Audit And Internal Review

(UK Stream) PART 2 TUESDAY 9 DECEMBER 2003

QUESTION PAPER Time allowed 3 hours This paper is divided into two sections Section A

ALL THREE questions are compulsory and MUST be answered

Section B

TWO questions ONLY to be answered

Paper 2.6(GBR)

Audit and Internal Review

Section A – ALL THREE questions are compulsory and MUST be attempted 1

Internal auditors often assist management in performing internal review assignments covering, for example, human resources, procurement (purchasing), marketing and treasury activities. Such reviews involve: (i)

the identification of risks;

(ii) the identification of control systems and procedures implemented to manage those risks; (iii) tests of controls to ensure that internal controls are operating effectively; (iv) an evaluation of the overall effectiveness of the design and operation of controls in managing the risks identified. You are the internal auditor for a private company, Cleanco. Cleanco provides cleaning services to shops and offices and has a reputation for high quality work. You have been asked to review the human resources, procurement and marketing functions within the company. Cleanco employs about 500 cleaning staff, all of whom are on the payroll, and most of whom work part-time. Cleanco does not employ sub-contractors. Cleanco has a high turnover of staff. The company buys its computers, office stationery and furniture, cleaning materials, equipment and work clothes for staff, from a variety of different suppliers. It processes its payroll in-house. The company has recently decided to out-source its marketing to a large, aggressive, third party company that will advertise Cleanco’s services by means of direct mail, sometimes by offering discounts; this company has been criticised in the past for breaching advertising regulations. There is growing price competition in Cleanco’s market. Cleanco is struggling to maintain its profitability and would like to expand its client base. Cleanco has three main functions: (i) human resources; (ii) procurement; (iii) marketing. Required: For each of the three main functions at Cleanco describe the: (a) risks that you expect the company to face; (b) controls you expect to be in place to manage the risks you have identified in (a), above; (c) tests of control you should perform to check that the controls you have identified in (b) above are operating properly. Marks will be awarded as follows: (i)

Human resources.

(8 marks)

(ii) Procurement.

(6 marks)

(iii) Marketing.

(6 marks)

You may present your answer in tabular format, if you wish. (20 marks)

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SAS 300 Accounting and internal control systems and audit risk assessments deals with internal control objectives and internal controls. SAS 400 Audit evidence deals with audit objectives and audit procedures. A proper understanding of internal controls is essential to auditors in order that they understand the business and are able to effectively plan and execute tests of controls and an appropriate level of substantive procedures. You are the auditor of a small manufacturing company, Dinko, that pays its staff in cash and by bank transfer and maintains its payroll on a small stand-alone computer. Required: (a) For the payroll department at Dinko, describe the: (i)

internal control objectives that should be in place;

(4 marks)

(ii) internal control environment and internal control procedures that should be in place to achieve the internal control objectives. (6 marks) (b)

For the payroll charges and payroll balances (including cash) in the financial statements of Dinko: (i)

describe the external auditor audit objectives;

(4 marks)

(ii) list the tests of control and substantive procedures that will be applied in order to achieve the audit objectives identified in (b) (i) above. (6 marks) (20 marks)

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(a) Describe external auditors’ responsibilities and the work that they should perform in relation to the going concern status of companies. (5 marks) (b) Describe the possible audit reports that can be issued where the going concern status of a company is called into question; your answer should describe the circumstances in which they can be issued. (5 marks) Corsco is a large telecommunications company that is listed on the Stock Exchange. It is highly geared because, like many such companies, it borrowed a large sum to pay for a licence to operate a mobile phone network with technology that has not proved popular. The company’s share price has dropped by 50% during the last three years and there have been several changes of senior management during that period. There has been considerable speculation in the press over the last six months about whether the company can survive without being taken over by a rival. There have been three approaches made to the company by other companies regarding a possible takeover but all have failed, mainly because the bidders pulled out of the deal as a result of the drop in share prices generally. The company has net assets, but has found it necessary to severely curtail its capital investment program. Some commentators consider this to be fundamental to the future growth of the business, others consider that the existing business is fundamentally sound. It has also been necessary for the company to restructure its finances. Detailed disclosures of all of these matters have always been made in the financial statements. No reference has been made to the going concern status of the company in previous auditors’ reports on financial statements and the deterioration in circumstances in the current year is no worse than it has been in previous years. Required: (c) On the basis of the information provided above, describe the audit report that you consider is likely to be issued in the case of Corsco, giving reasons. (4 marks) (d) Explain the difficulties that would be faced by Corsco and its auditors if Corsco’s audit report made reference to going concern issues. (6 marks) (20 marks)

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[P.T.O.

Section B – TWO questions ONLY to be attempted 4

You are an audit manager in an audit firm with ten offices and 250 staff. Your firm is the auditor of Calva, a chain of supermarkets. Your firm has been the auditor of this client for many years. All of the planning work and tests of control have been completed for Calva for the year ended 31 December 2003. Staff are still working on substantive procedures. The company operates a continuous stock checking system with good records and you have tested this system and will be relying on the records for the year-end figure. The company is intending to invest a substantial amount in opening new stores during the next year and it has been negotiating with both banks and property companies in relation to leases. Required: (a) Describe the objectives of the following and how these objectives will be met in the audit of Calva: (i)

overall review of financial statements;

(4 marks)

(ii) review of working papers.

(6 marks)

(b) Describe the: (i)

auditors’ responsibilities with regard to subsequent events;

(ii) procedures that should be applied during the subsequent events review at Calva.

(6 marks) (4 marks) (20 marks)

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Ajio is a charity whose constitution requires that it raises funds for educational projects. These projects seek to educate children and support teachers in certain countries. Charities in the country from which Ajio operates have recently become subject to new audit and accounting regulations. Charity income consists of cash collections at fund raising events, telephone appeals, and bequests (money left to the charity by deceased persons). The charity is small and the trustees do not consider that the charity can afford to employ a qualified accountant. The charity employs a parttime bookkeeper and relies on volunteers for fund raising. Your firm has been appointed as accountants and auditors to this charity because of the new regulations. Accounts have been prepared (but not audited) in the past by a volunteer who is a recently retired Chartered Certified Accountant. Required: (a) Describe the risks associated with the audit of Ajio under the headings inherent risk, control risk and detection risk and explain the implications of these risks for overall audit risk. (10 marks) (b) List and explain the audit tests to be performed on income and expenditure from fund raising events. (10 marks) NB: In part (a) you may deal with inherent risk and control risk together. You are not required to deal with the detail of accounting for charities in either part of the question. (20 marks)

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6

Client confidentiality underpins the relationship between Chartered Certified Accountants in practice and their clients. It is a core element of ACCA’s Rules of Professional Conduct. Required: (a) Explain the circumstances in which ACCA’s Rules of Professional Conduct permit or require external auditors to disclose information relating to their clients to third parties without the knowledge or consent of the client. (8 marks) (b) A waste disposal company has breached tax regulations, environmental regulations and health and safety regulations. The auditor has been approached by the tax authorities, the government body supervising the award of licences to such companies and a trade union representative. All of them have asked the auditor to provide them with information about the company. The auditor has also been approached by the police. They are investigating a suspected fraud perpetrated by the managing director of the company and they wish to ask the auditor certain questions about him. Required: Describe how the auditor should respond to these types of request.

(12 marks) (20 marks)

End of Question Paper

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