Question

Ernestina has been operating a small retail store called “Look and Pick” selling shoes since 2010. In 2015 she sought to expand her operations due to a rise in demand for the shoes. She approached Abigail and Williams, who are her friends and bankers to invest in the business. After some weeks of due diligence, they invested in the business with an expectation of increased returns on their investment.

Although, there exist internal controls in the business, it is deficient. In order to ensure transparency and accountability, Abigail insisted that internal auditor(s) be engaged. Ernestina, expressed concern that, auditors in general will not add any value to the business but only a drain on the coffers of the business. Upon the insistence of Abigail and Williams, internal auditors namely; Felicia, Partey, Adams and Bernice were engaged. Also, Vashti and Associates were engaged as external auditors.

During the first meeting with the external auditors, Ernestina reiterated that, they were going to pay so much for their services hence, they expected nothing but absolute assurance, a position the auditors disagree with.

Felicia, one of the internal auditors, on realizing deficiency in the internal controls suggested to her colleagues that, they develop comprehensive and robust internal controls for management. The other internal auditors requested for some time to think about the issue in order to make a decision.

Required

1. Identify and explain 5 key issues arising from the case.

2. Is Ernestina right in demanding absolute assurance from the auditors? Justify your answer with 5 reasons thoroughly explained.

3. Discuss, using 5 thematic areas, the distinction between internal and external audit.

4. What is your view regarding developing internal controls for management as suggested by Eunice?

Answer 1

1. The five key issues arising in the case are as :

• Conflicts and Disagreement amongst the partners of the company : There was disagreement amongst Ernestina, Abigail and Williams about keeping internal auditor in the company.
• Auditor as an additional cost to the company : Auditor acts as an additional cost to the company without adding any value.
• Investors look for profit maximization : Investors who invest in the company always are keen on profit maximization and look for good returns on their investment.
• Expansion of the firm requires additional investors : At the time of expansion of the firm, additional investors are required which would probably lead to certain conflicts and disagreements.
• Too many auditors have certain conflicts : If there are too many auditors, it would lead to certain conflicts.

2. Ernestina is right in demanding absolute assurance. This is because :

• Keeping an auditor is an additional cost to the company and the owners need proper justification where the money goes.
• As the auditors are being kept based on the demand of other partners , so Ernestina wanted to prove her point in a justified way.
• Ernestina do not want to be in a state of uncertainty which might lead to certain problems at a later stage.
• The assurance given by the auditors would act as a benchmark to judge the performance of the auditors at a later stage.
• Ernestina wanted some returns on the investmnet being done by her and wanted to have a cordial relations with her partners in the firm.

3. Internal audit finds out the discrepancy in the business practices and risks of the company whereas external audit investigates the financial statements of the company.

Internal auditors are appointed by the company whereas external auditors are appointed based on shareholders.

Internal auditors works in favor of the management while external auditors works for the shareholders.

Internal audit is being condusted throughout the year as and when required, wheraes external audit is being conducted once in a year.

Internal audit looks after the daily operations of the company so can provide consultation to the employees, but external audit works in a very rigid way and do not offer any advice.

4. There should be a robust internal controls on the management as a strong management only would lead to strong position of the company to the shareholders in the form of higher profits. If the management is controlled, higher revenues and lower costs lead to higher profits of the company, quite attractive to the shareholders and the management as well.