AF304 Auditing

Final Exam Revision Solutions

Question 1
Weakness 1: Inappropriate procedures for credit approval.
• The credit manager approves credit to contractors based on the credit manager’s familiarity
with the contractor’s reputation.
• Credit is approved on an ad-hoc basis, without any credit check with an external party such
as a credit rating agency, or the contractor’s bank.
• Furthermore, no reference is made to the contractor’s credit limit or past payment record.
(The credit manager should have read only access to the account receivable subsidiary
ledger.)
• Inappropriate credit approval procedures could result in the extension of credit to high-risk
customers, and consequently, a high level of bad debts.
• Furthermore, the credit manager may receive kickbacks in return for approving credit to
uncreditworthy customers. The credit manager could also approve credit for uncreditworthy
relatives or friends.

Weakness 2: Inadequate segregation of duties regarding the accounts receivable supervisor.

• The accounts receivable supervisor verifies details on the charge forms, and corrects any
errors (including pricing errors), and prepares invoices.
• There is no independent manual or computer check of the details on the corrected charge
form before the invoice is prepared.
• The accounts receivable supervisor could fraudulently alter details on the charge forms
prepared by the sales associate, and use these altered details to prepare the invoice.
• Therefore the accounts receivable supervisor could lower prices charged to customers in
return for kickbacks, or lower prices relatives and friends.

Weakness 3: No use of control totals to compare charge forms and invoices.

• There is no control to ensure that the daily total of the dollar amount of the charge forms
reconcile with the daily total value of invoices prepared. (Any difference between the
control total relating to the charge forms and the control total relating to the invoices should
be explained by error corrections, which should have been independently verified. See
Weakness 2.)
• Therefore, any illegitimate discrepancies between the charge forms and invoices (due to
error or fraud), are not identified, followed up, and corrected.
• The reconciliation of control total of the charge forms and the invoices should be performed
by an independent person, other than the accounts receivable supervisor and the sales
associate.

Weakness 4: No reconciliation of accounts receivable subsidiary ledger with control

account.
• There is no reconciliation of the accounts receivable subsidiary ledger with the accounts
receivable control account to ensure that the sum of the subsidiary ledger account balances
reconciles with balance of the control account.
• The reconciliation of subsidiary ledger and the control account should be performed by an
independent person, other than the accounts receivable supervisor.
• Therefore, any discrepancies between the subsidiary ledger and the control account (due to
error or fraud), are not identified, followed up, and corrected.
• The accounts receivable supervisor could post unauthorised credits to the accounts of
particular customers/debtors, in return for kickbacks. For example, credits for returned
goods, where goods were not returned, credits for payments, where payments were not
made, credits for bad debt write-offs, where the write off was not approved.
• In addition to reconciling the sum of the subsidiary ledger account balances with the
balance of the control account, there should be a reconciliation of sum of the payments
posted to individual accounts in the subsidiary ledger on a particular day with the amount
banked on that day (or the previous day), a reconciliation of the sum of the amounts written
off from individual accounts in the subsidiary ledger on a particular day with the total
amount of bad debts approved for write off.

Weakness 5: The accounts receivable supervisor can influence whether a particular

contractor is granted additional credit, or whether a particular account is approved for write
off as bad.
• The accounts receivable supervisor can influence whether a particular contractor is granted
additional credit, by incorrectly omitting the contractor’s account from the monthly report
of overdue accounts submitted to the bookkeeper (in return for a kickback, or as a favour
for a friend or relative). In these circumstances, the bookkeeper will not notify the credit
manager not to grant additional credit to the contractor (and the bookkeeper will not
authorise the account to be written off).
• The accounts receivable supervisor can also influence whether a particular account is
approved for write off as bad, by incorrectly including collectable accounts in the monthly
report of overdue accounts submitted to the bookkeeper (in return for kickback, or as a
favour for a friend or relative). In these circumstances, the bookkeeper will authorise the
account to be written off.

Weakness 6: Inadequate segregation of duties regarding the cashier (No. 1).

• The cashier opens the mail, lists the enclosed cheques for deposit, and deposits the cheques.
• There is no independent check of the completeness of the cheques deposited in Everyday
Supplies’ bank account.
• The cashier could misappropriate a cheque by not including the cheque in the list of cheques
for deposit, not passing the remittance advice to the bookkeeper, and depositing the cheque
into the cashier’s own bank account. Alternatively, the cashier could misappropriate a
cheque, and replace the cheque with subsequent cheque(s) received from another customer,
and replace the subsequent cheque(s) with the next cheque(s) received from another
customer etcetera (i.e. lapping). In these circumstances the cashier would delay listing the
misappropriated cheque for deposit, and delay passing the remittance advice relating to
misappropriated cheque to the bookkeeper.
Weakness 7: Inadequate segregation of duties regarding the cashier (No. 2).
• The cashier performs the monthly bank reconciliation, and deposits the cheques and cash
into Everyday Supplies’ bank account. Furthermore, the cashier retains the verified deposit
slips.
• There is no independent check of the handling of cheque receipts, and their deposit into
Everyday Supplies’ bank account. The bank reconciliation should be performed by an
independent person, other than the cashier and bookkeeper.

Weakness 8: Automatic write-off of accounts receivable six months overdue.

• The bookkeeper automatically authorises accounts receivable to be written off six months
after they are first listed in the monthly report of overdue accounts.
• There is no investigation of the reasons why the account is overdue. The contractor
concerned should be contacted by Everyday Supplies, and asked to explain. Everyday
Supplies may need to follow up/investigate the explanation. For example, the contractor
may explain that payment was made six months ago. Further investigation may reveal that
the cheque was misappropriated by the cashier. (See Weakness 6.)
• This criteria for writing off accounts is too inflexible/rigid. There is no analysis of the
collectability of the account receivable.

Weakness 9: Credit manager notified of overdue accounts receivable six months after they
become overdue.
• The bookkeeper notifies the credit manager not to grant additional credit to a contractor
when the bookkeeper authorises the write off of the contractor’s debt, six months after the
debt was first listed in the monthly report of overdue accounts.
• During this six-month period after the contractor was first reported as being overdue, the
credit manager may approve additional credit for the contractor.
• The granting of additional credit to customers with overdue accounts receivable is likely to
exacerbate bad debt problems. (No additional credit should be granted to contractors with
overdue accounts receivable.)

Weakness 10: The bookkeeper can influence whether a particular contractor is granted
additional credit.
• The bookkeeper can influence whether a particular contractor is granted additional credit,
by incorrectly failing to notify the credit manager that the bookkeeper has authorised the
write off of the contractor’s account (in return for a kickback, or as a favour for a friend or
relative).
• The failure of the bookkeeper to notify the credit manager is likely to result in the extension
of additional credit to uncreditworthy customers, and increase bad debt problems.

Weakness 11: Inadequate segregation of duties regarding the bookkeeper.

• The bookkeeper authorises the write off of bad debts and records journal entries (including
bad debt write offs), and maintains the general ledger.
• There is no independent authorisation of the write off of bad debts, by higher level
management.
• The bookkeeper could authorise the write off of accounts receivable for contractors in return
for kickbacks, or as favours for relatives and friends.
Question 2
(a) Key (b) Key (c) Explanation: (d) Substantive test of detail:
account assertion at
balance at risk:
risk:
Inventory Accuracy, Electronic components • Identify inventory on hand in
valuation and supplied by Peter James the warehouse supplied by Peter
allocation have potential quality James and determine whether
problems, which means the items have been
customers may return appropriately valued at the
these products and stock lower of cost and net realisable
may need to be written value by comparing to
off as obsolete. subsequent sales prices.
• Review inventory returned
subsequent to year end and
reassess the value of the
inventory on hand at year end.

Accounts Accuracy, Creative Ltd is at risk of • Conduct subsequent receipts

receivable valuation and defaulting, because it is testing on receipts from
allocation experiencing financial Creative Ltd.
difficulties and may not • Review correspondence and
be in a position to minutes of discussions/meetings
continue paying the between High Tech Ltd and
amounts it owes to High Creative Ltd to support future
Tech Ltd. payment.
Question 3
Denners Ltd and Minners Ltd
The first point to establish is if the sale took place before the year end. If it did then it needs to
be established if it is probable that the amount will be paid to Denners and if it can be reliably
measured. It will also need to be established the amount and probability of any recovery from
Minners. If the sale took place before the year then a provision should be made for any probable
amount payable to Denners but only provide for the receivable from Minners if this is virtually
certain.

It would appear that Tanners is not disputing the claim and therefore the amount of $450 000
should be provided for as a liability. The amount recoverable from Minners (whether this is
$450 000 or some other figure) should only be recorded as a contingent receivable if the amount
is considered to be virtually certain. Further evidence required would be assessing the
probabilities and values of the amounts payable and receivable. The best source of this would
be by receiving a legal opinion from Tanners’ lawyers.

If the sale took place after the year end it would be a material post balance sheet event and
disclosed, no adjustment would be required to be included in payables or receivables.

Factory fire
The fire took place after the year end and therefore is a non-adjusting post balance sheet event
as it does not affect the asset or liability values at 30 June 2015. The losses should not be
recorded in the year to June 2015, other than by way of a disclosure note highlighting the issue.
Additional information will be required to establish the amount of the losses.

Jonners Ltd
Assuming the amounts owed by Jonners Ltd was for goods purchased prior to the year-end,
this would be an adjusting event as the condition existed at the end of the reporting period. On
the other hand, any amounts owing for goods purchased after year-end would be a disclosing
event. Additional information would be required as to the amount owed at year-end (adjusting
event) and the amount owed for goods purchased in the next period (disclosing event). More
information would also be required as to the likelihood of receiving any of the outstanding
funds from Jonners so that the appropriate carrying amount, if any, of the trade receivable can
be determined along with the amount to be provided for in the provision for doubtful debts.
Question 4
Situation (i)
• Accrued wages and employee entitlements should be adjusted for the pay rise.
• This situation represents a disagreement with management. While the error is material,
itis unlikely to be pervasive, therefore a qualified opinion should be issued.

Situation (ii)
• Purchases, accrued creditors and stock in transit: need to be adjusted for the $AUD
value of the goods.
• This situation represents a disagreement with management. While the error is material,
it is unlikely that the incorrect treatment of one shipment would be pervasive, therefore
a qualified opinion should be issued.

Situation (iii)
• As there is no error in the financial report, no balances need to be adjusted and so no
modification is required.
• The information accompanying the financial report is inconsistent with the financial
report. Therefore, an unmodified opinion with an emphasis of matter paragraph should
be issued.

Situation (iv)
• As the NZ auditors were unable to gain sufficient, appropriate audit evidence in relation
to inventories, it is not possible to ascertain whether any adjustments are required.
• This situation represents a limitation on the scope of the audit. As the NZ division
represents only 10% of operations it is unlikely to be pervasive, but is material, so a
qualified opinion should be issued.

Situation (v)
• No balances require adjustment. However, a contingent liability note should be included
in the financial report, although this would be a delicate situation due to the risk that this
disclosure may be taken as an admission of liability by the group.
• This situation represents a disagreement with management on the basis of lack of
disclosure. As the error is material but the non-disclosure is not likely to be pervasive, a
qualified opinion should be issued.