the
invoices are input into the system, there is a
risk that they may be misplaced and not
entered. This would result in an
understatement of trade payables and
Cherry failing to make payment to the
suppliers on time.
Purchase invoices are not being agreed to
the relevant goods received notes (GRNs)
prior to authorisation and payment by the
finance director. This could result in invoices
being paid for goods which were not
received.
BPP LEARNING MEDIA
Controls
The purchase ledger clerk should record the
invoices in the ledger on a daily rather than
weekly basis.
If this is not practical, then upon receipt of the
invoices, each should be attributed a
sequential number and filed. When these are
logged into the ledger, the clerk should check
that there are no breaks in the sequence.
All purchase invoices should be matched to
the related GRN; the details should be agreed
prior to the invoice being logged in the
purchase ledger.
 Answer: June 2015 Sec B Question 4 4
Deficiencies Controls
Purchase invoices are not sequentially All purchase invoices should be sequentially
numbered. Failing to sequentially number them numbered and on a regular basis a sequence
means that Cherry’s finance department are check of unrecorded invoices should be
unable to monitor if all invoices have been performed.
completely recorded; this could result in a
failure to make payment to a supplier on time.
If the invoices are sequentially numbered, then
a sequence check can be performed for any
unrecorded invoices.
Invoices are authorised by the finance director, The policy of making payment after 60 days
but payment is only made 60 days after the should be reviewed. Consideration should be
invoice is input. There is the risk that Cherry is given to earlier payment if the settlement
missing out on early settlement discounts. discounts are sufficient. If not, invoices should
Also, failing to pay in accordance with the be paid in accordance with the supplier’s
supplier’s payment terms can lead to a loss of payment terms.
supplier goodwill as well as the risk that
suppliers may refuse to supply goods to
Cherry.

BPP LEARNING MEDIA

 The payroll system 1
Assertions: Occurrence and existence
Control objectives
To ensure that payment is made only to bona fide employees of the entity
Controls
(i) Segregation of duties between HR and payroll functions
(ii) Personnel files held for all employees
(iii) Authorisation procedures for hiring, termination, time worked, wage
rates, overtime, benefits etc
(iv) Any change in employment status informed to HR department
(v) Use of time clocks to record time worked
(vi) Clock cards approved by supervisor
(vii) Only employees with valid employee numbers are paid
(viii) Payroll budgets in place, reviewed by management
BPP LEARNING MEDIA
 The payroll system 2
Tests of controls
(i) Observe and evaluate proper segregation of duties.
(ii) Review a sample of starters and leavers in the year to ensure
correct documentation in place.
(iii) Review and test authorisation procedures in place.
(iv) Review policies and procedures in place for changing status and
consider if adequate. Review personnel files for a sample of
employees whose status changed in year.
(v) Observe employees' use of time clocks.
(vi) Inspect a sample of clock cards for evidence of approval by
appropriate level of management.
(vii) Review and test procedures for entering and removing employee
numbers from the payroll master file.
(viii) Review budgeting procedures.
BPP LEARNING MEDIA
 The payroll system 3

Assertion: Completeness
Control objective
To ensure that all payroll costs are recorded for work done by employees
Controls
(i) Pre-numbered clock cards in use
(ii) Segregation of duties
(iii) Regular reconciliations of payroll records and employee costs
recorded in the general ledger
(iv) Comparison of cheques and bank transfer list with payroll
(v) Preparation and authorisation of cheques and bank transfer list

BPP LEARNING MEDIA

 The payroll system 4

Tests of controls
(i) Review numerical sequence of clock cards.
(ii) Observe and evaluate proper segregation of duties.
(iii) Review a sample of reconciliations to ensure they are properly
carried out and reviewed by an independent person.
(iv) Enquire whether comparisons are made between payment records
and payroll and inspect any documentary evidence of the review.
(v) Examine paid cheques or a certified copy of the bank list for
employees paid by cheque or bank transfer to ensure proper
authorisation.

BPP LEARNING MEDIA

 The payroll system 5

Assertions: Accuracy, valuation and allocation

Control objective 1
To ensure that all benefits and deductions are computed correctly
Controls
(i) Re-performance of a sample of payroll benefit and deduction
calculations
(ii) Payroll budgets in place and reviewed by management
(iii) Agreement of gross earnings and total tax deducted with taxation
returns
Tests of controls
(i) Review documentary evidence that recalculation occurred
(ii) Review budgeting procedures
(iii) Inspect documentation for evidence of management's review
BPP LEARNING MEDIA
 The payroll system 6

Assertions: Accuracy, valuation and allocation

Control objective 2
To ensure that payroll transactions are correctly recorded in the
accounting system
Controls
(i) Changes to master file verified through 'before and after' reports
(ii) Payroll master file reconciled to general ledger
Tests of controls
(i) Review reconciliations of 'before and after' reports to payroll master
file
(ii) Review reconciliations of payroll master file to general ledger and
confirm whether discrepancies are followed up promptly and
resolved

BPP LEARNING MEDIA

 The payroll system 7

Assertion: Cut-off
Control objective
To ensure that payroll transactions are recorded in the correct accounting
period
Controls
All starters, leavers, changes to salary and deductions are reported
promptly to payroll department and changes are updated to the payroll
master file promptly
Tests of controls
(i) Review entity's procedures for reporting changes to the payroll
department
(ii) Verify sample of starters and leavers

BPP LEARNING MEDIA

 The payroll system 8

Assertion: Presentation
Control objective
To ensure that payroll transactions are properly classified in the financial
statements
Controls
(i) Chart of accounts
(ii) Independent approval and review of accounts charged to payroll
(iii) Payroll budgets in place and reviewed by management
Tests of controls
(i) Review chart of accounts
(ii) Review procedures for classifying payroll costs
(iii) Review budgeting procedures

BPP LEARNING MEDIA

 Exam link: The payroll system 1

• Deficiencies of the payroll system have been examined in the

December 2013 and June 2014 exams.
• When suggesting recommendations, make sure they are sensible
and relevant to the scenario you are presented with in the
question.
• The September 2016 exam tested controls in relation to the
prevention of payroll fraud (Section B, Q16).
• The Mar/July 2020 hybrid exam tested the matters to consider
when deciding whether a deficiency in internal control is significant
(Section B, Q17), and direct controls in relation to several areas
including payroll.
• The Sep/Dec 2020 hybrid exam tested direct controls and tests of
controls in a number of systems.

BPP LEARNING MEDIA

 Exam link: The payroll system 2

The September 2013 edition of Student Accountant contains an

excellent article on the audit of wages:
http://www.accaglobal.com/en/student/acca-qual-student-
journey/qual-resource/acca-qualification/f8/technical-articles/the-
audit-of-wages.html

BPP LEARNING MEDIA

 The inventory system 1

There are three approaches to the audit of inventory, and the approach
taken depends on whether controls around inventory are assessed as
strong or weak.
Approach 1
Perpetual inventory can be relied on if controls are strong.
Approach 2
Inventory count near year-end and adjusted by perpetual inventory, only
if controls are strong.
Approach 3
Year-end count: use a substantive approach (see Chapter 13).

BPP LEARNING MEDIA

 The inventory system 2

Assertions: Occurrence and existence

Control objective 1
To ensure that all inventory movements are authorised and recorded
Controls
(i) Pre-numbered documentation (GDNs and GRNs) in use
(ii) Reconciliations of inventory records with general ledger
(iii) Segregation of duties
Tests of controls
(i) Review documentation in use
(ii) Review a sample of reconciliations to confirm they are performed
and then reviewed by a more senior individual
(iii) Observe and evaluate proper segregation of duties

BPP LEARNING MEDIA

 The inventory system 3
Assertions: Occurrence and existence
Control objective 2
To ensure that inventory included on the statement of financial position
physically exists
Controls
(i) Physical safeguards to ensure inventory is not stolen
(ii) Separate responsibilities for maintenance of records and custodianship
(iii) Inventory counted regularly
Tests of controls
(i) Review security systems in place
(ii) Review policies and procedures in place and discuss them with relevant
staff
(iii) Review procedures for counting inventory and attend inventory count

BPP LEARNING MEDIA

 The inventory system 4

Assertion: Completeness
Control objective
To ensure that all purchases and sales of inventory have been recorded
in the accounting system
Controls
(i) Procedures in place to include inventory held at third parties and
exclude inventory held on consignment for third parties
(ii) Reconciliations of accounting records with physical inventory
Tests of controls
(i) Review entity's procedures relating to consignment inventory
(ii) Review reconciliations performed and whether reviewed by an
independent person

BPP LEARNING MEDIA

 The inventory system 5

Assertion: Rights and obligations

Control objective
To ensure that inventory records only include items that belong to the
entity

Controls
Procedures in place to include inventory held at third parties and exclude
inventory held on consignment for third parties

Tests of controls
Review entity's procedures relating to consignment inventory

BPP LEARNING MEDIA

 The inventory system 6

Assertions: Accuracy, valuation and allocation

Control objective 1
To ensure that inventory quantities have been accurately determined

Controls
Periodic or annual comparison of inventory with amounts shown in
perpetual inventory records

Tests of controls
Review and test entity's procedures for taking physical inventory

BPP LEARNING MEDIA

 The inventory system 7

Assertions: Accuracy, valuation and allocation

Control objective
To ensure that inventory is properly stated at the lower of cost and net
realisable value
Controls
(i) Standard costs reviewed by management
(ii) Review of cost accumulation and variance reports
(iii) Inventory managers review inventory regularly to identify slow-moving,
obsolete and excess inventory
Tests of controls
(i) Review and test entity's procedures for developing standard costs
(ii) Inspect variance reports produced
(iii) Discuss with managers how this is done and observe procedure

BPP LEARNING MEDIA

 The inventory system 8

Assertion: Cut-off
Control objective
To ensure that all purchases and sales of inventory are recorded in the
correct accounting period
Controls
(i) All dispatch documents processed daily to record the dispatch of
finished goods
(ii) All goods inwards reports processed daily to record the receipt of
inventory
(iii) Reconciliations of inventory records with general ledger
Tests of controls
(i) and (ii) Inspect documentation to confirm daily processing
(iii) Review reconciliations performed
BPP LEARNING MEDIA
 The inventory system 9

Assertions: Presentation
Control objective 1
To ensure that inventory transactions and balances are properly
identified and classified in the financial statements

Controls
Orders for materials and production data forms used to process goods
through manufacturing

Tests of controls
Review entity's procedures and documentation used to classify inventory

BPP LEARNING MEDIA

 The inventory system 10

Assertions: Presentation
Control objective 2
To ensure that disclosures relating to classification and valuation are
sufficient

Controls
Approval by Finance Director

Tests of controls
Review entity's working papers for evidence of review

BPP LEARNING MEDIA

 Exam link: The inventory system

• Deficiencies in the inventory system were examined in June 2010,

December 2010 and June 2012. Question 5 in the March/June
2016 Sample Questions also examines this area.
• The requirement was to explain the deficiencies, followed by
recommendations to overcome them.
• Spend time planning your answer – go through the scenario
line by line, noting down the potential deficiencies in the system.

BPP LEARNING MEDIA

 The bank and cash system 1

• The following slides look at the controls around cash.

• Controls around cash payments and receipts are designed to help
prevent theft and fraud.
• First we will look at the controls around cash payments, followed by
controls around cash receipts.

BPP LEARNING MEDIA

 The bank and cash system 2

Cash payments
Assertion: Occurrence
Control objective
To ensure that only valid cash payments are made
Controls
(i) Segregation of duties
(ii) Supplier statements independently reviewed and reconciled to trade
payables records
(iii) Monthly bank reconciliations prepared and reviewed
(iv) Only authorised staff able to make electronic cash payments and
issue cheques
(v) Electronic cash payments and cheques prepared only after all source
documents have been independently approved
BPP LEARNING MEDIA
 The bank and cash system 3

Tests of controls
(i) Observe and evaluate proper segregation of duties
(ii) Review procedures for reconciling supplier statements
(iii) Review reconciliations to confirm whether undertaken and reviewed
(iv) Review delegated list of authority for cash payments
(v) Inspect relevant documentation for evidence of approval by senior
personnel

BPP LEARNING MEDIA

 The bank and cash system 4

Cash payments
Assertion: Completeness
Control objective
To ensure that all cash payments that occurred are recorded
Controls
(i) Segregation of duties
(ii) Supplier statements independently reviewed and reconciled to trade
payables records
(iii) Monthly bank reconciliations prepared and reviewed
(iv) Review of cash payments by manager before release
(v) Daily cash payments reconciled to posting to payables accounts
(vi) Use of pre-numbered cheques

BPP LEARNING MEDIA

 The bank and cash system 5

Tests of controls
(i) Observe and evaluate proper segregation of duties
(ii) Review procedures for reconciling supplier statements
(iii) Review reconciliations to confirm whether undertaken and reviewed
(iv) Inspect sample of listings for evidence of senior review
(v) Review a sample of reconciliations for evidence that they have been
done
(vi) Examine evidence to verify use of pre-numbered cheques

BPP LEARNING MEDIA

 The bank and cash system 6
Cash payments
Assertions: Accuracy, valuation and allocation
Control objective 1
To ensure that cash payments are recorded correctly in the ledger
Controls
(i) Reconciliation of daily payments report to electronic cash payment
transfers and cheques issued
(ii) Supplier statements reconciled to payables accounts regularly
(iii) Monthly bank reconciliations of bank statements to ledger account
Tests of controls
(i) Review reconciliations to ensure performed and reviewed
(ii) Review reconciliations for a sample of accounts
(iii) Review bank reconciliations for evidence performed and reviewed

BPP LEARNING MEDIA

 The bank and cash system 7
Cash payments
Assertions: Classification
Control objective 2
To ensure that cash payments are posted to the correct payable accounts
and to the general ledger
Controls
(i) Supplier statements reconciled to payables accounts regularly
(ii) Agreement of monthly cash payments journal to general ledger posting
(iii) Payable accounts reconciled to general ledger control account
Tests of controls
(i) Review reconciliations for a sample of accounts
(ii) Review postings from journal to general ledger
(iii) Review reconciliations for evidence performed and reviewed

BPP LEARNING MEDIA

 The bank and cash system 8
Cash payments
Assertion: Cut-off
Control objective
To ensure that cash payments are recorded in the correct accounting
period
Controls
Reconciliation of electronic funds transfers and cheques issued with
postings to cash payments journal and payable accounts
Tests of controls
Review reconciliation to confirm it is done regularly

BPP LEARNING MEDIA

 The bank and cash system 9

Cash payments
Assertions: Presentation
Control objective
To ensure that cash payments are charged to the correct accounts
Controls
(i) Chart of accounts
(ii) Independent approval and review of general ledger assignment
Tests of controls
(i) Review cash payments journal to assess reasonableness of charging
of accounts
(ii) Review assignment of general ledger account

BPP LEARNING MEDIA

 The bank and cash system 10

Cash receipts
Assertions: Occurrence
Control objective
To ensure that all valid cash receipts are received and deposited
Controls
(i) Segregation of duties
(ii) Use of electronic cash receipts transfer not received or deposited
(iii) Monthly bank reconciliations performed and independently reviewed
(iv) Use of cash registers or point-of-sale devices
(v) Periodic inspections of cash sales procedures
(vi) Restrictive endorsement of cheques immediately on receipt

BPP LEARNING MEDIA

 The bank and cash system 10 (cont’d)

Cash receipts
Assertions: Occurrence
Controls continued
(vii) Mail opened by two staff members
(viii) Immediate preparation of cash book or list of mail receipts
(ix) Independent check of agreement of cash/cheques to be deposited
at bank with register totals and receipts listing
(x) Independent check of agreement of bank deposit slip with daily
cash summary

BPP LEARNING MEDIA

 The bank and cash system 11
Cash receipts
Assertions: Occurrence
Tests of controls
(i) Observe and evaluate proper segregation of duties
(ii) Examine application controls for electronic cash receipts transfer
(iii) Review monthly bank reconciliations to ensure performed and reviewed
(iv) Observe cash sales procedures
(v) Enquire with managers about results of inspections
(vi) Observe mail opening, including endorsement of cheques
(vii) Observe mail opening procedures
(viii) Observe preparation of cash receipts' records
(ix) Review documentation for evidence of independent check

BPP LEARNING MEDIA

 The bank and cash system 12

Cash receipts
Assertion: Completeness
Control objective
To ensure that all cash receipts are recorded
Controls
(i) Segregation of duties
(ii) Use of electronic cash receipts transfer not received or deposited
(iii) Monthly bank reconciliations performed and independently reviewed
(iv) Daily cash receipts listing reconciled with posting to customer
accounts
(v) Customer statements prepared and sent out on a regular basis

BPP LEARNING MEDIA

 The bank and cash system 13

Cash receipts
Assertion: Completeness
Tests of controls
(i) Observe and evaluate proper segregation of duties
(ii) Observe application controls for electronic cash receipts transfer
(iii) Review monthly bank reconciliations to confirm performed and
independently reviewed
(iv) Review reconciliation
(v) Enquire of management about handling of customer statements
(vi) Examine a sample of customers and note frequency of statements

BPP LEARNING MEDIA

 The bank and cash system 14

Cash receipts
Assertions: Accuracy, valuation and allocation
Control objective 1
To ensure that cash receipts are recorded at correct amounts
Controls
(i) Daily remittance report reconciled to control listing of remittance
advices
(ii) Monthly bank reconciliation performed and reviewed independently
Tests of controls
(i) Review reconciliations
(ii) Review reconciliations for evidence performed and reviewed

BPP LEARNING MEDIA

 The bank and cash system 15

Cash receipts
Assertions: Classification
Control objective 2
To ensure that cash receipts are posted to correct receivables accounts
and to the general ledger
Controls
(i) Daily remittance report reconciled daily with postings to cash receipts
journal and customer accounts
(ii) Monthly customer statements sent out
(iii) Monthly cash receipts journal agreed to general ledger posting
(iv) Receivables ledger reconciled to control account

BPP LEARNING MEDIA

 The bank and cash system 16

Cash receipts
Assertions: Classification
Tests of controls
(i) Review reconciliations
(ii) Review entity's procedures for sending out statements
(iii) Review journal and posting to general ledger

BPP LEARNING MEDIA

 The bank and cash system 17

Cash receipts
Assertion: Cut-off
Control objective
To ensure that cash receipts are recorded in the correct accounting
period
Controls
Bank reconciliation at period-end
Tests of controls
Review reconciliation to confirm it has been done and reviewed

BPP LEARNING MEDIA

 The bank and cash system 18

Cash receipts
Assertions: Presentation and disclosure
Control objective
To ensure that cash receipts are charged to the correct accounts
Controls
(i) Chart of accounts in place and regularly reviewed
(ii) Codes in place for different types of receipts
Tests of controls
(i) Inspect any documentary evidence (eg emails requesting update to
chart of accounts as a result of review)
(ii) Test application controls for proper codes

BPP LEARNING MEDIA

 Exam link: Cash controls

• Internal control deficiencies relating to cash were tested in the

December 2016 exam (Section B, Q18).
• Cash controls around cash payments and receipts will also be
relevant to controls in the purchasing and sales systems
respectively, so could be examined on a question on deficiencies
in a purchases or sales system.

BPP LEARNING MEDIA

 Non-current assets 1

• To a large extent, controls over non-current assets focus on the

distinction between capital and revenue expenditure.
• It is important that an entity has controls in place to ensure that capital
and revenue expenditure are accounted for correctly as errors will
result in the misstatement of profit and net assets.
• Management may have an incentive to misclassify expenditure in
order to manipulate profit or for tax purposes.
• Costs which are susceptible to incorrect accounting treatment are
repairs and maintenance, research and development, and
website/software costs.

BPP LEARNING MEDIA

 Real world example: WorldCom

In 2001, WorldCom recognised over $3 billion of operating costs as

capital expenditure on its statement of financial position. These costs
related to 'line costs' – fees that the company had to pay other
telecom companies for the right to access their networks.
If the company had recognised this as revenue expenditure that year,
it would have made a loss, but by capitalising the costs, it managed
to smooth its earnings.
The fraud was uncovered by WorldCom's internal auditors and its
new external auditors, KPMG.

BPP LEARNING MEDIA

 Non-current assets 2

Assertion: Authorisation
Control objectives
To ensure that expenditure is properly authorised
Controls
(i) Orders for capital items should be authorised by appropriate levels of
management.
(ii) Order should be requisitioned on appropriate (different to revenue)
documentation.
(iii) Invoices should be approved by the person who authorised the order.
(iv) Invoices should be marked with the appropriate general ledger code.

BPP LEARNING MEDIA

 Non-current assets 3

Tests of controls
(i) Review policies and procedures in place.
(ii) Examine a sample of orders for appropriate authorisation.
(iii) Inspect invoices to verify the invoice has been appropriately
approved.
(iv) Inspect invoices to verify the invoice has the correct general ledger
code marked on it.

BPP LEARNING MEDIA

 Non-current assets 4

Assertion: Completeness
Control objectives
To ensure that all non-current assets are correctly recorded in the
accounting system
Controls
(i) Capital items should be written up in the non-current asset register.
(ii) The non-current asset register should be reconciled regularly to the
general ledger and any differences should be investigated and
resolved promptly.

BPP LEARNING MEDIA

 Non-current assets 5

Assertion: Completeness
Tests of controls
Review reconciliations to ensure they are regularly carried out, reviewed
by a more senior person, and that all discrepancies are followed up and
resolved on a timely basis.

BPP LEARNING MEDIA

 Non-current assets 6

Assertion: Classification
Control objectives
To ensure that all expenditure is classified correctly in the financial
statements as capital or revenue expenditure
Controls
As for purchases system
Tests of controls
As for purchases system

BPP LEARNING MEDIA

 Question: Sep/Dec 21 (Sec B, Question 17b) 1

It is 1 July 20X5. Pomeranian Co is a manufacturer of fizzy drinks and operates

across the country. The company’s year end is 30 September 20X5. You are an
audit supervisor with Poodle & Co and you are reviewing extracts from the
internal controls documentation in preparation for the forthcoming audit.
Sales
All new customers of Pomeranian Co are required to pass suitable credit
checks. Upon passing the credit check customers are set up in the receivables
ledger master file and a credit limit is set by the sales director. The credit limits
are only then changed when a customer requests an increase.
Customers orders are processed by Pomeranian Co’s sales ordering
department and goods are dispatched from one of the company’s warehouses.
Sequentially numbered multi-part goods dispatched notes (GDNs) are
completed and a copy is filed in the warehouse when the goods are dispatched.
Copies of the GDNs are sent to the sales ordering department and the finance
department on a weekly basis.

BPP LEARNING MEDIA

 Question: Sep/Dec 21 (Sec B, Question 17b) 2
Pomeranian Co’s credit controller is currently on maternity leave for six months
and no one has taken over her duties. As part of the month-end procedures, a
clerk reconciles the receivables ledger control account to the receivables ledger
and the reconciliation are only reviewed by the financial controller if there are any
unreconciled differences.
Non-current assets
An annual capital expenditure budget is set for each department within
Pomeranian Co and is referred to as part of the approval process. Board approval
is required for any capital items costing more than $0.5 million. Capital
expenditure below this level can be authorised by the relevant head of
department.
Pomeranian Co has a head office and five factories, each of which includes a
warehouse. The company has an internal audit (IA) department which is required,
over a three-year cycle, to carry out a comparison between all the assets recorded
on the non-current assets register to those physically present in each of the
company’s 11 sites. The programme of visits for the current year means that by
the year end, IA will only have completed this comparison at one factory and one
warehouse.
BPP LEARNING MEDIA
 Question: Sep/Dec 21 (Sec B, Question 17b) 3

Purchases and inventory

Pomeranian Co maintains a perpetual inventory system in which finished goods
and raw materials, stored in the warehouses, are counted monthly throughout the
year rather than just being counted at the year end. Each of the five warehouse
managers are responsible for supervising the inventory counts at their sites and
ensuring that the counting teams are following the issued instructions.
The company calculates the cost of its inventory using standard costs, both for
internal management reporting and for inclusion in the year-end financial
statements. The basis of the standard costs was reviewed by the production
department approximately two years ago.
The company has a central purchasing department which is based at its head
office. All members of this department have full access to the supplier master file
data and a monthly exception report of any changes to master file date is
automatically generated and then filed by a purchasing clerk.

BPP LEARNING MEDIA

 Question: Sep/Dec 21 (Sec B, Question 17b) 4

Sequentially numbered goods received notes (GRNs) are produced by the

warehouse department when goods are received, a copy of which is
promptly sent to the purchases and finance departments. On receipt of the
purchase invoices, the finance clerk matches the invoices to the relevant
purchase order and then passes the documents to the finance director for
authorisation prior to input.
Required
(b) Identify and explain EIGHT deficiencies in Pomeranian Co’s internal
control system and provide a control recommendation to address
each of these deficiencies. (16 marks)

BPP LEARNING MEDIA

 Answer: Sep/Dec 21 (Sec B, Question 17b) 4
Control deficiency
Credit limits set by the sales director are only
changed when a customer requests an increase.
If credit limits are not reviewed regularly, they could
be out of date, resulting in limits being too high and
therefore sales being made to poor credit risks or,
alternatively, too low and therefore Pomeranian Co
losing potential revenue.
Goods dispatched notes (GDNs) are sent to the
finance department on a weekly basis.
If the finance department does not promptly receive
GDNs, this could result in goods being dispatched
but being invoiced late. This could result in revenue
cut-off issues and understated receivables.
The company’s credit controller is currently on
maternity leave for six months and no one has taken
over her duties.
Therefore, during this period no one has been
responsible for monitoring and chasing ageing
receivables. This could result in an increased risk of
irrecoverable receivables and lead to customers not
paying their outstanding balances on time, or at all,
leading to reduced cash flows
BPP LEARNING MEDIA
Control recommendation
Credit limits should continue to be set by the sales
director, however these limits should be reviewed
and amended as appropriate on a regular basis by a
responsible official for example the finance director
or sales director.
The copies of the GDNs should be sent to the
finance department on a more frequent basis, such
as daily.
The finance department should undertake a
sequence check of the GDNs to ensure none are
missing for processing.
During the period of the maternity leave an
alternative member of the finance department
should be trained in the credit control role (or a
temporary credit controller recruited) and assigned
responsibility for reviewing the aged receivables
listing and following up on any overdue customers.
 Answer: Sep/Dec 21 (Sec B, Question 17b) 5
Control deficiency
The monthly receivables ledger control account
(RLCA) reconciliation is only reviewed by the
financial controller if there are any unreconciled
differences.
The RLCA reconciliation could reconcile but still
contain significant errors as there could be
compensating errors which cancel each other
out or it may have been incorrectly prepared or
manipulated and this would not be identified. If
the reconciliation is not reviewed, then this
significantly reduces its effectiveness.
Capital expenditure items below $0.5 million are
authorised by the relevant head of department.
$0.5 million is a significant sum and although
department heads undertake the authorisation
process, there is still considerable scope for non-
business use or surplus assets being purchased
leading to reduced profits and cash flow for
Pomeranian Co.
BPP LEARNING MEDIA
Control recommendation
The RLCA reconciliations should be reviewed by
the financial controller on a monthly basis, even
if there are no exceptions, and the review should
be evidenced by way of signature on the
reconciliation.
The authorisation level for department heads
should be significantly reduced to a more
appropriate level, such as $25,000. Any sums in
excess of this should be approved by the board.
If this proves too onerous, a capital expenditure
committee of senior employees should be
established for authorisation of capital items.
This committee should report to the board.
 Answer: Sep/Dec 21 (Sec B, Question 17b) 6
Control deficiency
The internal audit department (IA) undertakes
physical verification of assets each year. It is
supposed to verify all assets over a three-year
cycle, however in the current year IA will only
complete the relevant procedures at one factory
and one warehouse.
The company has five factories and warehouses
and a head office. Therefore, on this basis it will
take over five years to physically verify all
11 sites. If the non-current assets register is not
physically verified on a regular basis, there is an
increased risk of assets being misappropriated
or obsolete assets still being included in the
register, as there is no check that the assets still
exist in good working order.
BPP LEARNING MEDIA
Control recommendation
IA should review its programme of visits to
assess if additional resources could be devoted
to ensure that all 11 sites are visited in line with
the policy of three years. This would ensure that
physical verification of all assets could be
completed more regularly. During visits any
assets which cannot be located should be
investigated fully to identify where they could be.
If they cannot be located, then they should be
written off.
 Answer: Sep/Dec 21 (Sec B, Question 17b) 7
Control deficiency
The warehouse manager at each of the company’s
five sites is responsible for supervising the monthly
perpetual inventory counts and ensuring that the
counting teams are following their instructions.
The warehouse managers may wish to hide
inefficiencies and inventory discrepancies so that
their departments are not criticised. This could result
in inventory count records being inaccurate as well
as an increase in inventory frauds.
The company costs its inventory using standard
costs, which are not being kept up to date.
If the standard costs were last reviewed two years
ago there is the risk that the costs are misstated as
changes in raw materials and wages costs may not
have been adjusted for. This could result in
inventory and profits being misstated.
In addition, for year-end reporting, IAS 2 Inventories
only allows standard costs to be used for valuation
purposes, if they are a close approximation to actual
costs, which is unlikely if the standard costs remain
unchanged for a long period of time. Therefore, the
inventory cost may not be in line with IAS 2.
BPP LEARNING MEDIA
Control recommendation
The inventory counts should be supervised by an
independent person, such as a member of
Pomeranian Co’s IA department.
A review of all standard costs currently in use should
be undertaken by a senior manager in the
production department. Actual costs for materials,
labour and overheads should be ascertained and
compared to the proposed standard costs to ensure
they are a close approximation.
The revised standard costs should be reviewed by
the production director who should evidence this
review. At least annually, a review of the standard
costs should be undertaken by the production
director to ensure they are up to date.
 Answer: Sep/Dec 21 (Sec B, Question 17b) 8
Control deficiency
Access to the master file data for suppliers is
available to all those in the purchasing
department and the monthly exception report of
changes to master file data is not reviewed.
All members of the purchasing department could
amend data and, potentially, add new suppliers
to the payables ledger system, and as the
exception report is not reviewed it is unlikely that
this would be identified. This leads to an
increased risk of fraud as clerks could add
fictitious suppliers and then place fraudulent
orders without detection.
Purchase invoices are not agreed to the relevant
goods received notes (GRNs) prior to
authorisation and input.
This could result in invoices being paid for goods
which were not received, resulting in increased
costs.
BPP LEARNING MEDIA
Control recommendation
The monthly exception report of changes to
master file data should be reviewed by a
responsible official, who should evidence this
review. Any unauthorised or unexpected
changes should be investigated, and appropriate
action taken.
The ability to make amendments to master file
data should be restricted to those required and
authorised to make changes to this data.
All purchase invoices should be matched to both
the purchase order and the related GRN. The
details should be agreed prior to the invoice
being authorised and logged in the payables
ledger.
 Communication of deficiencies in internal control 1

• Once auditors have documented and tested the system, they might
find that there are weaknesses in the system.
• These weaknesses are known as deficiencies.
• Auditors have responsibilities regarding deficiencies in internal
control, as set out in ISAs.
• ISA 265 Communicating deficiencies in internal control to those
charged with governance and management.
• Auditors must communicate significant deficiencies in internal
control to those charged with governance and management.

BPP LEARNING MEDIA

 Communication of deficiencies in internal control 2

• A deficiency in internal control exists when a control is designed,

implemented or operated in such a way that it is unable to prevent, or
detect and correct, misstatements in the financial statements on a
timely basis, or a control necessary to prevent, or detect and correct,
misstatements in the financial statements on a timely basis is missing.
• A significant deficiency in internal control is a deficiency or
combination of deficiencies in internal control that, in the auditor's
professional judgement, is of sufficient importance to merit the
attention of those charged with governance.

BPP LEARNING MEDIA

 Communication of deficiencies in internal control 3
Factors the auditor must consider when judging whether a deficiency is
significant enough to be reported to TCWG and management:

BPP LEARNING MEDIA

 Communication of deficiencies in internal control 4

• Auditors must communicate significant deficiencies in internal control

on a timely basis in writing.
• Include a description of the deficiencies and an explanation of their
potential effect.
• Include sufficient information to enable those charged with
governance and management to understand the context of the
communication.

BPP LEARNING MEDIA

 Communication of deficiencies in internal control 4

• Auditors can include recommendations.

• They can state that more deficiencies may have been identified had
the auditor undertaken more extensive procedures on internal control
or that some of the reported deficiencies need not have been
reported.
• They can include a statement that the written communication is for the
purpose of those charged with governance and may not be suitable
for other purposes.

BPP LEARNING MEDIA

 Reports to management 1

• The report to management is a by-product of the external audit.

• It may also be known as a management letter or letter on internal
control.
• The purpose of a report to management is to set out significant
deficiencies in internal control, the implications of those deficiencies,
and possible recommendations to mitigate the deficiencies.
• A report to management may be sent after both the interim audit and
the final audit visits.
• Such reports are for internal use and are not in the public domain.
• ISA 265 Communicating deficiencies in internal control to those
charged with governance and management

BPP LEARNING MEDIA

 Reports to management 2

Drafting the report to management

• Do not include language which conflicts with the opinion in the
auditor's report.
• State the accounting and internal control system were considered
only to the extent necessary to determine auditing procedures to
report on the financial statements, and not to determine the adequacy
of internal control for management purposes or to provide assurances
on the accounting and internal control system.
• State it discusses only deficiencies in internal control which have
come to the auditor's attention as a result of the audit and that other
deficiencies in internal control may exist.
• Include a statement that the report is provided for use only by
management (or another specific named party).

BPP LEARNING MEDIA

 Tackling the exam

• A very common requirement from the AA examining team is to ask

you to explain the deficiencies of a given system in a scenario
question, together with suggesting recommendations.
• However, you must be prepared to consider strengths as well as
deficiencies.
• This type of requirement is generally worth a lot of marks and is
regularly tested.

BPP LEARNING MEDIA

 ISA 260 (Revised)

• Matters the auditor would communicate to TCWG.

BPP LEARNING MEDIA

 Question: Sep/Dec 20 (Sec B, Question 17b) 1

It is 1 July 20X5. Swift Co prints books which it sells online and

supplies to retailers across the country. The company’s year end is
30 September 20X5. You are an audit supervisor with Toucan & Co,
preparing the draft audit programmes and reviewing the internal
controls documentation in preparation for the interim audit.
Payroll
Swift Co employs factory staff who are required to work a standard
shift of eight hours per day. No staff members are required to work
overtime. All staff members are paid monthly by bank transfer. The
company has a resources (HR) department which is responsible for
setting up all new joiners and a payroll department which processes
wages and salaries.
When a new employee joins the company, HR completes a joiners’
form which includes a unique employee number for each new
employee.

BPP LEARNING MEDIA

 Question: Sep/Dec 20 (Sec B, Question 17b) 2

The joiners’ form is then sent to the payroll department so that the
new employee can be set up for payment. The unique employee
number must be entered into the payroll system before the employee
can be added to payroll. On a monthly basis, an exception report
relating to changes to the payroll standing data is produced and
reviewed by the payroll manager who evidences this review.
Employee hours worked and their hourly wage rates are preset into
the system, which automatically calculates the gross and net pay
along with relevant deductions and generates employee payslips.
The payroll supervisor selects a sample of the payslips, re-performs
the gross to net pay calculations and investigates any discrepancies.
The sampled payslips are then signed as evidence of this review.
Purchases
The company has a purchasing department based at its head office.
When raw materials are required, the production supervisors submit
a requisition form to the purchasing department.
BPP LEARNING MEDIA
 Question: Sep/Dec 20 (Sec B, Question 17b) 3

A multi-part purchase order is generated and the purchasing

manager authorises orders up to $5,000. Orders over $5,000 are
authorised by the purchasing director. The warehouse team
processes goods received from suppliers. They agree the goods
received to the purchase order and check the quantity and the quality
of the goods. On completion of those checks a goods received note
(GRN) is produced. One copy of the GRN is then signed and filed in
the warehouse. Another copy of the GRN is sent to the finance
department.
A payable ledger clerk logs the purchase invoices in batches of 20
into the purchase day book utilising control totals. A batch control
sheet is completed for each set of 20 invoices and the clerk signs to
evidence the checks undertaken.
Supplier statement reconciliations are performed on a monthly basis.
All differences are fully investigated, and the financial controller
reviews these reconciliations. Invoices are paid in accordance with
the supplier’s credit terms.
BPP LEARNING MEDIA
 Question: Sep/Dec 20 (Sec B, Question 17b) 4

The finance director authorises the bank transfer payment list for
suppliers having first agreed the amounts to be paid to supporting
documentation and having reviewed the list for duplicate payments.
Auditors are required to document a company's accounting and
internal control systems as part of their audit process. Three methods
available for documenting internal controls are narrative notes,
flowcharts and questionnaires.
Required
(b) In respect of the internal control system of Swift Co:
(i) Identify and explain SEVEN DIRECT CONTROLS which the
auditor may seek to place reliance on; and
(ii) Describe a TEST OF CONTROL the auditor should perform to
assess if each of these direct controls is operating effectively.
(14 marks)

BPP LEARNING MEDIA

 Answer: Sep/Dec 20 (Sec B, Question 17b) 1

Direct control Test of control

Swift Co has a separate human resources (HR) Review the job descriptions of payroll and HR to
department, which is responsible for setting up all confirm the split of responsibilities with regards to
new employees. setting up new joiners.
Having a segregation of roles between HR and Discuss with members of the payroll department the
payroll departments reduces the risk of fictitious process for setting up new joiners and agree new
employees being set up and also being paid. joiners to documentation initiated by HR.
All new employees are assigned a unique employee Attempt to add a new joiner to the payroll system
number by HR. The payroll system is unable to without a unique employee number, the system
process new joiners without the inclusion of the should reject this addition.
unique employee number.
As payroll staff are unable to set up new joiners
without the employee number from the joiner form it
reduces the risk of fictitious employees being set up
by payroll.
On a monthly basis an exception report of changes Select a sample of monthly exception reports and
to payroll standing data is produced and reviewed review for evidence of review and follow up of any
by the payroll manager. unexpected changes by the payroll manager.
This ensures that any unauthorised amendments to
standing data are identified and investigated on a
timely basis so that the data used when the payroll
is run is valid and accurate.

BPP LEARNING MEDIA

 Answer: Sep/Dec 20 (Sec B, Question 17b) 2
Direct control
The payroll supervisor selects a sample of
payslips and recalculates the gross to net
pay calculations, compares the results to
the output from the payroll system and
investigates any discrepancies.
This reduces the risk that the automated
system generates errors during the payroll
processing. Any errors would be identified
on a timely basis to prevent wages being
over or under paid.
Purchase orders up to $5,000 are
authorised by the purchasing manager
and above $5,000 by the purchasing
director.
This ensures that goods are only
purchased which are required by Swift Co
and relate to genuine business expenses.
BPP LEARNING MEDIA
Test of control
Review the monthly payslips sampled by
the payroll supervisor for their signature
for evidence the review of calculations has
been undertaken.
For a sample of monthly payrolls re-
perform the gross to net pay calculation
and compare to the payroll system,
discuss any discrepancies with the payroll
supervisor.
Select a sample of purchase orders and
review for evidence of authorisation in
accordance with authorisation limits. Agree
this to the appropriate signature on the
approved signatories list.
 Answer: Sep/Dec 20 (Sec B, Question 17b) 3

Direct control Test of control

The warehouse department agrees the receipt
of goods from suppliers to a copy of the
purchase order and confirms the quantity and
quality of the goods received and signs the
goods received notes (GRNs) to evidence the
checks.
This ensures that Swift Co is not recording
liabilities and subsequently paying for the
receipt of inferior quality goods or for goods it
did not order.
During the interim audit observe the
warehouse department when receiving
goods to understand the level of checks
being undertaken.
Review a sample of GRNs held in the
warehouse department for signature, as
evidence of checks being undertaken on
receipt of goods.

Purchase invoices are logged into the Select a sample of control total sheets and
purchase day book in batches, utilising control review for evidence of control totals being
totals. utilised and the clerk’s signature.
Utilising control totals ensures both
completeness and accuracy over the input
of purchase invoices. If the invoices are not all
input completely and accurately, payables may
be misstated.

BPP LEARNING MEDIA

 Answer: Sep/Dec 20 (Sec B, Question 17b) 4
Direct control
Supplier statement reconciliations are
undertaken on a monthly basis and these
are reviewed by the financial controller.
This ensures that any errors in the recording
of purchases and payables are identified
and corrected in a timely manner and
therefore that payables are complete and
accurate.
The finance director authorises the bank
transfer payment list for suppliers after
agreeing the amounts to be paid to
supporting documentation and reviewing
for any duplicate payments.
This reduces the risk that suppliers could be
being paid an incorrect amount, or that
sums are being paid to fictitious suppliers.
BPP LEARNING MEDIA
Test of control
Review the file of reconciliations to ensure
that they are being performed on a regular
basis and that they have been reviewed by
a responsible official.
Re-perform a sample of the reconciliations
to ensure that they have been carried out
appropriately and discrepancies
investigated.
Review the payments list for evidence of
review by the finance director.
Enquire of accounts staff what supporting
documentation the finance director requests
when undertaking this review.