Topic 10: AYK 1

F8 AYK ANSWERS HTFT PARTNERSHIP

Topic 10: AYK 1

(a) Audit Work on Railway Trucks

Examine board minutes authorising the purchase of the trucks (authorisation)

Cast the non-current asset ledger; agree total of railway trucks to the general ledger and financial statements (completeness)

Ensure that railway trucks are actually stated as such in the non-current asset note. As a material item, separate disclosure of this category is allowed (disclosure)

Cast the non-current asset note in the financial statements. Ensure the note agrees to the amount disclosed in the balance sheet (disclosure)

For a sample of assets from the ledger, confirm existence by physically seeing the trucks (existence)

Identify the supplier of railway trucks from a purchase invoice. Obtain all invoices from this supplier and confirm completeness of recording in the noncurrent asset register (completeness).

Also, during non-current asset inspection, record details of some railway trucks and ensure those trucks are recorded in the non-current asset register

Examine a sample of purchase invoices to confirm ownership of the trucks (rights and obligations)

Review company policy for depreciation. As this is a new category of noncurrent asset, obtain representation letter point regarding accuracy of amount.

Confirm with amount charged in similar companies that the depreciation percentage appears to be correct (valuation and allocation)

Agree depreciation charged in the non-current asset note to the amount on the profit and loss account (valuation and allocation)

Recalculate a sample of depreciation calculations to ensure that they are accurate and that they conform to company policy (valuation and allocation)

Ensure that any sales tax has been correctly treated e.g. capitalised where this is non-recoverable (valuation and allocation)

Current value may also be confirmed using a specialist or appropriate trade journal and compared to the net book value shown in the non-current asset register (valuation and allocation).

(b) Issues to raise with management

Land and buildings

The depreciation rate has been correctly applied at 2% – given an estimated life for the land and buildings category of 50 years. However, the rate has been applied to the whole balance – that is land and buildings. In most companies, the value of land is not thought to decrease and therefore depreciation is not appropriate.

To allocate depreciation accurately, a split is required between the land and buildings amounts in the financial statements. Buildings will then be depreciated, but not the land.

Plant and machinery

Depreciation has been charged in full in the year of acquisition, but not charged at all in the year of disposal. This appears to be an appropriate accounting policy – charging depreciation in the year of disposal


would only amend the profit or loss on sale in that year and so have a neutral effect on the financial statements.

There appears to be an error in the disposals calculation as the depreciation amount exceeds the cost being eliminated There does not appear to be any logical reason for this situation and it should be discussed with the directors to identify the reason, if any, for this treatment.

If an error is found, then the depreciation amount must be decreased (or cost eliminated increased) and the profit or loss on sale amended accordingly.

Motor vehicles – point 1

The depreciation percentage stated in the financial statements is 33%. However, the calculation is either 25% on the year-end balance on cost brought forward and additions for the year. To be consistent, the non-current asset disclosure note must agree to the actual calculation in the non-current asset note.

The reason for the difference must be found and either the disclosure note or the depreciation calculation amended if there has been a change in the depreciation rate, then this must also be disclosed in the financial statements. There has not been a change in accounting policy – the policy of depreciation is unchanged, it is only the method of applying that policy that has changed. There is no need to amend the prior year figures.

Motor vehicles – point 2

The cost and depreciation eliminated on sale are the same amount; this is not surprising given that the assets were fully depreciated. However, the depreciation policy for motor vehicles is to depreciate the category over three years. If those vehicles are now being kept for six years, then the depreciation rate may need revising to show the actual useful life of the vehicles.

The depreciation rate needs to be discussed with company management, and if necessary the rate amended to reflect the actual life of the vehicles.


Topic 10 AYK 2

a) Obtaining a bank letter

Review the need to obtain a bank letter from the information obtained from the preliminary risk assessment.

Prepare a standard bank letter in the format agreed with banks in your jurisdiction. Obtain authorisation on that letter from a director of the company for the bank to disclose

information to the auditor. Where the company has provided their bank with a standing authority to disclose information to

the auditors, refer to this authority in the bank letter. The auditor sends the letter directly to the company’s bank with a request to send the reply directly

back to the auditors.

b)

Substantive procedures over bank balance:

Obtain the company’s bank reconciliation and check the additions to ensure arithmetical accuracy. Obtain a bank confirmation letter from the company’s bankers. Verify the balance per the bank statement to an original year end bank statement and also to the

bank confirmation letter. Verify the reconciliation’s balance per the cash book to the year end cash book. Trace all of the outstanding lodgements to the pre year end cash book, post year end bank

statement and also to paying-in-book pre year end. Examine any old unpresented cheques to assess if they need to be written back into the purchase

ledger as they are no longer valid to be presented. Trace all unpresented cheques through to a pre year end cash book and post year end statement.

For any unusual amounts or significant delays obtain explanations from management. Agree all balances listed on the bank confirmation letter to the company’s bank reconciliations or

the trial balance to ensure completeness of bank balances. Review the cash book and bank statements for any unusual items or large transfers around the

year end, as this could be evidence of window dressing. Examine the bank confirmation letter for details of any security provided by the company or any

legal right of set-off as this may require disclosure.


Topic 10: AYK 3

(a)

Test of control Objective of test

The auditor should attempt to enter an order for a fictitious customer account number. The system should not accept this order.

To ensure that orders are only accepted and processed for valid customers.

With the client’s permission, attempt to enter a sales order which will take a customer over the agreed credit limit, the system should reject the order.

To ensure that goods are not supplied to poor credit risks.

Inspect a sample of processed credit applications from the credit agency and follow through the credit limit agreed to the sales system.

To ensure that goods are only supplied to customers with good credit ratings.

Obtain a copy of the current price list and agree for a sample of invoices that relevant/current prices have been used.

To ensure that goods are only sold at authorised prices. Confirm discounts applied to invoices agree to the customer master file.

Attempt to process an order with a sales discount for a customer not normally entitled to discounts to assess the application controls.

To ensure that sales discounts are only provided to valid customers.

Inspect a sample of orders to confirm that an order acceptance email/letter has been generated. Observe the sales order clerk processing orders and assess whether the order acceptance is automatically generated.

To ensure that all orders are recorded completely and accurately.

Visit a warehouse and observe the goods despatch process to assess whether all goods are double checked against the goods despatch note (GDN) and the despatch list prior to sending out.

To ensure that goods are despatched correctly to customers and that they are of an adequate quality.

Inspect a sample of GDNs and agree that a valid sales invoice has been correctly raised.

To ensure that all goods despatched are correctly invoiced.

Review the last system generated sequence check of sales invoices to identify any omissions.

To ensure completeness of income for goods despatched.


(b)

Substantive procedures to confirm receivables balance for Tinkerbell

Perform a positive trade receivables circularisation of a representative sample of Tinkerbell’s year-end balances, for any non-replies, with Tinkerbell’s permission, send a reminder letter to follow up.

Review the after date cash receipts and follow through to pre-year-end receivable balances. Calculate average receivable days and compare this to prior year, investigate any significant

differences. Review the reconciliation of sales ledger control account to the sales ledger list of balances. Select a sample of goods despatched notes (GDN) before and just after the year end and follow

through to the sales invoice to ensure they are recorded in the correct accounting period. Inspect the aged receivables report to identify any slow moving balances, discuss these with the

credit control manager to assess whether an allowance or write down is necessary. For any slow moving/aged balances review customer correspondence to assess whether there are

any invoices in dispute. Review board minutes of Tinkerbell to assess whether there are any material disputed receivables. Review a sample of post year-end credit notes to identify any that relate to pre-year-end

transactions to verify that they have not been included in receivables. Review the sales ledger for any credit balances and discuss with management whether these

should be reclassified as payables. Select a sample of year-end receivable balances and agree back to valid supporting documentation

of GDN and sales order to ensure existence.

(c)

Select a representative sample of goods in inventory at the year end, agree the cost per the records to a recent purchase invoice and ensure that the cost is correctly stated.

Discuss with management of the basis of the standard costs applied to the inventory valuation, and how often these are reviewed and updated.

Review the level of variances between standard and actual costs and discuss with management how these are treated.

Obtain a breakdown of the standard costs and agree a sample of these costs to actual invoices or wage records to assess their reasonableness.

Select a sample of year end goods and review post year end sales invoices to ascertain if NRV is above cost or if an adjustment is required.

For a sample of manufactured items obtain cost sheets and confirm: o raw material costs to recent purchase invoices o labour costs to time sheets or wage records o overheads allocated are of a production nature.

Review aged inventory reports and identify any slow moving goods, discuss with management why these items have not been written down.

Review the inventory records to identify the level of adjustments made throughout the year for damaged/obsolete items. If significant consider whether the year end records require further


adjustments and discuss with management whether any further write downs/provision may be required.

Follow up any damaged/obsolete items noted by the auditor at the inventory counts attended, to ensure that the inventory records have been updated correctly.

Perform a review of the average inventory days for the current year and compare to prior year inventory days. Discuss any significant variations with management.

Compare the gross margin for current year with prior year. Fluctuations in gross margin could be due to inventory valuation issues. Discuss significant variations in the margin with management.

(d)

Substantive procedures to confirm Tinkerbell’s revenue:

Compare the overall level of revenue against prior years and budget and investigate any significant fluctuations.

Obtain a schedule of sales for the year broken down into the major categories of toys manufactured and compare this to the prior year breakdown and for any unusual movements discuss with management.

Calculate the gross margin for Tinkerbell and compare this to the prior year and investigate any significant fluctuations.

Select a sample of sales invoices for larger customers and recalculate the discounts allowed to ensure that these are accurate.

Recalculate for a sample of invoices that the sales tax has been correctly applied to the sales invoice.

Select a sample of customer orders and agree these to the despatch notes and sales invoices through to inclusion in the sales ledger to ensure completeness of revenue.

Select a sample of despatch notes both pre and post the year end, follow these through to sales invoices in the correct accounting period to ensure that cut-off has been correctly applied.

Select a sample of credit notes issued after the year end and follow through to sales invoice to ensure the returns were recorded in the proper period.


Topic 10: AYK 1 Test of control

(a) (i) Tests of control test the operating effectiveness of controls in preventing, detecting or correcting material misstatements.

Substantive procedures are aimed at detecting material misstatements at the assertion level. They include tests of detail of transactions, balances, disclosures and substantive analytical procedures.

(ii) Example tests of control over sales invoicing

Inspect numerical sequence of sales invoices, if any breaks in the sequence noted, enquire of management as to missing invoices.

Review a sample of sales invoices for evidence of authorisation by a responsible official of any discounts allowed.

Inspect customer statements for evidence of regular preparation.

Example substantive procedures over sales invoicing

Select a sample of pre and post year end goods despatch notes and follow through to pre or post year end sales invoices, to ensure the sales cut-off has been correctly applied.

Perform an analytical review of monthly sales, compare any trends to prior years and discuss significant fluctuations with management.

Review post year end credit notes to identify if any pre year end sales should be removed.

b)

Letter

Auditors address

Clients address

Dear Sirs

Please find enclosed an appendix of the deficiencies highlighted on the audit, the potential impact of those deficiencies and recommendations to manage these issues along with test of controls.

Identify and explain Control procedures Test of controls

A junior clerk opens the post unsupervised. This could result in cash being misappropriated.

A second member of the accounts team or staff independent of the accounts team should assist with the mail, one should open the post and the second should record cash received in the cash log.

Observe the mail opening process, to assess if the control is operating effectively.

Cash and cheques are secured in a small locked box and only banked every few days. A small

Cash and cheques should be ideally banked daily, if not then it should be stored in a fire proof

Enquire of management where the cash receipts not banked are stored.


locked box is not adequate for security of considerable cash receipts, as it can easily be stolen.

safe, and access to this safe should be restricted to supervised individuals.

Inspect the location to ensure cash is suitably secure.

Cash and cheques are only banked every few days and any member of the finance team performs this.

Cash and cheques should be banked every day.

Inspect the paying-in books to see if cash and cheques have been banked daily or less frequently. Review bank statements against the cash received log to confirm all amounts were banked promptly.

Cash should ideally not be held over-night as it is not secure. Also if any member of the team banks cash, then this could result in very junior clerks having access to significant amounts of money.

The cashier should prepare the paying-in book from the cash received log. Then a separate responsible individual should have responsibility for banking this cash.

Enquire of staff as to who performs the banking process and confirm this person is suitably responsible.

The cashier updates both the cash book and the sales ledger. This is weak segregation of duties, as the cashier could incorrectly enter a receipt and this would impact both the cash book and the sales ledger. In addition weak segregation of duties could increase the risk of a ‘teeming and lading’ fraud.

The cashier should update the cash book from the cash received log. A member of the sales ledger team should update the sales ledger.

Observe the process for recording cash received into the relevant ledgers and note if the segregation of duties is occurring.

Bank reconciliations are not performed every month and they do not appear to be reviewed by a senior member of the finance department. Errors in the cash cycle may not be promptly identified if reconciliations are performed infrequently.

Bank reconciliations should be performed monthly. A responsible individual should then review them.

Review the file of reconciliations for evidence of regular performance and review by senior finance team members.

If you should have any questions please do not hesitate to contact me

Yours sincerely

Auditor



a)

Prior year internal control questionnaires

Obtain the audit file from last year’s audit. Ensure that the documentation on the sales system is complete. Review the audit file for indications of deficiencies in the sales system and note these for investigation this year.

Obtain system documentation from the client. Review this to identify any changes made in the last 12 months.

Interview client staff to ascertain whether systems have changed this year and to ensure that the internal control questionnaires produced last year are correct infrequently

Perform walk-through checks. Trace a few transactions through the sales system to ensure that the internal control questionnaires on the audit file are accurate and can be relied upon to produce the audit programmes for this year.

During walk-through checks, ensure that the controls documented in the system notes are actually working, for example, verifying that documents are signed as indicated in the notes.

b)

Tests of control Reason for test

Review a sample of goods despatch notes (GDN) for signatures of the goods despatch staff and customer.

Ensures that the goods despatched are correctly recorded on the GDNs.

Review a sample of GDNs for signature of the accounts staff.

Ensures that the GDN details have been entered onto the computer system.

Observe despatch system ensuring Seeley staff have seen the customers’ identification card prior to goods being loaded into customers’ vans.

Ensures that goods are only despatched to authorised customers.

Review the error report on numeric sequence of GDNs produced in the accounts department and enquire action taken regarding omissions.

Ensures that the sequence of GDNs is complete.

Observe despatch process to ensure that the customers’ credit limit is reviewed prior to goods being despatched.

Ensures that goods are not despatched to poor/bad credit risks. Note: Reviewing credit limits is not specifically stated in the scenario; however, most despatch/ sales systems will have this control and most candidates mentioned this in their answers. Hence marks were awarded for this point.

Review a selection of invoices ensuring they have been signed by accounts staff.

Ensures the accurate transfer of goods despatched information from the GDN to the invoice.



a)

Test of controls Explain the reason

Request a pre-numbered purchase requisitions note

To see if the requisition note is pre numbered, and will test completeness of the requisitions

Review a sample of requisitions for existence of the signature of the chief buyer

This will confirm the requisitions have been authorised and relate to valid business expenditure

Review a sample of orders for existence of the purchase ledger clerk signature

This will confirm the requisition will agree with the order and that the amounts agree and have been authorised

Review the order and requisition note being attached together in the accounts department

This will confirm completeness and validity of the purchase, and will ensure goods are only paid for, for goods ordered.

Observe the goods inwards department check for damaged items on receipt of goods

To ensure only good quality purchases are accepted.

Trace a sample of good received notes back to the ordering department, and account department

To ensure the order had been fulfilled and the company pay for items that they have received. Confirming the transaction has occurred

Review the file in the goods inwards department for the good received notes

To confirm the goods have been received and have occurred.

Review the goods received note for evidence that a signature is present by a responsible person.

This will confirm that the goods have been received and agree back to the order.

Review for the signature on the purchase invoice This will confirm that the requisition, order and good received note have been agreed to the invoice, ensuring the company is only paying for goods ordered and received.

Review evidence of the FD authorising payments To ensure payments are made to valid suppliers and the right amount.

Review the file of monthly bank statements This is to ensure that they have taken place and will help confirm completeness of the transactions.



a)

Test of controls Reasons for the text

Observe the staff clocking in and clocking out To confirm the employees exit and that there number of hours clocked have been worked by valid employees

Input a dummy swipe card and trace the hours through the computer system

This will confirm that the system is accurate in recording the hours worked, so staff will only be paid for hours worked.

Review for existence of the FD reviewing and authorising the wages.

To ensure the wages are paid at the right rate, to the right people

Send an email to the payroll department and ask for them to read

This should confirm the read receipt function, showing the systems to be robust and working

Observe the wages being paid out, confirming identification is shown, and the employee counts their cash

To ensure the cash wages are given out to legitimate staff at the right amount

Review the wage slip for the signatures To ensure the employees have received the wages, and that this is documented


Topic 10: AYK 1 Not for profit

(a)

Not-for-profit organisations tend to have weaker systems due to:

Lack of segregation of duties, as the organisation will be restricted with the amount of staff; and

The use of volunteers, who are likely to be unqualified and have little awareness of the importance of controls

In not-for-profit organisations the transactions tend to be less formal, so there may not be the physical documentation of transactions. For example: a lot of income received by charities is by the way of donation. These transactions will not be accompanied by invoices, orders or dispatch notes.

Assessing the going concern of a not-for-profit organisation may also be more difficult, particularly for charities that are reliant on voluntary donations. Many issues, such as state of the economy, could impact on their ability to generate revenue in the short term.

Not-for-profit organisations do not have shareholders to report to. They are more likely to have trustees or governors, who are interested in performance criteria other than profits.

(b)

Audit risks in charity Effect on audit approach

Income is from voluntary donations only. It is difficult to estimate that income in the future will be sufficient to meet the expenditure of the charity. Audit of the going concern concept will therefore be quite difficult.

Completeness of income – where there are no controls to ensure income is complete for example sales invoices are not raised to obtain donations.

Audit tests are unlikely to be effective to meet the assertion of completeness. The audit report may need to be modified to explain the lack of evidence stating that completeness of income cannot be confirmed.

Funds can only be spent in accordance with the aims of the charity.

Careful review of expenditure will be necessary to ensure that expenditure is not 'ultra vires' the objectives of the charity. The auditor will need to review the constitution of the Polo charity carefully in this respect.

Taxation rules relevant to charities. The auditor will need to ensure that staff familiar with the taxation rules affecting the charity are on the audit team. There is a danger that taxation rules are not followed reflecting adversely on the audit firm.


Requirement to report expenditure in accordance with the constitution – administration expenditure can be no more than 10% of total income.

The trustees may attempt to hide 'excessive' expenditure on administration under other expense headings. As the auditor has to report on the accuracy of expenditure then audit procedures must focus on the accuracy of recording of expenditure.

Donations to charity for specific activities for example provision of sports equipment.

Documentation for any donation will need to be obtained and then expenditure agreed to the terms of the documentation. Any discrepancies will have to be reported to management.

Topic 10: AYK 1

Documents