Inventory System:

Is not a separate system. It is automatically included in purchase and sales systems.

Purchase system= Goods received.
Sales system= Goods out.
Important Consideration for inventory system:

Objectives:
1. Maintain adequate inventory level – If too high = Obsolescence and storage cost.
If too low = stock out and revenue loss.
Suggest control:
- Segregation of duty.
- Insurance.
- Security guard and CCTV.
- Firefighting equipment (sprinkler, fire extinguisher)
- Thermometer.
3. Confirm all inventory:
- Understate/Overstate inventory, payables and receivables
Suggest Controls:
- GRN with sequential numbered.
- PO should follow with GRN and confirm recorded (exclude from inventory & include with
receivable)

Substantive procedure of trade Receivable:

1. Perform a of a representative sample of client’s year-end balance.
2. Inspect the aged receivables report to identify any slow moving balances, discuss these
with management to assess whether an allowance or write down is necessary.
3. Calculate average receivable days and compare this to prior year, investigate any
significant differences.
4. Select a sample of good dispatched note (GDN) before and after the year end and follow
through to the sales invoice to ensure they are recorded in the correct recording period.
5. Select 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.
6. Review the receivable ledger for any credit balances and discuss with management
whether these should be reclassified as payables.
7. For any slow moving/aged balances review customer correspondence to assess
whether there are any invoices in dispute.
8. Review board meeting of client’s to assess whether there are any material disputed
receivables.

Development Expenditure:
  Obtain a schedule of capitalized costs within intangible assets, cast it and agree the
closing balance to the general ledger, trial balance and financial statements.
 Select a sample of capitalized costs and agree to invoices, payroll records or other source
documentation in order to confirm that the amount is correct and the cost relates to the
project.
 Discuss with the directors the decision to capitalize the costs from 1 st November 2014
onwards and assess whether this is based on the project meeting all of the conditions for
capitalization in ISA 38.
 Review a breakdown of the nature of the costs capitalized to identify if any research costs
have been incorrectly included. If so, request that management remove these and include
within profit or loss.
 Select a sample of costs recorded and research expenses and development costs and agree
to supporting documentation confirming the date of the expenditure to ensure that the
costs were allocated correctly.
 Review the market research reports to confirm that there is a market for the new process
and that the selling price is high enough to generate a profit.
 Review feasibility report at 1st nov 2014 and discuss with directors their view that the
process was technically feasible at that date.
 Review the budgets in relation to the development project and the cash flow forecast in
order to assess whether Peach Co had access to adequate cash resources to complete the
project as at the date of the capitalization.
 Discuss with the finance director the rationale for the useful life being applied, consider
its reasonableness and agree to supporting documentation.
 Recalculate the amortization charge and confirm that it covers the period for May to
august 2015.
 Review the disclosures for intangible assets in the draft financial statements in order to
confirm that they are in accordance with ISA 38.

Steps to confirm prior year flowcharts and system notes:

- Obtain the system notes from the last year’s audit and ensure that the documentation on
the purchases and payables system covers all expected stages and is complete.
- Review the audit file for the indications of weakness in the system and note these for
investigation this year.
- Review the prior year report to management to identify any recommendations which
were made over controls in this area as this may highlight potential changes which have
been made in the current year.
- Obtain the system documentation from the client, potentially in the form of a procedure
manual. Review this to identify any changes made in the last 12 months.
 - Interview client staff to ascertain whether systems and controls have changed including
the stores and warehouse to ensure that the flowcharts and notes produced last year is
correct.
- Perform walk-through tests by tracing a sample of transactions through the purchases and
payables system to ensure that the flowcharts and systems notes contained on the audit
file are accurate.
- During the walk-through tests , confirm the system notes and flowcharts accurately
reflect the control procedure which are in place and can be used to identify controls for
testing.
Question 213:
Answer:
1. Engagement letter for recurring/existing clients should be revised if any of the following
factors are present-
 Any indication of the entity misunderstanding of the objective nad scope of the
audit, this misunderstanding would need to be clarified.
 Any revised or special terms of audit engagement, this would require inclusion in
the engagement letter.
 Any legal or regulatory requirements. The engagement letter is a contract, hence
if any legal or regulatory changes occur, then the contract could be out of date.
 A change in the financial reporting framework adopted in the preparation of the
financial statement. The engagement letter clarifies the roles of the auditor and
those charged with governance, it identifies the reporting framework of the
financial statements, if this change, then the letter requires updating.
2. Matters to be included in an audit engagement letter:
- The objective and scope of the audit.
- The responsibilities of the auditor.
- The responsibilities of the management.
- Identification of the financial reporting framework for the preparation of thr financial
statement.
- Expected form and content of the any reports to be issued.
3. Understanding an Entity:
a) Prior year financial statement: Provides information in relation to the size of the company, the
key accounting policies, disclosure notes and whether the audit opinion was modified or not.
b) Discussion with the previous auditor/ access to their files:
Provide information on key issues identified during the prior year audit as well as audit
approach adopted.
c) Prior year report to management: If this can ben obtained from the previous auditors or from
management, it can provide information on the internal control deficiencies noted last year. If
these have not been rectified by management, then they could arise in the current year audit as
well and may impact the audit approach.
d) Discussions with management: Provide information in relation to the business, any important
issues which have arisen or changes to accounting policies from the prior year.

D) Audit risk and auditor’s response:

Substantive Procedure of Trade Receivable:

 Perform a positive trade receivable of a representative sample of client’s year end
balances.
 Inspect the aged receivable report to identify any slow moving balances discuss with
management to assess the allowance or write down is necessary.
 Calculate average receivable days and compare prior year to investigate any significant
differences.
 Select good dispatched note(GDN) before and after the year end and follow through sales
invoices to ensure whether they are recorded in the correct accounting period.
 Select a sample of post year end notes to identify any relate with pre year end
transactions to verify they have not been included in receivables.
 Review the receivable ledger for client’s balances and discuss with management whether
these should be reclassified as payables.
 For any slow moving/aged balances review the customer correspondence to assess there
are any invoices in disputes.
 Review the board meeting with client’s to assess whether there are any materials disputed
receivable.

For reply with differences-

1. The auditor should identify any disputed amounts, and identify whether these relate to timing
differences or whether there are possible errors in the records of the client.
2. Any differences due to timing, Such as cash in transit, should be matched with cash received
after the year end.
3. Any difference relates to goods in transit then this should be agreed to pre year end good
dispatched note.
4. The receivable ledger should be reviewed to identify any possible mis posting as these could
be a reason for a response wit

Examples of Revenue:-
 Samples of sales invoices traced to price lists.
 Sample of GDNs to invoices in sales ledger
 Sample of sequential GDNs around period and n correct period
 Revenue recognized as a current not deferred
 Sample of sales ledger entries to orders/GDNs.
Trade Receivable:
- Perform a positive trade receivable circulation of a representative sample of client’s year-
end balances.
- Inspect the aged receivable report to identify the slow moving balances
, discuss these with management to assess whether an allowance or write down is
necessary.
- Calculate average receivable days and compare this to prior year, investigate any
significant differences.
- Select a sample of good dispatched note (GDN) before and just after year end and follow
through to the sales invoices to ensure that they are recorded in the correct accounting
period.
- Select 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 receivable ledger for the credit balances and discuss with management
whether these should be reclassified as payables.
- For slow moving/aged balances review customer correspondence to assess whether there
are any invoices in dispute.
- Review board minute of client’s to assess whether there are any material disputed
receivables.’

For reply with differences:

- The auditor should identify any disputed amounts, and identify whether these relate to
timing differences, or whether there are possible errors in the records of the client.
- Any differences due to timing such as cash in transit should be matched with cash
received after the year end.
- Any differences relate to goods in transit then this should be agreed to pre year end good
delivery note.
- The receivable ledger should be reviewed to identify any possible mis postings as this
could be a reason for a response with a difference.
- If any balances have been flagged as disputed by the receivable, then these should be
discussed with management to identify whether a write down is necessary.

For non-reply differences:

- For any non-replies, with client permission, send a reminder letter to follow up.
- If the receivable does not respond to the follow up, then with client’s permission, the
senior should telephone the customer and ask whether they are able to respond in writing
to the circulation request.
- Review the after date cash receipts and follow through to the pre year end receivable
balances.
 - Select a sample of year-end receivable balances and agree back to valid supporting
documentation of GDN and sales order to ensure existence.
Types of receivable confirmation letters:
- Positive confirmation: Receivables asked to agree or disagree with the stated balance or
write the balance owing.
- Negative confirmation: Receivable asked to reply only if he disagrees with the balance.

Method of sending this letter:

- Obtain the receivable ledger and reconcile it to the control account.
- Select a sample of debtors to be circularized.

Method of sending this letter:

1. Obtain the receivables ledger and reconcile it to the account control.
2. Select a sample of debtors to be circularized.
3. Inform the client of the intended list.
4. Get the details of the debtors and prepare letter on client’s letterhead.
5. Get the letter signed by a senior person at the client.
6. Record name and amount circularized.
7. Post/fax letters ensuring the replies are sent directly to the auditor.
8. Record replies received and test the ones not signed.

Bad debt and receivable allowance audit procedure:

1. Obtain the list of doubtful debts and cast the list to ensure it has been correctly total, then
agree with general ledger balance for the allowance.
2. Discuss these doubtful debts with management (credit controller) to ensure why these are
considered to be potentially irrecoverable.
3. Review the correspondence with the customers to ensure whether they intend to pay or not.
4. If there is no correspondence, consider why. If client has not chased the debts, it suggests that,
management expect to receive money so they should not create allowance.
5. Review after date cash received to ensure the amount is still outstanding by inspecting bank
statement and remittance advices.
6. Enquire the company solicitors whether they have started proceeding against any customer for
which allowance have been made.
7. Enquire whether the customer is on stop. If not, enquire why the company is still trading with
customer. It maybe because the debt is not really doubtful.
8. Considering all evidence collected , estimated a reasonable allowance (auditor’s point
estimate) and compare with management’s allowance.

Receivable Circularization may confirm 3 assertions:

1. Existence: customer reply in response of circularization.
2. Right and obligation: If customer accepts them owing to client.
3. Valuation: If customer agrees the amount with circularization letter.

Confirm “VERC”:
1. Existence: Select a sample of year-end receivable balances and agree back to valid supporting
documentation of GDN and sales order to ensure existence.
1. Select a sample of year end receivable balance and agree back to valid supporting
documentation of GDN and sales order to ensure existence.
1. Select a sample of year end receivable balance and agree back to valid supporting
documentation of GDN and sales order to ensure existence.

Valuation:
1. Inspect the aged receivable report to identify any slow moving balances, discuss with manager
to assess whether an allowance or write down is necessary.
1.inspect the aged receivable report to identify any slow moving balances, discuss with manager
to assess whether an allowance or write down is necessary.
1. Inspect the aged receivable report to identify any slow moving balances, discuss with manager
to assess whether an allowance or write down is necessary.
2. Calculate average receivable days and compare this to prior year, investigate any significant
differences.
2. Calculate average receivable days and compare this to the prior year, investigate any
significant differences.
Right and obligation:
1. Perform a positive trade receivable circularization of a representative sample of client’s
year end balances, for any non-replies , with client’s permission , send a reminder letter
to follow up.
2. Perform a positive trade receivable circularization of a representative sample of client’s
year end balances, for any non-replies , with client’s permission, send a remainder letter
to follow up.
3. Perform a positive trade receivable circularization of representative sample of client’s
year end balances, for any non-replies, with client’s permission, send a reminder letter to
follow up.
Completeness:
1. Agree the receivable control account with the receivable ledger list of balance to verify
completeness.
1. agree the receivable ledger control account with the receivable ledger list of balance to verify
completeness.
1. Agree the receivable control account with receivable ldger list of balance to verify
completeness.
2.Review the reconciliation of receivable ledger control account to the receivable ledger list of
balances.
2. Review the reconciliation of receivable ledger control account to receivable ledger list of
balances.
2. Review the reconciliation of receivable ledger control account to receivable ledger list of
balances.

3. Select a sample of goods dispatched note(GDN) before and just after the year end and follow
through to the sales invoice to ensure they are recorded in the general ledger.
3. Select a sample of goods dispatched note (GDN) before and just after the year end and follow
through to the sales invoice to ensure they are recorded in the general ledger.
3. Select a sample of goods dispatched note (GDN) before and just after the year end and follow
through to the sales invoice to ensure they are recorded in the general ledger.

1. Select sample – year end receivable balance – agree back to valid supporting documentation –
GDN _ sales order _ ensure- EXISTENCE
2. Inspect _ aged receivable report _ identify _ slow moving balances _ discuss to assess_
whether allowance or write down is necessary _ VALUATION
3. Calculate _ average receivable days _ compare prior year_ investigate significance
differences.
4. Perform _ positive trade receivable circularization _ representative sample of client’s year-end
balances_ non replies_ client’s permission _ send follow up remainder letter _ Right &
Obligation.
5. Agree _ receivable ledger control account _with _ receivable ledger list of balance _
Completeness.
6. Review _ reconciliation _ receivable ledger control account to_ receivable ledger list of
balances.
7. Select sample_ goods dispatched note (GDN) _ before & after year end _ follow through _
sales invoice _ ensure _ general ledger.

Prepayments:
1.Inspect bank statement to ensure the payment has been made.
2. Inspect invoices to ensure payment relates to goods or services not yet received.
3. Recalculate the amount prepaid to confirm mathematical theory
4. Compare prepayments with the prior year to identify any missing items or any new
prepayments which require further testing. (EXISTENCE, VALUATION, COMPLTEMENTS)
analytical procedure.

Limitation of controls:
1. Human error: An entity may have an adequate internal control process over a particular area of the
FS. Human error in applying that control gives inherent limitations, for example, staff member may
review the bank reconciliation but not identity an error.
There is an error or change in the design of internal control which means it does not operate as intended.
2. Circumvention of internal control: No system of internal control will be completely effective at
preventing and detecting fraud and error. Employees may manipulate deficiencies in an entity’s internal
control for personal gain or to conceal fraudulent activity. This is more likely possible where there is
collusion between employees.
3. Management override of internal control: Management is in a position of power to override an
entity’s internal control regardless of the strength of the internal control system. Such management
override could be to conceal information or for personal financial gain.
4. Use of judgment on the nature and extent of controls: Management is responsible for implementing
controls which are design to prevent, detect and correct material misstatements and safeguard the
company’s assets. Professional judgment will be needed to determine the type and extent of internal
control needed within the company and certain control maybe absent or ineffective. In particular, system
maybe designed to deal with routine transactions and may therefore be inadequate in respect of non-
routine transactions.

b) Control deficiencies and recommendations:

Deficiencies Recommendation
1.Credit limit not reviewed: Credit limits should be reviewed to set by the sales
Credit limits set by the sales director are only director, however, there limits should be reviewed
changed when a customer requests to an increase. and amended as appropriate on a regular basis by a
If it not reviewed regularly , it could be out of date, responsible official, e.g. finance director or sales
resulting limits being too high and therefore sales director.
being made to poor credit risks or alternatively too
low which may lose potential revenue.
2. GDN sent weekly to finance: The copies of the GDNs should be sent to the
Good dispatched note are sent to the finance finance department on a more frequent basis,such
department on a weekly basis. as daily.
If the finace department does not promptly receive Finance department should undertake a sequence
GDNs , this could result in goods being dispatched check of GDNs to ensure none are missing for
but invoiced late.this could result in revenue cut-off processing.
issues and understated receivables.
No credit controller In this period company should be trained in th
The company’s credit controller is currently on credit control role. Or recruited temporarily credit
maternity leave for 6n month and no one has taken controller. And assigned responsibility for
over her duties. reviewing the aged receivables listing and
Therefore, during this period no one has been following up on any overdue customers.
responsible for monitoring and chasing ageing
receivables and lead to customer not paying their
outstanding balances on time, or at all, leading to
reduced cash flows.
Reconciliations only reviewed if differences RLCA should be reviewed by the fiinace controller
The monthly RLCA reconciliation is only reviewed on a monthly basis, even if there are no exceptions,
by the financial controller if there are any and review should be evidenced vy way of
unreconciled differences. signature on the reconciliation.
 The RLCA reconciliation could reconcile but still
contain significant errors as there could be
compensating errors which cancel each other out or
it may have been incorrectly prepared or
manipulated and this would not be identified.
If this reconciliation should not be reviewed, then
this significantly reduces its effectiveness.
Capex authorization limits too high The authorization level for department heads
Capital expenditure items below 0.5m are should be significantly reduced to a more
authorized by the relevant head of department. appropriate level, such as 25000. Any sum in
0.5m is a significant sum and although department excess of this should be approved by the board. If
heads undertake the authorization process, there is this proves too onerous, a capital expenditure
still considerable scope for non-business use or committee of senior employees should be
surplus assets being purchased leading to reduced established for authorisation capital items. This
profits and cash flow for this company. committee should report to the board.
Exception report not reviewed The monthly exception report of changes master
Access to the master file data for supplies is file data should be reviewed by a responsible
available to all those in the purchasing department official, who should evidence this review. Any
and the monthly exception report of changes to unauthorized or unexpected changes should be
master file data is not reviewed. investigated and appropriate action taken.
All members of the purchasing department could This ability to make amendments to master file data
amend data and potentially, add new suppliers to should be required and authorized to make change
the payables ledger system, and as the exception to this data.
report is not reviewed it is unlikely that this would
be identified. This leads to an increased risk of
fraud as clerks should add fictitious suppliers and
then place fraudulent orders without detection.

Purchase invoices not agreed to GDNs All purchase invoices should be matched to both
Purchase invoices are not agreed to the relevant the purchase order and related GRN. This detail
goods received notes prior to authorization and should be agreed prior to the invoice being
input. authorized and logged in the payables ledger.
This could result in invoices being paid for goods
which were not received, resulting in increased
costs.
Warehouse manager supervising counts
The warehouse manager at each of the company’s
five sites is responsible for supervising the monthly
perpetual inventory counts and ensuring that the
counting team are following their instructions bh

Sales tax liability:

1. Agree the year-end sales tax liability in the trial balance to the tax return/reconciliation submitted
to the tax authority and cast the return/reconciliation.
2. Recalculate the quarterly sales tax charged= 15% of the last quarter’s sales as per the sales day
book.
3. Recalculate the sales tax incurred as per the reconciliation is equal to 15% of the final quarter’s
purchases and expenses as per the purchase day book.
 4. Recalculate the amount payable to the tax authority as being sales tax charged less sales tax
incurred.
5. Compare the year-end sales tax liability to the prior year balance or budget and investigate any
significant differences.
6. Agree the subsequent payment to the post year-end cash book and bank statement to confirm
completeness and that it has been paid in line with terms of the tax liability.
7. Review any current and post year end correspondence with tax authority to assess whether there
are any additional outstanding payments due, if so, confirm they are included in the year end
liability.
8. Review any disclosures made of the sales tax liability to ensure that it is shown as a current
liability and assess whether the disclosures are in compliance with Accounting Standards and
Legislation.
Income tax payable accrual:
1. Agree the year end income tax payable accrual to the payroll records to confirm accuracy.
2. Recalculate the accrual to confirm accuracy.
3. Agree the subsequent payment to the post year-end cash book and bank statement to confirm
completeness.
4. Review any correspondence with tax authorities to assess whether there are any additional
outstanding payment due, if so, agree they are included in the year end accrual.
5. Review any disclosures made of the income tax accrual and assess these are in compliance with
accounting standards and legislation.

Provision liabilities:
No obligation created reporting date_____________ Overstated.
Not probable that payment will need to be made _______ Overstated.
Inappropriate estimate ____________ Understated.
Intangible assets:
Research cost capitalized – rather than expensed______ overstated.
Amortization – not charged on development projects which are now generating benefits for the
company__________ overstated.
Impairment charge has not been made for intangible assets which are impaired _______ Overstated.
Development costs _ have been expensed rather that – capitalized_________ Understated.
Property, plant and equipment:
Expenditure on repairs _ treated_____ Capital expensed.
Asset lives _ extended for depreciation purposes (Without justification for the increase)_____
overstated.
Asset orders, but not delivered by reporting date, but included in FS __________ Overstated.
Capital expenditure has been incorrectly expensed________ Understated.
Revenue_____ overstated,
It has been recognized before the performance obligations within the contract have been fulfilled.

Control Risk:
Misstatement , could occur and material , will not prevented, detected and corrected on a timely basis
by the entity’s controls.
 Client control in place____
- Authorisation
- Segregation of duties,
- Physical controls.
To prevent and detect misstatement occurring when transactions are initiated, processed and recorded.

Effective controls are in place,

The control system will either prevent the misstatements from occurring,
OR,
Will detect misstatement that have occurred.
Client can take action to correct them.
Controls are not effective,
Control risk will increase and there will be a greater risk of misstatement occurring in the FS.
Detection Risk:
The risk that procedures performed by the auditor to reduce audit risk to an acceptably low level will
not detect a misstatement that exists and that could be material.’

Sampling risk- Auditor’s conclusion based on sample , conclusion will be different if the whole
population are tested.
Non-sampling- auditor’s conclusion is inappropriate for any other reason. E.g.application of
inappropriate procedures or the failure to recognize a misstatement.
Auditor must amend the audit approach in response to risk assessment to ensure they detect the
material misstatement in FS.

Materiality by size:
- .5 – 1% revenue.
- 5-10% profit before tax
- 1-2% total assets.

Payroll Expense substantive procedures:

- Cast a sample of payroll records to confirm completeness and accuracy and agree to the total
wages and salaries expense per the payroll system to the trial balance.
- Cast a sample of payroll records to confirm completeness and accuracy and agree total wages and
salaries expense per payroll system to the trial balance.
- Recalculate the gross and net pay figures for a sample of employees and agree to the payroll
records.
- Recalculate the gross and net pay figures for a sample of employees and agree to the payroll
records.

Rights of auditor to fulfill their responsibility

- To access all accounting records and books at all times.
 - To receive notice of general meeting.
- To receive all information and explanation management necessary for conduct of the audit.
Inherent limitations of an audit arise from the nature of the financial reporting.
The nature of the audit procedures
The need for the audit to be conducted within a reasonable period of time and at a reasonable cost.

Audit Risk Audit Response

1. New audit client Audit team should be assigned suitably experienced
Audit team members is not familiar with the team, adequate time is allowed for team members
accounting policies, transactions and balances of to obtain an understanding of the entity and the risk
the company, there will be increased detection risk of material misstatement, including a detailed team
on the audit. briefing to cover the key areas of risk.
2.

Audit procedures:
1. Statement of financial statement.
2. Statement of profit or loss.
3. Accounting estimates.
4.Not for profit organization

Specific risk: valuation of inventory, Recoverability of receivables.

Auditor’s role is to obtain sufficient appropriate evidence that the financial statements are prepared in all
material respects with the relevant financial reporting framework.
Contain an action applied to a source to achieve an objective.

Existence of non-current asset:

- Select a sample of assets from the non-current assets register and physically inspect to verify the
existence.
Valuation of trade receivables:
- Inspect post year end bank statement to identify if payment has been received post year end. If so,
agree the amount to the receivables ledger at the year end.