Question

Case of Studies.

“How to do it” is a company which provides information and products for the DIY (Do-It-Yourself) sector. It has grown significantly in the past few years and turnover has increased from around $3m to over $15m per annum. The company was originally managed by the owners who, as it grew, hired staff from predominantly amongst people that they knew or were already known to other staff. Staff numbers had grown from less than 10 to over 60 during this period and many employees were married to, or in relationships with, others within the company. Audits are conducted annually and the audit company is well regarded and has been doing the audits since the company began. The auditors are regarded as part of the team and attend the Christmas function each year. At the most recent Christmas function one of the auditors commented to the general manager, as an aside during a conversation, that he was surprised that given the increase in turnover that the yearly profits were not higher. The general manager decided that during the Christmas break he would look at the auditor’s report and review the situation. The auditor’s report made no such statement but after examining the figures it was apparent that profits should have been higher. When the office re-opened he requested the auditors to undertake an examination specifically to discover why it was so. The auditors investigated and reported that the section manager responsible for major purchases had paid invoices to a company which he and his wife owned. The amount paid to the company was in excess of $500,000. The section manager was responsible for signing off on work completed, or supplies received, and authorising payments. His wife was responsible for issuing the cheques. Both were signatories to the cheque account.

a. What breaches of internal control were there (3 marks per breach, max 12 marks)

b. What modifications to procedures would you implement? (5 marks per modification, max 20 marks)

Answer 1

There was a Inherent Risk & Control Risk in the Company. The Related Party transactions should be disclosed in the Financial Statements as per Financial Reporting Framework. There was a manupulation of $5,00,000 in the books of Accounts. There was no rise in Profits with the rise in yearly Turnover. This indicates that there were booking of some bogus/fake expenses in the books of accounts.

Inherent Risk is assessed at Micro & Macro Level in the Financial Staements of the Company. Control Risk is assessed on the Internal Control of the Entity. If Inherent Risk & Control Risk are high then the Detection Risk should be kept at low by tha Auditor to make Audit Risk acceptable and vice-a-versa.

The Following modifications to procedures would be implemented:-

1.) Internal check Procedures should be implemented on Related Party Transactions.

2.) Cut Off Date Procedures.

3.) Checking in Detail the significant Entries at Year End.

4.) Internal Audit Team & Audit Committee should be set up in the Organisation.

5.) Analysis of ratio & trends of Profits with Turnover.

6.) Joint/Dual Authorisation in Issuing Cheque instead of Single Issuer.