Tutorial 12– Internal control (Week 13)

Question 1:
Shakira Sdn. Bhd. (Shakira) is a construction company located in Alor Setar. The company is in the
business for ten years. Your audit firm, Edwin Tan & Co is a newly appointed auditor to audit Shakira. A
team of five auditors have been doing the review for the past few days. You are the auditor in charge for
reviewing and evaluating the accounting system and related internal controls of the purchasing system.
Here is the description of the purchasing system and there are no other controls apart from those
described.

Shakira has no separate department for purchasing. Employees place orders of building materials from
the construction site offices. The order forms that has been generated will retained by the respective site
offices. A copy of order forms is sent to the accounting department and mailed to the supplier.

Once the building materials are received by the respective site offices, the materials are either
immediately use for construction or kept in the store. Here, no employee is assigned to inspect the
materials. However, the site offices must ensure that the shipping document and purchase order must be
sent to the accounts payable clerk in the accounting department.

When the supplier’s invoice is received, the accounts payable clerk checks the details, initials and staples
the shipping document with purchase order. Then, the accounts payable clerk records the invoice in the
purchase register. The invoice is subsequently sent to the respective site offices’ manager for perusal. The
respective manager approves the invoice and returns it to the accounts payable clerk. The approved
purchase invoices are entered in the purchase journal and posted to the general ledger and accounts
payable ledger on a weekly basis.

The cashier pays the suppliers on monthly basis upon receiving instructions from the accounts payable
clerk. The accounts payable control account is reconciled every month by the accounts payable clerk who
is also responsible for the reconciliation of the suppliers’ statement of account.

Required:

(a) Idenfity and explain ANY SIX (6) deficiency in Shakira Sdn. Bhd. purchasing system.
(9 marks)

(b) Explain ANY FOUR (4) types of audit tests that are normally performed by the auditors. Each test
must be supported by an appripriate example of related audit procedure. (8 marks)

(c) Explain how the size of Shakira Sdn. Bhd. affects its internal control system. (3 marks)

ANSWER:

(a).

Internal Control Weaknesses Possible Errors

(0.5 mark each) (1 mark each)

1. No authorization is required in order Unauthorised ordering of goods

for the employees to place order for may expose the company to
the goods. employee fraud.

2. No evidence of list of authorised Potential collusion between

supplier to be used. employees and unauthorised
supplier to manipulate the prices of
 goods.

3. No physical checks of goods received Quality of goods may be

against the purchase order and compromised – may lead to
despatch note. unsatisfactory stock valuation.

4. No check exists to agree quantities Possibility that amount ordered or

stated on invoice to the quantities goods received might not be
ordered and received. valued as invoiced and this might
lead to overpayment.

5. No segregation of duties between Failure to detect fraud/error on the

processing of invoices for payment purchase entries.
and recording transactions in the
purchase journal, general ledger and
reconciliation of purchase control
account and list of account payable
balances.

6. No internal verification on the input of Possibility of falsified transactions,

purchase invoices and recording overcharging or overpayment.
entries.

7. No authorised cancellation of Possible of overstatement or

documents which have been passed purchases and liabilities and the
for payment to prevent reuse. incidence of duplicate payment by
invoices not being cancelled after
payments were made.

(B)

Related Audit Procedures (0.5 marks

Audit Test (1.5 marks each) each)

1. Test of controls Account for a sequence of

A test of controls is an audit purchase orders (prenumbered)
procedure to test the effectiveness and trace selected ones to related
of a control used by a client entity suppliers’ invoices and purchase
to prevent or detect material journal entries.
misstatements. Depending on the Examine signatures of authorised
results of this test, auditors may persons on the purchase and
choose to rely upon a client's payment documents.
system of controls as part of their
auditing activities.

2. Analytical procedures Obtain list of account payables,

Analytical procedures involve a recompute and compare with the
comparison of recorded values general ledger.
with expectations developed by the Reperformance/reconciliation of
auditor. They consists of purchase ledger control account
evaluations of financial information with the list of account payable.
made by a study of plausible Compare the purchase account
 relationships among both financial and account payable balances
and nonfinancial data. with previous years.

3. Substantive test of transactions Examine suppliers’ invoices and

Substantive test of transactions other internal documentation in
means substantively verifying and support of recorded transactions
checking of value of the given in the purchase journal.
transactions. The basic element Compare dates of despatch notes
involve in substantive test of and suppliers’ invoices with the
transactions is the value of dates in the purchase journal.
transaction and substantive test of
transactions is done to detect
whether transaction value is
overstated or understated.

4. Test of details of balances Confirm account payable

Test of details of balances means balances directly with suppliers.
substantively test the financial year Obtain suppliers’ statements
ending balances of the ledgers. directly from suppliers and
The basic element is the ledger reconcile to the list of account
account balance and it is done to payable.
check for discrepancy in the
different factors affect the balance
it is either overstated or
understated.

(Any 4 points x 2 = 8 marks)

(c)
Small company may not have adequate financial capability to have a more formal and robust internal
control system as compared to larger companies.

Small companies may take comfort that they can effectively control the small number of employees and
the management/ owner may take comfort that they know everyone in the company.

Small companies may feel that there is no need for a robust/ formal internal control system since the
management/ owner can closely monitor and involve in the operations.

Small companies assume that they are better able to identify variances or any discrepancy from
expectation and inaccuracies in financial data. (Any 3 points x 1 = 3 marks)

1
Tutorial 13 on audit report (Week 14)
Question 1

You are the audit manager of James & Co. and currently reviewing the audit files for several of
your clients for which the audit fieldwork has been completed. The audit seniors have raised the
following issues in the audit of two clients:

(a) Company A has incurred a net loss of RM5 million for the year end. A’s current liabilities
exceeded its current assets by RM2 million and its total liabilities exceeded its total assets by
RM4 million. This is indicated in note 8 to the accounts and also that the auditor is uncertain
whether A will be able to meet its future liabilities. Management is positive that the problem
can be overcome. (5 marks)

(b) On 3 Oct 2015 a letter was received informing Company B that a debtor who owed B
RM500 000 as at 30 September 2015 had been declared a bankrupt. At the time of the audit it
was expected that unsecured creditors would receive nothing in respect of this debt. The
directors did not provide for the loss on the grounds that the notification was not received by
the balance sheet date. {PBT 1 500 000 and total debts= 7 000 000} (5 marks)

(c) After the year-end, one of the company’s factories and part of the administration building
was destroyed by fire. The company’s warehouse is not affected. Inventories records were
destroyed too. The closing inventory at year-end is at RM1 000 000. The auditor has relied
on the inventory-count at year-end and past year’s working papers to verify the inventories at
balance sheet date. This has been properly disclosed in the notes to the accounts. Profit
before tax is RM10 000 000. (4 marks)

Required:

(a) Discuss the importance of any three (3) elements contained in a statutory audit report. (6
marks)
(b) Discuss the implications of each issue on the audit report, including an assessment of
whether it is material. (14 marks)
The allocation of marks for each issue is shown above.

(a) Discuss the importance of any three (3) elements contained in a statutory audit report. (6
marks)
 Introductory paragraph is to identify the fs being audited. This enables the users to
understand the subject matter covered in the audit.
 Scope paragraph: to show to users of financial statements management’s
responsibility and auditor’s responsibilities. Reason to narrow down expectation gap of
the public as to auditor’s responsibilities.
 Auditors’ opinion is to enable shareholders to know the performance of the company
and whether the fs is reliable by stating the type of opinion to be issued in the audit
report.

(b) Discuss the implications of each issue on the audit report, including an assessment of
whether it is material. (14 marks)
 The allocation of marks for each issue is shown above.

1. Company A’s current liabilities exceeded its current assets by RM2 million and its total
liabilities exceeded its total assets by RM4 million. (5 marks)
 There is concern about the future survival of the business. As there is a deficit and incurring a
loss.
 Depending on whether auditor is satisfied with the management’s plan that it can overcome
the going concern problem.
 If it is possible that the problem can be resolved, there is still a going concern uncertainty as
to whether the company can survive.
 This information is material and thus, it should be disclose adequately in the financial
statements.
 If adequately disclosed, Emphasis of matter to note x to the accounts – Going concern
uncertainty.
 If not adequately disclosed, the audit report should be qualified.
 However, if the auditor is not convinced that the plan will work and it is doubtful and
unlikely the company will survive in the next 12 months, then the financial statements should
not be prepared based on going concern basis.
 Break-up basis shall be used and the audit report shall be EOM, emphasizing the note to the
disclosures that the financial statements are prepared based on break-up basis.
 Otherwise,
be issued. the financial statements is misleading and it is pervasive. Adverse opinion should

2. Debtor who owed the company RM500 000 declared a bankrupt after the year-end. (5 marks)
 The fact is that the debt is already outstanding at and after year-end and there is
indication that the debt is not collectible.
 Thus, although the debtor is declared a bankrupt after the year-end, it gives further
information as to collectability of the debts. It is an adjusting event.
 Since unsecured debtors would receive nothing, the debts should be written off.
Amount
 uses is material
judgement
material but ie. 33.33the
to consider
not pervasive. % of PBT on
impact but the
not financial
pervasive.statements.
7% of total
In debts – Auditor
this case, it is
 Since there is a disagreement to provide by the directors, a qualified opinion except for is
issued.

3. Inventories record was destroyed. (4 marks)

 The closing inventory is material since it forms 10% of Profit before tax.
 Inventory records were destroyed by the fire. Auditor may not be able to perform
vouching and tracing and find out what makes up the inventory.
 Auditor may not be able to conclude on the whether the inventory is fairly stated
due to limitation of scope.
 Since auditor has relied on inventory count at year-end, there is no limitation of
scope since there is alternative evidence.
 In addition, the event was properly disclosed in the notes to the accounts including the
extent of the damage on the buildings and its impact on the company’s business.
 Thus, the financial statements can be concluded and not misleading.
 As a result, a standard unqualified audit report.

Question 2

(a) What do you mean by an unqualified audit report and what does it imply?
(5 marks) True and fair view.
  Whether the financial information has been prepared using acceptable accounting
policies, which have been consistently applied.
 The financial information complies with relevant regulations and statutory
requirements.
 The view presented by the financial information as a whole is consistent with the
auditor’s knowledge of the business of the entity,
 There is adequate disclosure of all material matters relevant to the proper
presentation of the financial information.
 The auditor has obtained all the information and explanations needed for the audit.
 All other reporting duties of the auditor under section 174 have been satisfied.

(b) What are the Three (3) types of modified report ie. A report other than a standardized
unqualified audit report?
 Qualified
 Adverse
 Disclaimer

(c) What are the FOUR (4) conditions that influence the type of audit report?
 Immaterial? Material? Fundamental
 Disagreement?
 Limitation of scope?
 Uncertainty?

(d) Explain how materiality affects audit report?

Materiality level Disagreement-auditor able to Limitation of scope- auditor

form an opinion. unable to form an opinion.

Immaterial Unqualified Unqualified

Qualified (scope and

Material Qualified (opinion only) opinion)

Highly material Adverse Disclaimer

Question 3
For each of the mutually exclusive situations above, state the type of auditor’s report to be issued
and explain the reasons for it.

(a) HSB’s trade receivables confirmation letters were not well received by the audit team. Out of
80 samples sent out, only 27 responded to the auditors and these replies were duly filed in the
audit working papers. It was documented that when the audit team requested for alternative
statements or evidence to facilitate alternative work for trade receivables, the management
has not provided any evidences as at the date of review. (4 marks)
 The confirmation letters are important to achieve many assertions and reliable
evidence.
 If the evidence of confirmation were not completely available, it is a limitation of
scope.
 Since it involves many receivables, it is likely to be considered material.
 Since
“exceptit for”
is material, and there is a limitation of scope, issue qualified report using
 If alternative evidence can be obtained, a standard unqualified report shall be issued.

(b) During your audit of AX Sdn. Bhd., you found that a material amount of inventory had been
excluded from the inventory amount shown in the financial statements. After discussing the
problem with the directors, you were convinced that it was an unintentional oversight and the
directors were taking necessary steps to rectify the error. (3 marks)
 Material Inventory excluded from financial statements. This means inventory is not
completely recorded.
 Auditor need to find out whether there are any more such incidents for purpose of
determining the extent of misstatements.
 Since the auditor is convinced that it was an unintentional oversight, and the error is
rectified, the financial statements are true and fair.
 A standard unqualified audit report shall be issued.

(c) You are auditing Diversified Resources Bhd.‘s financial statements for the year ended 31
March
2015. The company is a defendant in a lawsuit involving a breach of contract. The legal
counsel of the company has indicated that the company is likely to lose the case and that will
have a significant impact on the continuity of the company. However, the company does not
want to disclose this information in the financial statements. (4 marks)
 Lawsuit involving a breach of contract. The issue is whether DRB will need to pay
compensation or what other effect that may arise.
 The legal counsel indicated that the case is likely to be unfavorable and significant
impact on the continuity of the business. This means there may be going concern
problem.
 There is uncertainty as to whether the company is able to survive and thus, this is
material information to be disclosed to the shareholders.
 Since the directors do not want to disclose this information, there is a disagreement
issue.
Issue qualified report with adverse since there is a significant impact.
Tutorial 13 – Computer in Auditing ( Week 14)
Question 1
a. Describe two (2) types of control in an information technology environment. (6 marks)
b. Describe two (2) types of audit approach in an IT environment. (4 marks)
c. Describe any THREE (3) effects of IT on an organization’s internal controls. (6 marks)
d. Describe THREE (3) security and access controls on IT that may be implemented by an
organization (6 marks)
Question 1 answer
a. Describe two (2) types of control in an information technology environment. (6 marks)
i. General control: It relates to the overall environment within which computer base
accounting systems are developed, maintained and operated to all the applications.
ii. Application control: It applies to the processing of individual accounting applications such
as payroll or sales system.
b. Describe two (2) types of audit approach in an IT environment. (4 marks)
i. Audit around the computer: concerning only the input and output
ii. Audit through the computer: concerning about the input, output and also the processing
routines of the computer.
c. Three effects of IT on an organization’s internal controls are:-
o IT affects all the factors that affect the control environment.
o IT affects the business risks that influence the achievement of entity objectives.
o It affects the control procedures that ensure management’s directives are carried out.
o IT affects the information and communication requirement
o IT affects the monitoring activities.

d. Security and access controls are;

• Restricting access to computers to authorized users only such as locked doors, authorized
cards.
• Password to restrict access to programme and data files.
• Logging or trail to record and monitor access to computer files and programmes.
• Secure storage of backup data in a safe and separate location.
Question 2
Fozz, a limited liability company, manufactures food. Its auditors recently completed their audit of
the company for the year ended 31 Dec 20x0 and resigned. The directors approached your firm and
asked to be the auditor of the company.
Your firm’s audit partner’s has been told by the directors that the company is about to develop a
new, on line computer based accounting system. They have stated that they will require the
company’s auditors to give guidance on the controls to be exercise over the development of the
new system.
Required :
(a) Explain the four effects of computer accounting system on internal control.
(b) Explain why it is important for a strong control to be exercised over the development of the
new computer accounting system.
(c) Outline five examples of controls to prevent unauthorized changes to data files that you
would expect to find in the new accounting system of Fozz.
(d) Describe the effect that the existence of the new accounting system will have on the
planning of the financial statements audit of the company.
Question 2 answer
a. Explain the four effects of computer accounting system on internal control.
o IT affects all the factors that affect the control environment.
o IT affects the business risks that influence the achievement of entity objectives.
o It affects the control procedures that ensure management’s directives are carried out.
o IT affects the information and communication requirement
o IT affects the monitoring activities.
b. Explain why it is important for a strong control to be exercised over the development of the
new computer accounting system.
• Consistent application of predefined business rules and performance of complex
calculations in processing large volume of transactions or data.
• Enhancement of the timeliness, availability and accuracy of information.
• Facilitation of additional analysis of information.
• Enhancement of the ability to monitor the performance of the entity’s activities and its
policies and procedures.
• Reduction in the risk that controls will be circumvented.
• Enhancement of the ability to achieve effective segregation of duties by implementing
security controls in applications, databases and operating system.
c. Outline five examples of controls to prevent unauthorized changes to data files that you
would expect to find in the new accounting system of Fozz.
Under general controls
• Data centre and network operations control
• System software acquisition, change and maintenance control
• Access security control
• Application system acquisition, development and maintenance control.
Under application controls
• Data capture controls
• Data validation controls.
• Processing controls.
• Output controls.
• Error controls.
d. Describe the effect that the existence of the new accounting system will have on the
planning of the financial statements audit of the company.
Question 3
You are assigned to audit Bestplus Bhd., a listed company operate under a fully computerized
information system environment.
As an audit senior, please explain to your inexperienced audit juniors the meaning of the following
in connection with computer auditing:
Required:
(a) Explain the term “audit trail”.
(b) Explain why there is often a loss of visible audit trail in many computer-based accounting
systems.
(c) Explain each of the following terms.
i) Audit around computer
ii) Audit through computer
(d) Describe factors that should be considered by you in determining the audit approach.
Question 3 answer
(a)
Audit trail means a chain of evidence provided by documentation or other cross referencing that
connects account balances and other summary results with original transaction data.
(b)
In an advanced IT system, many computer based programs lack of visible audit trail because it only
exist in electronic form. There are fewer hardcopy form of documents. Most of the data is stored in
the electronic format which lack audit trail.
(c)
i) Audit around computer: concerning only the input and output
ii) Audit through computer: concerning about the input, output and also the processing
routines of the computer.
(d)
i) Staff requirement and use of experts
ii) Consideration of materiality and risk