Question

Alver Group is a car wash company and its financial year end 29.03.20X3. Company purchases washing equipment on yearly basis. Some of them are used in for business operations and some of them leased out to the external customers. The Purchase system of the company is as follows: There is purchase order for each purchase transaction but no one controls authorize the raise of purchase order. As a result, some of the purchase transactions still remains without purchase orders. At the period end it was evident that, some of the recorded purchase orders do not relates to the company’s business operations. Some of the equipment are bought by third parties but purchase orders were raised by Omega. Additional monitoring activities over the purchase system discovered that some of the amounts in general ledger is not correct. Required: Describe which financial statement assertions that are breached. For each assertion introduce suitable control and test of control

Answer 1

Financial statements assertions: Companies prepare their financial statements by making implicit or explicit claims and representations regarding the accuracy of their financial statements and internal control over financial reporting. These representations are called as audit assertions. Internal and external auditors test the relevant assertions to confirm that various account balances and classes of transactions are accurate and truthfully represent the financial condition of the company.

Alver Group: The assertions being tested in this scenario are regarding a particular class of transactions (Purchase transactions). So the assertions for classes of transactions are relevant. In this case the following assertions have been breached.

Occurrence: This assertion is the claim that the transactions recognized in the financial statements have in fact occurred and relate to the entity.

In the case of Alver Group there is no control in place to ensure that only authorized personnel can raise a purchase order. As a result fake purchase orders can be raised and recorded in the books of account even if no purchase has actually happened. Also, purchase orders can be placed for equipments that are not necessary for the business.

Also, it was noted that some of the purchases did not relate to the business operations and also some of the purchases were made by third parties but the purchase orders were raised by Omega (Since not stated in the question Omega is assumed to be some accounting software or accounting service company of Alver Group). This is again a beach of occurrence as the transaction was not executed for the company's business and therefore does not relate to the company. It seems like some third parties took advantage of ineffective controls in Alver Group to make purchases for their business.

Control suggestion: An authorized personnel should be at place who alone can raise purchase orders. Raising a purchase order should require a system password which is handed over only to the authorized personnel. This way unauthorized issue of purchase order can be avoided.

Test of control: The auditor can try to raise a purchase order without a password and see if the order gets executed. If it can't be placed without the password then the control is working effectively.

Completeness: This assertion is the claim that all transactions entered into by the business has been recorded.

In the case of Alver Group there is no control in place to ensure that only authorized purchase orders are executed. This is clearly evident as there are purchase transactions without a purchase order. If there is no reconciliation of purchase order to purchases executed then it is possible that some of the purchase transactions are unauthorized and may not be recorded in the books. This would not ensure completeness of transactions.

Control suggestion: The purchases department should not be allowed to execute the purchases without a purchase order. This should be communicated to the person in charge of executing purchases.

Test of control: Should look for cash disbursements in the bank statement to ensure on a sample basis that payments for purchase transaction has a corresponding purchase order. If there is no purchase order then the person in charge of executing purchases can be held accountable. It is easy to ensure completeness of purchases if all purchases require a purchase order as the purchases book can be reconciled with the list of purchase orders authorized.

Accuracy: This assertion is the claim that all transaction amounts are accurately recorded.

The incorrect entries in the general ledger means that the transactions recorded are not accurate.

Control suggestion: The raised purchase order should have a identification number which must be entered by the book keeper while recording purchase transactions. The system should be directed to throw an error if the amount entered in the transaction does not equal to the amount mentioned in the purchase order.

Test of control: The auditor can generate a dummy purchase order and try to record the transaction using the identification number but with a different amount. If the transaction cannot be recorded then the control is effective.