ACFI 210 Audit and Assurance

Question One

During the audit of Jumble Ltd, you discovered that some of the company's customers had paid Jumble’s sales invoices twice. The overpayments had not been refunded by Jumble and had been credited to its statement of profit or loss. The managing director (MD) of Jumble told you that these customers, which are government bodies, periodically pay the same invoice twice. The MD also said that he has no intention of repaying the money unless the customers ask for it to be repaid.

Requirement

State, with reasons, the action you and your audit firm should take in respect of this matter.

(6 marks)

Question Two

Morsby Ltd (Morsby) is seeking to increase its overdraft facility. Morsby’s bank requires the audited financial statements for the year ended 30 June 2021 to be available prior to agreeing the new facility. Morsby's finance director has told its auditors that they need to complete its audit by 31 August 2021. He has also said that a member of the audit firm’s staff will be required to assist Morsby staff with the preparation of the financial statements to meet this deadline.

Requirement

Identify and explain the ethical threats to the audit firm in the context of Morsby’s requests. State the actions the audit firm should take to mitigate these threats.

(6 marks)

Question Three

During the external audit of Bloom Ltd (Bloom), a chemical manufacturer, you were told by an employee of Bloom that the company frequently fails to provide its factory workers with the legally required protective clothing when working with hazardous chemicals.

Requirement

Explain why this information should be considered by your firm during the external audit.

(6 marks)

Question Four

Frank Collet is an audit manager at a medium-sized professional services firm. In a recent performance review, Frank has been identified as underperforming and he has been given some new targets to help improve his work. One of the targets is for Frank to identify non-audit work that may benefit his current audit clients. Frank’s annual bonus will be linked to the revenue generated by any new non-audit work his firm undertakes for Frank’s current audit clients.

Identify and explain the ethical issues arising from these circumstances and outline the steps Frank and his firm should undertake to address these issues.

(5 marks)

Question Five

Your firm has been engaged by Moors Ltd (Moors) to provide assurance on its financial information for the six months ended 30 June 2021. Moors produces a range of cakes which it sells to supermarkets in the UK and the rest of Europe. Supermarkets are invoiced in their local currency. In the six months ended 30 June 2021, Moors opened a number of its own bakeries in the UK selling directly to consumers and has increased cake production using spare capacity in its factory.

Your preliminary analytical procedures have identified the following as possible matters of significance to discuss with management:

Using the information above, identify the enquiries you should make of the management of Moors that will assist your review of the financial information.

(7 marks)

Question Six

Funworld plc (Funworld) is a manufacturer of children’s toys. It sells to a wide variety of customers, including wholesalers and retailers. The company’s accounting year end is 31 May 2021.

Funworld has a large factory, four large warehouses and a head office. After manufacture, the toys are stored in one of the warehouses until they are despatched to customers. The company does not have an internal audit department.

Sales ordering, goods despatched and invoicing

Each customer has a unique customer account number and this is used by Funworld to enter sales orders when they are received in writing from customers. The orders are entered by an order clerk and the system automatically checks that the goods are available and that the order will not take the customer over their credit limit. For new customers, a sales manager completes a credit application. This is checked using a credit agency and a credit limit is entered into the system by the credit controller. Funworld has a price list, which is updated twice a year. Larger customers are entitled to a discount; this is agreed by the sales director and set up within the customer master file.

Once the order is entered, an acceptance is automatically sent to the customer by mail/email confirming the goods ordered and a likely despatch date. The order is then sorted by address of customer. The warehouse closest to the customer receives the order electronically and a despatch list and sequentially numbered goods despatch notes (GDNs) are automatically generated. The warehouse team pack the goods from the despatch list and, before they are sent out, a second member of the team double checks the despatch list to the GDN, which accompanies the goods.

Once despatched, a copy of the GDN is sent to the accounts team at head office and a sequentially numbered sales invoice is raised and checked to the GDN. Periodically a computer sequence check is performed for any missing sales invoice numbers.

Fraud

During the year a material fraud was uncovered. It involved cash/cheque receipts from customers being diverted into employees’ personal accounts. To cover up the fraud, receipts from subsequent unrelated customers would then be recorded against the earlier outstanding receivable balances and this cycle of fraud would continue.

The fraud occurred because two members of staff ‘who were related’ colluded. One processed cash receipts and prepared the weekly bank reconciliation; the other employee recorded customer receipts in the sales ledger. An unrelated sales ledger clerk was supposed to send out monthly customer statements, but this was not performed. The bank reconciliations each had a small unreconciled amount, but nobody reviewed the reconciliations after they were prepared. The fraud was only uncovered when the one of the employees became ill while the other was on holiday. The staff taking over the role discovered that cash receipts from different customers were being applied to older receivable balances to hide the earlier sums stolen.

Requirements

(a) Describe FIVE key tests of controls that the auditor of Funworld should carry out on the revenue system, and for each test explain the objective. (You may wish to adopt a two-column approach).

(14 marks)

(b) Describe the substantive procedures the auditor should perform to confirm Funworld’s year-end receivables balance.

(10 marks)

(c) Identify and explain controls Funworld should implement to reduce the risk of a similar fraud occurring again and, for each control, describe how it would mitigate the risk.

(7 marks)

(d) Describe the substantive procedures that the auditor should perform to confirm Funworld’s revenue.

(9 marks)

Total: 40 marks

Question Seven

The audit firm where you work has recently been appointed as auditor of Pullis Ltd. Pullis owns a chain of 42 UK-based retail stores, selling luxury French clothing. The company operates a UK-based warehouse from which it supplies all 42 stores with inventory.

The company purchases its inventory from a small number of major fashion wholesalers based in France. The majority of inventory items are the previous year’s designs, which the wholesalers supply to Pullis at discounted prices. Pullis places all its orders centrally three times a year, coinciding with the Spring, Summer, and Winter seasons. All transactions are conducted in euro and payment is due in full on arrival of the goods in the UK.

Most of the Pullis’ sales are conducted by cash, cheque, or credit card. In order to remain competitive with other major high street retailers, the company offers a returns policy to its customers which allows goods to be returned to the store within a reasonable time of purchase, for any reason, with a full refund offered. Goods returned under this policy are then sold on in bulk through the trade, sometimes at less than their original cost to Pullis.

Clothes are transferred between stores when there is a shortage of some items of clothing at one store and a surplus at another. Initial audit testing has discovered that there are poor accounting records for these transfers.

Pullis’s managing director, aged 59, is also the company’s main shareholder. He adopts a very hands-on approach to the business; he is involved in all major decisions and rarely delegates. He is known for his lavish lifestyle and in order to finance this he seeks each year to grow the business and improve upon the previous year’s profitability.

The company has recently acquired new offices adjacent to its central warehouse. The purchase was financed by significant bank borrowings under fixed-term loans, which require annual capital repayments.

Requirements

(a) Explain the audit risk model. In so doing describe and distinguish the different elements of audit risk (i.e. inherent risk, control risk and detection risk).

(6 marks)

(b) Identify, from the circumstances outlined above, the factors which indicate high audit risk in respect of the audit of Pullis Ltd and, for each factor identified, explain why it contributes to high audit risk.

(14 marks)

(c) Explain, and justify, the internal controls which Pullis Ltd should put in place to ensure appropriate monitoring of cash receipts and custody of cash.

(10 marks)

Total: 30 marks