Management of audit practice

Africom Holdings Ltd. is listed on the Nairobi Securities Exchange and as such, its consolidated financial statements are prepared in accordance with International Financial Reporting Standards (IFRS) and are subject to regulatory oversight by the Capital Markets Authority of Kenya. Group structure and operations:

 Analyse FOUR areas the auditor could consider during the preliminary planning of the Africom Holdings group audit.                          

The above issues have prompted the firm’s top management to consider implementing International Standard on Quality Management 1(ISQM1) to enhance their quality management system and address these deficiencies. 

Analyse SIX components of ISQM1 that XYZ Auditors should focus on to address the issues raised to comply with the standard. 

The finance director is responsible for the preparation of a detailed annual budget for property, plant and equipment (PPE) which is based on a five-year budget and approved by the board of directors after consultation with the audit committee. Once the budget is approved by the board it is held in a computer file, which is the basis of any purchase order. When equipment is delivered to the company, a pre-numbered goods received note (GRN) is raised and a copy is sent to the accounting and finance department. This note is used to update the PPE budget to reflect the movement. The equipment is carefully inspected by the production personnel and tested if operating properly. An operational certificate is prepared by the production department and is used by the accounting and finance department together with the GRN to check against the purchase invoice when it is received. At the same time as the purchase invoice enters the purchases system, the computerised PPE register is updated. Access to the PPE register is restricted to the personnel in the accounting and finance department. On a regular basis throughout the year, the PPE register is compared to plant and equipment on site by the accounting personnel using identification numbers in the register and permanently marked on to each item in the factory. The internal audit department also tests on a sample basis the operation of the system from the budget preparation to entry in the PPE register. Internal audit staff also compare a sample of entries in the PPE register with the equipment in the factories. 

As part of your work as external auditors, you have reviewed the PPE audit programme of the internal auditors and come to the conclusion that the basis of their testing is a representative sample of purchases invoices.

(i). Identify THREE strengths in Thermotech Boilers control environment in the area of PPE and explain how each of the strengths reduces the control risk. 

(ii). Citing FOUR reasons, explain why testing of a representative sample of purchases invoices to prove completeness of PPE records is not sufficient.  

(ii) Describe FOUR quality control procedures that are applicable to an audit engagement.

 Describe FIVE specific roles and responsibilities of an Audit Committee.

The company maintains the details of the inventory quantities on its computer. These inventory quantities are updated from the goods received notes and the sales invoices. The company carries out the inventory count each month when all the fast moving and high value inventory is counted, and a third of the remaining inventory is counted in rotation so that all the items are counted at least four times a year. You attended the inventory count on the second Sunday of October 2022 and a further inventory count on the first Sunday of November 2022. 

The company’s year-end was 31 October 2022 and the inventory quantities as at that date as shown by the computer had been used in the valuation of the inventory. No inventory was counted at the year end.

(a). Describe the principal matters that you should have checked and the matters you should have recorded when you attended the company’s inventory count on the second Sunday of October 2022.

(b). Explain the checks you will perform in confirming the sales and purchases cut offs have been correctly carried out at the year end. 

(c). Discuss the work you will carry out to check that the book inventory records have been correctly updated from the inventory count. 

(d). Summarise the work you will carry out to satisfy yourself that the inventory quantities used in the relation of the inventory at the year end is correct.  

This is a non-trading parent company, which wholly owns three subsidiaries: D Ltd., S Ltd. and P Ltd. all of which are involved with the core manufacturing and marketing operations of the group. This year, the directors decided to diversify the group’s activities in order to reduce risk exposure. Non-controlling interests representing long-term investments have been made in two companies. In the consolidated statement of financial position, these investments are accounted for as associates, as Lavenda Ltd. is able to exert significant influence over the companies. As part of their remuneration, the directors of Lavenda Ltd. receive a bonus based on the profit before tax of the group. In April 2022, the group finance director resigned from office after a disagreement with the chief executive officer over changes to accounting estimates. A new group finance director is yet to be appointed.

This company mills, blends, packages and distributes healthy flours and natural spices. During the year, the factory was extended by the self-construction of a new processing area, at a total cost of Sh.8 million which is material in the context of the company’s financial statements as well as the Group. A loan of Sh.8 million with an interest rate of 5% per annum had been taken out to finance the construction. The construction took 6 months to complete and the new processing area was ready for use on 1 August 2022. The processing area began to be used on 1 November 2022. The estimated useful life of the extended factory is 15 years.

This company’s operations involve the manufacture and distribution of peanut butter and other bread spreads. S Ltd. is involved in a court case with a competitor, F Foods Ltd., which alleges that a design used in S Ltd. printed material copies one of F Foods Ltd.’s designs which are protected under copyright. A verbal confirmation was made from S Ltd. lawyers that a claim of Sh.2.5 million has been made against S Ltd., which is probable to be paid. S Ltd. has not made a provision. 

This company is a new and significant acquisition, purchased in June 2022. It is located in North Africa and has been purchased to supply peanuts and other ingredients for the goods produced by S Ltd. It is now supplying approximately half of the ingredients used in S Ltd. The country in which P Ltd. is situated has not adopted International Financial Reporting Standards, meaning that P Ltd.’s financial statements are prepared using local accounting rules. The company uses local currency to measure and present its financial statements.

P Ltd. is audited by a small local firm, ABC & Co, also based in North Africa. Assume that Audit regulations in that country are not based on International Standards on Auditing. 

(a) Evaluate the principal audit risks to be considered in your planning of the final audit of the consolidated financial statements for the year ended 31 December 2022. 

(b)  Describe the procedures that should be performed in deciding the extent of reliance to be placed on the work of ABC & Co. 

(c) Recommend the principal audit procedures that should be performed on the classification of non-controlling investments made by Lavenda Ltd.   

Required: 

In light of the above statement: 

(i) Explain the difference between “assurance” and “non-assurance” services as provided by external auditors. 

(ii) Describe the work of the partner charged with the responsibility of driving the quality agenda in external audits. 

(iii) Discuss FOUR principal tenets of ISQM 1.

The major donor has placed a condition that operating cost must not exceed 10% of the total budget. Funding from each of the donors is designated and restricted to specific projects. In some instances, donor funds have not been disbursed in time making it necessary for SDT to seek for bank overdrafts to continue meeting fixed costs and ongoing projects. The Executive Director has requested you not to mention the loans in the financial statements or management letter as the donors may raise concerns. Furthermore, the overdraft has been fully repaid by period end. 

Two employees have sued SDT for wrongful dismissal and claimed Sh.10 million. In order to demonstrate to the courts that SDT does not have money to meet such a claim, Sh.11 million was withdrawn from the entity‘s account and banked in the Executive Director’s personal account. The director is not ready to give you his bank statement as he claims it is personal. 

In an effort to reflect that SDT is not overly reliant on the major donor, a material amount has been included as “other income”. This constitutes cash injections by the Executive Director from his own sources. In order to meet the 10% operating cost requirements, actual operating costs are understated materially by crediting them and debiting the director’s loan account. Most expenses are paid by cash even though the SDT’s policy is that amounts beyond Sh.15,000 should be paid by cheque. To achieve this, two petty cash floats are maintained, one by the receptionist which is subject to stringent controls and general cash maintained by the Executive Director where no cash count is ever done and no independent control is exercised. 

Prepare a memorandum to the non-executive directors of SDT detailing issues noted, their implications and how to correct them.

Your firm, XYZ CPA, where you are the Manager - Business Advisory, has been hired to provide internal audit services to Radar Ltd. In discussing with S, you discover that there is a small audit team headed by W, a recently qualified accountant. Before heading the internal audit, W was a junior finance manager in the company. Members of the internal audit team at Radar Ltd. would be redeployed to the finance department once XYZ CPA starts provision of the internal audit services. 

S has briefed you of many instances where management policies were ignored. In addition, J has recently discovered a fraud in one office whereby an accounts manager was authorising payments of invoices received from fictitious suppliers, with the payment being channelled to the accounts manager’s personal bank account.

(i). Evaluate the benefits to Radar Ltd. from outsourcing its internal audit function. 

(ii). Explain the potential impact on the external audit of Radar Ltd. if the internal audit function is outsourced

(iii). Recommend procedures that could be used by XYZ CPA to quantify any financial loss suffered by Radar Ltd. due to the above fraud. 

(iv).  Compare responsibilities of external auditors and of management in relation to the prevention and detection of fraud. 

(v).  Assess two benefits and one limitation that may arise from setting up an audit committee in Radar Ltd.    

The church’s Board of Deacons and the Finance Committee are of the view that though Annlisa Keya was not directly responsible for the loss, she failed by not discovering the fraud in time. They have recommended her suspension and possible dismissal. There are also worries that, because of the high cash volumes transacted in the church, the risk of errors and fraud in cash management is significant. 

Annlisa has suggested to the Board of Deacons and Finance Committee to engage an independent auditor to carry out an investigation. 

Your audit firm has been invited to a preparatory meeting of the Board of Deacons as the potential auditor for the assignment. 

(i) Highlight the issues you would raise during this meeting regarding the entire investigation process. 

(ii) Describe the essential principles that you must observe to conduct an effective investigation. 

(iii) Recommend an effective internal control system for cash handled by the church.

(i) Describe the audit work that you would perform to check the standard cost per unit of a line of finished stock. Comment on how accurate this standard cost has to be. 

(ii) Explain the work that you would perform to confirm that the variances are being determined correctly.

(iii) Comment on the overheads that you would include in the value of stock and those that you would not include, citing relevant examples.

(iv) State two variances that you would include and those that you would exclude when adjusting the value of stock from standard cost to actual cost.  

​​​You are a newly appointed internal auditor of Zito Ltd., a company that is currently experiencing financial difficulties. As a condition for obtaining bank loans, the company management has agreed to maintain certain liquidity ratios, asset to liquidity ratios and gross profit margins. 

(i) Isolate the areas which could have attracted adverse comments from the auditors. 

(ii) Design a programme for the substantive tests which would provide reassurance that the cheque payments are not made improperly to creditors. 

(iii) Describe the controls to be instituted over the custody and authorisation of the cheque payments.

(a) Describe the controls that should be incorporated in the new system before it: 

(i) Issues an order confirmation to a customer. 

(ii) Raises a dispatch note and authorises dispatch of goods to the customer. 

(b) Describe the controls which should be exercised over: 

(i) Changing customer details including adding new customers, amending their details and deleting customers. 

(ii) Changing customer credit limits. (2 marks) (iii) Changing the selling prices of products. 

(c) Describe: 

(i) The credit control criteria that the automated sales accounting system should use to decide whether to prevent dispatches to customers. 

(ii) The manual procedures which should be exercised before the system allows goods to be dispatched to a company where the computer's criteria rejects dispatch of the goods.

(i) Whether to apply statistical or judgemental sampling technique. 

(ii) Determining the size of the sample to be used for testing.

MSCC’s draft accounts for the year ended 31 December 2020 are summarised as follows:

During your visit, a review of the audit working papers revealed the following:

Identify and comment on the implications of these findings for XYZ and Co. quality control policies and procedures.   

 

Your firm was appointed the auditor of Taka Ltd., a provider of waste management services, in January 2020. You have visited the audit team at Taka Ltd.'s head office. The team comprises an audit senior, an audit assistant and two trainees.

Taka Ltd.'s draft accounts for the year ended 31 December 2019 show revenues of Sh.118 million (2018 Sh.8.3 million) and total assets of Sh.40 million (2018 Sh.30 million). During your visit, a review of the audit working papers revealed the following:

Discuss the implications of the two findings above for Dundee Associate's quality control policies and procedures.

The Chief Executive Officer of Reward Ltd. has requested for advice on the accounting treatment and disclosure of payments being made for security consultancy services. The payments, which aim to ensure that consignments are not impounded in the destination country of a major customer, may be material to the financial statements for the year ending 31 December 2021. Reward Ltd. does not treat these payments as tax deductible. 

Required: 

Explore the ethical and other professional issues raised by the above matter and indicate the action, if any, that your firm should now take.

The company has approached you, as an independent audit consultant, to advise on the general guidelines to be followed to ensure the best auditor is engaged. 

From your professional background, advise the company on some of the key guidelines to observe in the tender for audit services.

Required: 

Citing three areas, discuss the role and place of the audit committee within the corporate governance structure.

1. Producing invoices. 

2. Updating the master file on trade receivables. 

3. Analysing sales so as to produce credit entries to stock control accounts. 

In order for the computer bureau to discharge its functions, Synergy Ltd. provides the bureau with the following information: 

(i) Details of quantities and type of sale transactions. 

(ii) Cash receipts. 

(iii) Price lists and alterations. 

(iv) Bad debts and special credits. 

(a) Citing ten areas of interest, describe the internal control system you would recommend to the management of Synergy Ltd. covering sales and delivery of input to the computer bureau. 

(b) Describe six audit procedures you would carry out to verify the sales of Synergy Ltd. 

(c) Explain four drawbacks of outsourcing of the payroll function by the management of Synergy Ltd.

The finance director has identified the following as key risk areas in the company: 

Summarise two control measures that might be put in place to deal with each of the issues noted above.

The company's previous auditors recently resigned. The Managing Director of Buru Ltd. states that this was due to "a disagreement on the accounting treatment of commission earned and further because they thought their controls were not very good". 

You are aware that Buru Ltd. has been investigated by the Financial Services Authority for alleged non-compliance with its regulations. 

As well as performing the audit, the Managing Director would like your firm to give business development advice. 

Discuss six ethical and other professional issues raised in the above scenario and recommend any actions that should be taken.

In view of the situation explained above, describe the changes that you would effect: 

(i) During the interim audit. 

(ii) At the final audit visit.

Required: 

Evaluate the importance of each of the following qualities in selecting an effective engagement team: 

(i) Independence. 

(ii) Scope of the assignment. 

(iii) Complexity of the assignment. 

(iv) Duration of the assignment. 

(v) Client expectations and requests.

The statements of financial position of the two companies as at 31 December 2015 were as follows:

Statements of financial position as at 31 December 2015:

The subsidiary company was audited by another auditing firm and the directors of the holding company agreed through a resolution that the audit firm would continue to audit the subsidiary company for the year ended 31 December 2015. 

(a) Describe the matters you would consider in the audit of the holding company, Bakari Ltd. 

(b) Summarise the information that you would require from the auditors of the subsidiary company, Makali Ltd.

Required:

Evaluate six matters that should be considered before accepting the audit engagement in the event your firm is successful in the tender.