SESSION 14 – PART C QUESTIONS

1. Diyol

Diyol Del Co (Diyol) manufactures custom made furniture and its year
end is 30 April.

You are the audit supervisor of Jaimse & Co and are developing the
audit programmes for Diyol's forthcoming interim audit.

You have ascertained that Diyol purchases its raw materials from a
wide range of approved suppliers. 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.

Diyol has an internal audit department which has provided you with
details of the internal controls around the non-current assets cycle.
One such control is that upon receipt of a new asset, each asset is
assigned a unique serial number and this is recorded on the asset
and in the non-current assets register.

i. As part of audit planning, the audit team needs to obtain an

understanding of the company's system of internal control.
Paul, the audit junior, is unsure what a company's internal
control comprises.

Which of the following is NOT a component of an entity's

internal control?

A. The control environment

B. Control activities relevant to the audit
C. The selection and application of accounting policies
D. The information system relevant to financial reporting

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 ii. Which of the following are the most likely consequences of
the internal control deficiency described in the requisition
system for raw materials?

(1) Fraudulent purchases may be made, leading to funds being

diverted to third parties for illegal purposes.

(2) Stock-outs may occur, resulting in the company being

unable to meet orders and lost revenue.

(3) Unnecessary purchases may be made, resulting in excess

obsolescent raw materials accumulating in inventory
requiring to be written down.

(4) Raw materials of poor quality may be purchased, resulting in

low quality products being produced, customer goodwill
being lost and going concern risks.

A. 1 and 3
B. 2 and 3
C. 1 and 4
D. 2 and 4

iii. While reviewing Diyol's purchases cycle, you identified that

goods received notes for raw material purchases are not
sequentially numbered.

Which of the following areas would you consider to be

most at risk of material misstatement, as a result of this
internal control deficiency?

A. Rights and obligations of inventory

B. Valuation of payables
C. Existence of inventory
D. Completeness of payables

iv. You now turn your attention to Diyol's non-current assets cycle.

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 Which of the following statements is correct regarding
audit procedures concerning the non-current assets cycle?

A. If the same ordering documentation is used in the non-

current assets cycle as in the purchases cycle, it will not be
necessary to produce additional systems documentation.

B. Because there are likely to be fewer capital purchases than

standard purchases in the year, it may not be cost efficient to
undertake tests of controls.

C. Because the control risk around the non-current assets cycle

is likely to be high, it is important to perform tests of controls.

D. The non-current assets cycle is likely to have a lower risk of

material misstatement than the purchases cycle.

v. In relation to the control relating to the receipt of a new

asset, which TWO of the following describe the MOST
RELIABLE audit procedures which enable the auditor to
assess whether this control is operating effectively?

(1) Select a sample of capital additions on site, agree that a

serial number is recorded on the asset and confirm it is
included in the non-current assets register

(2) Select a sample of assets recorded on the non-current

assets register, confirm that it includes a serial number for
each asset and agree the number to the physical asset

(3) Inspect the non-current asset register and verify that there
are no duplicated serial numbers

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 (4) Observe the receipt of assets to confirm that serial numbers
are assigned and recorded

A. 1 and 3
B. 2 and 3
C. 1 and 4
D. 2 and 4

Answers:

i. C. The selection and application of accounting policies

The selection and application of accounting policies is one of the

areas in which the auditor is required to gain an understanding, as
part of the auditor's risk assessment procedures. It is not a
component of internal control. The other components of internal
control are the risk assessment process and monitoring of
controls.

ii. B. 2 and 3

The fact that raw materials are being ordered without reviewing
inventory levels means that both stock-outs and excess
obsolescent inventory are likely. The lack of authorisation means
that fraudulent purchases could be made, but there is an approved
supplier list and money-laundering risks seem far-fetched.
Likewise, poorer quality goods may be ordered but the approved
supplier list does act as a control here – and going concern risks
are irrelevant.

iii. D. Completeness of payables

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 The fact that goods received notes (GRNs) are not sequentially
numbered means that GRNs may be omitted from accounting
records and it would be difficult to trace the unrecorded GRNs. As
a result, the risk is that payables (and inventory) is understated.

iv. B. Because there are likely to be fewer capital purchases than

standard purchases in the year, it may not be cost efficient to
undertake tests of controls.

It is likely that the number of capital purchases in the year will be

less than the number of standard purchases in the year. If the
invoices are not segregated, it may not be cost efficient to test the
controls over this area, in which case substantive testing would
have to be undertaken. Although controls around the non-current
assets cycle will probably resemble those around the purchases
cycle, the auditor should still understand how the company's
system records capital invoices. The risk of material misstatement
in relation to the non-current assets cycle is high, because orders
are likely to be of a less routine nature, larger amounts may be
involved, and there may be an incentive to account creatively for
tax or other purposes.

v. A. 1 and 3

The direction of the test is important here. If the sample of serial

numbers were taken from the non-current assets register, the
physical assets which were not assigned serial numbers and/or
were not recorded would not be identified. Reviewing the non-
current register to identify duplicate serial numbers will identify
instances when the serial numbers assigned were not unique,
making it difficult to trace the related assets. Observation is a valid
audit procedure, but it provides a weak form of audit evidence,
since it does not assure the auditor that the control would be
operated when the auditor is not there to observe it.

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2. Brighton

You are the audit senior on the interim audit of Brighton Co. The
company introduced a new system at the beginning of this financial
year. You have discussed the new system with the sales director, and
have noted the following two points in particular:

(1) Existing and new customers input their orders into computerised
order forms on Brighton Co's website. The order notes the items
requested, the billing and sales addresses, and the customer
number (if any). The system checks whether goods are in stock
and approves the order instantly if so. The order is forwarded
automatically to the sales department to be prepared.

(2) When an order is ready to send out, the sales department inputs
the details into their system, and if it matches the order, a goods
outward note is produced and the invoicing department is notified
automatically. Staff have experienced multiple issues of goods
outward notes not matching on the system, and have often
resorted to simply printing the order and using it as a goods
outward note. The printed order is then taken to the invoicing
department for invoicing.

The partner has requested that you document the new system
fully during the interim audit. She wants the system notes to be
easy to update, and to contain an element of evaluation of the
system.

i. In relation to orders received through the website which

of the following control objectives is met?

A. Goods are sold to customers with good credit ratings.

B. The company is able to fulfil the orders.
C. Customers do not exceed credit limits.
D. Changes in customer data are authorised.

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 ii. Your audit junior has identified four possible risks arising
from the use of the printed order as a goods outward note
and subsequent hand delivery to the invoicing department.

Which TWO of the below risks arise from the identified

system deficiency?

A. Orders are not fulfilled.

B. Goods are sent out but not invoiced.
C. Goods are invoiced but not sent out.
D. Wrong goods are sent to customers.

iii. You are reviewing the audit plan for tests of controls over
invoicing.

Which TWO of the procedures relate to the

completeness assertion?

A. Observe the invoicing clerk to ensure that prices are

checked to the official price list.

B. Review a sample of invoices to ensure their numerical

sequence.
C. Review a sample of goods out notes to ensure they have
been matched to sales invoices.
D. Review a sample of sales invoices to verify evidence that
the calculations were checked before they were sent to
customers.

iv. Your audit junior is seeking to understand when deficiencies

in internal control would be judged to be significant and
therefore should be reported to those charged with
governance.

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 Which TWO of the following factors would influence
your judgement of whether the control deficiencies
identified at Brighton are significant?

A. The likelihood of material misstatement resulting

B. The fact that the system is new
C. The number of deficiencies identified
D. The fact that the deficiencies are associated with the
sales system

v. In the light of the partner's request concerning

documentation, you are considering different options for
recording the system.

Which of the following recording methods most suits

her requirements?

A. A computerised ICEQ
B. Computerised narrative notes
C. A flowchart
D. Copying the company's control manual

Answers:

i. B. The company is able to fulfil the orders.

It is a deficiency in the system that the other three objectives do

not appear to be met.

ii. B. Goods are sent out but not invoiced.

D. Wrong goods are sent to customers.

This is because there is a risk that the printed orders will not be
invoiced properly as they may be lost or overlooked (being outside
the electronic system), hence the second risk. In addition, if the

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 reason the GRN details do not match is that they have been
fulfilled incorrectly (rather than due to simple typographical errors),
the staff member may assume it is a typing issue and simply print
the order, but not double check the goods properly against it,
hence the fourth risk. In this situation, a customer might be sent 50
goods rather than the ordered 5, but only be invoiced for 5, as the
invoice is generated from the order.

This issue should not cause goods to be invoiced without being

sent out, as invoices are generated from goods out notes or orders
being used as goods out notes.

It should also not cause orders not to be fulfilled, as the issue

arises when the order has been processed, so the order has not
been overlooked.

iii. B. Review a sample of invoices to ensure their numerical

sequence.

C. Review a sample of goods out notes to ensure they have been

matched to sales invoices.

The other two procedures relate to accuracy.

iv. A. The likelihood of material misstatement resulting

C. The number of deficiencies identified

The likelihood of material misstatement occurring is a key factor in

determining whether the deficiency is significant. The number of
deficiencies is a factor, as deficiencies may become significant if
there is a significant combination of deficiencies.

A control deficiency does not increase in significance simply due to

the area of business it relates to, but may become significant if
there is a risk of fraud. There is no more significant risk of fraud in
the sales system than in other systems, for example, the

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 purchases system or payroll system, so the business area is not a
critical factor.

Similarly, a deficiency is a deficiency regardless of whether the

related control is new or not. In fact, an old deficiency might be
more significant than a new one if, say, it had been previously
reported and not acted on.

v. A. A computerised ICEQ

This is the only option that has the element of evaluation that the
partner requires. The fact that it is computerised should also
influence how easy it is to update, therefore addressing her
second issue.

3. Edvin Co

You are a member of the recently formed internal audit department of

Edvin Co. The company manufactures snacks such as potato chips
which are supplied to large and small food retailers. Management and
those charged with governance of Edvin Co have concerns about the
effectiveness of their sales and despatch system and have asked the
internal audit function to document and review the system. The
following deficiencies have been identified:

(1) Availability of inventory is not checked at the time of ordering

(2) Telephone orders are not recorded immediately

(3) Order forms are not sequentially numbered

(4) The online ordering system allows customers to exceed their

credit limit

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i. Match the control deficiencies to an appropriate explanation
of the issue.

Deficiency Explanation
(1) A) Risk of incorrect orders being despatched
(2) B) Risk of irrecoverable debts
(3) C) Risk of orders not being fulfilled on a timely
basis
(4) D) Orders may go missing leading to unfulfilled
orders

ii. Which TWO of the following are appropriate

recommendations to address the credit limit system
deficiency?

A. Credit limits should be reviewed by a responsible official on a

regular basis and amended as appropriate

B. Sales order clerks should be allowed to use discretion to raise

credit limits to avoid losing revenue

C. The online ordering system should be programmed to allow

orders up to a maximum of 5% in excess of the credit limit

D. Orders exceeding the customer’s credit limit should be sent to a

responsible official for approval

iii. Which TWO of the following are NOT objectives of Edvin Co’s
sales and despatch system?

A. To ensure that orders are only accepted if goods are available

B. To ensure that all orders are recorded completely and

accurately

C. To ensure discounts allowed are only given to valid customers

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 D. To ensure all requisitions are authorised before orders are
placed

E. To ensure discounts received are accounted for completely and

accurately

F. To ensure that all goods despatched are correctly invoiced

iv. Which of the following recommendations should be made to

address deficiencies (2) and (3)?

1. Order clerks should have online access to view real‐time

inventory quantities at the time of ordering.

2. Order forms should be sequentially pre‐numbered and a

regular sequence check should be performed.

3. All orders should be entered directly into the ordering system

as the customer is placing the order

4. Customers should be instructed not to place orders by

telephone.

A. 1 and 2 only
B. 2 and 3 only
C. 2, 3 and 4
D. 1, 3 and 4

v. In respect of internal control questionnaires select whether

the following statements are true or false.

True False
Internal control questionnaires
An efficient method of systems
documentation

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 Does not consider all likely controls in a
system
Narrative notes
Usually very easy to identify missing controls
Facilitates understanding by junior team
members

Answers:
i. 1C, 2A, 3D, 4B

Deficiency Explanation

(1) Availability of C) Risk of orders not being fulfilled

inventory is not checked at on a timely basis
the time of ordering

(2) Telephone orders are A) Risk of incorrect orders being

not recorded immediately despatched

(3) Order forms are not D) Orders may go missing leading

sequentially numbered to unfulfilled orders

(4) The online ordering B) Risk of irrecoverable debts

system allows customers to
exceed their credit limit

ii. A. Credit limits should be reviewed by a responsible official on a

regular basis and amended as appropriate
D Orders exceeding the customer’s credit limit should be sent to
a responsible official for approval

iii. D. To ensure all requisitions are authorised before orders are

placed

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 E To ensure discounts received are accounted for completely
and accurately
True False
Internal control questionnaires

An efficient method of systems

True
documentation

Does not consider all likely controls in a

False
system

Narrative notes

Usually very easy to identify missing controls False

Facilitates understanding by junior team

True
members

Requisitions and discounts received are elements of a purchases

system. A control objective should also refer to the risk the control
is designed to mitigate, rather than the control itself

iv. B. 2 and 3 only

Requisitions and discounts received are elements of a purchases

system. A control objective should also refer to the risk the control
is designed to mitigate, rather than the control itself.

v. Internal control questionnaires are prepared in advance which

makes them an efficient method of documentation and can ensure
that all likely controls are considered, although more unusual
controls may be missed.

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 Narrative notes are simple to record and easy to understand.
However, due to the level of detail, missing controls may be
difficult to identify

4. Eric Co

Eric Co has recently upgraded its computer system to enable greater

automation of transaction processing. The new system has integrated
the sales, inventory and purchasing systems resulting in minimal
manual entry.

Sales orders are entered into the system manually. The inventory
system is automatically updated to reflect that inventory has been
allocated to an order. The system will flag if there is insufficient
inventory to fulfil the order. The inventory system is linked to the
purchasing system so that when inventory falls to a minimum level a
purchase order is automatically created and sent to the purchasing
manager for authorisation. Once the manager clicks ‘authorised’ the
order is automatically sent electronically to the approved supplier for
that item. The system is backed up daily to ensure minimal loss of
data in the event of a system failure.

Eric Co’s internal auditors were present during the implementation of

the new system and performed tests during the process to ensure the
information transferred into the new system was free from error. The
internal audit plan of work has been updated to include regular tests
of the system throughout the year to ensure it is working effectively.

The external auditor of Eric Co is planning to use computer‐assisted

audit techniques during the audit for the first time this year as a result
of the new system and is also planning to use the work of Eric Co’s
internal audit department if possible.

i. Which of the following is NOT a test of control in respect of

Eric Co’s system?

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 A. Trace a sample of purchase orders through to the approved
supplier list to ensure the supplier used is approved

B. Trace a sales order through to the system and into the sales
day book to ensure it is recorded

C. Review a sample of purchases orders in the system to

ensure they are authorised within the system

D. Inspect copies of the back‐ups taken to ensure these are

taken on a daily basis

ii. Select whether the following controls identified in Eric Co’s

systems are general or application controls.

General Application
Daily backups of
the system
Authorisation of
purchase orders
Minimum order
quantities
Automatic updating
of inventory once
goods are sold

iii. Which of the following procedures provides the MOST

reliable evidence that the inventory system updates
automatically once an order has been received?

A. Review the inventory level of an item, enter a sales order

into the system and review the inventory level again after the
order has been placed

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 B. Count a sample of items of inventory in the warehouse and
agree the quantities to the quantities stated in the inventory
system

C. Review the inventory report detailing quantities of items to

identify unusually high or low quantities

D. Contact a sample of customers to enquire whether they have

experienced delays in orders being processed due to
insufficient inventory being held

iv. Which of the following controls can be tested by placing a

dummy sales order for a large quantity of goods into the
system?

Control
The inventory system is
automatically updated to reflect
that inventory has been
allocated to a sales order
The system will flag if there is
insufficient inventory to fulfil the
order
When inventory falls to a
minimum level a purchase
order is automatically created
and sent to the purchasing
manager for authorisation
The purchase order is
automatically sent
electronically to the approved
supplier for that item

v. Which TWO of the following procedures should be performed

by the external auditor of Eric Co to identify whether the

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 work of Eric Co’s internal audit department can be relied
upon?

A. Review the internal auditor’s working papers to ensure

sufficient appropriate evidence has been obtained

B. Engage an independent expert to assess the new system

and validate the reliability of the internal audit department’s
work

C. Re‐perform a sample of procedures performed by the

internal auditor to ensure the same conclusion is reached

D. Assess whether Eric Co has an audit committee in place

responsible for overseeing the internal audit function. If so,
the external auditor can rely on the work performed by the
internal auditor without the need for further work

Answers:

i. B. Trace a sales order through to the system and into the sales
day book to ensure it is recorded

Tracing a transaction through the system to ensure it is recorded

in the sales day book is a substantive procedure testing the
assertion of completeness.

ii.

General Application
Daily backups of Yes
the system
Authorisation of Yes
purchase orders

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 Minimum order Yes
quantities
Automatic updating Yes
of inventory once
goods are sold

Backups relates to the whole computer system therefore are a

general control. Authorisation, minimum order quantities and
automatic updating of inventory relate to individual aspects of the
purchasing and inventory systems therefore are application controls.

iii. A. Review the inventory level of an item, enter a sales order into
the system and review the inventory level again after the order has
been placed

Reviewing inventory levels immediately before and after a sales

order has been processed enables the auditor to ensure the
inventory level is updated automatically. Counting a sample of
items to agree the quantities in the system does not prove the
system updates automatically. The quantities may agree because
that type of inventory may not have been sold recently and the
quantities reflect the results of the last inventory count. Reviewing
the inventory quantities in the system does not confirm the
quantities held in the warehouse or that the system updates
automatically. The auditor would not contact a customer to make
an enquiry such as the one described.

iv.

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 Control
The inventory system is automatically updated to Yes
reflect that inventory has been allocated to a sales
order
The system will flag if there is insufficient inventory Yes
to fulfil the order
When inventory falls to a minimum level a Yes
purchase order is automatically created and sent
to the purchasing manager for authorisation
The purchase order is automatically sent Yes
electronically to the approved supplier for that item
v. A. Review the internal auditor’s working papers to ensure
sufficient appropriate evidence has been obtained
C. Re‐perform a sample of procedures performed by the internal
auditor to ensure the same conclusion is reached

To rely on the internal auditor’s work, the external auditor should

review the internal auditor’s working papers and re‐perform a
sample of the tests again. An expert would not need to be used in
this situation as the auditor can easily see if the internal auditor
has performed the work properly by re‐performing a sample of
tests.

5. Melinda Co

Melinda Co (Melinda) operates a chain of hotels across the country.

Melinda employs in excess of 250 permanent employees and its year
end is 31 August 20X4. You are the audit supervisor of Santo & Co
and are currently reviewing the documentation of Melinda's payroll
system, detailed below, in preparation for the interim audit.

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 Melinda's payroll system

Permanent employees work a standard number of hours per week as

specified in their employment contract. However, when the hotels are
busy, staff can be requested by management to work additional shifts
as overtime. This can either be paid on a monthly basis or taken as
days off.

Employees record any overtime worked and days taken off on weekly
overtime sheets which are sent to the payroll department. The
standard hours per employee are automatically set up in the system
and the overtime sheets are entered by clerks into the payroll
package, which automatically calculates the gross and net pay along
with relevant deductions. These calculations are not checked at all.
Wages are increased by the rate of inflation each year and the clerks
are responsible for updating the standing data in the payroll system.

Employees are paid on a monthly basis by bank transfer for their

contracted weekly hours and for any overtime worked in the previous
month. If employees choose to be paid for overtime, authorisation is
required by department heads of any overtime in excess of 30% of
standard hours. If employees choose instead to take days off, the
payroll clerks should check back to the 'overtime worked' report;
however this report is not always checked.

The 'overtime worked' report, which details any overtime recorded by

employees, is run by the payroll department weekly and emailed to
department heads for authorisation. The payroll department asks
department heads to only report if there are any errors recorded.
Department heads are required to arrange for overtime sheets to be
authorised by an alternative responsible official if they are away on
annual leave; however there are instances where this arrangement
has not occurred.

The payroll package produces a list of payments per employee; this

links into the bank system to produce a list of automatic payments.
The finance director reviews the total list of bank transfers and

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 compares this to the total amount to be paid per the payroll records; if
any issues arise then the automatic bank transfer can be manually
changed by the finance director.

Required

i. In respect of the payroll system of Melinda Co:

A. Identify and explain FIVE deficiencies;

B. Recommend a control to address each of these

deficiencies; and

C. Describe a test of control Santo & Co should perform to

assess if each of these controls is operating effectively.

Note. The total marks will be split equally between each part.
Prepare your answer using three columns headed Control
deficiency, Control recommendation and Test of control
respectively.

ii. Explain the difference between an interim and a final audit.

Answers:

i.
Deficiencies Recommended Test of control
controls
The gross and net A senior member of Obtain the
pay automatically the payroll recalculations
calculated by the department should performed by the
payroll package are reperform a sample senior payroll
not checked at all. of the gross and net reviewer for
pay calculations. evidence that the
The lack of checking Any discrepancies automatic
increases the risk that

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 errors are being should be calculations have
accumulated without investigated. been reviewed.
being detected. This
could lead to wages
being over- or
understated.

The clerks update the Changes to the Observe a payroll

standing data to standing data to clerk attempting to
reflect the increase of reflect the annual make changes to
wages each year. wage increase payroll standing
should be made by a data, to determine
The apparent lack of senior member of whether the system
authorisation to the payroll rejects the changes
changes in standing department.
data increases the
risk of errors, leading
to the over- or
understatement of
wages, and the
incorrect payment of
wages.

Only payment for All overtime hours Review a sample of

overtime in excess of worked, whether in the weekly overtime
30% of the standard lieu of pay or sheets for evidence
hours are authorised holidays, must be of signature by the
by department heads. authorised by the head of the
relevant department department
This increases the head. The concerned.
risk of employees authorisation should
claiming for overtime be evidenced by
not worked, leading to signatures.
additional payroll
costs.
The payroll clerks do Payroll clerks must Review a sample of
not always check the agree holidays taken holidays taken in lieu
overtime worked in lieu to the of overtime to verify
report before overtime report, and whether the payroll

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 employees take time record that this has clerk has agreed the
off in lieu of overtime been done. Where time taken in lieu to
worked. inconsistencies are the overtime report.
identified, the payroll
This increases the clerks should notify
risk of employees the relevant
taking unauthorised department head.
leave, leading, again,
to wages being paid
for days which have
not been worked.
The finance director The finance director Inspect payment lists
reviews the total list of
should agree a for evidence that the
bank transfers and sample of the finance director has
compares this to the employees on the agreed a sample of
total payable per the payroll records to the payees to the payroll
payroll records. payment list, and records, and vice
vice versa, to ensure versa.
This process does not that payments are
prevent employees to complete, and made
be omitted from the only to bona fide
payroll. There is employees.
equally a risk of
fictitious employees,
or employees who
have left the
company, appearing
on payroll. As a
result, fraudulent
payments could be
made.

ii. The differences between an interim and a final audit can be

summarised as follows:

Interim audit

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 This is conducted during the period of review to carry out
procedures that would be difficult to perform at the year end
because of time constraints.

No statutory requirement to perform interim audit.

Procedures

 Inherent risk assessment and gaining an understanding of

the entity

 Documenting and evaluating the entity's system of internal

control

 Carrying out tests of control on the company's internal

controls to ensure they are operating as expected

Final Audit
After the year end to express an audit opinion on the financial
statements covering the entire period being audited. The
performance of the final audit is a statutory requirement.
Procedure

Substantive procedures involving verification of statement of

financial position balances and amounts in the statement of profit
or loss

 Obtaining third-party confirmations

 Analytical procedures relating to figures in the financial

statements

 Subsequent events review

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