AUDIT AND ASSURANCE (SKILL) MID DIET LIVE BROADCAST. (b) (i) Describe FIVE types of procedures for obtaining audit evidence; and

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1 AUDIT AND ASSURANCE (SKILL) MID DIET LIVE BROADCAST Question 1 a). Auditor s substantive procedures are designed in a manner to confirm financial statements assertion. Assertions are also directors representation Required: Describe FOUR main assertions and audit procedures each to confirm the assertions on Income Statement and Statement of Financial Position (10 marks) (b) (i) Describe FIVE types of procedures for obtaining audit evidence; and (ii) For each procedure, describe an example relevant to the audit of property, plant and equipment. Note: The total marks will be split equally between each part. (10 marks) Bristol Hotels Co operates a chain of 18 hotels located across the country. Each hotel has bedrooms, a restaurant and 1

2 leisure club facilities. Most visitors to the restaurant and leisure club are hotel guests; however, these facilities are open to the public as well. Hotel guests generally charge any costs to their room but other visitors must make payment directly to the hotel staff. During the year, senior management noticed an increased level of cash discrepancies and inventory discrepancies, and they suspect that some employees have been stealing cash and goods from the hotels. They are keen to prevent this from reoccurring and are considering establishing an internal audit department to undertake a fraud investigation. Required: (c) Explain how the new internal audit department of Bristol Hotels Co could assist the directors in preventing and detecting fraud and error. (3 marks) (d) Describe the limitations of Bristol Hotels Co establishing and maintaining an internal audit department. (2 marks) The directors would like the internal audit department to have as broad a role as possible, as this will make the 2

3 decision to recruit an internal audit department more cost effective. Required: (d) Describe additional functions, other than fraud investigations, the directors of Bristol Hotels Co could ask the internal audit department to undertake. (5 marks) (30 marks) 3

4 Please find below suggested solutions to our live class discussion questions on Audit and Assurance. Tutorial Substantive procedures involve verification of transactions and account balances to supporting records such as invoices and ledgers. The purpose of substantive procedures is to identify material misstatements in the financial statements. Substantive procedures consist of two activities as follows: 1) Analytical Substantive Procedures (simply known as analytical procedures or analytical review) 2) Test of Details, which is sub-divided into: a) Test of transactions [i.e. test of income statement figures] AND b) Test of account balances [i.e. test of statement of financial position figures]). Analytical procedures have been defined as the relationship between financial data and non-financial data of the same period (month by month) or different periods (year by year) to highlight significant differences. Analytical procedures also include assessment of relevant accounting ratios and trends and investigation into unexpected variances. 4

5 Q.1 Answers a).substantive Procedures & Financial Statement Assertions: are also directors representations. The table below shows FOUR types of assertions and their respective audit procedures. The tabulated audit procedures for each transaction or account balance reflect various ways of confirming an assertion. Income Statement Assertions Revenue Completeness: All transactions are recorded Select a sample of sales invoices in sequence and Accuracy: Transactions amounts recorded correctly Select a sample of sales invoices Occurrence: Transactions actually took place Select a sample of sales invoices Cut-off: Transactions recorded in correct accounting period Select a sample of sales invoices just before and after 5

6 Purchases trace to sales journal. Compare current year purchases with previous year to assess reasonableness of variance. Payroll Agree list of payroll total with general ledger and statement of financial position. and trace price quoted to official price list. Obtain purchase journals and cast total totals to confirm it correctness. Select a sample of employees and recalculate net pay using appropriate tax rates. and agree with goods dispatch notes. Select sample of purchase orders and agree with purchase invoices and good received notes. Select a sample of employees time sheets and compare with payroll list and bank payments. year end to confirm that it have been included and excluded respectively. Select a sample of purchase invoices just before and after year end to confirm that it have been included and excluded respectively. Select a sample of employees time sheets and net pays before and after year end and trace to correct accounting year. Statement of Financial Position (SFP) Assertions Noncurrent assets (NCAs) Completeness: All balances (assets & liabilities) are recorded Obtain list of NCAs and agree with general ledger and SFP. Existence: Balances (assets & liabilities) are real Visit locations of NCAs and inspect conditions of NCAs. Valuation: Assets & liabilities amount are correct Recalculate depreciation charges and agree with account. Right & Obligation: Entity has control over assets or responsibility to pay liabilities Review appropriate ownership documents to confirm document details relate to 6

7 Receivables Agree list of receivables total with receivable control accounts. Inventories Obtain and cast inventory list total and agree with SFP. Send confirmation letters to sample receivables. Attend inventory count and inspect sample inventories. Review receivables list to ensure bad debts are excluded. Review inventory list and assess allowance for slow moving items. entity. Review addressees of sample sale invoices and GDNs with receivables ledger. Review sample of purchase invoices and GRNs and confirm entity indeed purchased items. b).(i) Procedures to obtain evidence and (ii) audit test relevant to property, plant and equipment: a)(i) Inspection Inspection involves examining records or documents, whether internal or external, in paper form, electronic form, or other media, or a physical examination of an asset. (ii) Inspect a sample of capital items at the client site to ensure they exist, are in use and in good condition, and agree included in the non-current assets register to confirm completeness of assets. Inspect capital expenditure forms for evidence of authorization by a responsible official. 7

8 b).(i) Observation Observation consists of looking at a process or procedure being performed by others. (ii) Observe the process for logging property, plant and equipment invoices into the system to ensure that all invoices are entered completely and accurately. Observe the process of physical confirmation of noncurrent assets undertaken by internal audit/finance department c).(i) Analytical procedures Analytical procedures consist of evaluations of financial information through analysis of plausible relationships among both financial and non-financial data. Analytical procedures also encompass such investigation as is necessary of identified fluctuations or relationships that are inconsistent with other relevant information or that differ from expected values by a significant amount. (ii) Undertake a proof in total calculation for depreciation, taking into account additions and disposals, compare it to the actual charge and investigate any significant differences. Review monthly depreciation charges to identify any significant fluctuations and discuss with management. d).(i) Inquiry 8

9 Inquiry consists of seeking information from knowledgeable persons, both financial and non-financial, within the entity or outside the entity. (ii) Discuss with management whether there have been any changes in useful lives or residual values of assets as this will impact the depreciation calculation. Inquire of department heads the process they follow in authorizing capital expenditure orders to ensure that it follows the specified company authorization process. e).(i) Recalculation Recalculation consists of checking the mathematical accuracy of documents or records. Recalculation may be performed manually or electronically. (ii) Recalculate the depreciation charge for a sample of assets and agree the charge to the non-current assets register. Recalculate the profit or loss on disposal for a sample of assets disposed off in the year to ensure accuracy. f).(i) External confirmation An external confirmation represents audit evidence obtained by the auditor as a direct written response to the auditor from a third party, in paper form, electronic form or by other medium. 9

10 (ii) Obtain a confirmation from the company s bank or lawyers of any non-current assets held as security for loans, as this will require disclosure in the financial statements. Write to the firm who have undertaken the valuation of property, plant and equipment for the year and obtain a copy of their report in order to undertake testing of the assumptions and calculations. g.(i) Reperformance Reperformance involves the auditor s independent execution of procedures or controls that were originally performed as part of the entity s internal control. (ii) Reperform the non-current asset register reconciliation to the general ledger to ensure accuracy. Select a sample of authorized capital expenditure orders; match to the invoice and to inclusion in the non-current assets register to ensure completeness of the capital expenditure cycle. (c) Preventing and detecting fraud and error The directors of Bristol Hotels Co (Bristol) are responsible for the prevention and detection of fraud and error. However, the new internal audit department can help the directors by assessing the main areas of fraud risk, assessing the adequacy and effectiveness of control systems and helping to develop controls to mitigate key risks. 10

11 Having developed the controls, they can undertake regular reviews of compliance by each hotel of these controls. Where non-compliance is identified, they can instigate further training if necessary or report suspected frauds to senior management. Where fraud is suspected, the internal audit department can undertake a detailed fraud investigation to identify who is involved, likely sums stolen and gather evidence for any subsequent police investigation. In addition, the presence of an internal audit department can itself act as a fraud deterrent, as the risk of being discovered means individuals are less likely to undertake fraudulent activities. (d) Limitations of establishing and maintaining an internal audit department The internal auditors of Bristol will be employees of the company and so this can impair their independence, as they may not report issues to those charged with governance for fear of losing their job. Although some internal auditors are professionally qualified, there is no requirement to be qualified, as there is for external auditors. Hence, there may be gaps in the 11

12 experience and technical knowledge of the internal audit department. The cost of establishing an internal audit department can be significant; hence prior to recruiting a team, the management of Bristol should consider carefully the roles the team can perform and whether this will generate sufficient value for money. As Bristol has not previously had any form of internal audit, there may be some resistance from employees of the company. They may be uncomfortable with the idea of their work being reviewed, especially if the first role of the department is to undertake fraud investigations. e).additional functions for Bristol s internal audit department Monitoring asset levels The internal audit department could undertake inventory counts at the restaurants of the 18 hotels. There is likely to be a significant level of goods held at each hotel. Internal audit could count actual levels of goods held and compare them to the 12

13 hotels records. If consistent negative differences occur for a hotel, then this may be an early indicator of fraud. If positive differences are highlighted, then it could be because employees have not been adequately trained on how to record inventory. Cash controls at hotels Bristol s internal auditors could undertake controls testing over cash receipts and cash counts. It is likely that cash at each hotel will be significant as there would be cash at the reception, restaurant and leisure club. Each hotel should have tight controls over the cash receipts process. These controls should be tested at each location as well as performance of a cash count to reduce the level of errors. Customer satisfaction levels In order to improve the overall guest experience in the hotel, members of the internal audit department could undertake mystery guest reviews, where they enter the hotel as a guest, stay the night, eat and drink in the restaurant and visit the leisure club. They then rate the overall hotel experience. This is fed back to each hotel to improve customer service and can provide the basis for further training, if necessary. 13

14 Overall review of financial/operational controls The department could undertake reviews of controls at head office, as well as individual hotels and make recommendations to management over such areas as the purchasing process as well as the payroll cycle. IT system reviews Bristol is likely to have a relatively complex computer system linking all of the tills in the hotels to head office. The internal audit department could be asked to perform a review over the computer environment and controls. Value for money review The internal audit department could be asked to assess whether Bristol is obtaining value for money in areas such as capital expenditure. Regulatory compliance Beistol s operations include leisure clubs, restaurants and hotel rooms. There will be various laws and regulations such as health and safety, food hygiene and fire prevention that impact Bristol. The internal audit department could help to monitor compliance with these regulations. 14

15 Question 2 a) Distinguish between (i) Internal audit and External audit (8 marks) (ii) Interim Audit and Final Audit (4 marks b) ISA 300 Planning an Audit of Financial Statements provides guidance to assist auditors in planning an audit. Required: Explain the benefits of audit planning. (4 marks) (c) List and explain the purpose of FOUR items that should be included on every working paper prepared by the audit team. (4 marks) (20 marks) 15

16 Q2. Answers a). Difference between Internal and External Audits 1.Objective External Audit The Objective of the external auditor is to express an opinion on the truth and fairness of the financial statements Internal Audit The main objective of internal audit is to improve a company s operations, by reviewing the efficiency and effectiveness of the company s internal controls. 16

17 2.Reporting External auditors report to the shareholders or members of the company. External audit reports are contained within the financial statements and hence are publicly available. Internal auditors normally report to Management or those charged with governance. Internal audit reports are not publicly available and are only intended to be seen by the addressee of the report. The reports are normally provided to the board of directors and those charged with governance such as the audit committee. 3.Scope of Work The external auditor s work is limited to verifying the truth and fairness of the The internal auditor can have a wide scope of work and it is determined by the requirements of ma those charged with 17

18 financial statements of the company. governance. Commonly internal audit focus on the company s internal control environment,but any other area of a company s operations can be reviewed. 4.Relationship with Company External auditors are appointed by the company s shareholders. They are independent of the company. Internal auditors are appointed by management. As internal auditors are normally employees of the company theylack independence. However, the internal audit department can be outsourced and this can increase their 18

19 independence. (b) Differences between an interim and a final audit Interim audit The interim audit is that part of the audit which takes place before the year end. The auditor uses the interim audit to carry out procedures which would be difficult to perform at the year end because of time pressure. There is no requirement to undertake an interim audit; factors to consider when deciding upon whether to have one include the size and complexity of the company along with the effectiveness of internal controls. Typical procedures undertaken during the interim audit include documenting and testing of internal controls, testing of profit and loss transactions for the year to date and identification of potential problems which may affect the final audit work. Final audit The final audit will take place after the year end and concludes with the auditor forming and expressing an 19

20 opinion on the financial statements for the whole year subject to audit. It is important to note that the final opinion takes account of conclusions formed at both the interim and final audit. Typical work carried out at the final audit includes follow up of items noted at the inventory count, obtaining confirmations from third parties, analytical reviews of figures in the financial statements, substantive procedures of account balances and transactions, review of events after the reporting period and going concern review. (c) Benefits of audit planning Audit planning is addressed by ISA 300 Planning an Audit of Financial Statements. It states that adequate planning benefits the audit of financial statements in several ways: Helping the auditor to devote appropriate attention to important areas of the audit. Helping the auditor to identify and resolve potential problems on a timely basis. Helping the auditor to properly organize and manage the audit engagement so that it is performed in an effective and efficient manner. 20

21 Assisting in the selection of engagement team members with appropriate levels of capabilities and competence to respond to anticipated risks and the proper assignment of work to them. Facilitating the direction and supervision of engagement team members and the review of their work. Assisting, where applicable, in coordination of work done by experts. (d) Working papers Name of client identifies the client being audited. Year-end date identifies the year end to which the audit working papers relate. Subject identifies the area of the financial statements that is being audited, the topic area of the working paper, such as receivables circularization. Working paper reference provides a clear reference to identify the number of the working paper, for example, being the 12th working paper in the audit of receivables. Preparer identifies the name of the audit team member who prepared the working paper, so any queries can be directed to the relevant person. Date prepared the date that the audit work was performed by the team member; this helps to identify what 21

22 was known at the time and what issues may have occurred subsequently. Reviewer the name of the audit team member who reviewed the working paper; this provides evidence that the audit work was reviewed by an appropriate member of the team. Date of review the date the audit work was reviewed by the senior member of the team; this should be prior to the date that the audit report was signed. Objective of work/test the aim of the work being performed, could be the related financial statement assertion; this provides the context for why the audit procedure is being performed. Details of work performed the audit tests performed along with sufficient detail of items selected for testing. Results of work performed whether any exceptions arose in the audit work and if any further work is required. Conclusion the overall conclusion on the audit work performed, whether the area is true and fair. 22

23 Question 3 Tom Beke is the managing director of Eternits, a private company. Eternits is currently audited by Haris & Co. Tom has informed you that the directors of Eternits wish to appoint your firm, Infinite & Co as auditors in place of Haris & Co, but they consider that Haris & Co will not be willing to resign. Required: (a). Assuming that Haris & Co are not willing to resign, set out the statutory and other procedures which will have to be followed by Eternits, your firm and which may be adopted by Haris & Co in connection with this proposed appointment. You should assume that Infinite & Co have adequate resources to take on the audit of Eternits, and that there are no issues surrounding independence or client intergrity. (b).assuming that Haris & Co are willing to resign part way through their term of office, set out the procedures to be followed by Haris & Co and Eternits in order to effect the resignation. (20 marks) 23

24 Q 3 Answers a) Statutory and other procedures to dismiss Haris and Co and appoint Infinite and Co Before Infinite and Co can accept nomination as auditor of Eternits i.the directors of Eternits should write to Haris and Co informing them of the company s intention to nominate Infinite and Co as its next auditors. ii.with Eternits s permission, Infinite and Co should write to Haris and Co asking if there is any professional reason why Infinite and Co should not accept nomination. iii.haris and Co will then write back to Eternits asking for permission to respond. iv.eternits should give that permission. v.provided that Haris and Co give no professional reasons why Infinite and Co should not accept appointment, Infinite and Co should write to Eternits formally accepting nomination. 24

25 Before and at the general meeting at which Haris and Co will be removed from office and Infinite and Co appointed as auditors. i.haris and Co should be given notice of the meeting by Eternits ii.haris and Co have the right to attend the meeting and make statements to the members of Eternits. iii.alternatively, Haris and Co may require written statements to be circulated to the members in advance of the meeting. iv.at the meeting, the shareholders should vote on the appointment of Infinite and Co as auditors. A simple majority will secure the appointment. v.there is no vote to dismiss Haris and Co. They are simply not re-appointed. vi.infinite and Co should send a letter of engagement to Eternits vii. Documentation should be filled by Eternits with the appropriate regulatory authority. b)procedures if Haris and Co are willing to resign 25

26 i.haris and Co should tender their resignation to Eternits in writing. ii.eternits should file this with the appropriate regulatory authority. iii.eternits and Co should prepare a statement of circumstances of the resignation, if they believe there are circumstances of relevance to the shareholders or creditors of the company. If no such circumstances exist, Haris and Co should make a statement to this effect. This statement should be sent: Q 3 Answers a) Statutory and other procedures to dismiss Haris and Co and appoint Infinite and Co Before Infinite and Co can accept nomination as auditor of Eternits i.the directors of Eternits should write to Haris and Co informing them of the company s intention to nominate Infinite and Co as its next auditors. ii.with Eternits s permission, Infinite and Co should write to Haris and Co asking if there is any professional reason why Infinite and Co should not accept nomination. 26

27 iii.haris and Co will then write back to Eternits asking for permission to respond. iv.eternits should give that permission. v.provided that Haris and Co give no professional reasons why Infinite and Co should not accept appointment, Infinite and Co should write to Eternits formally accepting nomination. Before and at the general meeting at which Haris and Co will be removed from office and Infinite and Co appointed as auditors. i.haris and Co should be given notice of the meeting by Eternits ii.haris and Co have the right to attend the meeting and make statements to the members of Eternits. iii.alternatively, Haris and Co may require written statements to be circulated to the members in advance of the meeting. iv.at the meeting, the shareholders should vote on the appointment of Infinite and Co as auditors. A simple majority will secure the appointment. 27

28 v.there is no vote to dismiss Haris and Co. They are simply not re-appointed. vi.infinite and Co should send a letter of engagement to Eternits vii. Documentation should be filled by Eternits with the appropriate regulatory authority. b)procedures if Haris and Co are willing to resign i.haris and Co should tender their resignation to Eternits in writing. ii.eternits should file this with the appropriate regulatory authority. iii.eternits and Co should prepare a statement of circumstances of the resignation, if they believe there are circumstances of relevance to the shareholders or creditors of the company. If no such circumstances exist, Haris and Co should make a statement to this effect. This statement should be sent: By Haris and Co to the regulatory authority By Eterntis to all persons entitled to receive a copy of the company s financial statements (principally the shareholders) and to the Registrar of Companies. 28

29 iv. Haris and Co may require the directors of Eternits to call a meeting of the shareholders in order to discuss the circumstances of the resignation. Q 3 Answers a) Statutory and other procedures to dismiss Haris and Co and appoint Infinite and Co Before Infinite and Co can accept nomination as auditor of Eternits i.the directors of Eternits should write to Haris and Co informing them of the company s intention to nominate Infinite and Co as its next auditors. ii.with Eternits s permission, Infinite and Co should write to Haris and Co asking if there is any professional reason why Infinite and Co should not accept nomination. iii.haris and Co will then write back to Eternits asking for permission to respond. iv.eternits should give that permission. v.provided that Haris and Co give no professional reasons why Infinite and Co should not accept appointment, Infinite 29

30 and Co should write to Eternits formally accepting nomination. Before and at the general meeting at which Haris and Co will be removed from office and Infinite and Co appointed as auditors. i.haris and Co should be given notice of the meeting by Eternits ii.haris and Co have the right to attend the meeting and make statements to the members of Eternits. iii.alternatively, Haris and Co may require written statements to be circulated to the members in advance of the meeting. iv.at the meeting, the shareholders should vote on the appointment of Infinite and Co as auditors. A simple majority will secure the appointment. v.there is no vote to dismiss Haris and Co. They are simply not re-appointed. vi.infinite and Co should send a letter of engagement to Eternits 30

31 vii. Documentation should be filled by Eternits with the appropriate regulatory authority. b)procedures if Haris and Co are willing to resign i.haris and Co should tender their resignation to Eternits in writing. ii.eternits should file this with the appropriate regulatory authority. iii.eternits and Co should prepare a statement of circumstances of the resignation, if they believe there are circumstances of relevance to the shareholders or creditors of the company. If no such circumstances exist, Haris and Co should make a statement to this effect. This statement should be sent: By Haris and Co to the regulatory authority By Eterntis to all persons entitled to receive a copy of the company s financial statements (principally the shareholders) and to the Registrar of Companies. iv. Haris and Co may require the directors of Eternits to call a meeting of the shareholders in order to discuss the circumstances of the resignation. Q 3 Answers a) Statutory and other procedures to dismiss Haris and Co and appoint Infinite and Co 31

32 Before Infinite and Co can accept nomination as auditor of Eternits i.the directors of Eternits should write to Haris and Co informing them of the company s intention to nominate Infinite and Co as its next auditors. ii.with Eternits s permission, Infinite and Co should write to Haris and Co asking if there is any professional reason why Infinite and Co should not accept nomination. iii.haris and Co will then write back to Eternits asking for permission to respond. iv.eternits should give that permission. v.provided that Haris and Co give no professional reasons why Infinite and Co should not accept appointment, Infinite and Co should write to Eternits formally accepting nomination. Before and at the general meeting at which Haris and Co will be removed from office and Infinite and Co appointed as auditors. 32

33 i.haris and Co should be given notice of the meeting by Eternits ii.haris and Co have the right to attend the meeting and make statements to the members of Eternits. iii.alternatively, Haris and Co may require written statements to be circulated to the members in advance of the meeting. iv.at the meeting, the shareholders should vote on the appointment of Infinite and Co as auditors. A simple majority will secure the appointment. v.there is no vote to dismiss Haris and Co. They are simply not re-appointed. vi.infinite and Co should send a letter of engagement to Eternits vii. Documentation should be filled by Eternits with the appropriate regulatory authority. b)procedures if Haris and Co are willing to resign i.haris and Co should tender their resignation to Eternits in writing. ii.eternits should file this with the appropriate regulatory authority. 33

34 iii.eternits and Co should prepare a statement of circumstances of the resignation, if they believe there are circumstances of relevance to the shareholders or creditors of the company. If no such circumstances exist, Haris and Co should make a statement to this effect. This statement should be sent: By Haris and Co to the regulatory authority By Eterntis to all persons entitled to receive a copy of the company s financial statements (principally the shareholders) and to the Registrar of Companies. iv. Haris and Co may require the directors of Eternits to call a meeting of the shareholders in order to discuss the circumstances of the resignation. By Haris and Co to the regulatory authority By Eterntis to all persons entitled to receive a copy of the company s financial statements (principally the shareholders) and to the Registrar of Companies. iv. Haris and Co may require the directors of Eternits to call a meeting of the shareholders in order to discuss the circumstances of the resignation. 34