Question

You are the audit senior on the Wendig Limited (Wendig) engagement and have commenced planning for the 2019 audit. You have been able to obtain the following information concerning the various segments of the business:

1. Inventory Balances and Purchase Transactions

Although fairly voluminous, purchase transactions at Wendig are not complex. Inventories are tightly controlled so that overstocking and obsolescence are normally not a problem. Inventory, although not as liquid as cash, is subject to theft. At Wendig, finished packaged products are shipped immediately to customers, although large quantities of purchased merchandise are maintained on hand. The personnel handling purchases and inventory transactions are, in general, competent. Access to warehouse is unrestricted.

2. Trade Receivables and Credit Sales System

These transactions are not particularly complex at Wendig, nor (except for the allowance for doubtful debts account) is there any degree of estimation involved. The persons processing revenue and trade receivables transactions are thoroughly familiar with the procedures and are generally competent. Sales transactions processing does, however, entail the completion of many transactions. Competition from overseas is becoming an issue, and because of the poor general economic conditions some customers have requested extensions of time to pay.

3. Property, Plant and Equipment (PPE)

There are generally few fixed asset transactions. The transactions are often not complex but an element of risk can be introduced when management has to make decisions concerning whether to capitalise or expense items. PPE, being less liquid than other assets, is generally not subject to theft. In recent years a number of PPE items have been manufactured in-house. You have noticed, as a result of your analytical procedures, that repairs and maintenance expense has dropped considerably in the last two years. Asset registers are maintained on a timely basis, and staff are generally competent.

4. Trade Payables Transactions and Balances

Although not complex, the volume of trade payables transactions is high. There is a risk with trade payables balances that personnel may fail to record them in the books, as the company has applied to the bank for an increase in its overdraft and wants to impress the bank with a strong current ratio. At Wendig a request form is first prepared for all items that are to be paid through the cash disbursements system. The previous trade payables clerk, who had been with the company for eight years, left in December 2018. A new clerk was hired but is not yet thoroughly familiar with the procedures.

Required

For each of the above account balances and classes of transactions (provide justifications in each case):

1. Determine any significant risks with reference to relevant facts;
2. Identify the key assertions at risk (as per ASA 315.A128); ( 10 Marks)
3. Outline internal controls relevant to the audit.( 10 Marks)

Answer 1

The Key assertions with the risk involved are the following;

1. Inventory & Purchase transactions: The inventory control and purchase transaction are streamlined. But the access to warehouse is unrestricted. This leads to potential rik of inventory theft and as a result the inventory may be overstated in the books. A thorough physical count of inventory will be required to reconcile the book and physical balance.

2. Trade Receivables & Credit Sales : Though the transactions are simple and the staff are familiar, the transaction volume is very high. The huge volume may lead to transactional accounting errors in receivables , sales revenue, Tax or discount amounts which can be a mterial risk related transactions.

There is another risk related to the estimation od allowance for doubtful debts.Due to the poor economic condition prevailing., many customers are asking for extension of credit days and this is an indication that there will be a need to have a higher provision for bad debts. Therefore there is a business and economic risk of under reporting the allowance for bad debts unless the estimation is revised on a higher side.

There is also a business risk of future loss of sales revenue as the competion from foreign companies is increasing and that may result in financial risk for future revenue estoimates anmd projections.

3. PPE : A large amount of PPE are made in house and recently there is a trend of lower repair and maintenance cost reporting. This is a risk that repair and maintenance cost has been wrongly taken for capitalization. This will result in deferment of cost and higher profitability reporting in current years. This is a material risk of misstament of income and asset amounts in financial statements.

4. Accounts Payable : The transaction volume is high and the experienced clerk has left and a new clerk ( not so familiar with the process) is handling transactions. There is a clear risk of transactional errors related to  reporting trade payables and expennses. This may lead to under or over statement of liabilities , assets and expenses.

As the company is applying for bank overdraft , it needs to show a better current ratio which may lead to direction to underreport Accounts Payable. There is a material risk that Accounts Payable may not be recorded within the period. This is a material risk of under reporting the liabilities due to lack of internal controls.

Internal controls are the mechanisms, rules, and procedures implemented by a company to ensure the integrity of financial and accounting information, promote accountability and prevent fraud.

• Besides complying with laws and regulations, and preventing employees from stealing assets or committing fraud, internal controls can help improve operational efficiency by improving the accuracy and timeliness of financial reporting.
• Internal audits play a critical role in a company’s internal controls and corporate governance, now that the Sarbanes-Oxley Act of 2002 has made managers legally responsible for the accuracy of its financial statements.