Question

In: Accounting

Background information Gifts Ltd (Gifts) operates 30 specialty gift stores. The company’s year-end is 30 June...

Background information

Gifts Ltd (Gifts) operates 30 specialty gift stores. The company’s year-end is 30 June 2018. The audit manager and partner recently attended a planning meeting with the finance director and have provided you with the planning notes below. You are the audit senior, and this is your first year on this audit. The audit manager has asked you to undertake some research to gain an understanding of Gifts, so that you are able to assist in the planning process. He has then asked that you identify relevant audit risks from the notes below and also consider how the team should respond to these risks. Gifts spent $2.1 million in refurbishing all of its stores and extending their central warehouse. In order to finance this refurbishment, Gifts borrowed $2 million from the bank. This is due to be repaid over five years. The company will be performing a year-end inventory count at the central warehouse, as well as at all 30 stores, on 30 June 2018. Inventory is valued at selling price less an average profit margin, as the finance director believes that this is a close approximation of cost. Prior to the 2018 financial year, each store maintained its own financial records and submitted returns monthly to head office. During the 2018 financial year all accounting records were centralised within head office. Therefore, at the beginning of the 2018 financial year, each store’s opening balances were transferred into head office’s accounting records. The increased workload at head office has led to some changes in the finance department and in May 2018 the financial controller left. Her replacement will start in late June 2018.

REQUIRED

: a) List two (2) sources of information that would be of use in gaining an understanding of Gifts, and for each source describe what information you would expect to obtain.

b) Using the background information provided above, identify six (6) audit risks and explain the auditor’s response to each risk in planning the audit of Gifts.

Part C.2 The finance director of Gifts is considering establishing an internal audit department and is unsure what factors he should consider when making his decision.

REQUIRED: Bearing in mind the differences and similarities between the roles of an internal auditor compared to an external auditor, outline four (4) factors the finance director should consider before establishing an internal audit department.

Solutions

Expert Solution

B)

1. Internal control over financial reporting.

The PCAOB issued an audit practice alert in October on applying board standards to audits of internal control over financial reporting. In December 2012, the PCAOB issued a report on common problems to avoid in audits of internal control over financial reporting. The CAQ report summarizes areas of focus in the October audit practice alert. “Understanding the flow of transactions and identifying the risks of material misstatement—including the types of potential misstatements that can occur and the likely sources of those potential misstatements—is necessary for the auditor to select appropriate controls to test and to evaluate whether those controls adequately address the risks,” the report says.

2. Professional skepticism.

The requirement for the auditor to exercise professional skepticism was the topic of a PCAOB audit practice alert in December 2012. Auditors should maintain a questioning mind and have the confidence to challenge management representations after gathering and evaluating appropriate evidence, according to the CAQ report.

3. Engagement quality review.

Earlier this month, the PCAOB released a report advising audit firms to take steps to make sure that engagement quality reviews identify the audit deficiencies they are meant to detect. The CAQ report advises the engagement quality reviewer to carry out responsibilities with objectivity and application of due care, with the firm appropriately addressing the reviewer’s findings before issuing the audit report.

4. Accounting estimates, including fair value estimates.

When evaluating how reasonable an estimate is, auditors normally focus on inputs and assumptions that are significant to the estimate; are sensitive to variations; deviate from historical patterns; and are subjective and susceptible to misstatement and bias, the CAQ report says.

5. Substantive analytical procedures.

Although substantive analytical procedures may be effective tests for relevant assertions related to certain accounts, these procedures may not always be effective in providing the appropriate level of assurance, according to the CAQ report.

6. Inaccurate or omitted disclosures.

Auditors should communicate to management or the audit committee, as appropriate, whether the financial statements are presented fairly in all material respects, in conformity with the applicable financial reporting framework, the CAQ report says.

C)

Following factors should be considered:-

1. Make a Internal audit team considering well professionals,

2. Establish a strong internal control system within organization,

3. Allocate the work to different professional,

4. Work done professionals should be cross checked by others

main similarities between internal and external audit are as follows:

  • Both the external and internal auditor carry out testing routines and this may involve examining and analyzing many transactions.
  • Both the internal auditor and the external auditor will be worried if procedures were very poor and/or there was a basic ignorance of the importance of adhering to them.
  • Both tend to be deeply involved in information systems since this is a major element of managerial control as well as being fundamental to the financial reporting process.
  • Both are based in a professional discipline and operate to professional standards.
  • Both seek active co-operation between the two functions.
  • Both are intimately tied up with the organization’s systems of internal control.
  • Both are concerned with the occurrence and effect of errors and misstatement that affect the final accounts.
  • Both produce formal audit reports on their activities.

There are multiple differences between the internal audit and external audit functions, which are as follows:

  • Internal auditors are company employees, while external auditors work for an outside audit firm.
  • Internal auditors are hired by the company, while external auditors are appointed by a shareholder vote.
  • Internal auditors do not have to be CPAs, while a CPA must direct the activities of the external auditors.
  • Internal auditors are responsible to management, while external auditors are responsible to the shareholders.
  • Internal auditors can issue their findings in any type of report format, while external auditors must use specific formats for their audit opinions and management letters.
  • Internal audit reports are used by management, while external audit reports are used by stakeholders, such as investors, creditors, and lenders.
  • Internal auditors can be used to provide advice and other consulting assistance to employees, while external auditors are constrained from supporting an audit client too closely.
  • Internal auditors will examine issues related to company business practices and risks, while external auditors examine the financial records and issue an opinion regarding the financial statements of the company.
  • Internal audits are conducted throughout the year, while external auditors conduct a single annual audit. If a client is publicly-held, external auditors will also provide review services three times per year.

A)  

When trying to deter fraud, most companies focus their time on developing effective internal control procedures and segregation of duties. Though developing these types of systems are important, a common element of the COSO Internal Control Framework that is often overlooked is the organization’s control environment.

The control environment is important to all organizations since it is the first element of the COSO Internal Control Framework and, more importantly, the foundation of the internal control structure.   The control environment, which has also been described as the “tone at the top” includes management’s integrity and ethical values, management’s philosophy and operating style, and the oversight provided by the board of directors. Many times managers and owners set the control environment for their organization by their actions and thought process without even knowing it. For instance, if a manager is reluctant to follow company policy or consistently demonstrating the quality of getting ahead no matter what the cost, then the manager may be inadvertently influencing the company’s culture and enticing employees to do the same.

To ensure that the control environment is acting as a solid foundation for internal control matters, management should consider the following:
• Develop and implement a code of conduct that states what is regarded as acceptable business practices
• Maintain high ethical expectations with employees, suppliers, customers, investors, competitors, and others. Ethical behavior at the top permeates down throughout the organization.
• Be wary of placing undue pressure on employees to meet unrealistic performance targets, especially for short term results.
• Develop formal job descriptions to define the tasks of a particular job.
• Ensure that the board of directors, if any, exercises oversight relating to financial reporting and internal control.

By setting the tone of the organization’s control environment, managers are able to influence the consciousness and the moral compass of the rest of the organization in an inexpensive yet very powerful way.


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