Audit and Assurance -

Part 2
HOCHIMINH City Open University
Advance Study Programme 2024
 • The sales system
• The purchases system
Chapter 10 • The inventory system
Tests of controls • The bank and cash system
• The payroll system
• Revenue and capital expenditure
 Syllabus learning outcomes
• Describe control objectives, control procedures,
activities and tests of control in relation to: the sales
system, the purchases system, the payroll system, the
inventory system, the cash system, non-current assets.
 Overview
Audit evidence Internal audit reports

Tests of controls

Sales Purchases Payroll

Revenue and capital

Bank and cash Inventory
expenditure
Chronology of an audit
The sales system 1
 The sales system 2
Assertions: Occurrence and existence
Control objectives
To ensure that one person is not responsible
for taking orders, recording sales and receiving payment

Controls
Segregation of duties

Tests of controls
Observe and evaluate whether proper segregation of
duties is operating
 The sales system 3
Assertions: Occurrence and existence
Control objectives
To ensure that recorded sales transactions represent
goods or services provided

Controls
• Sales are only recorded if there is an approved sales
order form and shipping/dispatch documentation
• Accounting for numerical sequences of invoices
• Monthly customer statements sent out and customer
queries and complaints handled independently
 The sales system 4
Tests of controls
• For a sample of sales invoices ensure there is
a related sales order form that has been
authorised and shipping documentation.
• Examine application controls for authorisation.
• Review and test entity's procedures for accounting for
numerical sequences of invoices.
• Review entity's procedures for sending
out monthly statements and dealing with
customer queries and complaints.
 The sales system 5
Assertions: Occurrence and existence
Control objectives
To ensure that goods and services are only supplied to
customers with good credit ratings.

Controls
• Authorisation of credit terms to customers (senior staff
authorisation, references/credit checks for new customers,
regular review of credit limits)
• Authorisation by senior staff required for changes in other
customer data such as address etc
• Orders not accepted unless credit limits reviewed first
 The sales system 6
Assertions: Occurrence and existence
Tests of controls
• Review entity's procedures for granting credit to
customers.
• Examine a sample of sales orders for evidence of
proper credit approval by the appropriate senior staff
member.
• Examine application controls for credit limits.
• Review all new customer files to ensure satisfactory
credit references have been obtained.
 The sales system 7
Assertions: Occurrence and existence
Control objectives
To ensure that goods and services are provided at authorised
prices and on authorised terms.

Controls
Authorised price lists and specified terms of trade in place.

Tests of controls
Verify that price lists and terms of trade are properly
documented, authorised and communicated.
Examine application controls for authorised prices and terms.
 The sales system 8
Assertion: Completeness
Control objectives
To ensure that all revenue relating to goods dispatched is
recorded.

Controls
Accounting for numerical sequences of invoices.

Tests of controls
Review and test entity's procedures for accounting for
numerical sequences of invoices.
 The sales system 9
Assertion: Completeness
Control objectives
To ensure that all goods and services sold are correctly
invoiced.

Controls
(i) Shipping/dispatch documentation is matched to sales
invoices.
(ii) Sales invoices are reconciled to the daily sales report.
(iii)An open-order file is maintained and reviewed
regularly.
 The sales system 10
Assertion: Completeness
Tests of Controls
(i) For a sample of shipping/dispatch documents,
inspect to ensure each has been matched to a
related sales invoice that was subsequently recorded.
(ii) Review a sample of reconciliations performed.
(iii)Inspect the open-order file for unfilled orders.
 The sales system 11
Assertion: Accuracy
Control objectives
To ensure that all sales and adjustments are correctly
journalised, summarised and posted to the correct accounts.

Controls
Sales invoices and matching documents required for all
entries and the date and reference of the entry are written
on each document.

Tests of controls
Review supporting documents for a sample of sales entries to
ensure they contain the written details that indicate they
were referred to when entered.
 The sales system 12
Assertion: Cut-off
Control objectives
To ensure that transactions have been recorded in the
correct period.
Controls
(i) All shipping documentation is forwarded to the invoicing
section on a daily basis.
(ii) Daily invoicing of goods shipped.
Tests of controls
(i) Compare dates on sales invoices with dates of
corresponding shipping documentation.
(ii) Compare dates on sales invoices with dates recorded in
the sales ledger.
 The sales system 13
Assertion: Classification assertions
Control objectives
To ensure that all transactions are properly classified in
accounts
Controls
(i) Chart of accounts in place which is regularly reviewed and
updated
(ii) Codes in place for different types of products or services
Tests of controls
(i) Inspect any documentary evidence of review (such as
emails requesting update to chart of accounts as a result
of review)
(ii) Test application controls for proper codes
 Tackling the exam: the sales system
• Deficiencies in the sales system were examined in the
Specimen Paper (section B, question 6a).
• The most typical requirement you will get is to explain
the deficiencies and the consequences of them,
followed by recommendations to overcome them.
Sometimes you are also required to suggested
associated tests of controls.
• The best way to present your answer is in a table
format – this allows you to link the deficiencies with
the consequences and recommendations, and also
gives your answer structure. But make sure you present
your answer neatly.
• Don't forget to use a ruler for tables and headings!
 Tackling the exam
• Tests of controls are very likely to be examined as the
examiner will want to see that students understand the
difference between tests of controls and substantive tests.
• Another area of confusion is the difference between control
objectives, controls and tests of controls.
• Control objectives tell you what the control is trying to
achieve and will always start 'To ensure that….'.
• Controls are the processes in place to achieve the control
objectives eg monthly bank reconciliations.
• Tests of controls are carried out by the auditor and are
procedures to gain evidence about whether controls are
working, so to test the control of monthly bank
reconciliations, the auditor would inspect all the bank
reconciliations for the year to see if they had been done
every month.
The purchases system 1
 The purchases system 2
Assertions: Occurrence and existence
Control objective
To ensure that recorded purchases represent goods and
services received.
 The purchases system 3
Assertions: Occurrence and existence
Controls
(i) Authorisation procedures and policies in place for
ordering goods and services
(ii) Segregation of duties
(iii)Purchase orders raised for each purchase and authorised
by appropriate senior personnel
(iv)Approved purchase order for each receipt of goods
(v) Staff receiving goods check them to the purchase order
(vi)Stores clerks sign for goods received
(vii)Purchase orders and GRNs are matched with the
suppliers' invoices
 The purchases system 4
Assertions: Occurrence and existence
Tests of controls
(i) Inspect policies and procedures in place.
(ii) Observe and evaluate segregation of duties.
(iii) Examine a sample of purchase orders to ensure they have been appropriately
authorised.
Review the delegated list of authority for purchases.
(iv) For a sample of GRNs, ensure there is a related purchase order that has been
properly approved.
(v) Observe receipts of goods by staff to confirm whether the check is done.
(vi) Inspect a sample to confirm whether stores staff undertake this check.
(vii) Examine supporting documentation to ensure it has been matched for a
sample of invoices.
 The purchases system 5
Assertions: Completeness

Control objectives
To ensure that all purchase transactions that occurred have
been recorded

Controls
(i) Purchase orders and GRNs are matched with the
suppliers' invoices
(ii) Periodic accounting for pre-numbered GRNs and
purchase orders
(iii)Independent check of amount recorded in the purchase
journal
 The purchases system 6
Assertions: Completeness

Tests of controls
(i) For a sample of purchase orders in the year ensure
each has been matched to a related invoice that was
subsequently recorded.
(ii) Review entity's procedures for accounting for pre-
numbered documents.
(iii)Examine application controls.
Examine documentation for evidence of this check.
 The purchases system 7
Assertions: Rights and obligations

Control objectives
To ensure that recorded purchases represent the liabilities of
the entity

Controls
Purchase orders and GRNs are matched with the suppliers'
invoices

Tests of controls
Examine supporting documentation to ensure it has been
matched for a sample of invoices
 The purchases system 8
Assertions: Accuracy, classification and valuation

Control objectives
To ensure that purchase transactions are correctly recorded
in the accounting system

Controls
(i) Purchase orders and GRNs are matched with the
suppliers' invoices
(ii) Mathematical accuracy of the supplier's invoice is verified
(iii)Amount posted to general ledger is reconciled to the
purchases ledger
(iv)Chart of accounts in place
 The purchases system 9
Assertions: Accuracy, classification and valuation
Tests of controls
(i) Examine supporting documentation for a sample of
invoices.
(ii)Review a sample of invoices for evidence the accuracy
has been verified (eg signature or initials) and
reperform the check.
(iii)Review reconciliations for evidence of this check.
(iv)Review purchases journal and general ledger for
reasonableness.
 The purchases system 10
Assertion: Cut-off
Control objectives
To ensure that purchase transactions are recorded in the
correct accounting period
Controls
(i) All goods received reports forwarded to accounts payable
department daily
(ii)Procedures in place that require recording of purchases as
soon as possible after goods/services received
Tests of controls
(i) Compare dates on reports to dates on relevant vouchers
(ii)Compare dates on vouchers with dates they were
recorded in the purchases journal
 Tackling the exam: The purchases system
• Deficiencies in the purchases system were
examined in the December 2010 and June 2013
papers.
• The requirement was to explain the deficiencies
and the consequences of them, followed by
recommendations to overcome them.
• Do not produce a covering letter unless it is
specifically asked for as you won't get any credit for
doing so.
• We will work through the June 2013 question in the
next few slides.
 Question: June 2013 question 1b
Introduction
Fox Industries Co (Fox) manufactures engineering parts. It
has one operating site and a customer base spread across
Europe. The company's year end was 30 April 20X3. Below
is a description of the purchasing and payments system.
Purchasing system
Whenever production materials are required, the relevant
department sends a requisition form to the ordering
department. An order clerk raises a purchase order and
contacts a number of suppliers to see which can despatch
the goods first. This supplier is then chosen. The order
clerk sends out the purchase order. This is not
sequentially numbered and only orders above $5,000
require authorisation.
 Question: June 2013 question 1b (cont'd)
Purchase invoices are input daily by the purchase ledger clerk, who
has been in the role for many years and, as an experienced team
member, he does not apply any application controls over the input
process. Every week the purchase day book automatically updates
the purchase ledger, the purchase ledger is then posted manually to
the general ledger by the purchase ledger clerk.
Payments system
Fox maintains a current account and a number of saving (deposit)
accounts. The current account is reconciled weekly but the saving
(deposit) accounts are only reconciled every two months.
In order to maximise their cash and bank balance, Fox has a policy of
delaying payments to all suppliers for as long as possible. Suppliers
are paid by a bank transfer. The finance director is given the total
amount of the payments list, which he authorises and then
processes the bank payments.
 Question: June 2013 question 1b (cont'd)
Required:
As the external auditors of Fox Industries Co, write a
report to management in respect of the purchasing and
payments system described above which:
(i) Identifies and explains four deficiencies in the system
(ii) Explains the possible implication of each deficiency
(iii)Provides a recommendation to address each
deficiency
A covering letter IS required.
Note. Up to two marks will be awarded within this
requirement for presentation and the remaining marks
will be split equally between each part.
(14 marks)
 Approach: June 2013 question 1b
Firstly, look at the requirement carefully: there are 14 marks
available but two of these are presentation marks. The 12 remaining
marks are split between the requirements equally so four marks
each for deficiencies, implications and recommendations.
Note the requirement for four deficiencies so make sure you have
four but no more as you won't get credit for more than four.
The requirement specifically asks for a covering letter so ensure this
includes the necessary points as per ISA 265.
The deficiencies, implications and recommendations should be in a
separate Appendix and presented in a tabular format.
The next two slides highlight the possible deficiency areas in colour.
You will see from this and from the model answer that follows that
there are more than four deficiencies that you can choose to include
in your answer.
 Approach: June 2013 question 1b (cont'd)
Introduction
Fox Industries Co (Fox) manufactures engineering parts. It
has one operating site and a customer base spread across
Europe. The company's year end was 30 April 20X3. Below
is a description of the purchasing and payments system.
Purchasing system
Whenever production materials are required, the relevant
department sends a requisition form to the ordering
department. An order clerk raises a purchase order and
contacts a number of suppliers to see which can despatch
the goods first. This supplier is then chosen. The order
clerk sends out the purchase order. This is not
sequentially numbered and only orders above $5,000
require authorisation.
 Approach: June 2013 question 1b (cont'd)
Purchase invoices are input daily by the purchase ledger clerk, who
has been in the role for many years and, as an experienced team
member, he does not apply any application controls over the input
process. Every week the purchase day book automatically updates
the purchase ledger, the purchase ledger is then posted manually to
the general ledger by the purchase ledger clerk.
Payments system
Fox maintains a current account and a number of saving (deposit)
accounts. The current account is reconciled weekly but the saving
(deposit) accounts are only reconciled every two months.
In order to maximise their cash and bank balance, Fox has a policy of
delaying payments to all suppliers for as long as possible. Suppliers
are paid by a bank transfer. The finance director is given the total
amount of the payments list, which he authorises and then
processes the bank payments.
 Answer: June 2013 question 1b
Address (audit firm)
1 June 20X3
Address (Fox)
To the Board of Directors, Fox Industries Co,
Financial statements for the year ended 30 April 20X3
Please find attached in an Appendix to this letter deficiencies in internal control
found within the purchases and payments system during our recent external
audit. This details only the significant deficiencies identified during our audit. If
more extensive procedures on internal control had been carried out, we may
have identified and reported more deficiencies.
This report to management is solely for the use of Fox Industries Co. It must not
be disclosed to a third party, or quoted or referred to, without our consent. No
responsibility is assumed by us to any other person.
Yours faithfully,
Audit firm
 Answer: June 2013 question 1b (cont'd)
Deficiency Implication Recommendation
Purchase orders are not Orders can be made for All orders should be reviewed
reviewed by a second person unauthorised goods up to a before the order is placed and
before the order is sent out value of $5,000. signed off and dated as
unless the amount is greater authorised by a more senior
than $5,000. team member. Delegated levels
of authority should be in place.
The purchase order clerk Goods of poor quality could be An approved suppliers list should
chooses the supplier based on ordered or a higher price may be be in place so that the company
the supplier who can deliver paid for goods from particular knows exactly who the supplier is
the goods fastest. suppliers. and how much the goods cost.
Purchase orders are not Purchase orders can be lost and Purchase orders should be
sequentially numbered. there is no way of keeping track sequentially numbered and
of unfulfilled orders. multi-part. Order forms should
be filed in sequential order and
reviewed on a weekly basis to
flag any unfulfilled orders for
chasing up.
 Answer: June 2013 question 1b (cont'd)
Deficiency Implication Recommendation
Purchase invoices are not Invoices for incorrect amounts Purchase invoices should be
matched back to the purchase and incorrect goods may be matched back to the purchase
order before being input onto entered onto the system and order to ensure they tally up
the system. paid for. before being input onto the
system. A copy of the order
should be attached to the invoice
and filed away.
The purchase ledger clerk does The lack of application controls There should be some application
not use any application controls increases the risk of errors being controls in place over the input of
over the input of purchase made during the input of invoices to the system, such as
invoices to the ledger. invoices to the ledger. This could control totals and document
result in misstatements in the totals.
financial statements and also
errors in amounts paid to
suppliers and a consequent loss
of goodwill.
 Answer: June 2013 question 1b (cont'd)
Deficiency Implication Recommendation
The purchase ledger clerk posts Errors may be made during the The system should be set up so
the purchase ledger to the posting process as it is done that the purchase ledger is posted
general ledger manually. manually. automatically to the general
ledger. A reconciliation between
the two should be performed
each week by the purchase ledger
clerk and this should be signed off
and dated as reviewed by the
finance director.

Deposit accounts are not Unreconciled differences may go Deposit accounts should be
reconciled on a timely basis, unnoticed for a long period of reconciled at the same time as
only every two months. time. The length of time between the current account. All
reconciliations may also increase reconciliations should be signed
the risk of fraud being off and dated to evidence review
perpetrated by employees. by a more senior person, with all
differences fully investigated and
resolved on a timely basis.
 Answer: June 2013 question 1b (cont'd)
Deficiency Implication Recommendation
Payment to suppliers is delayed Prompt payment discounts are Suppliers should be paid as soon
for as long as possible. not taken advantage of and as possible to take advantage of
suppliers may not look early settlement discounts and
favourably on the company if it to promote and maintain good
takes too long to pay and relations with suppliers.
therefore may refuse credit later
on, if the company is viewed as
unreliable.

The finance director authorises Unauthorised amounts may be The finance director should
the total amount of the missed as the finance director review the detailed list of
payment list, without a review does not see the detail of the payments and query any
of the detail. payments on the list. This opens amounts and supplier names
the company up to the risk of that appear erroneous or
fraud and error. suspicious. The review should be
evidenced by the finance
director's signature and date.
 The inventory system 1
There are three approaches to the audit of inventory, and the
approach taken depends on whether controls around
inventory are assessed as strong or weak.
Approach 1
Perpetual inventory can be relied on if controls are strong.

Approach 2
Inventory count near year-end and adjusted by perpetual
inventory, only if controls are strong.

Approach 3
Year-end count: use a substantive approach (see Chapter 13).
 The inventory system 2
Assertions: Occurrence and existence
Control objective 1
To ensure that all inventory movements are authorised and
recorded
Controls
(i) Pre-numbered documentation (GDNs and GRNs) in use
(ii) Reconciliations of inventory records with general ledger
(iii)Segregation of duties
Tests of controls
(i) Review documentation in use
(ii) Review a sample of reconciliations to confirm they are
performed and then reviewed by a more senior individual
(iii)Observe and evaluate proper segregation of duties
 The inventory system 3
Assertions: Occurrence and existence
Control objective 2
To ensure that inventory included on the statement of financial position physically
exists
Controls
(i) Physical safeguards to ensure inventory is not stolen
(ii) Separate responsibilities for maintenance of records and custodianship
(iii) Inventory counted regularly
Tests of controls
(i) Review security systems in place
(ii) Review policies and procedures in place and discuss them with relevant staff
(iii) Review procedures for counting inventory and attend inventory count
 The inventory system 4
Assertion: Completeness
Control objective
To ensure that all purchases and sales of inventory have been
recorded in the accounting system
Controls
(i) Procedures in place to include inventory held at third parties
and exclude inventory held on consignment for third parties
(ii) Reconciliations of accounting records with physical inventory
Tests of controls
(i) Review entity's procedures relating to consignment inventory
(ii) Review reconciliations performed and whether reviewed by an
independent person
 The inventory system 5
Assertion: Rights and obligations
Control objective 4
To ensure that inventory records only include items that
belong to the entity

Controls
Procedures in place to include inventory held at third parties
and exclude inventory held on consignment for third parties

Tests of controls
Review entity's procedures relating to consignment inventory
 The inventory system 6
Assertions: Accuracy, classification and valuation

Control objective 1
To ensure that inventory quantities have been accurately
determined

Controls
Periodic or annual comparison of inventory with amounts
shown in perpetual inventory records

Tests of controls
Review and test entity's procedures for taking physical
inventory
 The inventory system 7
Assertions: Accuracy, classification and valuation
Control objective
To ensure that inventory is properly stated at the lower of cost and net realisable
value
Controls
(i) Standard costs reviewed by management
(ii) Review of cost accumulation and variance reports
(iii) Inventory managers review inventory regularly to identify slow-moving,
obsolete and excess inventory
Tests of controls
(i) Review and test entity's procedures for developing standard costs
(ii) Inspect variance reports produced
(iii) Discuss with managers how this is done and observe procedure
 The inventory system 8
Assertion: Cut-off
Control objective
To ensure that all purchases and sales of inventory are
recorded in the correct accounting period
Controls
(i) All dispatch documents processed daily to record the
dispatch of finished goods
(ii) All goods inwards reports processed daily to record the
receipt of inventory
(iii)Reconciliations of inventory records with general ledger
Tests of controls
(i) and (ii) Inspect documentation to confirm daily processing
(iii) Review reconciliations performed
 The inventory system 9
Assertions: Presentation and disclosure

Control objective 1
To ensure that inventory transactions and balances are
properly identified and classified in the financial statements

Controls
Orders for materials and production data forms used to
process goods through manufacturing

Tests of controls
Review entity's procedures and documentation used to
classify inventory
 The inventory system 10
Assertions: Presentation and disclosure

Control objective 2
To ensure that disclosures relating to classification and
valuation are sufficient

Controls
Approval by Finance Director

Tests of controls
Review entity's working papers for evidence of review
 Exam link: The inventory system
• Deficiencies in the inventory system were examined
in June 2010, December 2010 and June 2012.
• The requirement was to explain the deficiencies
and the consequences of them, followed by
recommendations to overcome them.
• Spend time planning your answer – go through the
scenario line-by-line, noting down the potential
deficiencies in the system.
• Again, present your answers in a table, using a ruler
for the table and headings.
 The bank and cash system 1
• The following slides look at the controls around cash.
• Controls around cash payments and receipts are
designed to help prevent theft and fraud.
• First we will look at the controls around cash
payments, followed by controls around cash receipts.
 The bank and cash system 2
Cash payments
Assertion: Occurrence
Control objective
To ensure that only valid cash payments are made
Controls
(i) Segregation of duties
(ii) Supplier statements independently reviewed and reconciled to
trade payables records
(iii) Monthly bank reconciliations prepared and reviewed
(iv) Only authorised staff able to make electronic cash payments
and issue cheques
(v) Electronic cash payments and cheques prepared only after all
source documents have been independently approved
 The bank and cash system 3
Tests of controls
(i) Observe and evaluate proper segregation of duties.
(ii) Review procedures for reconciling supplier
statements.
(iii)Review reconciliations to confirm whether
undertaken and reviewed.
(iv)Review delegated list of authority for cash payments.
(v) Inspect relevant documentation for evidence of
approval by senior personnel.
 The bank and cash system 4
Cash payments
Assertion: Completeness
Control objective
To ensure that all cash payments that occurred are recorded
Controls
(i) Segregation of duties
(ii) Supplier statements independently reviewed and
reconciled to trade payables records
(iii)Monthly bank reconciliations prepared and reviewed
(iv)Review of cash payments by manager before release
(v) Daily cash payments reconciled to posting to payables
accounts
(vi)Use of pre-numbered cheques
 The bank and cash system 5
Tests of controls
(i) Observe and evaluate proper segregation of duties.
(ii) Review procedures for reconciling supplier
statements.
(iii)Review reconciliations to confirm whether
undertaken and reviewed.
(iv)Inspect sample of listings for evidence of senior
review.
(v) Review a sample of reconciliations for evidence that
they have been done.
(vi)Examine evidence to verify use of pre-numbered
cheques.
 The bank and cash system 6
Cash payments
Assertions: Accuracy, classification and valuation
Control objective 1
To ensure that cash payments are recorded correctly in the ledger
Controls
(i) Reconciliation of daily payments report to electronic cash payment transfers
and cheques issued
(ii) Supplier statements reconciled to payables accounts regularly
(iii) Monthly bank reconciliations of bank statements to ledger account
Tests of controls
(i) Review reconciliations to ensure performed and reviewed
(ii) Review reconciliations for a sample of accounts
(iii) Review bank reconciliations for evidence performed and reviewed
 The bank and cash system 7
Cash payments
Assertions: Accuracy, classification and valuation
Control objective 2
To ensure that cash payments are posted to the correct payable accounts and to the
general ledger
Controls
(i) Supplier statements reconciled to payables accounts regularly
(ii) Agreement of monthly cash payments journal to general ledger posting
(iii) Payable accounts reconciled to general ledger control account
Tests of controls
(i) Review reconciliations for a sample of accounts
(ii) Review postings from journal to general ledger
(iii) Review reconciliations for evidence performed and reviewed
 The bank and cash system 8
Cash payments
Assertion: Cut-off
Control objective
To ensure that cash payments are recorded in the
correct accounting period
Controls
Reconciliation of electronic funds transfers and cheques
issued with postings to cash payments journal and
payable accounts
Tests of controls
Review reconciliation to confirm it is done regularly
 The bank and cash system 9
Cash payments
Assertions: Presentation and disclosure
Control objective
To ensure that cash payments are charged to the correct
accounts
Controls
(i) Chart of accounts
(ii) Independent approval and review of general ledger
assignment
Tests of controls
(i) Review cash payments journal to assess reasonableness
of charging of accounts
(ii) Review assignment of general ledger account
 The bank and cash system 10
Cash receipts
Assertions: Occurrence
Control objective
To ensure that all valid cash receipts are received and deposited
Controls
(i) Segregation of duties
(ii) Use of electronic cash receipts transfer not received or
deposited
(iii) Monthly bank reconciliations performed and independently
reviewed
(iv) Use of cash registers or point-of-sale devices
(v) Periodic inspections of cash sales procedures
(vi) Restrictive endorsement of cheques immediately on receipt
 The bank and cash system 11
Cash receipts
Assertions: Occurrence
Controls continued
(vii)Mail opened by two staff members
(viii) Immediate preparation of cash book or list of mail
receipts
(ix) Independent check of agreement of cash/cheques to
be deposited at bank with register totals and
receipts listing
(x) Independent check of agreement of bank deposit
slip with daily cash summary
 The bank and cash system 12
Cash receipts
Assertions: Occurrence
Tests of controls
(i) Observe and evaluate proper segregation of duties
(ii) Examine application controls for electronic cash receipts transfer
(iii) Review monthly bank reconciliations to ensure performed and reviewed
(iv) Observe cash sales procedures
(v) Inquire with managers about results of inspections
(vi) Observe mail opening, including endorsement of cheques
(vii) Observe mail opening procedures
(viii)Observe preparation of cash receipts' records
(ix) Review documentation for evidence of independent check
(x) Review documentation for evidence of independent check
 The bank and cash system 13
Cash receipts
Assertion: Completeness
Control objective
To ensure that all cash receipts are recorded
Controls
(i) Segregation of duties
(ii) Use of electronic cash receipts transfer not received or
deposited
(iii) Monthly bank reconciliations performed and independently
reviewed
(iv) Daily cash receipts listing reconciled with posting to customer
accounts
(v) Customer statements prepared and sent out on a regular basis
 The bank and cash system 14
Cash receipts
Assertion: Completeness
Tests of controls
(i) Observe and evaluate proper segregation of duties
(ii) Observe application controls for electronic cash receipts
transfer
(iii)Review monthly bank reconciliations to confirm
performed and independently reviewed
(iv)Review reconciliation
(v) Inquire of management about handling of customer
statements
Examine a sample of customers and note frequency of
statements
 The bank and cash system 15
Cash receipts
Assertions: Accuracy, classification and valuation
Control objective 1
To ensure that cash receipts are recorded at correct amounts
Controls
(i) Daily remittance report reconciled to control listing of
remittance advices
(ii) Monthly bank reconciliation performed and reviewed
independently
Tests of controls
(i) Review reconciliations
(ii) Review reconciliations for evidence performed and
reviewed
 The bank and cash system 16
Cash receipts
Assertions: Accuracy, classification and valuation
Control objective 2
To ensure that cash receipts are posted to correct receivables
accounts and to the general ledger
Controls
(i) Daily remittance report reconciled daily with postings to
cash receipts journal and customer accounts
(ii) Monthly customer statements sent out
(iii)Monthly cash receipts journal agreed to general ledger
posting
(iv)Receivables' ledger reconciled to control account
 The bank and cash system 17
Cash receipts
Assertions: Accuracy, classification and valuation
Tests of controls
(i) Review reconciliations
(ii) Review entity's procedures for sending out
statements
(iii)Review journal and posting to general ledger
(iv)Review reconciliations
 The bank and cash system 18
Cash receipts
Assertion: Cut-off
Control objective
To ensure that cash receipts are recorded in the correct
accounting period
Controls
Bank reconciliation at period-end
Tests of controls
Review reconciliation to confirm it has been done and
reviewed
 The bank and cash system 19
Cash receipts
Assertions: Presentation and disclosure
Control objective
To ensure that cash receipts are charged to the correct
accounts
Controls
(i) Chart of accounts in place and regularly reviewed
(ii) Codes in place for different types of receipts
Tests of controls
(i) Inspect any documentary evidence (eg emails requesting
update to chart of accounts as a result of review)
(ii) Test application controls for proper codes
 Exam link: Cash controls
• Cash controls around cash payments and receipts
will also be relevant to controls in the purchasing
and sales systems respectively, so could be
examined on a question on deficiencies in a
purchases or sales system.
 The payroll system 1
Assertions: Occurrence and existence
Control objectives
To ensure that payment is made only to bona fide employees of the entity
Controls
(i) Segregation of duties between HR and payroll functions
(ii) Personnel files held for all employees
(iii) Authorisation procedures for hiring, termination, time worked, wage rates,
overtime, benefits etc
(iv) Any change in employment status informed to HR department
(v) Use of time clocks to record time worked
(vi) Clock cards approved by supervisor
(vii) Only employees with valid employee numbers are paid
(viii) Payroll budgets in place, reviewed by management
 The payroll system 2
Tests of controls
(i) Observe and evaluate proper segregation of duties.
(ii) Review a sample of starters and leavers in the year to
ensure correct documentation in place.
(iii) Review and test authorisation procedures in place.
(iv) Review policies and procedures in place for changing
status and consider if adequate. Review personnel files
for a sample of employees whose status changed in year.
(v) Observe employees' use of time clocks.
(vi) Inspect a sample of clock cards for evidence of approval
by appropriate level of management.
(vii) Review and test procedures for entering and removing
employee numbers from the payroll master file.
(viii)Review budgeting procedures.
 The payroll system 3
Assertion: Completeness
Control objective
To ensure that all payroll costs are recorded for work done by
employees
Controls
(i) Pre-numbered clock cards in use
(ii) Segregation of duties
(iii)Regular reconciliations of payroll records and employee
costs recorded in the general ledger
(iv)Comparison of cheques and bank transfer list with payroll
(v) Preparation and authorisation of cheques and bank
transfer list
 The payroll system 4
Tests of controls
(i) Review numerical sequence of clock cards.
(ii) Observe and evaluate proper segregation of duties.
(iii)Review a sample of reconciliations to ensure they are
properly carried out and reviewed by an independent
person.
(iv)Inquire whether comparisons are made between
payment records and payroll and inspect any
documentary evidence of the review.
(v) Examine paid cheques or a certified copy of the bank
list for employees paid by cheque or bank transfer to
ensure proper authorisation.
 The payroll system 5
Assertions: Accuracy, valuation and classification
Control objective 1
To ensure that all benefits and deductions are computed correctly
Controls
Re-performance of a sample of payroll benefit and deduction
calculations
Payroll budgets in place and reviewed by management
Agreement of gross earnings and total tax deducted with taxation
returns
Tests of controls
Review documentary evidence that recalculation occurred
Review budgeting procedures
Inspect documentation for evidence of management's review
 The payroll system 6
Assertions: Accuracy, valuation and classification
Control objective 2
To ensure that payroll transactions are correctly recorded in
the accounting system
Controls
(i) Changes to master file verified through 'before and after'
reports
(ii) Payroll master file reconciled to general ledger
Tests of controls
(i) Review reconciliations of 'before and after' reports to
payroll master file
(ii) Review reconciliations of payroll master file to general
ledger and confirm whether discrepancies are followed
up promptly and resolved
 The payroll system 7
Assertion: Cut-off
Control objective
To ensure that payroll transactions are recorded in the
correct accounting period
Controls
All starters, leavers, changes to salary and deductions are
reported promptly to payroll department and changes are
updated to the payroll master file promptly

Tests of controls
• Review entity's procedures for reporting changes to the
payroll department
• Verify sample of starters and leavers
 The payroll system 8
Assertion: Presentation and disclosure
Control objective
To ensure that payroll transactions are properly classified in
the financial statements
Controls
• Chart of accounts
• Independent approval and review of accounts charged to
payroll
• Payroll budgets in place and reviewed by management
Tests of controls
• Review chart of accounts
• Review procedures for classifying payroll costs
• Review budgeting procedures
 Exam link: The payroll system 1
• Deficiencies in the payroll system have only been
examined once so far by the current F8 examiner, in
the December 2011 paper (question 1).
• There is a good chance then that this might be
tested again soon.
• Again, with this type of answer, present your
answers in a table, using a ruler for the table and
headings.
• When suggesting recommendations, make sure
they are sensible and relevant to the scenario you
are presented with in the question.
 Exam link: The payroll system 2
The September 2013 edition of Student Accountant
contains an excellent article on the audit of wages:
http://www.accaglobal.com/en/student/acca-qual-
student-journey/qual-resource/acca-
qualification/f8/technical-articles/the-audit-of-
wages.html
 Revenue and capital expenditure 1
• It is important that an entity has controls in place to
ensure that capital and revenue expenditure are
accounted for correctly as errors will result in the
misstatement of profit and net assets.
• Management may have an incentive to misclassify
expenditure in order to manipulate profit or for tax
purposes.
• Costs which are susceptible to incorrect accounting
treatment are repairs and maintenance, research and
development, and website/software costs.
 Real World Example: WorldCom
In 2001, WorldCom recognised over $3 billion of
operating costs as capital expenditure on its
statement of financial position. These costs related to
'line costs' – fees that the company had to pay other
telecom companies for the right to access their
networks.
If the company had recognised this as revenue
expenditure that year, it would have made a loss, but
by capitalising the costs, it managed to smooth its
earnings.
The fraud was uncovered by WorldCom's internal
auditors and its new external auditors, KPMG.
 Revenue and capital expenditure 2
Assertion: Authorisation
Control objectives
To ensure that expenditure is properly authorised

Controls
(i) Orders for capital items should be authorised by
appropriate levels of management.
(ii) Order should be requisitioned on appropriate (different
to revenue) documentation.
(iii)Invoices should be approved by the person who
authorised the order.
(iv)Invoices should be marked with the appropriate general
ledger code.
 Revenue and capital expenditure 3
Tests of controls
(i) Review policies and procedures in place.
(ii) Examine a sample of orders for appropriate
authorisation.
(iii)Inspect invoices to verify the invoice has been
appropriately approved.
(iv)Inspect invoices to verify the invoice has the correct
general ledger code marked on it.
 Revenue and capital expenditure 4
Assertion: Completeness
Control objectives
To ensure that all non-current assets are correctly
recorded in the accounting system

Controls
(i) Capital items should be written up in the non-current
asset register.
(ii) The non-current asset register should be reconciled
regularly to the general ledger and any differences
should be investigated and resolved promptly.
 Revenue and capital expenditure 5
Assertion: Completeness
Tests of controls
Review reconciliations to ensure they are regularly
carried out, reviewed by a more senior person, and that
all discrepancies are followed up and resolved on a
timely basis.
 Revenue and capital expenditure 6
Assertion: Classification
Control objectives
To ensure that all expenditure is classified correctly in
the financial statements as capital or revenue
expenditure

Controls
As for purchases system

Tests of controls
As for purchases system
 Question: Specimen exam (Sec B, question 6a)

Garcia International Co (Garcia) is a manufacturer of electrical

equipment. It has factories across the country and its customer base
includes retailers as well as individuals, to whom direct sales are made
through their website. The company's year end is 30 September 20X4.
You are an audit supervisor of Suarez & Co and are currently reviewing
documentation of Garcia's internal control in preparation for the interim
audit.
Garcia's website allows individuals to order goods directly, and full
payment is taken in advance. Currently the website is not integrated into
the inventory system and inventory levels are not checked at the time
when orders are placed. Inventory is valued at the lower of cost and net
realisable value.
 Question: Specimen exam (Sec B, question 6a) cont'd

Goods are despatched via local couriers; however, they do not always
record customer signatures as proof that the customer has received the
goods. Over the past 12 months there have been customer complaints
about the delay between sales orders and receipt of goods. Garcia has
investigated these and found that, in each case, the sales order had
been entered into the sales system correctly but was not forwarded to
the despatch department for fulfilling.
Garcia's retail customers undergo credit checks prior to being accepted
and credit limits are set accordingly by sales ledger clerks. These
customers place their orders through one of the sales team, who
decides on sales discount levels.
 Question: Specimen exam (Sec B, question 6a) cont'd

Raw materials used in the manufacturing process are purchased from a

wide range of suppliers. As a result of staff changes in the purchase
ledger department, supplier statement reconciliations are no longer
performed. Additionally, changes to supplier details in the purchase
ledger master file can be undertaken by purchase ledger clerks as well as
supervisors.
In the past six months Garcia has changed part of its manufacturing
process and as a result some new equipment has been purchased,
however, there are considerable levels of plant and equipment which
are now surplus to requirement. Purchase requisitions for all new
equipment have been authorised by production supervisors and little
has been done to reduce the surplus of old equipment.
 Question: Specimen exam (Sec B, question 6a) cont'd

Required:
(a) In respect of the internal control of Garcia International Co:
(i) Identify and explain SIX deficiencies;
(ii) Recommend a control to address each of these deficiencies; and
(iii) Describe a test of control Suarez & Co would perform to
assess if each of these controls is operating effectively.
Note. The total marks will be split equally between each part.
(18 marks)
 Answer: Specimen exam (Sec B, question 6a)

Deficiency and explanation Recommended control Test of control

The website and inventory system The website should be fully Use test data to order items not
are not integrated. This could result integrated with the inventory currently in stock to ensure that the
in orders made via the website not system so that orders are processed customer is informed and an
being fulfilled and consequent loss of only when the item is in stock. approximate time is given for when
revenue and customer goodwill. Where an item is out of stock, the the item is next expected to be in
website should be able to inform stock.
customers when stock would be
replenished.
Couriers do not always take a Couriers must take a signature from Inspect a sample of goods
signature from the customer on the customer on delivery of the despatched notes to confirm that
delivery. This gives rise to the risk of goods as proof of delivery. customer signatures have been
theft by couriers and the risk that taken.
customers who have had their item
delivered claim not to have received
it, leading to goods being despatched
twice.
 Answer: Specimen exam (Sec B, question 6a) cont'd

Deficiency and explanation Recommended control Test of control

There is a long delay between the As soon as an order has been For a sample of sales orders,
placing of the order and the made, it should be entered into compare the time of the order to
despatch of the products. This will the sales system and sent to the the time the order was
result in a loss of customer despatch department straightaway despatched to ensure that
goodwill and damage and with a copy of the sales order despatch of orders is being carried
reputation of the company. form. The system should flag any out on a timely basis.
outstanding sales orders past a Review the report of outstanding
certain period. sales orders.

Sales ledger clerks set credit limits For any new retail customers, For a sample of new customers,
for retail customers without any limits should be authorised by a review the credit limits set to
monitoring. Inappropriate limits senior manager and reviewed on a ensure they are reasonable and
could be set, resulting in goods regular basis. were authorised by an appropriate
not being paid for and senior staff member.
irrecoverable debts.
 Answer: Specimen exam (Sec B, question 6a) cont'd

Deficiency and explanation Recommended control Test of control

The sales team decide on the level Discount levels should be set by an Review the discount levels for a
of discounts for retail customers. authorised manager. Any changes sample of customers to ensure
This could lead to levels of discount to the discount level should be they were set by appropriate
being offered at too high an discussed and authorised by a personnel and any changes were
amount, resulting in loss of senior manager. authorised.
revenue.

The company uses a wide range of A preferred supplier list should be Review the raw material purchase
suppliers. As a result, it may be set up and used when purchasing orders against the supplier list to
missing out on bulk discounts. raw materials. confirm that only preferred
There is also a risk of raw materials suppliers are used.
not being of the required quality,
affecting customer goodwill.
 Answer: Specimen exam (Sec B, question 6a) cont'd

Deficiency and explanation Recommended control Test of control

Supplier statement reconciliations Monthly supplier reconciliations Inspect supplier statement

are not performed. This could must be undertaken by purchase reconciliations to ensure they have
result in errors in the recording of ledger clerks and reviewed by the been prepared each month and
purchases and disputes with finance director, with any then reviewed by a more senior
suppliers. discrepancies being investigated on staff member.
a timely basis.

Purchase ledger clerks can make Only authorised personnel should Review the register of
changes to supplier details in the have the ability to amend details in amendments made to the
purchase ledger master file. This the purchase ledger master file. purchase ledger master file to
could result in fraud through the confirm that only authorised staff
set up of fictitious suppliers. have made changes.