Audit And Assurance MCQ Quiz - Objective Question with Answer for Audit And Assurance - Download Free PDF
Last updated on May 26, 2025
Latest Audit And Assurance MCQ Objective Questions
Audit And Assurance Question 1:
Ric Co
This scenario relates to four requirements.
It is 1 July 20X5. You are the audit supervisor of Matt & Co and are currently planning the audit of an existing client, Ric Co, for the year ended 31 May 20X5. Ric Co is a pharmaceutical company, which manufactures and supplies a wide range of medical supplies. The draft financial statements show revenue of $35.6m and profit before tax of $5.9m.
Ric Co’s previous finance director left the company in January 20X5 after it was discovered that he had been claiming fraudulent expenses from the company for a significant period. A new finance director was appointed in February 20X5. She was previously a financial controller of a bank and has expressed surprise that Matt & Co had not uncovered the fraud during last year’s audit.
During the year Ric Co has spent $1.8m on developing several new products. These projects are at different stages of development and the draft financial statements show the full amount of $1.8m within intangible assets. In order to fund this development, $2.0m was borrowed from the bank and is due for repayment over a ten-year period. The bank has attached minimum profit targets as part of the loan covenants.
The new finance director has informed the audit partner that since the year end there has been an increased number of sales returns and that in the month of June over $0.5m of goods sold in May were returned.
Matt & Co attended the year-end inventory count at Ric Co’s warehouse. The auditor present raised concerns that during the count there were movements of goods in and out the warehouse and this process did not seem well controlled.
During the year, a review of plant and equipment in the factory was undertaken and surplus plant was sold, resulting in a profit on disposal of $210,000.
Requirements:
(a) State Matt& Co’s responsibilities in relation to the prevention and detection of fraud and error. (4 marks)
(b) Describe SIX audit risks, and explain the auditor’s response to each risk, in planning the audit of Ric Co.
(12 marks)
(c) Ric Co’s new finance director has read about review engagements and is interested in the possibility of Matt & Co undertaking these in the future. However, she is unsure how these engagements differ from an external audit and how much assurance would be gained from this type of engagement.
(i) Explain the purpose of review engagements and how these differ from external audits; and
(2 marks)
(ii) Describe the level of assurance provided by external audits and review engagements.
(2 marks)
(20 marks)
Answer (Detailed Solution Below)
Audit And Assurance Question 1 Detailed Solution
(a) Fraud responsibility
Matt & Co must conduct an audit in accordance with ISA 240 The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements and are responsible for obtaining reasonable assurance that the financial statements taken as a whole are free from material misstatement, whether caused by fraud or error.
In order to fulfil this responsibility, Matt & Co is required to identify and assess the risks of material misstatement of the financial statements due to fraud.
They need to obtain sufficient appropriate audit evidence regarding the assessed risks of material misstatement due to fraud, through designing and implementing appropriate responses. In addition, Matt & Co must respond appropriately to fraud or suspected fraud identified during the audit.
When obtaining reasonable assurance, Matt & Co is responsible for maintaining professional scepticism throughout the audit, considering the potential for management override of controls and recognising the fact that audit procedures which are effective in detecting error may not be effective in detecting fraud.
To ensure that the whole engagement team is aware of the risks and responsibilities for fraud and error, ISAs require that a discussion is held within the team. For members not present at the meeting, Ric’s audit engagement partner should determine which matters are to be communicated to them.
(b) Audit risks and auditor’s responses
| Audit risk | Auditor’s response |
|
Ric’s previous finance director (FD) left in January after it was discovered that he had been committing fraud with regards to expenses claimed. There is a risk that the FD may have undertaken other fraudulent transactions; these would need to be written off in the statement of profit or loss. If these have not been uncovered, the financial statements could include errors. |
Discuss with the new FD what steps have been taken to identify any further frauds by the previous FD. The team should maintain their professional scepticism and be alert to the risk of further fraud and errors. |
| The new FD appointed in February 20X5 was previously a financial controller of a bank. As a pharmaceutical company is very different to a bank, the new FD may not be sufficiently experienced to prepare the financial statements, leading to errors. | During the audit, careful attention should be paid to any changes in accounting policies and in particular any key judgmental decisions made by the finance director. |
|
During the year, Ric spent $1.8m on developing new products; these are at different stages and the total amount has been capitalised as an intangible asset. An intangible asset can only be recognised if all the criteria of IAS 38 Intangible Assets are met. The cost of projects that may not reach the final development stage should be expensed rather than capitalised. Intangible assets and profit could be overstated. |
A breakdown of the development expenditure should be reviewed and tested in detail to ensure that only projects which meet the capitalisation criteria are included as an intangible asset, with the balance being expensed. |
|
Ric has borrowed $2.0m from the bank as a 10-year loan. This loan needs to be correctly split between current and non-current liabilities in order to ensure correct disclosure. Also as the level of debt has increased, there should be additional finance costs. There is a risk that this has been omitted from the statement of profit or loss, leading to understated finance costs and overstated profit. |
During the audit, the team would need to confirm that the $2m loan finance was received. Also, the split between current and non-current liabilities and disclosures should be reviewed in detail to ensure compliance with relevant accounting standards. The finance costs should be recalculated and any increase agreed to the loan documentation for confirmation of interest rates and cashbook and bank statements to confirm the amount was paid and is not, therefore, a year-end payable. |
| The loan has a minimum profit target covenant. If this is breached, the loan would be instantly repayable and would be classified as a current liability. | Review the covenant calculations prepared by Ric and identify whether any defaults have occurred; if so, determine the effect on the company. |
| If Ric does not have sufficient cash for the loan repayment, there could be going concern implications. Also, there is a risk of profit manipulation to meet any covenants. | The team should maintain their professional scepticism and be alert to the risk that profit has been overstated to ensure compliance with the covenant. |
|
There have been a significant number of sales returns made subsequent to the year end. As these relate to pre-year-end sales, they should be removed from revenue in the draft financial statements and the inventory reinstated. If the sales returns have not been correctly recorded, revenue will be overstated and inventory understated. |
Review a sample of the post-year-end sales returns and confirm that if they relate to pre-year-end sales, the revenue has been reversed and the inventory included in the year-end inventory balance in the general ledger and financial statements. In addition, the reason for the increased level of returns should be discussed with management. This will help to assess if there are underlying issues with the net realisable value of inventory. |
| During Ric’s year-end inventory count there were movements of goods in and out. If these goods in transit were not carefully controlled, goods could have been omitted or counted twice. This would result in inventory being under or overstated. | During the final audit, the goods received notes and goods despatched notes received during the inventory count should be reviewed and followed through into the inventory count records as correctly included or not. |
|
Surplus plant and equipment was sold during the year, resulting in a profit on disposal of $210,000. As there is a minimum profit loan covenant, there is a risk that this profit on disposal may not have been correctly calculated, resulting in overstated profits. In addition, significant profits or losses on disposal are an indication that the depreciation policy of plant and equipment may not be appropriate. Therefore depreciation may be overstated. |
Recalculate the profit and loss on disposal calculations and agree all items to supporting documentation. Discuss the depreciation policy for plant and equipment with the finance director to assess its reasonableness. |
(c) Review engagements
(i) Purpose and how differ from external audit
Review engagements are often undertaken as an alternative to an audit, and involve a practitioner reviewing financial data, such as six-monthly figures. This would involve the practitioner undertaking procedures to state whether anything has come to their attention which causes the practitioner to believe that the financial data is not in accordance with the financial reporting framework.
A review engagement differs to an external audit in that the procedures undertaken are not nearly as comprehensive as those in an audit; only analytical procedures and enquiry are used extensively. In addition, the practitioner does not need to comply with ISAs as these only relate to external audits.
(ii) Levels of assurance provided
External audit – A high but not absolute level of assurance is provided; this is known as reasonable assurance. This provides comfort that the financial statements present fairly in all material respects (show a true and fair view) and are free of material misstatements.
Review engagements – where an opinion is being provided, the practitioner obtains sufficient evidence to be satisfied that the subject matter is plausible; in this case negative assurance is given whereby the practitioner confirms that nothing has come to their attention which indicates that the subject matter contains material misstatements
Audit And Assurance Question 2:
Brad Co
It is 1 July 20X5. Brad Co operates an electric power station, which produces electricity 24 hours a day, seven days a week. The company’s year end is 31 July 20X5. You are an audit manager of Liam & Co, the auditor of Brad Co. The interim audit has been completed and you are reviewing the documentation describing Brad Co’s payroll system.
The payroll system is not integrated within the computerised accounting system.
Systems notes – payroll
Brad Co employs over 250 people and approximately 70% of the employees work in production at the power station. There are three shifts every day with employees working eight hours each. The production employees are paid weekly in cash. The remaining 30% of employees work at the head office in non-production roles and are paid monthly by bank transfer.
The company has a human resources (HR) department, responsible for setting up all new joiners. Pre-printed forms are completed by HR for all new employees and, once verified, a copy is sent to the payroll department for the employee to be set up for payment. This form includes the staff member’s employee number and payroll cannot set up new joiners without this information. To encourage staff to attend work on time for all shifts, Brad Co introduced a discretionary bonus, paid every three months, for production staff. The production supervisors determine the amounts to be paid and notify the payroll department. This quarterly bonus is entered into the system by a clerk and each entry is checked by a senior clerk for input errors prior to processing. The senior clerk signs the bonus listing as evidence of undertaking this review.
Production employees are issued with clock cards and are required to swipe their cards at the beginning and end of their shift. This process is supervised by security staff 24 hours a day. Each card identifies the employee number and links into the hours worked report produced by the payroll system, which automatically calculates the gross and net pay along with relevant deductions. These calculations are not checked.
In addition to tax deductions from pay, some employees’ wages are reduced for such items as repayments of student loans owed to the central government. All employers have a statutory obligation to remit funds on a timely basis and to maintain accounting records which reconcile with annual loan statements sent by the government to employers. At Brad Co student loan deduction forms are completed by the relevant employee and payments are made directly to the government until the employee notifies HR that the loan has been repaid in full.
On a quarterly basis, exception reports relating to changes to the payroll standing data are produced and reviewed by the payroll director. No overtime is worked by employees. Employees are entitled to take 28 holiday days annually. Holiday request forms are required to be completed and authorised by relevant line managers; however, this does not always occur.
On a monthly basis, for employees paid by bank transfer, the senior payroll manager reviews the list of bank payments and agrees this to the payroll records prior to authorising the payment. If any errors are noted, the payroll senior manager amends the records.
For production employees paid in cash, the necessary amount of cash is delivered weekly from the bank by a security company. Two members of the payroll department produce the pay packets; one is responsible for preparing them and the other checks the finished pay packets. Both members of staff are required to sign the weekly payroll listing on completion of this task. The pay packets are then delivered to the production supervisors, who distribute them to employees at the end of the employees’ shift, as they know each member of their production team.
Monthly management accounts are produced which detail variances between budgeted amounts and actual. Revenue and key production costs are detailed; however, as there are no overtime costs, wages and salaries are not analysed.
Requirements:
(a) In respect of the payroll system for Brad Co:
(i) Identify and explain FIVE DIRECT CONTROLS which the auditor may plan to on; and
(ii) Describe a TEST OF CONTROL the auditor should perform to determine if each of these direct controls is operating effectively.
| Direct control | Test of control |
Note: The total marks will be split equally between each part. (10 marks)
(b) Identify and explain FIVE DEFICIENCIES in Brad Co’s payroll system and provide a recommendation to address each of these deficiencies. (10 marks)
| Control deficiency | Control recommendation |
(c) The finance director is interested in establishing an internal audit department (IAD). In the company she previously worked for the IAD carried out inventory counts; however, as this is not relevant for Brad Co, she has asked for guidance on what other assignments an IAD could be asked to perform.
Describe assignments the internal audit department of Brad Co could carry out. (5 marks)
(d) Brad Co deducts employment taxes from its employees’ wages on a weekly/monthly basis and pays these to the local taxation authorities in the following month. At the year end the financial statements will contain an accrual for income tax payable on employment income.
Describe the substantive procedures the auditor should perform to confirm the year-end accrual for tax payable on employment income (5 marks)
(30 marks)
Answer (Detailed Solution Below)
Audit And Assurance Question 2 Detailed Solution
(a) Direct controls and tests of control
| Direct control | Test of control |
|
Brad Co has a separate human resources (HR) department which is responsible for setting up all new employees. Segregation of roles between HR and payroll departments reduces the risk that fictitious employees could be set up and paid. |
Review the job descriptions of payroll and HR to confirm the split of responsibilities with regards to setting up new joiners. Discuss with members of the payroll department the process for setting up new joiners and for confirmation that the process is initiated by HR. |
|
Pre-printed forms are completed by HR for all new employees, and includes assignment of a unique employee number, and once verified, a copy is sent to the payroll department. Payroll is unable to set up new joiners without information from these forms. The use of pre-printed forms ensures that all relevant information (e.g. tax IDs) is obtained about employees before set up. This minimises the risk of incorrect wage and tax payments. Also, as payroll is unable to set up new joiners without the forms and employee number, it reduces the risk that payroll could set up fictitious employees. |
Select a sample of new employees added to the payroll during the year; review the joiner forms for evidence of completion of all parts and that the information was verified as accurate and was received by payroll before adding to the system. Select a sample of edit reports for changes to payroll during the year; agree a sample of new employees added to payroll to the joiners forms. |
|
The quarterly production bonus is input by a clerk into the payroll system, each entry is checked by a senior clerk for input errors before processing, and they evidence their review via signature. This reduces the risk of input errors resulting in over/underpayment of the bonus to employees. |
If attending Brad Co at the time of bonus processing, observe the clerk inputting and senior clerk checking the bonus payments into the payroll system. Also, obtain listings of quarterly bonus payments and review for evidence of signature by the senior clerk who checks for input errors. |
|
Production employees are issued with clock cards and are required to swipe their cards at the beginning and end of their shift, this process is supervised by security staff 24 hours a day. This should ensure that genuine employees are only paid for the work actually done, and reduces the risk of paying employees who do not complete their eight-hour shift. Also, due to the supervision, it is unlikely that one employee could swipe in others. |
Observe the use of clock cards by employees when entering the power station. Confirm the security team is supervising the process and following up on discrepancies through discussions with the security staff. |
|
The clock card information identifies the employee number and links into the hours worked report produced by the payroll system. As the hours worked are automatically transferred into the payroll system, this reduces the risk of input errors in entering hours to be paid in calculating payroll, ensuring that employees are paid the correct amount. |
Utilise test data procedures to input dummy clock card information, verify this has been updated into the payroll system. |
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On a quarterly basis, exception reports of changes to payroll standing data are produced and reviewed by the payroll director. This should ensure that any unauthorised amendments to standing data are identified and resolved on a timely basis.
|
Select a sample of quarterly exception reports and review for evidence of review and follow up of any unexpected changes by the payroll director. |
|
For production employees paid in cash, cash is received weekly from the bank by a security company. It is likely the sum of money required to pay over 175 employees would be considerable. It is important that cash is adequately safeguarded to reduce the risk of misappropriation. |
Enquire of payroll clerks how cash is delivered to Brad Co for weekly pay packets. Review a sample of invoices from the security company to Brad Co for delivery of cash. |
|
The pay packets are prepared by two members of staff with one preparing and one checking the pay packets and this is evidenced by each staff member signing the weekly listing. This segregation of duties should prevent fraud and errors going undetected. |
Observe the preparation process ensuring that two members of staff are involved and that pay packets are checked for accuracy. For a sample of weeks throughout the year, inspect the weekly payroll listing for two signatures evidencing the staff involved. |
(b) Deficiencies and recommendations
| Control deficiency | Control recommendation |
|
Production supervisors determine the amount of the discretionary bonus to be paid to employees. Production supervisors should not determine this as they could pay extra bonuses to friends or family members, resulting in additional payroll costs. |
The bonus should be determined by a responsible official (e.g. the production director) and formulated based on a written policy. If significant in value, it should be formally agreed by the board of directors. The bonus should be communicated in writing to the payroll department. |
|
Wages calculations generated by the payroll system are not checked. Therefore, system errors occur during the payroll processing would not be identified. Wages could be over or under calculated, leading to an additional payroll cost or loss of employee goodwill, respectively. |
A senior member of the payroll team should recalculate the gross to net pay workings for a sample of employees and compare their results to the output from the payroll system. These calculations should be signed as approved before payments are made. |
|
Student loan deduction forms are completed by relevant employees and paid directly to government. As payments continue until the employee notifies HR, and employees may not monitor payments closely, there is the risk of overpayments, which need to be reclaimed, leading to employee dissatisfaction. In the case of underpayments, Brad Co has an obligation to remit funds on time and to reconcile to annual loan statements. Failure to do so could result in non-compliance by both the company and employee, resulting in fines or penalties. |
The payroll department should maintain a schedule, by employee, of payments to third parties as well as the cumulative balance owing. This statement should be reconciled to the loan statement received from the government and sent to the employee for agreement at least annually. In accordance with the schedule, payments which are due to cease shortly should be confirmed in writing with the third party, before stopping. |
|
Holiday request forms are required to be completed and authorised by relevant line managers; however, this does not always occur. Employees taking unauthorised leave may result in an overpayment of wages. It could also create production difficulties if an insufficient number of employees are present to operate the power plant. |
Employees should be informed that they will not be able to take holiday without completion of a holiday request form, with authorisation from the line manager. Payroll clerks should not process holiday payments without agreement to the authorised holiday form. |
|
The senior payroll manager reviews the bank transfer listing before authorising the payments and also amends the payroll records for any changes required. There is a lack of segregation of duties as it is the payroll team which processes the amounts and the senior payroll manager who authorises payments. The senior manager could fraudulently increase the amounts to be paid to certain employees, process this payment as well as amend the records. |
The senior payroll manager should not be able to process changes to the payroll system as well as authorise payments. The bank transfer listing should be authorised by someone outside the payroll department, such as the finance director. |
|
The pay packets are delivered to the production supervisors, who distribute them to employees at the end of their shift. The supervisor is not sufficiently independent to pay wages out. They could adjust pay packets to increase those of close friends whilst reducing others. Also, although the production supervisors know their team members, payment of wages without proof of identity increases the risk that wages could be paid to incorrect employees. |
All pay packets should be distributed by the payroll department, directly to employees, upon sight of the employee’s clock card and photographic identification as this confirms proof of identity. Pay packets issued to production supervisors should be reconciled to wages distributed (as confirmed by employees’ signatures) and pay packets returned to payroll due to staff absences. Any differences should be investigated immediately. As employees work eight-hour shifts over 24 hours, operating a shift system for the payroll department on wages pay out day should be considered. This should ensure there are sufficient payroll employees to pay out wages for each shift, with the same level of controls operating. |
|
Monthly management accounts do not analyse the variances between actual and budgeted wages and salaries; this is because there are no overtime costs. However, wages and salaries are a significant expense and management needs to understand why variances may have arisen. These could arise due to the recruitment of extra employees which was not budgeted or an increase in wage pay out rates. The board would need to monitor the wages and salaries costs; if too high, this would affect the company’s profitability. |
The monthly management accounts should be amended to include an analysis of wages and salaries compared to the budgeted costs. These should be broken down to each relevant department and could also include an analysis of headcount numbers compared to budget. |
(c) Assignments for internal audit department (IAD)
Value for money review – The IAD could be asked to assess whether Raspberry Co is obtaining value for money in areas such as asset expenditure.
Review of financial/operational controls – The IAD could review controls at head office and the power station and make recommendations to management over such areas as the purchasing process as well as the payroll cycle.
Monitoring asset levels – The IAD could physically verify property, plant and equipment (PPE) at the production site and head office and compare the assets seen to the PPE register. There is likely to be a significant level of PPE and the asset register must be kept up to date to ensure continuous production. If significant negative differences occur, this may be due to theft or fraud.
Regulatory compliance – As Brad Co produces electricity and operates a power station, it will be subject to a large number of laws and regulations such as health and safety and environmental legislation. The IAD could help to monitor compliance with these regulations.
IT system reviews – The company is likely to have a relatively complex computer system linking production data to head office. The IAD could be asked to perform a review over the computer environment and controls.
Cash controls – The IAD could test controls over cash payments. A 70% of employees are paid in cash, cash held each week is likely to be significant; therefore, the cash controls in payroll should be tested to reduce the level of errors.
Fraud investigations – The IAD can be asked to investigate any specific cases of suspected fraud as well as review the controls implemented to prevent/detect fraud.
The scenario specified “other assignments”; so no credit would be awarded to inventory counts.
(d) Substantive procedures on the accrual for tax payable on employment income
- Compare the accrual for income tax payable to the prior year, investigate any significant differences.
- Agree the year-end income tax payable accrual to the general ledger and payroll records to confirm accuracy.
- Re-perform the calculation of the accrual to confirm accuracy and discuss any unexpected variances with management.
- Agree the subsequent payment to the post-year-end cash book and bank statements to confirm completeness.
- Review any correspondence with tax authorities to assess whether there are any additional outstanding payments due; if so, agree they are included in the year-end accrual.
- Review any disclosures regarding the income tax accrual and assess whether they comply with IFRS Accounting Standards and legislation.
Audit And Assurance Question 3:
Vin Co
It is 1 July 20X5 and you are an audit manager of Rome & Co and you are currently responsible for the audits of two existing clients:
Vin Co manufactures hair products and its year ended on 31 May 20X5. You are finalising the audit programmes for the forthcoming year-end audit.
Paul Co is a distributor of electronic goods and its year ended on 30 April 20X5. The audit is almost complete and the auditor´s report is due to be signed shortly.
The following matters have been brought to your attention for each company.
Vin Co – Receivables
Vin Co´s draft year-end trade receivables are $3.85m (20X4: $2.45m) and revenue for the year is slightly increased on 20X4. Vin Co has a large number of customers with balances ranging from $5,000 to $45,000. Positive confirmation requests have been sent based on the yearend balances. The majority of responses from customers agreed to the balances as per Vin Co’s list of individual customer balances; however, the following exceptions were noted:
Due to the increase in receivables, Vin Co has recently recruited an additional credit controller to chase outstanding receivables. As a result of the additional focus on chasing outstanding receivables the finance director thinks it is not necessary to continue to maintain a significant allowance for receivables and has reduced the closing allowance from $125,000 to $5,000.
Paul Co – Going concern
During the year under audit Paul Co has consistently paid a number of its suppliers significantly later than usual and only after several reminders. As a result some of its suppliers have withdrawn credit terms meaning the company must pay cash on delivery. The company has also just received notification that its main supplier who provides the company with over 60% of its specialist electrical equipment has ceased to trade.
The overdraft has increased significantly over the year and the directors have informed you that the overdraft facility is due for renewal next month, and they are confident it will be renewed. The directors have decided that in order to conserve cash, no final dividend will be paid in 20X5.
Requirements:
(a) Describe the procedures the auditor should perform to resolve the exceptions noted for each customer’s response to the positive confirmation request. (8 marks)
(b) Describe substantive procedures the auditor should perform to obtain sufficient and appropriate audit evidence in relation to the allowance for receivables in the current year. (4 marks)
(c) Identify and explain THREE potential indicators that Paul Co is NOT a going concern. (3 marks)
(d) Describe the audit procedures the auditor should perform in assessing whether or not Paul Co is a going concern. (5 marks)
Answer (Detailed Solution Below)
Audit And Assurance Question 3 Detailed Solution
(a) Procedures to resolve exceptions in customers’ responses
Alan Co
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For the non-response from Alan Co, with the client’s permission, the team should arrange to send a follow-up written confirmation request.
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If Alan Co does not respond to the follow up, with the client’s permission, the auditor should telephone the customer and ask whether they are able to respond in writing to the request.
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If there is still no response, the auditor should undertake alternative procedures to confirm the balance owing from Alan Co. Such as detailed testing of the balance by agreeing to sales invoices and goods dispatched notes (GDN).
Flyn Co
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For the response from Flyn Co, with a difference of $5,850 the auditor should identify any disputed amounts, and identify whether these relate to timing differences or whether there are possible errors in the records of Vin.
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If the difference is due to timing, such as cash in transit, this should be agreed to post-year-end cash receipts in the cash book.
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If the difference relates to goods in transit, this should be agreed to a pre-year-end GDN.
Merik Co
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The reason for the credit balance with Merik should be discussed with the credit controller or finance department to understand how a credit balance has arisen.
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Review the list of individual supplier balances to identify if Merik is a supplier as well as a customer; if so, a purchase invoice may have been posted in error to the receivables account rather than payables account.
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If the difference is due to credit notes, this should be agreed to pre-year-end credit notes dispatched around the year-end date.
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The list of individual customer balances should be reviewed to identify any possible mis-postings as this could be a reason for the difference with Merik Co.
(b) Substantive procedures for allowance for trade receivables
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Discuss with the finance director the rationale for not providing against any receivables and consider the reasonableness of the allowance.
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Obtain a breakdown of the opening allowance of $125,000 and consider if the receivables allowed for in the prior year have been fully recovered, through the additional credit control procedures, or now fully written off.
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Inspect the aged trade receivables listing to identify any slow moving or old receivable balances and discuss the status of these balances with the credit controllers to assess whether they are likely to be collected.
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Review whether there are any after-date cash receipts for identified slow moving/old receivable balances.
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Review customer correspondence to identify any balances which are in dispute or unlikely to be paid and confirm if these were considered in determining the allowance.
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Inspect board minutes to identify any significant concerns in relation to payments by customers and assess if these have been considered when determining the allowance.
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Recalculate the potential level of trade receivables which are not recoverable and compare to allowance and discuss differences with management.
(c) Indicators that Paul Co is NOT a going concern
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Paul Co has paid some of its suppliers considerably later than usual and only after many reminders; therefore, some of them have withdrawn credit terms, meaning the company must pay cash on delivery. This suggests that the company was struggling to meet their liability as they fell due and will also put significant additional pressure on the company’s cash flow, because the company will have to pay for goods on delivery but is likely to have to wait for cash from its receivables due to credit terms.
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Paul Co’s main supplier who provides over 60% of the company’s specialist equipment has just stopped trading. If the equipment is highly specialised, there is a risk that PaulCo may not be able to obtain these products from other suppliers which would affect the company’s ability to trade. More likely, there are other suppliers available but they may be more expensive or may not offer favourable credit terms which will increase the outflows of PaulCo and worsen the cash flow position.
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Paul Co’s overdraft has grown significantly during the year and is due for renewal within the next month. If the bank does not renew the overdraft and t alternative finance cannot be obtained, PaulCo may not be able to meet its liabilities as they fall due, especially if suppliers continue to demand cash on delivery, and may not be able to continue to trade.
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To conserve cash, Paul Co has decided not to pay a final dividend for the year ended 30 April 20X5. As a result, shareholders may lose faith in the company and seek to sell their shares; also, they are highly unlikely to invest further equity and Paul Co may need to raise finance to repay the overdraft.
(d) Audit procedures to assess going concern
Obtain the cash flow forecast and review the cash in and outflows. Assess the assumptions for reasonableness and discuss the findings with management to understand if the company will have sufficient cash.
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Perform a sensitivity analysis on the cash flows to understand the margin of safety the company has in terms of its net cash in/outflow.
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Evaluate management’s plans for future actions, including contingency plans for financing and plans for generating revenue, and consider the feasibility of these plans.
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Review the post-year-end sales and order book to assess if the levels of trade are likely to increase and if the revenue figures in the cash flow forecast are reasonable.
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Review any agreements with the bank to determine whether any covenants have been breached, especially in relation to the overdraft.
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Review any bank correspondence to assess the likelihood of the bank renewing the overdraft facility.
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Review post-year-end correspondence with suppliers to identify if any have threatened legal action or any others have refused to supply goods.
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Inspect any contracts or correspondence with suppliers to confirm supply of the specialist equipment. If no new supplier has been confirmed, discuss with management their plans to ensure the company can continue to meet customer demand.
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Enquire of the lawyers of Paul Co regarding the existence of any litigation.
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Perform audit procedures to identify subsequent events that might indicate or mitigate the risk that the going concern basis is not appropriate.
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Review the post-year-end board minutes to identify any other issues which might indicate further financial difficulties for the company.
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Review post-year-end management accounts to assess if in line with cash flow forecast.
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Consider whether any additional disclosures as required by IAS® 1 Presentation of Financial Statements in relation to material uncertainties over going concern should be included in the financial statements.
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Conclude whether the going concern basis is appropriate for the preparation of the financial statements.
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Obtain management’s written representation that Paul Co is a going concern.
Audit And Assurance Question 4:
Comprehension:
Joey hotels
The following scenario relates to questions 1–5
Joey hotels Co (JH) operates a chain of 18 hotels located across the country. Each hotel has bedrooms, a restaurant and 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 number of discrepancies in cash balances and amounts of inventory that suggests that some employees have been stealing cash and goods from the hotels. Management is keen to prevent this from recurring and is considering establishing an internal audit department to undertake a fraud investigation.
The chief executive has suggested that one of the responsibilities of the internal audit department would be to determine relevant benchmarks to compare the performance of a number of
Which of the following are additional functions that the internal audit department might be required to undertake?
(1) Testing controls over cash receipts and cash counts
(2) Reviewing the computer environment and controls
(3) Monitoring compliance with laws and regulations
(4) Reviewing employees’ eligibility for promotions
Answer (Detailed Solution Below)
Audit And Assurance Question 4 Detailed Solution
The correct option is option 3
Additional Information:
- These are additional functions that could be undertaken by the internal audit department. (4) is not because the role of internal audit is to evaluate and improve the effectiveness of risk management, control and governance processes. Reviews of employees’ eligibility for promotion would be undertaken by the HR department.
Audit And Assurance Question 5:
Comprehension:
Joey hotels
The following scenario relates to questions 1–5
Joey hotels Co (JH) operates a chain of 18 hotels located across the country. Each hotel has bedrooms, a restaurant and 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 number of discrepancies in cash balances and amounts of inventory that suggests that some employees have been stealing cash and goods from the hotels. Management is keen to prevent this from recurring and is considering establishing an internal audit department to undertake a fraud investigation.
The chief executive has suggested that one of the responsibilities of the internal audit department would be to determine relevant benchmarks to compare the performance of a number of
Which of the following conclusions could be drawn by the internal audit department if it undertakes the inventory counts?
(1) If actual quantities are generally lower than recorded quantities, there may be obsolete inventory
(2) If actual quantities for a specific hotel are lower than recorded quantities, this may indicate fraud
(3) If actual quantities are higher than recorded quantities, employees may not have been adequately trained on how to record inventory movements
(4) If there are no differences, there are no inventory issues
Answer (Detailed Solution Below)
Audit And Assurance Question 5 Detailed Solution
The correct option is option 1
Additional Information:
- (1) is not valid, because holding obsolete inventory would not necessarily result in any difference and could result in higher physical quantities (e.g. if obsolete inventory is identified and adjusted on the records but not physically removed). (4) is not valid, because even if there is no difference there could still be inventory issues, such as obsolescence or fraud (involving falsification of the records as well as theft of inventory).
Top Audit And Assurance MCQ Objective Questions
Audit And Assurance Question 6:
According to RBI guidelines on Wilful Defaulters, what is the accelerated provisioning requirement for a “Doubtful I” asset in the second year of being classified as an NPA?
Answer (Detailed Solution Below)
Audit And Assurance Question 6 Detailed Solution
The correct answer is 40%
Key Points
- Doubtful I assets require accelerated provisioning of 40% in the second year of being NPA.
- The provisioning requirement for secured portions is 25% for the first year of a “Doubtful I” asset.
- Regular provisioning is usually lower, while accelerated provisioning increases risk mitigation.
- Provisioning rates are determined by asset classification and NPA duration.
Additional Information
- Doubtful I Assets: Classified as “Doubtful” based on the duration of NPA status.
- Accelerated Provisioning: Mandated for high-risk assets to cushion potential losses.
- Regular Provisioning: Standard provisioning percentages without accelerated factors.
- Provisioning policies vary for secured and unsecured portions to manage risk levels effectively.
Audit And Assurance Question 7:
Ric Co
This scenario relates to four requirements.
It is 1 July 20X5. You are the audit supervisor of Matt & Co and are currently planning the audit of an existing client, Ric Co, for the year ended 31 May 20X5. Ric Co is a pharmaceutical company, which manufactures and supplies a wide range of medical supplies. The draft financial statements show revenue of $35.6m and profit before tax of $5.9m.
Ric Co’s previous finance director left the company in January 20X5 after it was discovered that he had been claiming fraudulent expenses from the company for a significant period. A new finance director was appointed in February 20X5. She was previously a financial controller of a bank and has expressed surprise that Matt & Co had not uncovered the fraud during last year’s audit.
During the year Ric Co has spent $1.8m on developing several new products. These projects are at different stages of development and the draft financial statements show the full amount of $1.8m within intangible assets. In order to fund this development, $2.0m was borrowed from the bank and is due for repayment over a ten-year period. The bank has attached minimum profit targets as part of the loan covenants.
The new finance director has informed the audit partner that since the year end there has been an increased number of sales returns and that in the month of June over $0.5m of goods sold in May were returned.
Matt & Co attended the year-end inventory count at Ric Co’s warehouse. The auditor present raised concerns that during the count there were movements of goods in and out the warehouse and this process did not seem well controlled.
During the year, a review of plant and equipment in the factory was undertaken and surplus plant was sold, resulting in a profit on disposal of $210,000.
Requirements:
(a) State Matt& Co’s responsibilities in relation to the prevention and detection of fraud and error. (4 marks)
(b) Describe SIX audit risks, and explain the auditor’s response to each risk, in planning the audit of Ric Co.
(12 marks)
(c) Ric Co’s new finance director has read about review engagements and is interested in the possibility of Matt & Co undertaking these in the future. However, she is unsure how these engagements differ from an external audit and how much assurance would be gained from this type of engagement.
(i) Explain the purpose of review engagements and how these differ from external audits; and
(2 marks)
(ii) Describe the level of assurance provided by external audits and review engagements.
(2 marks)
(20 marks)
Answer (Detailed Solution Below)
Audit And Assurance Question 7 Detailed Solution
(a) Fraud responsibility
Matt & Co must conduct an audit in accordance with ISA 240 The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements and are responsible for obtaining reasonable assurance that the financial statements taken as a whole are free from material misstatement, whether caused by fraud or error.
In order to fulfil this responsibility, Matt & Co is required to identify and assess the risks of material misstatement of the financial statements due to fraud.
They need to obtain sufficient appropriate audit evidence regarding the assessed risks of material misstatement due to fraud, through designing and implementing appropriate responses. In addition, Matt & Co must respond appropriately to fraud or suspected fraud identified during the audit.
When obtaining reasonable assurance, Matt & Co is responsible for maintaining professional scepticism throughout the audit, considering the potential for management override of controls and recognising the fact that audit procedures which are effective in detecting error may not be effective in detecting fraud.
To ensure that the whole engagement team is aware of the risks and responsibilities for fraud and error, ISAs require that a discussion is held within the team. For members not present at the meeting, Ric’s audit engagement partner should determine which matters are to be communicated to them.
(b) Audit risks and auditor’s responses
| Audit risk | Auditor’s response |
|
Ric’s previous finance director (FD) left in January after it was discovered that he had been committing fraud with regards to expenses claimed. There is a risk that the FD may have undertaken other fraudulent transactions; these would need to be written off in the statement of profit or loss. If these have not been uncovered, the financial statements could include errors. |
Discuss with the new FD what steps have been taken to identify any further frauds by the previous FD. The team should maintain their professional scepticism and be alert to the risk of further fraud and errors. |
| The new FD appointed in February 20X5 was previously a financial controller of a bank. As a pharmaceutical company is very different to a bank, the new FD may not be sufficiently experienced to prepare the financial statements, leading to errors. | During the audit, careful attention should be paid to any changes in accounting policies and in particular any key judgmental decisions made by the finance director. |
|
During the year, Ric spent $1.8m on developing new products; these are at different stages and the total amount has been capitalised as an intangible asset. An intangible asset can only be recognised if all the criteria of IAS 38 Intangible Assets are met. The cost of projects that may not reach the final development stage should be expensed rather than capitalised. Intangible assets and profit could be overstated. |
A breakdown of the development expenditure should be reviewed and tested in detail to ensure that only projects which meet the capitalisation criteria are included as an intangible asset, with the balance being expensed. |
|
Ric has borrowed $2.0m from the bank as a 10-year loan. This loan needs to be correctly split between current and non-current liabilities in order to ensure correct disclosure. Also as the level of debt has increased, there should be additional finance costs. There is a risk that this has been omitted from the statement of profit or loss, leading to understated finance costs and overstated profit. |
During the audit, the team would need to confirm that the $2m loan finance was received. Also, the split between current and non-current liabilities and disclosures should be reviewed in detail to ensure compliance with relevant accounting standards. The finance costs should be recalculated and any increase agreed to the loan documentation for confirmation of interest rates and cashbook and bank statements to confirm the amount was paid and is not, therefore, a year-end payable. |
| The loan has a minimum profit target covenant. If this is breached, the loan would be instantly repayable and would be classified as a current liability. | Review the covenant calculations prepared by Ric and identify whether any defaults have occurred; if so, determine the effect on the company. |
| If Ric does not have sufficient cash for the loan repayment, there could be going concern implications. Also, there is a risk of profit manipulation to meet any covenants. | The team should maintain their professional scepticism and be alert to the risk that profit has been overstated to ensure compliance with the covenant. |
|
There have been a significant number of sales returns made subsequent to the year end. As these relate to pre-year-end sales, they should be removed from revenue in the draft financial statements and the inventory reinstated. If the sales returns have not been correctly recorded, revenue will be overstated and inventory understated. |
Review a sample of the post-year-end sales returns and confirm that if they relate to pre-year-end sales, the revenue has been reversed and the inventory included in the year-end inventory balance in the general ledger and financial statements. In addition, the reason for the increased level of returns should be discussed with management. This will help to assess if there are underlying issues with the net realisable value of inventory. |
| During Ric’s year-end inventory count there were movements of goods in and out. If these goods in transit were not carefully controlled, goods could have been omitted or counted twice. This would result in inventory being under or overstated. | During the final audit, the goods received notes and goods despatched notes received during the inventory count should be reviewed and followed through into the inventory count records as correctly included or not. |
|
Surplus plant and equipment was sold during the year, resulting in a profit on disposal of $210,000. As there is a minimum profit loan covenant, there is a risk that this profit on disposal may not have been correctly calculated, resulting in overstated profits. In addition, significant profits or losses on disposal are an indication that the depreciation policy of plant and equipment may not be appropriate. Therefore depreciation may be overstated. |
Recalculate the profit and loss on disposal calculations and agree all items to supporting documentation. Discuss the depreciation policy for plant and equipment with the finance director to assess its reasonableness. |
(c) Review engagements
(i) Purpose and how differ from external audit
Review engagements are often undertaken as an alternative to an audit, and involve a practitioner reviewing financial data, such as six-monthly figures. This would involve the practitioner undertaking procedures to state whether anything has come to their attention which causes the practitioner to believe that the financial data is not in accordance with the financial reporting framework.
A review engagement differs to an external audit in that the procedures undertaken are not nearly as comprehensive as those in an audit; only analytical procedures and enquiry are used extensively. In addition, the practitioner does not need to comply with ISAs as these only relate to external audits.
(ii) Levels of assurance provided
External audit – A high but not absolute level of assurance is provided; this is known as reasonable assurance. This provides comfort that the financial statements present fairly in all material respects (show a true and fair view) and are free of material misstatements.
Review engagements – where an opinion is being provided, the practitioner obtains sufficient evidence to be satisfied that the subject matter is plausible; in this case negative assurance is given whereby the practitioner confirms that nothing has come to their attention which indicates that the subject matter contains material misstatements
Audit And Assurance Question 8:
Brad Co
It is 1 July 20X5. Brad Co operates an electric power station, which produces electricity 24 hours a day, seven days a week. The company’s year end is 31 July 20X5. You are an audit manager of Liam & Co, the auditor of Brad Co. The interim audit has been completed and you are reviewing the documentation describing Brad Co’s payroll system.
The payroll system is not integrated within the computerised accounting system.
Systems notes – payroll
Brad Co employs over 250 people and approximately 70% of the employees work in production at the power station. There are three shifts every day with employees working eight hours each. The production employees are paid weekly in cash. The remaining 30% of employees work at the head office in non-production roles and are paid monthly by bank transfer.
The company has a human resources (HR) department, responsible for setting up all new joiners. Pre-printed forms are completed by HR for all new employees and, once verified, a copy is sent to the payroll department for the employee to be set up for payment. This form includes the staff member’s employee number and payroll cannot set up new joiners without this information. To encourage staff to attend work on time for all shifts, Brad Co introduced a discretionary bonus, paid every three months, for production staff. The production supervisors determine the amounts to be paid and notify the payroll department. This quarterly bonus is entered into the system by a clerk and each entry is checked by a senior clerk for input errors prior to processing. The senior clerk signs the bonus listing as evidence of undertaking this review.
Production employees are issued with clock cards and are required to swipe their cards at the beginning and end of their shift. This process is supervised by security staff 24 hours a day. Each card identifies the employee number and links into the hours worked report produced by the payroll system, which automatically calculates the gross and net pay along with relevant deductions. These calculations are not checked.
In addition to tax deductions from pay, some employees’ wages are reduced for such items as repayments of student loans owed to the central government. All employers have a statutory obligation to remit funds on a timely basis and to maintain accounting records which reconcile with annual loan statements sent by the government to employers. At Brad Co student loan deduction forms are completed by the relevant employee and payments are made directly to the government until the employee notifies HR that the loan has been repaid in full.
On a quarterly basis, exception reports relating to changes to the payroll standing data are produced and reviewed by the payroll director. No overtime is worked by employees. Employees are entitled to take 28 holiday days annually. Holiday request forms are required to be completed and authorised by relevant line managers; however, this does not always occur.
On a monthly basis, for employees paid by bank transfer, the senior payroll manager reviews the list of bank payments and agrees this to the payroll records prior to authorising the payment. If any errors are noted, the payroll senior manager amends the records.
For production employees paid in cash, the necessary amount of cash is delivered weekly from the bank by a security company. Two members of the payroll department produce the pay packets; one is responsible for preparing them and the other checks the finished pay packets. Both members of staff are required to sign the weekly payroll listing on completion of this task. The pay packets are then delivered to the production supervisors, who distribute them to employees at the end of the employees’ shift, as they know each member of their production team.
Monthly management accounts are produced which detail variances between budgeted amounts and actual. Revenue and key production costs are detailed; however, as there are no overtime costs, wages and salaries are not analysed.
Requirements:
(a) In respect of the payroll system for Brad Co:
(i) Identify and explain FIVE DIRECT CONTROLS which the auditor may plan to on; and
(ii) Describe a TEST OF CONTROL the auditor should perform to determine if each of these direct controls is operating effectively.
| Direct control | Test of control |
Note: The total marks will be split equally between each part. (10 marks)
(b) Identify and explain FIVE DEFICIENCIES in Brad Co’s payroll system and provide a recommendation to address each of these deficiencies. (10 marks)
| Control deficiency | Control recommendation |
(c) The finance director is interested in establishing an internal audit department (IAD). In the company she previously worked for the IAD carried out inventory counts; however, as this is not relevant for Brad Co, she has asked for guidance on what other assignments an IAD could be asked to perform.
Describe assignments the internal audit department of Brad Co could carry out. (5 marks)
(d) Brad Co deducts employment taxes from its employees’ wages on a weekly/monthly basis and pays these to the local taxation authorities in the following month. At the year end the financial statements will contain an accrual for income tax payable on employment income.
Describe the substantive procedures the auditor should perform to confirm the year-end accrual for tax payable on employment income (5 marks)
(30 marks)
Answer (Detailed Solution Below)
Audit And Assurance Question 8 Detailed Solution
(a) Direct controls and tests of control
| Direct control | Test of control |
|
Brad Co has a separate human resources (HR) department which is responsible for setting up all new employees. Segregation of roles between HR and payroll departments reduces the risk that fictitious employees could be set up and paid. |
Review the job descriptions of payroll and HR to confirm the split of responsibilities with regards to setting up new joiners. Discuss with members of the payroll department the process for setting up new joiners and for confirmation that the process is initiated by HR. |
|
Pre-printed forms are completed by HR for all new employees, and includes assignment of a unique employee number, and once verified, a copy is sent to the payroll department. Payroll is unable to set up new joiners without information from these forms. The use of pre-printed forms ensures that all relevant information (e.g. tax IDs) is obtained about employees before set up. This minimises the risk of incorrect wage and tax payments. Also, as payroll is unable to set up new joiners without the forms and employee number, it reduces the risk that payroll could set up fictitious employees. |
Select a sample of new employees added to the payroll during the year; review the joiner forms for evidence of completion of all parts and that the information was verified as accurate and was received by payroll before adding to the system. Select a sample of edit reports for changes to payroll during the year; agree a sample of new employees added to payroll to the joiners forms. |
|
The quarterly production bonus is input by a clerk into the payroll system, each entry is checked by a senior clerk for input errors before processing, and they evidence their review via signature. This reduces the risk of input errors resulting in over/underpayment of the bonus to employees. |
If attending Brad Co at the time of bonus processing, observe the clerk inputting and senior clerk checking the bonus payments into the payroll system. Also, obtain listings of quarterly bonus payments and review for evidence of signature by the senior clerk who checks for input errors. |
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Production employees are issued with clock cards and are required to swipe their cards at the beginning and end of their shift, this process is supervised by security staff 24 hours a day. This should ensure that genuine employees are only paid for the work actually done, and reduces the risk of paying employees who do not complete their eight-hour shift. Also, due to the supervision, it is unlikely that one employee could swipe in others. |
Observe the use of clock cards by employees when entering the power station. Confirm the security team is supervising the process and following up on discrepancies through discussions with the security staff. |
|
The clock card information identifies the employee number and links into the hours worked report produced by the payroll system. As the hours worked are automatically transferred into the payroll system, this reduces the risk of input errors in entering hours to be paid in calculating payroll, ensuring that employees are paid the correct amount. |
Utilise test data procedures to input dummy clock card information, verify this has been updated into the payroll system. |
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On a quarterly basis, exception reports of changes to payroll standing data are produced and reviewed by the payroll director. This should ensure that any unauthorised amendments to standing data are identified and resolved on a timely basis.
|
Select a sample of quarterly exception reports and review for evidence of review and follow up of any unexpected changes by the payroll director. |
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For production employees paid in cash, cash is received weekly from the bank by a security company. It is likely the sum of money required to pay over 175 employees would be considerable. It is important that cash is adequately safeguarded to reduce the risk of misappropriation. |
Enquire of payroll clerks how cash is delivered to Brad Co for weekly pay packets. Review a sample of invoices from the security company to Brad Co for delivery of cash. |
|
The pay packets are prepared by two members of staff with one preparing and one checking the pay packets and this is evidenced by each staff member signing the weekly listing. This segregation of duties should prevent fraud and errors going undetected. |
Observe the preparation process ensuring that two members of staff are involved and that pay packets are checked for accuracy. For a sample of weeks throughout the year, inspect the weekly payroll listing for two signatures evidencing the staff involved. |
(b) Deficiencies and recommendations
| Control deficiency | Control recommendation |
|
Production supervisors determine the amount of the discretionary bonus to be paid to employees. Production supervisors should not determine this as they could pay extra bonuses to friends or family members, resulting in additional payroll costs. |
The bonus should be determined by a responsible official (e.g. the production director) and formulated based on a written policy. If significant in value, it should be formally agreed by the board of directors. The bonus should be communicated in writing to the payroll department. |
|
Wages calculations generated by the payroll system are not checked. Therefore, system errors occur during the payroll processing would not be identified. Wages could be over or under calculated, leading to an additional payroll cost or loss of employee goodwill, respectively. |
A senior member of the payroll team should recalculate the gross to net pay workings for a sample of employees and compare their results to the output from the payroll system. These calculations should be signed as approved before payments are made. |
|
Student loan deduction forms are completed by relevant employees and paid directly to government. As payments continue until the employee notifies HR, and employees may not monitor payments closely, there is the risk of overpayments, which need to be reclaimed, leading to employee dissatisfaction. In the case of underpayments, Brad Co has an obligation to remit funds on time and to reconcile to annual loan statements. Failure to do so could result in non-compliance by both the company and employee, resulting in fines or penalties. |
The payroll department should maintain a schedule, by employee, of payments to third parties as well as the cumulative balance owing. This statement should be reconciled to the loan statement received from the government and sent to the employee for agreement at least annually. In accordance with the schedule, payments which are due to cease shortly should be confirmed in writing with the third party, before stopping. |
|
Holiday request forms are required to be completed and authorised by relevant line managers; however, this does not always occur. Employees taking unauthorised leave may result in an overpayment of wages. It could also create production difficulties if an insufficient number of employees are present to operate the power plant. |
Employees should be informed that they will not be able to take holiday without completion of a holiday request form, with authorisation from the line manager. Payroll clerks should not process holiday payments without agreement to the authorised holiday form. |
|
The senior payroll manager reviews the bank transfer listing before authorising the payments and also amends the payroll records for any changes required. There is a lack of segregation of duties as it is the payroll team which processes the amounts and the senior payroll manager who authorises payments. The senior manager could fraudulently increase the amounts to be paid to certain employees, process this payment as well as amend the records. |
The senior payroll manager should not be able to process changes to the payroll system as well as authorise payments. The bank transfer listing should be authorised by someone outside the payroll department, such as the finance director. |
|
The pay packets are delivered to the production supervisors, who distribute them to employees at the end of their shift. The supervisor is not sufficiently independent to pay wages out. They could adjust pay packets to increase those of close friends whilst reducing others. Also, although the production supervisors know their team members, payment of wages without proof of identity increases the risk that wages could be paid to incorrect employees. |
All pay packets should be distributed by the payroll department, directly to employees, upon sight of the employee’s clock card and photographic identification as this confirms proof of identity. Pay packets issued to production supervisors should be reconciled to wages distributed (as confirmed by employees’ signatures) and pay packets returned to payroll due to staff absences. Any differences should be investigated immediately. As employees work eight-hour shifts over 24 hours, operating a shift system for the payroll department on wages pay out day should be considered. This should ensure there are sufficient payroll employees to pay out wages for each shift, with the same level of controls operating. |
|
Monthly management accounts do not analyse the variances between actual and budgeted wages and salaries; this is because there are no overtime costs. However, wages and salaries are a significant expense and management needs to understand why variances may have arisen. These could arise due to the recruitment of extra employees which was not budgeted or an increase in wage pay out rates. The board would need to monitor the wages and salaries costs; if too high, this would affect the company’s profitability. |
The monthly management accounts should be amended to include an analysis of wages and salaries compared to the budgeted costs. These should be broken down to each relevant department and could also include an analysis of headcount numbers compared to budget. |
(c) Assignments for internal audit department (IAD)
Value for money review – The IAD could be asked to assess whether Raspberry Co is obtaining value for money in areas such as asset expenditure.
Review of financial/operational controls – The IAD could review controls at head office and the power station and make recommendations to management over such areas as the purchasing process as well as the payroll cycle.
Monitoring asset levels – The IAD could physically verify property, plant and equipment (PPE) at the production site and head office and compare the assets seen to the PPE register. There is likely to be a significant level of PPE and the asset register must be kept up to date to ensure continuous production. If significant negative differences occur, this may be due to theft or fraud.
Regulatory compliance – As Brad Co produces electricity and operates a power station, it will be subject to a large number of laws and regulations such as health and safety and environmental legislation. The IAD could help to monitor compliance with these regulations.
IT system reviews – The company is likely to have a relatively complex computer system linking production data to head office. The IAD could be asked to perform a review over the computer environment and controls.
Cash controls – The IAD could test controls over cash payments. A 70% of employees are paid in cash, cash held each week is likely to be significant; therefore, the cash controls in payroll should be tested to reduce the level of errors.
Fraud investigations – The IAD can be asked to investigate any specific cases of suspected fraud as well as review the controls implemented to prevent/detect fraud.
The scenario specified “other assignments”; so no credit would be awarded to inventory counts.
(d) Substantive procedures on the accrual for tax payable on employment income
- Compare the accrual for income tax payable to the prior year, investigate any significant differences.
- Agree the year-end income tax payable accrual to the general ledger and payroll records to confirm accuracy.
- Re-perform the calculation of the accrual to confirm accuracy and discuss any unexpected variances with management.
- Agree the subsequent payment to the post-year-end cash book and bank statements to confirm completeness.
- Review any correspondence with tax authorities to assess whether there are any additional outstanding payments due; if so, agree they are included in the year-end accrual.
- Review any disclosures regarding the income tax accrual and assess whether they comply with IFRS Accounting Standards and legislation.
Audit And Assurance Question 9:
Vin Co
It is 1 July 20X5 and you are an audit manager of Rome & Co and you are currently responsible for the audits of two existing clients:
Vin Co manufactures hair products and its year ended on 31 May 20X5. You are finalising the audit programmes for the forthcoming year-end audit.
Paul Co is a distributor of electronic goods and its year ended on 30 April 20X5. The audit is almost complete and the auditor´s report is due to be signed shortly.
The following matters have been brought to your attention for each company.
Vin Co – Receivables
Vin Co´s draft year-end trade receivables are $3.85m (20X4: $2.45m) and revenue for the year is slightly increased on 20X4. Vin Co has a large number of customers with balances ranging from $5,000 to $45,000. Positive confirmation requests have been sent based on the yearend balances. The majority of responses from customers agreed to the balances as per Vin Co’s list of individual customer balances; however, the following exceptions were noted:
Due to the increase in receivables, Vin Co has recently recruited an additional credit controller to chase outstanding receivables. As a result of the additional focus on chasing outstanding receivables the finance director thinks it is not necessary to continue to maintain a significant allowance for receivables and has reduced the closing allowance from $125,000 to $5,000.
Paul Co – Going concern
During the year under audit Paul Co has consistently paid a number of its suppliers significantly later than usual and only after several reminders. As a result some of its suppliers have withdrawn credit terms meaning the company must pay cash on delivery. The company has also just received notification that its main supplier who provides the company with over 60% of its specialist electrical equipment has ceased to trade.
The overdraft has increased significantly over the year and the directors have informed you that the overdraft facility is due for renewal next month, and they are confident it will be renewed. The directors have decided that in order to conserve cash, no final dividend will be paid in 20X5.
Requirements:
(a) Describe the procedures the auditor should perform to resolve the exceptions noted for each customer’s response to the positive confirmation request. (8 marks)
(b) Describe substantive procedures the auditor should perform to obtain sufficient and appropriate audit evidence in relation to the allowance for receivables in the current year. (4 marks)
(c) Identify and explain THREE potential indicators that Paul Co is NOT a going concern. (3 marks)
(d) Describe the audit procedures the auditor should perform in assessing whether or not Paul Co is a going concern. (5 marks)
Answer (Detailed Solution Below)
Audit And Assurance Question 9 Detailed Solution
(a) Procedures to resolve exceptions in customers’ responses
Alan Co
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For the non-response from Alan Co, with the client’s permission, the team should arrange to send a follow-up written confirmation request.
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If Alan Co does not respond to the follow up, with the client’s permission, the auditor should telephone the customer and ask whether they are able to respond in writing to the request.
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If there is still no response, the auditor should undertake alternative procedures to confirm the balance owing from Alan Co. Such as detailed testing of the balance by agreeing to sales invoices and goods dispatched notes (GDN).
Flyn Co
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For the response from Flyn Co, with a difference of $5,850 the auditor should identify any disputed amounts, and identify whether these relate to timing differences or whether there are possible errors in the records of Vin.
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If the difference is due to timing, such as cash in transit, this should be agreed to post-year-end cash receipts in the cash book.
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If the difference relates to goods in transit, this should be agreed to a pre-year-end GDN.
Merik Co
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The reason for the credit balance with Merik should be discussed with the credit controller or finance department to understand how a credit balance has arisen.
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Review the list of individual supplier balances to identify if Merik is a supplier as well as a customer; if so, a purchase invoice may have been posted in error to the receivables account rather than payables account.
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If the difference is due to credit notes, this should be agreed to pre-year-end credit notes dispatched around the year-end date.
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The list of individual customer balances should be reviewed to identify any possible mis-postings as this could be a reason for the difference with Merik Co.
(b) Substantive procedures for allowance for trade receivables
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Discuss with the finance director the rationale for not providing against any receivables and consider the reasonableness of the allowance.
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Obtain a breakdown of the opening allowance of $125,000 and consider if the receivables allowed for in the prior year have been fully recovered, through the additional credit control procedures, or now fully written off.
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Inspect the aged trade receivables listing to identify any slow moving or old receivable balances and discuss the status of these balances with the credit controllers to assess whether they are likely to be collected.
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Review whether there are any after-date cash receipts for identified slow moving/old receivable balances.
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Review customer correspondence to identify any balances which are in dispute or unlikely to be paid and confirm if these were considered in determining the allowance.
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Inspect board minutes to identify any significant concerns in relation to payments by customers and assess if these have been considered when determining the allowance.
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Recalculate the potential level of trade receivables which are not recoverable and compare to allowance and discuss differences with management.
(c) Indicators that Paul Co is NOT a going concern
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Paul Co has paid some of its suppliers considerably later than usual and only after many reminders; therefore, some of them have withdrawn credit terms, meaning the company must pay cash on delivery. This suggests that the company was struggling to meet their liability as they fell due and will also put significant additional pressure on the company’s cash flow, because the company will have to pay for goods on delivery but is likely to have to wait for cash from its receivables due to credit terms.
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Paul Co’s main supplier who provides over 60% of the company’s specialist equipment has just stopped trading. If the equipment is highly specialised, there is a risk that PaulCo may not be able to obtain these products from other suppliers which would affect the company’s ability to trade. More likely, there are other suppliers available but they may be more expensive or may not offer favourable credit terms which will increase the outflows of PaulCo and worsen the cash flow position.
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Paul Co’s overdraft has grown significantly during the year and is due for renewal within the next month. If the bank does not renew the overdraft and t alternative finance cannot be obtained, PaulCo may not be able to meet its liabilities as they fall due, especially if suppliers continue to demand cash on delivery, and may not be able to continue to trade.
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To conserve cash, Paul Co has decided not to pay a final dividend for the year ended 30 April 20X5. As a result, shareholders may lose faith in the company and seek to sell their shares; also, they are highly unlikely to invest further equity and Paul Co may need to raise finance to repay the overdraft.
(d) Audit procedures to assess going concern
Obtain the cash flow forecast and review the cash in and outflows. Assess the assumptions for reasonableness and discuss the findings with management to understand if the company will have sufficient cash.
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Perform a sensitivity analysis on the cash flows to understand the margin of safety the company has in terms of its net cash in/outflow.
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Evaluate management’s plans for future actions, including contingency plans for financing and plans for generating revenue, and consider the feasibility of these plans.
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Review the post-year-end sales and order book to assess if the levels of trade are likely to increase and if the revenue figures in the cash flow forecast are reasonable.
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Review any agreements with the bank to determine whether any covenants have been breached, especially in relation to the overdraft.
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Review any bank correspondence to assess the likelihood of the bank renewing the overdraft facility.
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Review post-year-end correspondence with suppliers to identify if any have threatened legal action or any others have refused to supply goods.
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Inspect any contracts or correspondence with suppliers to confirm supply of the specialist equipment. If no new supplier has been confirmed, discuss with management their plans to ensure the company can continue to meet customer demand.
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Enquire of the lawyers of Paul Co regarding the existence of any litigation.
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Perform audit procedures to identify subsequent events that might indicate or mitigate the risk that the going concern basis is not appropriate.
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Review the post-year-end board minutes to identify any other issues which might indicate further financial difficulties for the company.
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Review post-year-end management accounts to assess if in line with cash flow forecast.
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Consider whether any additional disclosures as required by IAS® 1 Presentation of Financial Statements in relation to material uncertainties over going concern should be included in the financial statements.
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Conclude whether the going concern basis is appropriate for the preparation of the financial statements.
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Obtain management’s written representation that Paul Co is a going concern.
Audit And Assurance Question 10:
Comprehension:
Joey hotels
The following scenario relates to questions 1–5
Joey hotels Co (JH) operates a chain of 18 hotels located across the country. Each hotel has bedrooms, a restaurant and 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 number of discrepancies in cash balances and amounts of inventory that suggests that some employees have been stealing cash and goods from the hotels. Management is keen to prevent this from recurring and is considering establishing an internal audit department to undertake a fraud investigation.
The chief executive has suggested that one of the responsibilities of the internal audit department would be to determine relevant benchmarks to compare the performance of a number of
Which of the following are additional functions that the internal audit department might be required to undertake?
(1) Testing controls over cash receipts and cash counts
(2) Reviewing the computer environment and controls
(3) Monitoring compliance with laws and regulations
(4) Reviewing employees’ eligibility for promotions
Answer (Detailed Solution Below)
Audit And Assurance Question 10 Detailed Solution
The correct option is option 3
Additional Information:
- These are additional functions that could be undertaken by the internal audit department. (4) is not because the role of internal audit is to evaluate and improve the effectiveness of risk management, control and governance processes. Reviews of employees’ eligibility for promotion would be undertaken by the HR department.
Audit And Assurance Question 11:
Comprehension:
Joey hotels
The following scenario relates to questions 1–5
Joey hotels Co (JH) operates a chain of 18 hotels located across the country. Each hotel has bedrooms, a restaurant and 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 number of discrepancies in cash balances and amounts of inventory that suggests that some employees have been stealing cash and goods from the hotels. Management is keen to prevent this from recurring and is considering establishing an internal audit department to undertake a fraud investigation.
The chief executive has suggested that one of the responsibilities of the internal audit department would be to determine relevant benchmarks to compare the performance of a number of
Which of the following conclusions could be drawn by the internal audit department if it undertakes the inventory counts?
(1) If actual quantities are generally lower than recorded quantities, there may be obsolete inventory
(2) If actual quantities for a specific hotel are lower than recorded quantities, this may indicate fraud
(3) If actual quantities are higher than recorded quantities, employees may not have been adequately trained on how to record inventory movements
(4) If there are no differences, there are no inventory issues
Answer (Detailed Solution Below)
Audit And Assurance Question 11 Detailed Solution
The correct option is option 1
Additional Information:
- (1) is not valid, because holding obsolete inventory would not necessarily result in any difference and could result in higher physical quantities (e.g. if obsolete inventory is identified and adjusted on the records but not physically removed). (4) is not valid, because even if there is no difference there could still be inventory issues, such as obsolescence or fraud (involving falsification of the records as well as theft of inventory).
Audit And Assurance Question 12:
Comprehension:
Joey hotels
The following scenario relates to questions 1–5
Joey hotels Co (JH) operates a chain of 18 hotels located across the country. Each hotel has bedrooms, a restaurant and 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 number of discrepancies in cash balances and amounts of inventory that suggests that some employees have been stealing cash and goods from the hotels. Management is keen to prevent this from recurring and is considering establishing an internal audit department to undertake a fraud investigation.
The chief executive has suggested that one of the responsibilities of the internal audit department would be to determine relevant benchmarks to compare the performance of a number of
Which of the following describes the internal audit assignment to determine benchmarks?
Answer (Detailed Solution Below)
Audit And Assurance Question 12 Detailed Solution
The correct option is option 2
Additional Information:
- Value for money (VFM) is defined as the evaluation of management’s achievements in terms of economy, efficiency and effectiveness of operations. VFM is the correct response as only this would deal with “relevant benchmarks”, “indicators” and “performance” for a company whose primary objective is to make a profit. (Best value audits apply to public sector and other entities that have a duty to deliver services.)
Audit And Assurance Question 13:
Comprehension:
Joey hotels
The following scenario relates to questions 1–5
Joey hotels Co (JH) operates a chain of 18 hotels located across the country. Each hotel has bedrooms, a restaurant and 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 number of discrepancies in cash balances and amounts of inventory that suggests that some employees have been stealing cash and goods from the hotels. Management is keen to prevent this from recurring and is considering establishing an internal audit department to undertake a fraud investigation.
The chief executive has suggested that one of the responsibilities of the internal audit department would be to determine relevant benchmarks to compare the performance of a number of
Which of the following are limitations of JH establishing and maintaining an internal audit department?
(1) That the internal auditors will be employees may impair their independence, as they may not report issues to those charged with governance for fear of losing their job
(2) As there is no requirement for internal auditors to be qualified, there may be gaps in the experience and technical knowledge of the department
(3) As JH has not previously had such a department, there may be some resistance to employees having their work reviewed, especially if the department’s first task is a fraud investigation
(4) As internal audit is required to be both objective and independent it can be difficult to find sufficient personnel to staff the department
Answer (Detailed Solution Below)
Audit And Assurance Question 13 Detailed Solution
The correct option is option 2
Additional Information:
- Each of these describe limitations of JH establishing and maintaining an internal audit department. (4) is not correct, because an internal audit department is not required to be independent. Although the internal audit function can be outsourced, it is often in-house and therefore never truly independent.
Audit And Assurance Question 14:
Comprehension:
Joey hotels
The following scenario relates to questions 1–5
Joey hotels Co (JH) operates a chain of 18 hotels located across the country. Each hotel has bedrooms, a restaurant and 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 number of discrepancies in cash balances and amounts of inventory that suggests that some employees have been stealing cash and goods from the hotels. Management is keen to prevent this from recurring and is considering establishing an internal audit department to undertake a fraud investigation.
The chief executive has suggested that one of the responsibilities of the internal audit department would be to determine relevant benchmarks to compare the performance of a number of
Which of the following describes how a new internal audit department could assist the directors of JH in preventing and detecting fraud and error?
(1) It could assess the main areas of fraud risk, as well as assess the adequacy and effectiveness of the system of internal control
(2) It could evaluate the appropriateness of a company’s objectives and the board’s strategies to achieve those objectives
(3) Having developed a system of internal control, it could undertake regular reviews of each hotel’s compliance with these controls
(4) Where fraud is suspected, it could undertake an investigation to identify who is involved, the likely amounts stolen and obtain evidence for any police investigation
Answer (Detailed Solution Below)
Audit And Assurance Question 14 Detailed Solution
The correct option is option 3
Additional Information:
- Each of these describe how a new internal audit department could assist JH’s directors in preventing and/or detecting fraud and/or error. (2) is not correct because it is not the role of internal audit to judge the company’s objectives or the board’s strategies to achieve those objectives. (Also, the appropriateness of such objectives and strategies would not assist in preventing and detecting fraud and error.)
Audit And Assurance Question 15:
Comprehension:
Lisa Co
It is 1 July 20X5. You are an audit supervisor at Aria & Co and you are involved in the audit of Lisa Co for the year ended 31 May 20X5. The company owns a significant amount of non-current assets including a number of properties.
Additions, disposal and depreciation
Lisa Co depreciates its properties, on the straight-line basis, at a rate of 5% per annum. The draft depreciation expense on buildings for 20X5 is $2m compared with $1.7m in 20X4.
On 31 May 20X5, Property A was sold for sales proceeds equal to 40% of its original cost. The property initially cost $6m and had been owned and depreciated for seven years.
The audit programme includes the following tests to be carried out in relation to additions made during the year:
Agree a sample of additions recorded in the non-current asset register to the cash book and purchase invoice ensuring that the purchase date is accurate and it is recorded at the correct amount
Compare total budgeted additions to actual additions in the year and investigate and corroborate any significant differences
Revaluation
On 31 May 20X5, the directors had all of the company’s remaining buildings revalued by an external expert. In the detailed audit approach it states that Aria & Co will rely on this valuation as part of the current year audit procedures.
In respect of the revaluation, which TWO of the following statements regarding reliance on the external expert are TRUE?
- In line with ISA 620 Using the Work of an Auditor's Expert, reliance can only be placed on an expert appointed by Aria & Co
- Obtaining the valuation report would constitute sufficient and appropriate evidence over the carrying amount of the buildings
- Reference to the work of the external expert should not be included in the auditor's report
- The objectivity of the valuer must be assessed before placing reliance on the valuation report
Answer (Detailed Solution Below)
Audit And Assurance Question 15 Detailed Solution
The correct option is option 3
Additional Information:
- As the expert is management’s expert (and not the auditor’s) the relevant standard is ISA 500 Audit Evidence. The auditor must evaluate the expert’s objectivity and competence and capabilities. The auditor has sole responsibility for the audit opinion and cannot refer to an expert in the auditor’s report.