ZAMBIA INSTITUTE OF CHARTERED ACCOUNTANTS ACCOUNTANTS CHARTERED ACCOUNTANTS EXAMINATIONS _______________ _______________ LICENTIATE LEVEL _______________ _______________ L4: AUDITING _________________ _________________ SERIES: JUNE 2012 ___________________ ___________________ TOTAL MARKS – 100 TIME ALLOWED: THREE (3) HOURS ____________________ _____________________ _ INSTRUCTIONS TO CANDIDATES
1.
2.
You have fifteen (15) (15) minutes reading reading time. Use it to study study the examination paper paper carefully so that you understand understand what to do do in each question. You will be told when to start writing. This paper is divided into TWO sections: Section A:
Two (2) Compulsory Questions. Questions .
Section B:
Three (3) Optional Questions. Attempt any Two (2).
3.
Enter your student number and your National Registration Card number on the front of the answer booklet. booklet. Your name must must NOT appear appear anywhere anywhere on your answer answer booklet.
4.
Do NOT write in pencil (except for graphs and diagrams).
5.
The marks shown against the requirement(s) for each question should be taken as an indication of the expected length and depth of the answer.
6.
All workings must must be done done in the answer booklet. booklet.
7.
Present legible and tidy work.
8.
Graph paper (if required) is provided at the end of the answer booklet.
SECTION A: Attempt BOTH questions questions in this section section.. QUESTION ONE You are an audit manager in Kasonde Mutale Chartered Accountants. Accountants. Your firm has just been appointed as external auditors of Yofinance Solutions Limited for the year ended 31 January 2012. Yofinance Solutions Limited is a rapidly expanding financial institution which provides various financial services such as loan facilities, secure financing, attractive investments and business advisory services to meet the needs of small and medium sized enterprises (SMEs). The company’s revenue has increased at an average rate of 30% per annum over the last three years, whilst net profit has remained almost constant over the same period. The draft financial statements show revenue of K 9,000 million and net profit of K450 million. The appointment is very important to your firm which expects to generate a significant amount of income from the assignment as Yofinance Solutions Limited has additionally asked Kasonde Mutale Chartered Accountants to provide tax advisory services to the company and wish the firm to represent Yofinance Solutions Limited in a dispute with the Zambia Revenue Authority regarding the amount of income tax payable for the previous year. In a meeting held with the directors of Yofinance Solutions Limited, the CEO of the company, Mr. Isaac Longwe, explained that it is important that Kasonde Mutale Chartered Accountants issue an unmodified report on the company’s financial statements by 29 February 2012, because the company wishes to use the audited financial statements to obtain finance from the bank in March 2012, 2012, to fund the company’s ongoing expansion program, under which the company expects to open five new branches on the Copperbelt. Mr Longwe offered to take the entire audit team on an all expenses paid for weekend to a luxury hotel in Livingstone if the above deadline was met. Your firm has appointed Mr Wiseman Banda as the partner in charge of the audit of Yofinance Solutions Limited. Mr Banda was until October 2011, employed as Finance Director at Yofinance Solutions Limited. He joined Kasonde Mutale Chartered Accountants as senior partner, after the expiry of his five year contract with Yofinance Solutions Limited and has been quite influential in securing your firms appointment as the company’s auditors. You have established that Yofinance solutions replaced its old computer system during the year ended 31 January 2012, with a new system and installed i nstalled new software packages as the hardware on the previous system was old and the software could not handle the increased volume and complexity of transactions. The company currently does not have an internal audit department as the directors are of the view that establishing an internal audit department is a mere waste of resources.
2
Required: (a)
(b)
Identify and explain factors that may threaten the independence of Kasonde Mutale Chartered Accountants in the audit of Yofinance solutions and describe how each threat should be managed. (8 marks) Explain why it is important to plan an audit.
(4 marks)
(c)
Identify and explain five (5) audit risks which will need to be addressed when planning the audit of Yofinance solutions Limited’s financial statements for the year ended 31 January 2012. (10 marks)
(d)
Explain the benefits to Yofinance Solutions of establishing an internal audit department. (8 marks) (Total: 30 marks)
QUESTION TWO Mapenzi Ltd sells office and household furniture to customers from five outlets. Each outlet is managed by a branch manager with the help of 15 sales assistants. The company’ s central administration and accounts is based at head office in Lusaka. The company operates a computer based accounting system. Sales are made on both cash and credit basis. For credit sales, sales assistants at each branch are responsible for the granting of credit, assessing the credit worthiness of customers and management of customer accounts. In order to meet sales targets at branches and attract more customers, credit limits are not given to individual customers. Sales assistants take orders in writing and for long standing and reliable customers telephone orders are accepted. The order is used by the sales assistant to prepare a three copy sales invoice with the relevant information using the company’ s authorised price list and an accompanying goods despatch note addressed to the customer for products as ordered. The sales assistants then gives the invoices to customers and the goods despatch notes to the company’s warehouse staff to accompany goods when collected by the customers. A copy of each invoice raised is retained at the branch by the branch manager who is responsible for compiling daily sales information and the remaining copies of each invoice raised are compiled and sent by the branch manager to the accounts department at head office. Accounts department staff at head office use the invoices received from branches to open customer accounts in the receivables ledger and the computerised system updates the company’s general ledger with the sales invoices postings. The invoices are then filed in numerical sequence. Your firm is the external auditor of Mapenzi Ltd for the year ended 31 December 2011 and you have been assigned to the audit of the company’s sales and receivables system. The draft financial statements show a receivables account balance of K660 million and you have been instructed to prepare a draft positive confirmation letter for circularisation.
3
Required: (a)
Outline four (4) objectives of internal controls that should be exercised over the sales system at Mapenzi Limited. (4 marks)
(b)
Explain the nature and purpose of a letter on internal controls (management letter). (2 marks)
(c)
Write a letter on internal controls to the management of Mapenzi Limited in respect of the sales system which: (i)
Identifies and explains four (4) deficiencies in the sales system;
(ii)
Explains the possible effect of each deficiency;
(iii)
Provides a recommendation to address each deficiency.
(14 marks)
(d)
In relation to receivables circularisation, distinguish between positive confirmation and negative confirmation of receivables. (2 marks)
(e)
Explain the steps you would take where no replies are received from the receivables circularisation letters and outline the alternative audit procedures you would perform to verify Mapenzi Limited’s year-end account receivables balance. (8 marks) (Total: 30 marks)
SECTION B: Attempt any TWO questions in this section QUESTION THREE You are an audit manager in WHC Chartered Accountants. In a recent meeting reviewing the performance of your firm, the engagement partner noted that your firm has recorded a remarkable increase in the number of clients requesting for forensic audit services from your firm. The engagement partner also noted that most of your audit clients have now implemented computer based accounting systems and in view of this, suggested that your firm in future should use an ‘audit through the computer’ approach rather than an ‘ audit a round the computer’ approach, when auditing computer based accounting systems of such clients. Required: (a)
Def ine the term ‘forensic audit’ and state three (3) applications of the use of forensic auditing. (5 marks)
(b)
Describe how the fundamental principles of the IFAC’s Code of Ethics for Professional Accountants apply to the provision of forensic audit services. (5 marks)
(c)
Explain the meaning of the terms ‘auditing a round the computer’ and ‘auditing through the computer’ describing the circumstances in which it would be appropriate to use each approach. (6 marks)
4
(d)
Outline the benefits that can be derived from using computer assisted audit techniques in carrying out tests on a computer based accounting system. (4 marks) (Total: 20 marks)
QUESTION FOUR Your firm is the external auditor of Tamanga Fashions Ltd, a clothing and footwear retail er which has a large central warehouse and more than 30 outlets across the country. The company maintains a perpetual inventory system and values inventory at the lower of cost and net realisable value in accordance with IAS 2: Inventories . The perpetual physical counting of inventory items is done by the company s internal audit department. You have just established that the cost of the inventory has correctly been determined. Required: (a)
Explain why the audit of inventory is important to auditors.
(4 marks)
(b)
Explain the meaning of four (4) assertions that relate to the audit of inventory. (4 marks)
(c)
Describe the audit procedures you will perform in order to rely on the perpetual inventory counting procedures at Tamanga Ltd and explain the purpose of each procedure. (8 marks)
(d)
Outline four (4) procedures that you will carry out to verify inventory has been valued appropriately at the lower of cost and net realizable value. (4 marks) (Total: 20 marks)
QUESTION FIVE (a)
ISA 560 (Redrafted) Subsequent events provide guidance on the auditor’s responsibilities in relation to subsequent events. Required: Explain the auditor’s responsibilities in relation to the following events. (i)
Events occurring from the reporting date up to the date of the auditor’s report.
(ii)
Events discovered after the date of the auditor’s report but before the date the financial statements are issued.
(iii)
Events discovered after the financial statements have been issued. (8 marks)
(b)
Your firm is the external auditor of Kamanga Plc. Kamanga Plc’ s financial statements for the year ended 31 January 2012 shows revenue of K2,028 million and profit before tax of K920 million. The following issues have arisen during the final review of the company’s financial statements.
5
Required: Discuss the treatment of each of the below issues and describe the impact on the audit report if each issue remains unresolved. (i)
Trade receivables in the statement of financial position have been recorded at K414 million. This amount includes a receivable amounting to K145 million from a customer who went into liquidation on 14 February 2012. You have ascertained from the liquidator that Kamanga Plc is unlikely to receive any amounts in respect of the debt. No entries have been made in the financial statements to account for this event. (4 marks)
(ii)
Your firm has not been able to access wages information for the period of November 2011 to January 2012, as Kamanga Plc’s computerised wages program became corrupt resulting in the loss of the wages records and backups for that period. Wages and salaries for the three month period amount to K122 million. (4 marks)
(iii)
Kamanga Plc is being sued by one of its major customers for K480 million for alleged breach of contract over a cancelled order. The outcome of the case will not be known until after the audit report has been signed. The company’s lawyers have advised that Kamanga Plc may have a possible obligation and the matter has accordingly been correctly disclosed in the financial statements as a contingent liability. (4 marks)
(Total: 20 marks)
END OF PAPER
6
L4: AUDITING SUGGESTED SOLUTIONS SOLUTION ONE (a)
Fee income Threats No details are provided regarding the fee income obtainable from Yofinance Solutions Limited. However, given that the appointment will generate a significant amount of income and the firm will also provide other services (tax advisory) besides the audit, the total practice fee receivable from the company may be quite substantial which may result in undue dependence on the company leading to self interest and intimidation threats. Safeguards Kasonde Mutale Chartered Accountants should ensure that no more than 15% of its recurring practice income (i.e. auditing and other work combined) is derived from this client. Obtaining more than 15% could indicate undue financial reliance on the client, and impair objectivity regarding the audit report through fear of issuing a modified report and losing the fee income from the audit client. If the 15% limit is close, Kasonde Mutale Chartered accountants may have to limit or decline offering other services so that independence is not impaired. An annual review will be required to ensure that the fee income rules are not be breached. Tax advisory services Threats Offering tax advisory services to Yofinance Solutions may give rise to a self review threat where the advice given will affect matters to be reflected in the financial statements. Objectivity is lost in such situations as the auditor is put in a position of evaluating a previous judgement or work performed for the purposes of forming an opinion on those financial statements. Safeguards to reduce the threat may include: -
Using professional who are not part of the audit team to perform the service
-
Having a tax professional, who was not involved in providing the tax service, advise the audit team on the service and review the financial statements
-
Obtaining advice on the service from an external tax professional
-
Obtaining pre-clearance or advice from the tax authorities
Income tax dispute Threats Representing Yofinance solutions regarding the tax dispute with the ZRA could be seen as an advocacy threat, as the audit firm will be promoting the position of the 7
client. Objectivity could be compromised because the audit firm will be seen to be taking the position that the client is correct, affecting judgement on the tax issue. Safeguard To remain independent, the audit firm should decline to represent the client in the tax dispute with the ZRA. Appointment of Mr Banda as engagement partner Self review and familiarity threats will arise from appointment of Mr Wiseman Banda as partner in charge of the audit of Yofinance Solutions Ltd. A self review threat arises because as Finance Director Mr Wiseman Banda was in a position to exert significant influence over the preparation of Yofinance’s accounting records and financial statements thus decisions and work performed and he will now as partner in charge of the audit will be required to evaluate his work leading to loss of objectivity. A familiarity arises through association with management and other employees at Yofinance solutions during the period he was employed at the company affecting his objectivity when assessing any work performed by the audit team. Appropriate safeguards will include: -
Removing Mr Banda from the assignment.
-
The firm should additionally a have a policy that prohibits newly appointed employees from being part of the audit team until a specific period of time, normally two years, has elapsed.
-
Having an independent professional review work performed by Mr Wiseman Banda.
Gifts and hospitality The offer of an all expenses paid weekend at a luxury hotel in Livingstone may appear to be a threat to independence; the audit staff may be favourably disposed towards Yofinance Solutions Limited and be less inclined to investigate potential errors. Safeguard Audit staffs are allowed to receive modest benefits on commercial terms; whether there is a benefit depends on how expensive the trip will be, in this case it appears to be significant. The offer should therefore be declined.
8
(b)
Importance of audit planning
(c)
The auditor should plan the audit work so that the engagement will be performed in an effective manner. To develop a general strategy and detailed approach for the specific nature, timing and extent of the audit work. This will help to ensure that the audit is carried out in an efficient and timely manner. So that attention is devoted to the important areas of the audit. Planning will also help to identify problem areas so they can be addressed in a timely fashion. To determine the amount of work to be carried out and therefore assist in determining the number of staff required to perform the audit work. To provide a document as a reference for an initial discussion of the approach to the audit with the company’s audit committee. The plan will also help ensure that audit work is co-ordinated with client staff: e.g. for production of specific documentation to assist the auditor. To act as a basis for the production of the audit plan. To facilitate the direction, supervision and review of work.
Nature of business The Financial services industry is a complex and highly regulated sector with strict regulatory controls this will increase the inherent risk associated with the financial statements of the company. New audit client The audit is risky for the audit firm because it is the first year of an audit. This increases detection risk as the audit firm has no previous experience of the company. This will make it difficult to for the firm to establish which areas of Yofinance solutions accounting systems are most susceptible to errors and also means that less reliance can be placed on analytical procedures. Control environment The company does not have an internal audit department and lack of appreciation of importance of internal audit by directors indicates a poor attitude towards internal control and the control environment in which the control systems should be operating may be weak as the company may not have desirable appropriate controls to help prevent, detect, correct and control misstatements. Rapid expansion /Over-trading The turnover of the company is growing quite rapidly, although this growth is not matched by net profits which have remained constant inspite of the increase in sales. The company is expanding and is opening new branches and there is risk that the business will exhaust any cash reserves as it continues to expand but does not generate sufficient additional cash to pay for that expansion, at the extreme the business may be forced into liquidation. Therefore the financial statements may not adequately disclose doubts about going concern.
9
Reliance on financial statements by Bank The directors require additional finance to expand the business. To provide this finance it is likely that the bank will require the audited financial statements. The directors will want to present a healthy set of financial statements to the bank and therefore there is risk that the figures may be manipulated and hence misstated. There will be increased risk of error throughout the financial statements particularly in areas that are subjective such as provisions. Strict deadline for completion of audit The directors expect an unmodified report to be signed by 31 January 2012.This will increase detection risk as the auditor is under time pressure and will additionally lack evidence of events after the reporting date. The audit firm must ensure that sufficient time and resources are allocated to the audit to ensure that the audit opinion can be supported. Pressure from the directors to complete the audit quickly will have to be resisted. Risk relating to the new computer system The company installed a new computer system during the year, there is risk that staff may not be familiar with the new system resulting in mistakes and errors. There is also risk of loss of data and misstatements occurring during system conversion with additional risk that the new system may not be functioning effectively. There may also be risk that the general computer controls might be weak because of the new hardware and software resulting in business interruption and loss of data. (d)
Benefits of establishing an internal audit department Monitoring effectiveness of internal controls Yofinance Solutions Ltd has to maintain a strong internal control system as the company is operating in a highly regulated industry. Internal audit can review the effectiveness of those controls and make recommendations to management for improvement where necessary. This will be particularly important as the company is rapidly expanding and the internal control system needs to be robust enough to support the increased level of operations. Value for Money Audit Internal audit can carry out value for money audits within Yofinance Solutions Limited. For example, a review could be undertaken on the cost effectiveness of the various control systems or whether investment advice being provided is costeffective given the nature of products being recommended and the income/commission generated from those products.
10
Risk assessment Internal audit could also carry out risk assessments on the investment portfolios being recommended to clients to ensure the portfolio matched the client’s risk profile and Yofinance risk appetite. Any weaknesses in this area would result in a recommendation to amend investments. Reports to the board As a financial services provider, staff in Yofinance will be producing various financial reports for their board. The internal audit department will be able to monitor the accuracy of those reports. This function will help enhance the accuracy and reliability of such reports. Liaison with external auditors The internal auditors can liaise with the external auditors, especially where it will be possible for the external auditors to place reliance on the work of internal audit. This will decrease the time and cost of the external audit. Regulation The Financial services industry is a highly regulated sector with strict regulatory controls and reports that Yofinance Solutions must produce and comply with. Establishing an internal audit department will therefore enable Yofinance solutions produce those reports more efficiently and ensure compliance with the regulatory regime. Image to clients and other stakeholders Codes of corporate governance increasingly suggest that it is good practice to have an internal audit department. By establishing an internal audit department the company will be perceived to be following good practices on corporate governance and will portray good image of the company to investors, clients and other stakeholders. Good controls will imply client monies are safe with Yofinance Solutions Limited. SOLUTION TWO (a)
Control objectives -
Goods are only supplied to authorised customers with good credit ratings Orders are recorded correctly regarding price, quantity, item and customer details Orders are fulfilled Customers are encouraged to pay promptly Orders are despatched to the correct customer All despatches are correctly recorded Despatches only relate to goods ordered and paid for by customers Invoices raised relate to goods supplied by the company All sales that have been invoiced and recorded in the general and sales ledgers. All credit notes issued are recorded in the general and sales ledger 11
- All entries made in the sales ledger are made to the correct sales ledger accounts. (b)
A letter on internal control (also referred to as a report to management or a management letter) is a letter forwarded by an auditor to senior management of a company which contains weaknesses identified in an entity’s system of internal control as identified by the auditor or members of his audit team, when performing tests of control and the purpose of the letter is to bring these weaknesses to the attention of management. The weaknesses identified in the main body of the letter should be those which could lead to fraud or material error in or omission from the company’s financial statements, and will be classified as those relating to: -
the design of the systems of accounting and internal control.
-
the operation of the systems of accounting and internal control.
For both categories the implications of the weaknesses should be identified, however minor control issues which the auditor would wish to bring to the attention of the company’s senior management should be included in an appendix to the letter of weakness or in a supplementary report. (c)
Management Mapenzi Ltd PO BOX B LUSAKA 17 January 2012 Dear Sirs Letter on internal controls We write to bring to your attention deficiencies in your company’s internal control systems and provide recommendations to alleviate those deficiencies. The matters dealt with in this letter came to our attention during the performance our normal audit procedures which are primarily designed for the purpose of expressing an opinion on the financial statements 1.
Credit control Deficiency Sales assistants are responsible for actioning all aspects of credit control. Implication The company is exposed to the increased possibility of losses arising from bad debts and fraudulent transactions because the sales assistants have a vested interest in granting new credit facilities in order to achieve sales targets and are also in a position to enter into fraudulent arrangements with customers. 12
Recommendations Granting of new credit facilities to customers should be vested in an independent official of the company, such as a credit controller, segregated from the sales and sales accounting function. 2.
Opening of customer accounts Deficiency There are inadequate controls over the opening of customer accounts in the trade receivables ledger and credit limits are not applied to customer accounts Implications The risk of losses through bad debts is increased as sales can be made to uncreditworthy customers or even to fictitious customers. Recommendations Rigorous controls should be implemented over the opening of customer accounts, such as credit checks, obtaining of trade/bank references and setting appropriate credit limits for customers, and the authorisation of new customer accounts by a responsible official of the company. Strict controls should be maintained over updating the receivables master file.
3.
Telephone orders Deficiency Telephone orders are accepted for the despatch of the company’s products. Implications There is an increased risk of customer disputes and the company’ s exposure to losses is increased as a consequence of goods being despatched in response to unauthorised or fake telephone orders. Recommendations The company should introduce robust procedures to facilitate clarity of and certainty of in the customer ordering process. The company should only accept written orders from genuine customers. Procedures for ordering from the company should be made clear to all customers, through the issue of terms and conditions of trading, and these should be strictly adhered to. Any doubts as to the authenticity of written orders received from customers should be removed before execution of those orders.
13
4.
Raising of sales invoices Deficiency Sales invoices are raised and forwarded to customers merely on receipt of a customer orders. Implications There is risk that sales revenue may be recognised incorrectly, before goods sold are received by the customer which may lead to overstatement of reported profits. Recommendations Current procedures with regard to the production of sales invoices and goods despatch notes should be modified. Sales invoices should be forwarded to customers only on receipt of confirmation of receipt of goods by customers. The stores warehouses should generate pre-numbered goods despatch notes to accompany all goods despatched and copies should be retained for control purposes. Sales invoices should be prepared and forwarded to customers only after the warehouses have confirmed that goods have been despatched, by for example forwarding a copy of the prenumbered despatch note. Copy invoices should then be forwarded to the accounts department for posting to the accounting records by appropriately experienced employees.
5.
Recording of sales invoices Deficiency Sales invoice transactions are entered in Mapenzi Ltd’s accounting records without prior authorisation from a responsible official of the company. Implications of Weakness Unauthorised transactions could be entered into the company’s accounting records, resulting in inaccurate reporting of financial information, unnecessary disputes with customers and loss of customer goodwill. Recommendation Accounts staff should match copies of authorised sales invoices with delivery notes and customer orders and forward to an appropriate authorised official (for example Mapenzi Ltd’s Accountant or Financial Director), for checking and authorisation prior to posting into the company’s accounting records. The above are the weaknesses which came to our attention during the audit. We wish to state that the above may not be the only weaknesses in your organisation. If you require any further information on the above, please do not hesitate to contact us. 14
Yours faithfully DA Chartered Accountants (d)
Positive and negative circularisation A positive receivables circularisation letter asks customers to confirm the accuracy of the balance shown or state in what respect the customer is in disagreement by providing full details of the balance as per their own records. It requires a response from the customer whether the customer agrees with the amount stated or not. A negative receivables confirmation on the other hand requests customers to respond to the company’s auditors only if they do not agree with the stated balance.
(e)
The following steps and alternative procedures can be performed: -
Where no replies are received from the initial circularisation letter, the auditor should send a second request.
-
If the customer does not reply to the second request the auditor should try to contact the customer directly e.g. by telephone, with the permission of the client.
If direct confirmation with the customer is not possible or successful, the following alternative procedures can be performed: -
Review cash received after the year end to see if the balances have been cleared.
-
Examine the accounts to identify whether the balance outstanding represents specific invoices and confirm their validity.
- Agree individual outstanding invoices to independent evidence such as delivery notes signed by the customers. -
Obtain explanations for invoices remaining unpaid after subsequent ones have been paid.
-
Review credit notes issued after the year-end to ensure that these have not been used to reduce the year- end receivables balance.
-
Scrutinise ledger balances/journals for unusual entries.
-
Perform analytical reviews considering particularly changes in the receivables collection period and in the age of profile of the receivables.
-
Test the company’s control over the issue of credit notes and write-off of bad debts.
15
SOLUTION THREE (a)
A forensic audit can be defined as the process of gathering, analysing and reporting on data, in a pre-defined context, for the purpose of finding facts and / evidence in the context of financial or legal disputes and/or irregularities and giving preventative advice in this area. It is the specific use of audit procedures within a forensic investigation to find facts and gather evidence. Forensic auditing can be applied to a number of situations including:
(b)
(i)
Fraud investigations to quantify losses from theft of cash or goods, identifying payments and receipts of bribes, identifying intentional misstatements in financial information etc.
(ii)
Negligence investigations - where the auditor is being sued for negligence, either or both parties to the case may employ forensic accountants to investigate the work done to provide evidence as to whether the work performed met the relevant standards. They may also be involved in establishing the amount of suffered by the plaintiff.
(iii)
Insurance claims- Forensic accountants are often employed by insurance companies to report on the validity of the amounts of losses being claimed as a means of resolving the disputes between the company and the claimant.
(iv)
Forensic auditing can also be applied to resolution of other disputes such as shareholders’ disputes, partnership disputes, contract disputes, business sales and purchase disputes and even matrimonial disputes to value the family business, gather financial evidence, identify hidden assets or to advise on settlement negotiations.
(v)
Forensic auditing can also be applied to investigations of terrorist financing.
Application of ethical principles to forensic Audits The IFAC Code of Ethics for Professional Accountants applies to all ZICA members involved in professional assignments, including forensic audits. Specific considerations in the application of each of the principles in providing forensic audits will be as follows: Integrity In providing forensic audit services, the accountant is likely to deal frequently with individuals who lack integrity, are dishonest, and attempt to conceal the true facts from the auditor. It is imperative that the auditor recognises this, and acts with impeccable integrity throughout the whole investigation. If there is any risk that their own intergrity may be compromised they should decline or withdraw from the assignment
16
Objectivity The accountant’s objectivity must be beyond question. The report that is the outcome of the forensic audit must be perceived as objectives. Any real or perceived threats to objectivity could undermine the credibility of the work performed by the accountant. Professional competence and due care Forensic audits will involve specialist skills (e.g. an understanding of how to gather specialist evidence) which accountants are unlikely to possess without extensive training. A firm should therefore carefully consider whether they have adequate skills and resources before accepting the assignment Confidentiality The principle of confidentiality still applies to forensic audits. However, in certain circumstances, such as during legal proceedings in a court case, the court may require the accountant to reveal information discovered during the audit. There is an overriding requirement for the accountant to disclose all of the information deemed necessary by the court. Outside of the court, the accountant must ensure faultless confidentiality, because much of the information they have access to will be highly sensitive. Professional behaviour Professional behaviour is important to protect the reputation of the individual and the profession as a whole given that a forensic audit may become a matter of public interest, and much media attention is often focused on the work of the forensic auditor. A highly professional attitude must be displayed at all times, in as any lapse in professional behaviour could also undermine the integrity of the forensic evidence, and of the credibility of the auditor. (c)
Auditing round the computer Auditing round the computer means comparing in detail the input to, and output from, the computer, ignoring the processing procedures that go on within the computer, and testing the general controls exercised over the computerised systems. This approach is only appropriate if the auditor is able to match input and output in detail, and has sufficient assurance about the computer package being used. Auditing through the computer Auditing through the computer means examining the detailed processing routines of the computer to determine whether the controls in the system are adequate to ensure complete and accurate processing of all data, and identify errors. This method should be used if there is lack of audit trail or if auditors are placing significant reliance on controls within the system. Auditors will often need to be place significant reliance on the controls within the computer, since these controls will be vital in ensuring that the company’s accounting records are not materially misstated. 17
(d)
The benefits of using Computer-assisted Audit Techniques (CAATs) (i)
They will enable the auditor test program controls in a computerised system, which will be difficult or impossible to test if CAATs are not used.
(ii)
They will enable the auditor to test a greater number of items quickly and accurately. This will also increase the overall confidence for the audit opinion that the auditor will give on the clients financial statements.
(iii)
They will allow the auditor to test the actual accounting system and records rather than printouts which are only a copy of those records and which could be incorrect.
(iv)
CAATs are cost effective after they have been setup and will enable either auditor perform audits on its clients computerised system cost effectively.
(v)
They will allow the auditor compare the results from using CAATs with the results obtained from ‘traditional’ testing if the two sources of evidence agree then this will increase overall audit confidence.
SOLUTION FOUR (a)
Importance of inventory -
-
-
-
-
-
Inventories are important to the financial statements because the inventory figure, particularly for manufacturing companies, may be material to the statement of financial position and income statement, both in the cur rent year and as a comparative figure. The valuation of inventories can be difficult and may require the use of judgement and inventories may thus easily be used to manipulate the appearance of both the income statement and the statement of financial position. In the income statement, there is a direct relationship between the inventory figure and the profit for the period. If closing inventories are overstated, profits will be overstated. Many key accounting and performance ratios are calculated using the inventory figure. These include inventory turnover, inventory days, the current ratio and working capital ratios. Many companies use these ratios for internal purposes and many third parties, such as investment analysts, also use these figures to assess performance. Poor inventory control will be reflected in inventory figures at the period-end. For many companies, excess inventory is a sign of serious problems. There is sometimes relatively little audit evidence for the inventory figure, particularly for small companies and it is therefore important for auditors to scrutinise the evidence available carefully and consider the scope for misstatement or deliberate manipulation of the inventory figure. Inventories may be high risk if they are valuable or easily portable.
18
(b)
Meaning of assertions relating to the audit of inventory Existence: Inventory recorded in the statement of financial position physically exists. Valuation: Costs relating to inventory are accurately determined and that inventory is recorded at the year end at the lower of cost and net realisable value, i.e., has been valued appropriately in accordance with IAS 2 Inventory. Completeness: All purchases and sales of inventory have been recorded and that all inventories pertaining to the entity at the year-end has been included in the statement of financial position. Rights and obligations: The entity has rights to the inventory recorded in the period and at the year end. Cut-off: Inventory cut- off has been applied correctly and inventory has been recorded in the correct period. Presentation and disclosure (classification, understandability): Disclosures relating to classification and valuation are adequate and in accordance with accounting standards.
(c)
Audit procedures 1.
Procedure Arrange a meeting with the internal audit department. Discuss the procedures carried out and review working papers produced during the continuous inventory checks. For any errors identified, ensure that appropriate adjustments were made to the perpetual inventory system. Purpose The purpose is to determine the extent to which reliance can be placed on the work of the department.
2.
Procedure Visit the warehouse and a number of outlets (especially those where value or volume of inventory is substantial or controls are weak. i.e. where risk is greater) and obtain a sample of inventory items already recorded on the perpetual inventory system and agree to physical inventory items. Purpose The is done to ensure that the inventory lines recorded on the computer system actually exists.
3.
Procedure For a sample of items held at warehouse and various outlets obtain details and agree to perpetual computer system. 19
Purpose The objective is to ensure that all inventory is recorded on the inventory computer system and ensure that there is completeness of recording records. 4.
Procedure Review the condition of the inventory, taking details of any which appear to be soiled, old or damaged. Purpose To confirm that any inventory which is damaged or unsaleable is correctly valued.
5.
Procedure Form an opinion regarding the overall accuracy of the perpetual inventory system. Purpose To confirm that inventory quantities have been correctly recorded.
6.
Procedure Ensure all inventory lines are counted at least once per year through discussions with the internal audit department. Purpose To confirm that all inventory is counted regularly.
(d)
PROCEDURE
For a sample of inventory you compare invoices to cost price used calculated
For a sample of inventories you compare the cost price used in the computation to the invoices
Review the client’s working papers on the evaluation of inventory.
For the sample of inventory, confirm that the value picked is at the lower of cost and net realisable value
NET REALISABLE VALUE -
Compare net realisable value to the sales invoices sold during the year and subsequent year
-
For a sample of damaged inventory, confirm that they are valued at lower than cost
20
-
For a sample of obsolete inventory , obtain management representation that they have been valued at lower than cost
-
Check for discounted inventory items sold below cost and confirm that it is valued at lower than cost
QUESTION FIVE (a)
ISA 560 (Redrafted) Subsequent Events differentiates the auditor’s responsibilities in relation to subsequent events depending on when the subsequent event occurs. (i)
Events occurring up to the date of the auditor’s report The auditor has an active duty to perform audit procedures designed to identify, and to obtain sufficient appropriate evidence of all events up to the date of the auditor’s report that may require adjustment of, or disclosure in, the financial statements. These procedures should be performed as close as possible to the date of the auditor’s report, and in addition, representations would be sought on the date that the report was signed. Such procedures would include reviewing management procedures for ensuring that subsequent events are identified, reading minutes of meetings of shareholders and management, reviewing the latest interim financial statements, and making appropriate enquiries of management. Where a material subsequent event is discovered, the auditor should consider whether management have properly accounted for and disclosed the event in the financial statements in accordance with IAS 10 Events after the Reporting Period .
(ii)
Facts discovered after the date of the auditor’s report but before the date the financial statements are issued. The auditor does not have any responsibility to perform audit procedures or make any enquiry regarding the financial statements or subsequent events after the date of the auditor’s report. In this period, it is the responsibility of management to inform the auditor of facts which may affect the financial statements. When the auditor becomes aware of a fact which may materially affect the financial statements, the matter should be discussed with management. If the financial statements are appropriately amended then a new audit report should be issued, and procedures relating to subsequent events should be extended to the date of the new audit report. If management does not amend the financial statements to reflect the subsequent event, in circumstances where the auditor believes they should be amended, the auditor will consider modifying the audit opinion.
(iii)
Facts discovered after the financial statements have been issued.
21
After the financial statements have been issued, the auditor has no obligation to make any enquiry regarding the financial statements. The auditor may however, become aware of a fact which existed at the date of the audit report, which if known at the date may have caused a modification to the auditor’s report. In such a case, the matter should be discussed with management. This could result in the revision of the financial statements, in which case the auditor should issue a new audit report on the revised financial statements. This report should include an emphasis of matter paragraph referring to a note to the financial statements in which the reason for the revision is fully discussed. If management do not revise the financial statements, the auditor should take legal advice with the objective of trying to prevent further reliance on the auditor’s report. (b)
(i)
Receivables This event is an example of an adjusting event after the reporting date that requires amendment to be made to the financial statements in accordance with IAS 10 Events after the Reporting date, as it provides information about the recoverability of the debt at the reporting date. The debt represents 35% of the total receivables balance (K145m/K414m), 15.8% of the profit for the year (K145m/K920m) and 7% of revenue (K145m/K2,028m) and is therefore clearly material. An adjustment will be required to reduce the receivables balance and profit for the period. If the matter remains unresolved and management does not make the required adjustments, the audit opinion would be modified on the basis that the accounts are not free from material misstatement and a qualified ‘except for’ opinion would be issued as the matter is material but not pervasive.
22
(ii)
Wages and Salaries Kamanga Plc’s wages program has been corrupted leading to a loss of payroll data for a period of three months (November 2011 to January 2012). The auditors should attempt to verify the payroll using alternative procedures. If they are unable to do this then payroll for the whole year would not have been verified. Wages and salaries for the three month period represents 13% of profit before tax (K122m/K920m) and 6% of revenue (K122m/K2,028m) and therefore is a material balance for which audit evidence has not been available. The auditors will need to modify the audit report as they are unable to obtain sufficient appropriate evidence in relation to a material, but not pervasive, element of wages and salaries and therefore a qualified opinion will be required. A basis for qualified opinion paragraph will be required to explain the limitation in relation to the lack of evidence over three months of payroll records. The opinion paragraph will be qualified ‘except for’ – due to insufficient appropriate audit evidence.
(iii)
Legal action The company is being sued by a customer for breach of contract. The matter has been correctly disclosed in accordance with IAS 37 Provisions, Contingent Liabilities and Contingent Assets . The lawsuit is for K480m which represents 52% of profit before tax (480m/920m) and (23.7% of revenue) hence is a material matter. This is an important matter which needs to be brought to the attention of the users. An emphasis of matter paragraph would need to be included in the audit report, in that the matter is appropriately disclosed but is fundamental to the users’ understanding of the financial statements; this will not affect the audit opinion which will be unmodified in relation to this matter. An emphasis of matter paragraph should be inserted after the opinion paragraph, the paragraph would explain clearly about the lawsuit and cross references to where in the financial statements the disclosure of this contingent liability can be found. END
23
