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In: Accounting

QUESTION 1 (30 marks) ABC Ltd is a wholesaler of furniture which has been in operation...

QUESTION 1

ABC Ltd is a wholesaler of furniture which has been in operation for ten years. It buys furniture from five major manufacturers and sells them to a range of customers. The company currently has a customer base of over 500 customers most of which are credit customers. The receivables balance comprises customers owing up to $2,000,000 to smaller balances of about $10,000, all with many different due dates for payments and credit limits. The level of receivables is considerably higher than last year and there are concerns about the creditworthiness of some customers.

The company has only recently computerised its operations including its accounting system. Manual invoices, receipts and cheques have been replaced with computer-generated documents. The sub-ledgers are now maintained in the accounting software which have facilitated more timely generation of statements much to the delight of customers. The sales process is initiated by a Purchase Order from the customer which is used to raise a system generated Sales Invoice and Delivery Slip. A copy of the Delivery Slip is given to the Security at the gate for logging and check off to allow passage of goods through the gate; another copy of the Delivery Slip is given for the customer to sign and then returned to the Sales Dept. All information is stored on ABC Ltd’s computer systems. There is no backup of data off site. The client’s staff are helpful although they cannot confirm completeness of documentation for the system.

You are the audit senior in charge assigned for ABC Ltd’s audit and you are in the process of planning the current year’s audit. You are contemplating the changes in the client’s audit environment and the impact that these changes will have on the audit risk and the audit methodology. Your audit assistant is curious why it is necessary to plan the audit from one year to the next. Why not just copy the previous year’s workpapers?

Required

1. Explain to the audit assistant the importance of and some of the benefits [at least four benefits] to be derived from having a tailored audit plan for each audit.

2. (a) Based on your risk assessment of the new computerized information system (CIS) environment, list two inherent risks of CIS you have identified and discuss how these factors impact the overall audit risk

(b) Outline the audit procedure which you will use in response to each risk identified in (a) above in planning the audit?

(c) State the approach for auditing in a computerized environment which you are using to design tests for testing controls over processing of data. Explain the reason for your choice, highlighting the benefits and drawbacks. State any assumption made as to resource availability.

(d) Explain how the choice of approach in (c) above is likely to impact audit risk? Identify the audit risk component which is most likely to be affected.

3. (a) Your audit plan notes that you will be testing the system of internal controls for the ‘three Es’. Explain the ‘three Es’ and the impact these will have on the audit if positive and if negative.

(b) State the audit procedure you will be using for the following:

i) To test the control over completeness of sales

ii) To test the accuracy and existence of receivables balances

(c) List the set of management assertions for “Sales” and “Accounts Receivable” which you will be testing.

Solutions

Expert Solution

Question 1

The building blocks of an effective audit is a well-tailored audit plan. Audit plans need to change from client to client as well as periods to periods. The need to change audit plans from client to client is obvious. The areas of risk and the types of transactions involved are inherently requiring a tailored audit plan for each client. However, the need for a different audit plan every year for the same client is more subtle. An audit is an objective examination and financial records and the process involved in building and maintaining these records. Both the processes and the financial records themselves are dynamic. Companies change business models, customers, vendors, operations systems and a lot more every year. These changes result in audit risks as well as the required assertions to shift from one area to another. For example, in the above case, after computerization of accounts, manual tampering of accounts may no longer be a significant risk. However, computer controls becomes a significant risk requiring a modification in the audit plan. Some of the benefits of tailoring an audit plan every year are:

a. Better risk assessment - Comparison of prior year audit plans with actual results help us better assess the risk involved in an audit. This gives the auditor a direction in terms of how detailed each assertion/area needs to be tested. For example, if errors in prior years and far less than expected by the respective year audit plans in the assets section, the audit may plan for more reliance on compliance testing than substantive testing for the current year.

b. Better understanding of audit environment - In the above example the company has computerized its accounting system. This is a change in the accounting environment. Essentially, the audit plan needs to consider for computer controls. A tailored plan every year ensures this is taken into account

c. Resource planning - A tailored plan can effectively help plan resources and time for an audit. In the above case, with the increase in transactions and size of the client, the resources required for substantive testing may be higher. While the computerisation may aid in compliance testing reducing the resource requirement for the same.

d. Flexibility - A tailored audit plan assists in flexibility in terms of which areas to focus upon each year. A new area might have arise due to certain business developments which may get ignored if the audit plan is not tailored.

Question 2(a)

a. Dependence on Sales Department for raising invoice as well as confirmation of delivery can allow them to inflate sales without anybody noticing

b. Lack of a backup system can lead to tampering of data without any audit trail left over.

Question 2(b)

a. The audit procedure to ensure there arent any inflated sales would be to check the invoices against the signed delivery recipts from the customer. This may be a 100% verification or a sample verification based on the quantum of transactions and the significance of the risk.

b. The audit trail is available in the form of offline records in the gate receipts and bank statments. The sales would have to be verified against the gate reciepts and the any sales collections should be verified against the bank statemetns.

Question 2(c)

In a CIS environment there is a lack of a visible audit trail. Hence traditional manual control systems will not be effective as it would not help us understand how transactions are processed. The options we have to test a CIS environment include:

a. Special/Exception Reports

b. Tagging and Tracing.

The preferred method in this case is tagging and tracing since it would provide a clear view of how a transaction goes through the system and is recorded with the manual and automated controls at each stage clearly highlighted. The reason this would be better approach is because of high level of receivables which would require tracing whether sales arent overstated at the process level. However this does result in the drawback that unusual transactions are not clearly highlighted. But considering that the company has diverse types of receivables and transactions this would provide a clear understanding whether the basic controls are operational.


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