acca f8

Answers Fundamentals Level – Skills Module, Paper F8 (INT) Audit and Assurance (International) December 2011 Answers 1 (a) Payroll system implications and recommendations 11 Implication Recommendation Clocking in process As there is no supervision of the clocking in process then, as witnessed, employees can clock in multiple employees simply by using their employee swipe cards. This will result in a substantially increased payroll cost for Chuck Industries. The clocking in and out procedures should be supervised by a responsible official to prevent one individual clocking in multiple employees. In addition, Chuck Industries could consider linking the access to the factory floor with the employee swipe card system. Hence employees can only access the factory one at a time upon presentation of their employee swipe card. In addition, this could create a weaker control environment whereby employees consider it acceptable not to follow controls. Employees should be reminded about the importance of following Chuck Industries’ policies and procedures, especially in relation to the clocking in/out process. Without supervision/monitoring of the clocking in or out process, employees could try to boost their hours worked by clocking out several hours after their shift has finished, this will lead to invalid and unauthorised overtime payments. Overtime hours should be reviewed by the production supervisor prior to payment, to ensure that only previously authorised overtime is paid for. Wages calculations The wages calculations are generated by the payroll system and there are no checks performed. Therefore, if system errors occur during the payroll processing then this would not be identified. This could result in wages being over or under calculated, leading to an additional payroll cost or loss of employee goodwill. A senior member of the payroll team should recalculate the gross to net pay workings for a sample of employees and compare their results to the output from the payroll system. These calculations should be signed as approved before wages payments are made. Hourly wage increase The hourly wage has been increased by the Human Resources (HR) department and notified to the payroll department verbally. As payroll can be a significant expense for a business, any decision to increase this should be made by the board as a whole and not just by HR. All increases of pay should be proposed by the HR department and then formally agreed by the board of directors. The payroll department should not accept verbal notifications of pay increases as it could be an unauthorised increase, or an effort by an employee in HR to increase the pay of certain members of staff, such as their friends. Written notification of the increase should be sent to payroll and HR and only then should the pay rise be incorporated into the payroll package. Wage payout The factory supervisor should not be given the pay packets of the night shift staff as this is a significant amount of cash, being approximately one-third of the workforce. This cash will not be in a secure location and so is open to the risk of theft. Consideration should be given to operating a shift system for the payroll department on Fridays. This will ensure that there are sufficient payroll employees to perform the wages payout to the night shift employees. Therefore the same controls applied to the morning and late afternoon shifts can be put in place for the night shift. In addition, the supervisor is not sufficiently independent to pay wages out. He could adjust pay packets to increase those of his close friends whilst reducing others. Employees who miss the payout by the payroll department will need to wait until Monday for their pay. No factory supervisor should be allowed to hand out wages. For employees absent on pay day, the supervisor retains the wages and only returns them on Monday. This cash is therefore not secure and is susceptible to loss or theft. Pay packets of absent employees should be safely secured in the safe overnight and then banked on Monday. Joiners/leavers Notification of joiners and leavers should be made on a timely basis to the payroll department, even if some staff are on holiday. Otherwise Chuck Industries could continue making payments to employees who have left, or pay new employees late, resulting in a loss of employee goodwill. During periods of illness or holidays, key roles of the affected employees should be reallocated to other members of the team to ensure that controls are maintained. Forms for new joiners should be completed when they are appointed with appropriate start dates filled in, these should then be distributed to all relevant departments. This should reduce the risk of new joiners being missed out by the payroll department. (b) Payroll substantive procedures – Agree the total wages and salaries expense per the payroll system to the detailed trial balance, investigate any differences. – Cast a sample of payroll records to confirm completeness and accuracy of the payroll expense. – For a sample of employees, recalculate the gross and net pay and agree to the payroll records to verify accuracy. – Re-perform calculation of statutory deductions to confirm whether correct deductions for this year have been included within the payroll expense. – Compare the total payroll expense to the prior year and investigate any significant differences. – Review monthly payroll charges, compare this to the prior year and budgets and discuss with management any significant variances. – Perform a proof in total of total wages and salaries, incorporating joiners and leavers and the pay increase. Compare this to the actual wages and salaries in the financial statements and investigate any significant differences. – Select a sample of joiners and leavers, agree their start/leaving date to supporting documentation, recalculate that their first/last pay packet was accurately calculated and recorded. – For salaries, agree the total net pay per the payroll records to the bank transfer listing of payments and to the cashbook. – For wages, agree the total cash withdrawn for wage payments equates to the weekly wages paid plus any surplus cash subsequently banked to confirm completeness and accuracy. – Agree the year-end tax liabilities to the payroll records, and subsequent payment to the post year-end cash book to confirm completeness. – Agree the individual wages and salaries per the payroll to the personnel records and records of hours worked per clocking in cards. (c) Laws and regulations Under ISA 250 Consideration of Laws and Regulations in an Audit of Financial Statements, management have a responsibility to ensure that the operations of Chuck Enterprises are conducted in accordance with the provisions of laws and regulations. This includes compliance with laws and regulations that determine amounts and disclosures in financial statements, including tax liabilities and charges. Auditors are not responsible for preventing non-compliance with laws and regulations, and cannot be expected to detect non-compliance with all laws and regulations. They have a responsibility to obtain reasonable assurance that the financial statements are free from material misstatement, whether caused by fraud or error. Blair & Co’s responsibility differs in relation to the two different categories of laws and regulations identified below: – Laws and regulations which have a DIRECT effect on the determination of material amounts and disclosures in financial statements. Here the auditor is responsible for obtaining sufficient appropriate audit evidence regarding compliance. – Laws and regulations which DO NOT HAVE A DIRECT EFFECT on the determination of material amounts and disclosures in financial statements, but may impact the entity’s ability to continue to trade. Here the auditor’s responsibility is limited to specified audit procedures to help identify non-compliance with those laws and regulations that may have a material effect on the financial statements. This includes inquiring with management whether the entity is in compliance with such laws and regulations, and inspecting correspondence with relevant licensing or regulatory authorities. Blair & Co also has a responsibility to remain alert, by maintaining professional scepticism, to the possibility that other audit procedures may bring instances of identified or suspected non-compliance with laws and regulations. (d) Substantive procedures to verify redundancy provision – Discuss with the directors of Chuck Industries as to whether they have formally announced their intention to make the sales ledger department redundant, to confirm that a present obligation exists at the year end. – If announced before the year end, review supporting documentation to verify that the decision has been formally announced. – Review the board minutes to ascertain whether it is probable that the redundancy payments will be paid. – Obtain a breakdown of the redundancy calculations by employee and cast it to ensure completeness. – Recalculate the redundancy provision to confirm completeness and agree components of the calculation to supporting documentation. – Review the post year-end period to identify whether any redundancy payments have been made, compare actual payments to the amounts provided to assess whether the provision is reasonable. – Obtain a written representation from management to confirm the completeness of the provision. – Review the disclosure of the redundancy provision to ensure compliance with IAS 37 Provisions, Contingent Liabilities and Contingent Assets. 12 (e) Reliance on internal audit ISA 610 Using the Work of Internal Auditors details the factors the external auditors should consider in order to place reliance on the work of the internal audit (IA) department as follows: Objectivity They should consider the status of IA within the company and if they are independent of other departments, in particular the finance department. In addition, consideration should be given as to who IA reports to, whether this is directly to those charged with governance or to a finance director. Technical competence The technical competence of IA staff should be considered. Consideration should be given to whether they are members of a professional body and have relevant qualifications and experience. Due professional care The external auditors should consider if the IA department have exercised due professional care, the work would need to have been properly planned including detailed work programmes, supervised, documented and reviewed. Communication In order to place reliance there needs to be effective communication between the internal auditors and the external auditor. This is most likely to occur when the IA department is free to communicate openly and regular meetings are held throughout the year. 2 (a) Internal control components ISA 315 Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and Its Environment considers the components of an entity’s internal control. It identifies the following components: (i) Control environment The control environment includes the governance and management functions and the attitudes, awareness, and actions of those charged with governance and management concerning the entity’s internal control and its importance in the entity. The control environment sets the tone of an organisation, influencing the control consciousness of its people. The control environment has many elements such as communication and enforcement of integrity and ethical values, commitment to competence, participation of those charged with governance, management’s philosophy and operating style, organisational structure, assignment of authority and responsibility and human resource policies and practices. (ii) Entity’s risk assessment process For financial reporting purposes, the entity’s risk assessment process includes how management identifies business risks relevant to the preparation of financial statements in accordance with the entity’s applicable financial reporting framework. It estimates their significance, assesses the likelihood of their occurrence, and decides upon actions to respond to and manage them and the results thereof. (iii) Information system, including the related business processes, relevant to financial reporting, and communication The information system relevant to financial reporting objectives, which includes the accounting system, consists of the procedures and records designed and established to initiate, record, process, and report entity transactions (as well as events and conditions) and to maintain accountability for the related assets, liabilities, and equity. (iv) Control activities relevant to the audit Control activities are the policies and procedures that help ensure that management directives are carried out. Control activities, whether within information technology or manual systems, have various objectives and are applied at various organisational and functional levels. (v) Monitoring of controls Monitoring of controls is a process to assess the effectiveness of internal control performance over time. It involves assessing the effectiveness of controls on a timely basis and taking necessary remedial actions. Management accomplishes the monitoring of controls through ongoing activities, separate evaluations, or a combination of the two. Ongoing monitoring activities are often built into the normal recurring activities of an entity and include regular management and supervisory activities. (b) Audit report elements The following elements should be included within an auditor’s report: Title – The auditor’s report shall have a title that clearly indicates that it is the report of an independent auditor, this distinguishes this report from any other. Addressee – The auditor’s report shall be addressed as required by the circumstances of the engagement, it is determined by law or regulation but is usually to the shareholders. 13 Introductory paragraph – The introductory paragraph in the auditor’s report shall identify the entity whose financial statements have been audited, state that the financial statements have been audited, identify the title of each statement that comprises the financial statements, refer to the summary of significant accounting policies and other explanatory information, and specify the date or period covered by each financial statement. Management’s responsibility for the financial statements – This section of the auditor’s report describes the responsibilities of those in the organisation who are responsible for the preparation of the financial statements. The description shall include an explanation that management is responsible for the preparation of the financial statements in accordance with the applicable financial reporting framework, and for such internal control it determines is necessary to enable the preparation of the financial statements that are free from material misstatement, whether due to fraud or error. Auditor’s responsibility – The auditor’s report shall state that the responsibility of the auditor is to express an opinion on the financial statements based on the audit and that the audit was conducted in accordance with International Standards on Auditing and ethical requirements and that the auditor plan and perform the audit to obtain reasonable assurance about whether the financial statements are free from material misstatement. Opinion paragraph – When expressing an unmodified opinion the auditor’s opinion shall either state that the financial statements ‘present fairly’ or ‘give a true and fair view’ in accordance with the applicable financial reporting framework. Other reporting responsibilities – If the auditor addresses other reporting responsibilities in the auditor’s report, these shall be addressed in a separate section in the auditor’s report titled ‘Report on Other Legal and Regulatory Requirements’. Signature of the auditor – The auditor’s report must be signed, this is normally the personal name of the auditor or, if a partner is signing on behalf of the audit firm, then the signature is of the name of the firm. Date of the auditor’s report – The auditor’s report shall be dated no earlier than the date on which the auditor has obtained sufficient appropriate audit evidence on which to base the auditor’s opinion on the financial statements. Auditor’s address – The auditor’s report shall name the location where the auditor practises. 3 (a) Components of audit risk Inherent risk The susceptibility of an assertion about a class of transaction, account balance or disclosure to a misstatement that could be material, either individually or when aggregated with other misstatements, before consideration of any related controls. Inherent risk is affected by the nature of an entity and factors which can result in an increase include: – Changes in the industry it operates in. – Operations that are subject to a high degree of regulation. – Going concern and liquidity issues including loss of significant customers. – Developing or offering new products or services, or moving into new lines of business. – Expanding into new locations. – Application of new accounting standards. – Accounting measurements that involve complex processes. – Events or transactions that involve significant accounting estimates. – Pending litigation and contingent liabilities. Control risk The risk that a misstatement that could occur in an assertion about a class of transaction, account balance or disclosure and that could be material, either individually or when aggregated with other misstatements, will not be prevented, or detected and corrected, on a timely basis by the entity’s internal control. The following factors can result in an increase in control risk: – Lack of personnel with appropriate accounting and financial reporting skills. – Changes in key personnel including departure of key management. – Deficiencies in internal control, especially those not addressed by management. – Changes in the information technology (IT) environment. – Installation of significant new IT systems related to financial reporting. Detection risk The risk that the procedures performed by the auditor to reduce audit risk to an acceptably low level will not detect a misstatement that exists and that could be material, either individually or when aggregated with other misstatements. Detection risk is affected by sampling and non-sampling risk and factors which can result in an increase include: – Inadequate planning. – Inappropriate assignment of personnel to the engagement team. – Failing to apply professional scepticism. – Inadequate supervision and review of the audit work performed. – Incorrect sampling techniques performed. – Incorrect sample sizes. 14 (b) Audit risks and responses 15 Audit risk Audit response The finance director of Abrahams is planning to capitalise the full $2·2 million of development expenditure incurred. However in order to be capitalised it must meet all of the criteria under IAS 38 Intangible Assets. There is a risk that some projects may not reach final development stage and hence should be expensed rather than capitalised. Intangible assets could be overstated and this risk is increased due to the loan covenant requirements to maintain a minimum level of assets. A breakdown of the development expenditure should be reviewed and tested in detail to ensure that only projects which meet the capitalisation criteria are included as an intangible asset, with the balance being expensed. The inventory valuation method used by Abrahams is standard costing. This method is acceptable under IAS 2 Inventories; however, only if standard cost is a close approximation to actual cost. Abra