DIA 2123

Auditing II
Test 1 (10%)

Lemon Sdn. Bhd. is a wholesaler of toys for local retailers. You are the audit manager and
have been assigned to plan for the audit of Lemon for the financial year ended 30 June 2023.
The following are the understanding obtained from the cash receipts and cash disbursement
system:
Receipts from customers
Customers will make payments directly to the bank account of Lemon and the bank
transaction slip will be emailed to the accounts officer. The accounts officer will prepare a
listing of payments received from customers on every Friday by checking her emails. The
accounts officer will record the receipts transactions into the bank ledger and the respective
individual receivables ledger based on listing of payment received prepared by her. After
updating the bank ledger, the account manager will verify the listing of payments received
from customers. This list has been prepared by the account officer to ensure its correctness
and completeness.
Payments to suppliers
Upon receiving the invoices from suppliers, the account clerk will verify the invoice details
against the purchase order issued before updating them into the purchase journal. When the
supplier invoices are due, the account clerk will issue payment vouchers and record the
transaction into the bank ledger and the respective individual payables ledger. The account
manager will prepare a listing of payment to suppliers based on the details in the payment
vouchers and will update the payment information into the online bank system. The finance
director will approve the payment directly to the suppliers’ bank account via the online bank
system.
Required:
(i). Explain any THREE (3) components of a company’s internal control system.
Control Environment.
Control environment includes competence of the company’s people, operating style
and the way management assigns the responsibility, the organization and development
of its people. The auditor assesses whether the control environment is conducive to
sound internal controls. Auditors look at management’s attitude towards internal
controls and the overall organizational structure.
Risk Assessment
Risk assessment is the company’s entity process for identifying risks to the
achievement of its objective forming a basis for determining how the risks should be
managed. It includes analysis of relevant risks including changes in the external
environment and the company itself. Auditors evaluate how well the company
identifies and respond to business risks, including how it manages the risk of material
misstatement in its financial reports.
 Control Activities.
This is established through policies and procedures and the activities include
approvals, authorizations, reviews of operating performance and security of assets.
Auditors test the effectiveness of control activities by performing various procedures,
inspections and re-performance of controls.

(6 marks)
(ii). Identify and explain any FIVE (5) weaknesses in cash receipts and disbursement
system of Lemon Sdn. Bhd.
Lack of segregations of duties.
The accounts officer responsible for preparing the listing of payments received,
recording transactions and updating the receivables ledger. It increases the risk of
errors and fraud because there is no independent verification of the accuracy and
completeness of recorded transactions. Thus, without adequate segregation of duties,
there is an increased risk of misappropriation of funds and undetected errors.

Delayed Recording of Cash Receipts

The accounts officer only prepares the listing only once a week on Fridays. This delay
can lead to discrepancies between the bank records and the company’s internal
records, making it difficult to instantly detect and correct errors. Delayed recording of
cash receipts can lead to issues in cash flow management and reporting inaccuracies.

Insufficient Verification of Supplier Invoices

The account clerk verifies supplier invoices against purchase orders but there is no
mention of verification against actual goods received. This lack of comprehensive
verification can lead to payments for goods not received or discrepancies between
invoice amounts and goods received. Inadequate verification can result in
overpayments or payments for non-existent goods, increasing the risk of financial
losses.

Inadequate Review of Payment Transactions

While the account manager prepares a listing of payments to suppliers and updates the
payment information in the online bank system, there is no mention of an independent
review of the payment vouchers before approval by the finance director. The absence
of an independent review increases the risk of unauthorized or incorrect payments
being processed, potentially leading to fraud or financial errors.

Potential for Email Fraud in Customer Payments

Customers email bank transaction slips to the accounts officer, who relies on these
proves of transactions can increases the risk of errors in recording them into the
journal. Thus, relying on the email bank transaction slips alone will result in
misappropriation of information slips and any missing slips will affect the cashflow
and recording process.
(10 marks)
(iii). Suggest ONE (1) recommendation that can be implemented for each of the
weaknesses identified in (ii).
 Lack of segregations of duties.
Implement a segregation of duties by assigning different individuals to prepare the
listing of payments received, record transactions into the bank ledger, verification and
update the receivables ledger.

Delayed Recording of Cash Receipts

Implement shorter gaps duration of recording of cash receipts so that any errors can
be detected and do correction.

Insufficient Verification of Supplier Invoices

Implement more people assigned to verify or double check the supplier’s invoices and
the goods received so that it tallies with the correct orders. Any discrepancies or
goods not received can be followed up with the supplier’s right away or at shorter
time to avoid overpayments.

Inadequate Review of Payment Transactions

Implement at least a thorough review of payment transactions before being approved
by the finance director. The double checking of the payment transactions to the
suppliers can ensure the correct listing and avoid overpayment or double payments to
the suppliers which can affect the cash flow recording after it.

Potential for Email Fraud in Customer Payments

Lemon Sdn Bhd can implement a better way to receive more proves of customer
payments by adding in at least two authorization for online transactions where at least
two individuals are required to approve and execute online banking transactions. The
account manager initiate the transaction and another senior manager or the finance
director providing final approval. Thus, it can detect any errors in between the process
of payments and proves received especially through email.

(10 marks)
(iv). Discuss any FIVE (5) procedures to be performed by the auditors on the bank
reconciliation obtained from the audit client.
Recalculation
Auditors should recalculates the bank reconciliation to confirm its mathematical
accuracy. This involves checking the addition and subtraction of deposits in transits,
outstanding checks, and other reconciling items. This ensures the reconciliation is
arithmetically correct, which is a fundamental step in validating the accuracy of the
reconciliation process.

Inspection
The auditors examine the documentation supporting each reconciling item, such as
deposits in transit, outstanding cheques, and other adjustments. For deposits in transit,
auditors may check the subsequent bank statement to see if they cleared shortly after
the reconciliation date. It ensures to verifies the existence, accuracy and legitimacy of
the reconciling items, ensuring that they are properly accounted for and valid.
 Analytical procedure (compare the bank balance with the bank statement).
Auditors compare the ending balance on the bank reconciliation to the bank statement
obtained directly from the bank. They should also verifty that the date of the bank
statement matches the reconciliation date. These confirms that the reconciliation starts
with the correct bank statement balance, providing a basis for verifying other
components of the reconciliation.

Trace Reconciliation Adjustments to the General Ledger

Auditors should trace adjustments made in the bank reconciliation (bank charges,
interest incomes or errors) back to the general ledger to ensure they have been
appropriately recorded in the company’s accounts. It ensures that all adjustments
reflected in the bank reconciliation are also accurately reflected in the company’s
financial records, maintaining consistency between the bank records and the general
ledger.

Assess Timing Differences

Auditors reviews timing differences, such as deposits in transit and outstanding
cheques, to determine if these are reasonable and consistent with prior periods. This
may involve comparing current reconciling items with those from previous
reconciliations to identify any unusual patterns or discrepancies. This can help detect
any unusual or suspicious activities such as deliberate floating of cheques between
accounts to artificially inflate the balance, by ensuring that timing differences are
justifiable and consistent.

(10 marks)
(v). Discuss any TWO (2) limitation of a company’s internal control system.
Human error and judgment limitations.
Internal controls are subject to human error and poor judgment. Employees might
misunderstand instructions, make errors in judgment or overlook critical aspects of a
control procedure. Fatigue, stress and other personal factors can negatively imoact the
effectiveness of internal controls.

Management override.
Collusion among employees or third parties can bypass internal controls leading to
fraudulent activities. Management can override established controls for various
reasons, such as to manipulate financial results or conceal unauthorized transactions.
(4 marks)
[Total: 40 marks]
End of Question