SEPT / DEC 2022
Scenario 1
This scenario relates to six requirements.
It is 1 July 20X5. Daley Co, a listed company, manufactures double glazed windows and doors. The
company's year end is 30 September 20X5. You are an audit supervisor with Cooper & Co and you are in
the process of reviewing the following extracts from the internal controls documentation in preparation for
the forthcoming audit:
Payroll
The company employs 210 staff in its factory who are paid on a weekly basis by bank transfer. Factory
staff have key cards and are required to swipe in and out at the beginning and end of their shift. This process
is supervised. Hours worked by employees are recorded electronically using the key card system which is
linked to the payroll system. Each week the hours worked are automatically transferred to the payroll
system. As the process is automated, no checks over this transfer are performed.
The payroll is run on a weekly basis and the system automatically calculates the wages to be paid. On a
sample basis, a payroll clerk checks gross to net pay calculations and compares these to the system-
generated balances to ensure the accuracy of the payroll system. If any changes to the payroll data are
required, the payroll clerk makes the amendment. An edit report of any amendments is produced weekly
by the system but is not reviewed.
Non-current assets
Daley Co has a head office and ten factories, with a warehouse included at each factory. The company has
an internal audit (IA) department which carries out a comparison between all of the assets recorded on the
non-current assets register to those physically present in each of Daley Co's 21 sites. This year's programme
of visits, which has been planned and carried out on the same basis as previous years, means that by 30
September 20X5, IA will only have completed this comparison at one factory and one warehouse.
During the year, the financial controller changed the company’s capitalisation accounting policy. In
accordance with the revised policy, only items of a capital nature exceeding $20,000 are accounted for as
additions to non-current assets in the statement of financial position. Any non-current assets purchased
below $20,000 are written off to the statement of profit or loss as an expense.
Bank and cash
On a weekly basis, a bank payments list is generated for supplier payments. The finance director reviews
the total amount of the bank payments list and authorises it. She then passes it to the financial controller
who processes it for payment.
Daley Co incurs a lot of petty cash expenditure and the finance department maintains a petty cash float of
$500 which is kept in the safe. It is used for making any sundry purchases by the company. When staff
wish to purchase sundry items, the required sum of cash is given to the staff member who signs for it. The
staff member is required to return any excess money to the finance department but there is currently no
requirement for receipts to be provided.
1
The cashier reconciles the main current account on a monthly basis as this contains the highest levels of
activity and reconciles the remaining three bank accounts every three months. The reconciliations are
reviewed by the finance director who evidences this review.
Required:
ISA 315 (Revised 2019) Identifying and Assessing the Risks of Material Misstatement states that an entity's
system of internal control consists of five components: control environment, the entity's risk assessment
process, the entity's process to monitor the system of internal control, the information system and
communication and control activities.
(a) Using the table below, describe the five components of an entity's system of internal control.
Note: You do not need to refer to the scenario to answer this requirement. (5 marks)
Component of internal control Description
Control environment
Entity's risk assessment process
Entity's process to monitor the system of internal control
Information system and communication
Control activities
(b) In respect of the system of internal control of Daley Co:
(i) Identify and explain FIVE deficiencies;
(ii) Recommend a control to address each of these deficiencies; and
(iii) Describe a TEST OF CONTROL the external auditors should perform to assess if each
of these controls, if implemented, is operating effectively.
Note: The total marks will be split equally between each part. (15 marks)
Control Deficiency Control Recommendation Test of Control
(c) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate audit evidence in relation to Daley Co's bank balances. (4 marks)
2
During the year, the Chair of Daley Co resigned due to his other commitments and Fred Johnson, who is
the chief executive of the company, took over this role. Fred has recently written to all shareholders to
inform them that any questions or comments they may have could only be raised at the company’s annual
general meeting and that any other communication with the board is not possible.
The executive directors' remuneration is set by the remuneration committee. The non-executive directors’
remuneration is set by the board and is based on pre-tax profit targets which are agreed by the board at the
start of each financial year. As the board is of the view that the internal control environment is very
effective, an audit committee has not been established.
(d) Describe THREE corporate governance deficiencies faced by Daley Co and provide a
recommendation to address each deficiency to ensure compliance with corporate governance
principles. (6 marks)
Deficiency Recommendation
(30 marks)
3
Scenario 2
This scenario relates to three requirements.
It is 1 July 20X5. You are the audit supervisor at Crow & Co and are finalising the planning for your new
client Magpie Co for the forthcoming audit for the year ending 31 July 20X5.
Magpie Co is a retailer of garden supplies which operates from 20 stores across the country and employs
400 staff. The audit manager has attended a meeting with the finance director and has provided you with
the following notes of that meeting and financial statement extracts:
Notes of planning meeting
During the year the company spent $0.75m on refurbishing its stores to improve the customer experience.
All of this expenditure has been recognised in the statement of financial position as property, plant and
equipment. In addition, the company also installed a new sales system during the year which records all
sales and receivables. The system enables daily sales from each store to be automatically reported to the
centralised finance department at the end of each working day. As the system is from a market leading
provider, it was not felt necessary to run the old and the new systems in parallel.
Customers are able to pay for their goods using either cash or credit card. At the end of the working day,
the store manager generates a report from each cash register which confirms the cash takings. The cash is
then counted and compared to the report. Since the new sales system was installed, head office now receives
daily cash takings reports which have shown an increasing number of cash shortages at each store. These
differences have not been investigated or reconciled on the basis that they have only been small amounts.
The company has a number of corporate customers who buy goods on 90 day credit terms and the level of
receivables which are overdue for payment has increased from the prior year. However, the finance director
has said she does not intend to make any further allowance for receivables as overdue payments are
becoming common in the industry.
The payables ledger clerk has carried out supplier statement reconciliations during the year and in a number
of instances the supplier statements have shown a balance owing by the company which is higher than the
balance on the payables ledger. These differences have been included as reconciling items on the supplier
statement reconciliations by the payables ledger clerk, but no further work has been performed on these
differences.
It has been discovered that the soil relating to a batch of plants with a cost price of $0.1m is contaminated,
meaning that the plants may not be able to be sold. Tests are currently being carried out to determine
whether the contamination can be remedied.
The report to management issued following the 20X4 audit indicated a significant number of deficiencies
noted in the payroll cycle of the business.
4
Financial statement extracts for the year ending 31 July are as follows:
The audit assistant has already calculated some key ratios for Magpie Co which you have confirmed as
accurate
Required:
ISA 210 Agreeing the Terms of Audit Engagements requires auditors to issue an audit engagement letter.
(a) Explain the PURPOSE of an audit engagement letter and list FOUR items which should be
included in an audit engagement letter. (4 marks)
(b) Using the table below, calculate the following TWO ratios, for BOTH years, to assist you in
planning the audit of Magpie Co: operating profit margin and payables payment period.
(2 marks)
(c) Using the information provided and the ratios calculated, describe SEVEN audit risks and
explain the auditor’s response to each risk in planning the audit of Magpie Co. (14 marks)
Ratio 20X5 20X4
Operating profit margin
Payables payment period
(20 marks)
5
Scenario 3
This scenario relates to four requirements.
It is 1 July 20X5. Pacific Co operates a chain of 14 retail stores across the country, selling its own range of
cosmetic products. You are the audit supervisor of Caribbean & Co and the final audit is due to commence
shortly for the year ended 31 May 20X5. Draft financial statements show revenue of $45.2m and profit
before tax of $4.1m. The following three matters have been brought to your attention:
Trade payables and accruals
As part of the year-end process, Pacific Co’s payables ledger is closed at the end of the day on 31 May.
Any invoices received after this date, relating to goods received before the year end, are recorded in the
goods received not invoiced (GRNI) accrual.
This year, the payables ledger was kept open in error until 1 June 20X5. As a result, a significant payment
run for suppliers made by bank transfer on 1 June 20X5 was recorded in the 20X5 payables ledger. The
finance director has confirmed that the year-end trade payables balance was corrected using a journal.
Provision for legal claims
In March 20X5, a number of claims were received by the company from customers who suffered severe
allergic reactions after using one of Pacific Co's products. They allege that the product ingredients listed on
the label were incorrect. An internal investigation has suggested that one batch of the product had been
incorrectly labelled. The finance director has recognised a provision in the draft financial statements of
$0.5m.
Revenue
The company’s revenue has increased by $3.9m during the year (20X4: total revenue $41.3m). The
management accounts record information for revenue by key product line, of which there are eight, and
also by store. In August 20X4, Pacific Co opened a new retail store, bringing the number of stores to 14. In
addition, it launched a number of new products across most of the key product lines.
Required:
(a) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate audit evidence in relation to the COMPLETENESS of Pacific Co’s trade payables
and accruals. (5 marks)
(b) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate audit evidence in relation to Pacific Co’s provision for the legal claims. (6 marks)
(c) Describe SUBSTANTIVE ANALYTICAL procedures the auditor should perform to obtain
sufficient and appropriate audit evidence in relation to Pacific Co's revenue. (4 marks)
6
During the audit of Pacific Co's provision for the legal claims, the audit team gathered audit evidence
showing that the provision should amount to $0.8m. The finance director has suggested that no adjustment
is made in the 20X5 financial statements as he believes $0.5m is a reasonable estimate and that the
difference of $0.3m is not material.
(d) Discuss the issue and describe the impact on the auditor’s report, if any, should this issue
remain unresolved. (5 marks)
(20 marks)
