Audit Planning and Weaknesses in Internal Controls

Part A: ABC Kids Care Ltd

ABC kids care Ltd (ABC) is listed on the Australian Securities Exchange. The company provides childcare services
for pre-school children. ABC has undertaken significant expansion of its operations over the past two years.
This strategy has resulted in the acquisition of a total of 400 new centres with childcare licences in Australia, New Zealand and the United Kingdom. The expansion strategy has been funded mainly from borrowings that
have been sourced in both local and foreign currency.

ABC’s board consists of five directors: three non-executive directors, the CEO and CFO. None of the three
nonexecutive directors have any formal qualifications or background in business.

The board has expressed concern about the pace of expansion, due to ABC’s accounting system failing to

effectively integrate the acquired companies’ complex information systems.

Requirement:
1) Explain inherent risk and why it is important to evaluate inherent risk as part of audit planning.
2) Provide the factors that influence inherent risk at the financial report level and the assertion level. 
3) Based on the background information, identify four inherent risk factors for ABC and explain their impact on the financial report.

SPC Ltd is a major manufacturer of industrial machinery. When the stores department requires items to be
purchased, they issue a three-part pre-numbered purchase requisition that needs to be approved by the stores
manager. Copy 1 is sent to the purchasing department, copy 2 is sent to the accounts payable department and
copy 3 is filed in the stores department.

On receipt of an approved purchase requisition, the purchasing department issues a five-part pre-numbered purchase order. Copy 1 is sent to the supplier, copies 2 and 3 are forwarded to the receiving department, copy 4 is forwarded to the accounts payable department and copy 5 is filed in the purchasing department.

When goods are received, the receiving department just stamps ‘order received’ on its two copies of the purchase order, which then forms its receiving record. One copy of the receiving record is filed in the receiving
department and the other is forwarded to the accounts payable department. The accounts payable department checks that there is a purchase requisition, purchase order and receiving record for each supplier invoice and then approves it for payment. The accounts payable department prepares a pre-numbered payment voucher and forwards it, along with the supplier’s invoice, purchase requisition, purchase order and receiving record, to the financial accountant, who signs the payment voucher, completes the payment by bank transfer to the supplier and returns the supporting documents to the accounts payable department.

At the end of the month, the assistant accountant undertakes a sequence check of all pre-numbered documents. The financial accountant receives the monthly bank statement, prepares a bank reconciliation and
investigates any reconciling items.

Requirement:
1) Discuss the difference between management controls and transaction controls.
2) Discuss the areas the auditor must understand in relation to the information systems relevant to financial reporting for an entity.
3) Regarding the above case, discuss the weaknesses in the SPC’s internal control concerning the purchases and payments functions and why each is a weakness and provide a recommendation as to how to overcome the weakness.