Sales System Controls and Auditing Risks: An Overview

Control Activities for a Sales System

Question 1 Star Buy Clothing (SBC) manufactures affordable ladies clothing.Due to its recent rapid growth it now requires a statutory audit and your firm has been appointed as auditor, in preparation for which you are conducting a review of its internal controls over sales. a) Advise FOUR control activities that you would expect to see operating in a sales system. Upon review of SBCs sales system you note the following information: Most of SBC’s sales are placed by personal customers using the website. Customers make their choices on the basis of the previous evening’s inventory file, and full payment is taken at the time of placing the order. The website is not integrated with the inventory file and inventory levels are not checked before the order is accepted. Goods are despatched to personal customers using external courier firms and customer signatures are supposed to be recorded as proof of delivery. However, in many instances orders are delivered with no signature having been obtained. A number of independent department stores also purchase a selection of SBC’s designs each season. They place their orders by phone with the sales clerks, sales clerks have become very friendly with some customers and are able to apply discounts to customers orders at their discretion. There have been complaints on several occasions of very late delivery of department store orders, which happened because the orders were accidentally left in an in-tray and not forwarded to the warehouse for packing and despatch for several days. b) Explain FIVE weaknesses in the SBC sales system and recommend improvements to address the weaknesses. (You should use a 2 column format using the headings ‘Weakness’ and ‘Improvements’.)  c) SBC is considering appointing an internal audit department going forwards. Discuss how as the external auditor, you could use the work of internal audit and advise the factors that you would need to consider before placing reliance on their work.

2 Question 2 James is a new recruit in your audit firm. He has just graduated from university and has no previous auditing experience. You are an audit supervisor assigned to be his training manager. James has approached you to seek clarification on some issues related to auditing a client for the first time. ISA 315 Identifying and assessing risks of material misstatement through understanding the entity and its environment, requires auditors to understand the entity and its environment, including its internal controls, in order to assess the risks of material misstatement of the financial statements whether due to fraud or error. The auditor will design and perform further audit procedures to respond the risks assessed. Required a) Critically evaluate FIVE (5) procedures that should be carried out to obtain an understanding of an entity in order to conduct its audit for the first time. b) ISA 300 Planning an audit of financial statements requires auditors to establish the overall strategy for an audit. Describe the key items that should be included in an audit strategy documentJames has now had a meeting with the new audit client, Dalma PLC, and has found out the following information: ? The company is managed by Mr Jones, the CEO of the firm, plus there is a marketing director, a commercial director and a finance director. ? The firm has been very successful in the past, however, since the commercial director Ms Swan left during the financial year there has been a sharp downturn in future projects. Due to this they have appointed an ambitious new commercial director Mr Black, who has implemented some practices to help boost sales. ? Mr Black has introduced commission payments. Commission is paid to staff who have enabled Dalma Plc to secure large contracts for future work. The directors’ bonuses this year will be based upon the number of signed contracts. ? Due to financial difficulties caused by the downturn in work, the company has arranged a long term loan of £30m. ? During the year the financial controller has been on maternity leave. The finance director was supposed to be covering for her, however, due to the financial strains he has been concentrating his time on the securing of the loan. c) Identify FOUR risks for the audit of Dalma Plc and for each risk identify the appropriate audit response. 3 Question 3 You are working for the audit firm Simbad LLP. it is now 31st May 2018 and you are working on the audit for Nala PLC for the year ending 31st March 2018. Nala provides pet supplies to high street Pet Shops. Nala has sales turnover of £20M for the year ended 31st March 2018. Nala has a main warehouse which houses most of the inventory and also has a number of smaller distribution centres across the UK. You have now completed your audit without any issues but during the closing meeting with the client on the 31st May they disclose to you that on the 10th May there was a big fire at their main warehouse and £2M of inventory was destroyed as well as damage to assets of £5M. The inventory in question had been in the warehouse for around 4 weeks. Required: a) Discuss the auditor’s responsibility for subsequent events, and state the audit procedures that should be carried out in relation to subsequent events. (8 marks) b) Given the situation, discuss the potential impact on the audit report, fully explaining your answers if: i) The directors include a subsequent events disclosure in the notes to the financial statements. ii) The directors make no subsequent events disclosure in the financial statements. c) On further investigation you have discovered that the accounts for one of the distribution centres for February and March 2018 have been accidentally destroyed. Given the situation above discuss the potential impact on the audit report, fully explaining your answers. d) Discuss the purpose of the management representation letter. What matters would you expect to see included in the Nala management representation letter.any THREE of the following questions in an essay format. All questions are weighted equally.] Question 4 Ansel Pte Ltd was set up six years ago by two plumbers who were made redundant by their employers. Ansel has been experiencing strong growth since it was started. The company usually refers to its auditors, Hansel & Co., for accounting services due to a lack of accounting expertise within. Hansel has been involved in the preparation of annual financial statements as well as for the statutory audit function. In view of the considerable increase in fees over the last six years, Ansel has proposed to Hansel whether it would be possible to calculate the audit fee as a percentage of Ansel’s profit for the next financial year. Hansel is a small firm of certified accountants. Although Ansel started as a small company, it now accounts for approximately 20% of Ansel’s gross fee income due to its significant growth over the past six years. Moreover, Hansel has plans to issue shares on the stock market in the near future. In an attempt to expand their client base, Ansel recently launched an advertising campaign in which they guarantee clients that only audit staff with experience in the relevant business sector will be allocated so as to maximise the efficiency of the audit. In response to the advertising campaign, Crane Ltd, a key competitor of Ansel has approached Hansel to replace their existing auditors for the current financial year. Required In the context of the above case study: (i) Evaluate FOUR (4) ethical threats which may affect the independence of Hansel & Co.; and (ii) For each threat recommend how it might be eliminated or mitigated to a satisfactory level.  5 Question 5 You are the audit senior of Eason Ltd for the financial year ended 31 December 2017. Eason produces various types of packet fruit juices under its own brand name (Sweety). The company also produces and supplies own brand fruit juice to a number of supermarket chains. You are currently planning the audit of Eason and have read the following notes which were prepared by the audit manager: 2017 has been tumultuous year for Eason Ltd. The owner, Janet Eason who also ran the business passed away suddenly in early 2017 due to a heart attack. Her two children have taken over the operations of the business. They are in their early 20s and have limited corporate experience. From the minutes of the management meetings, it appears that there are substantial disagreements and tensions over the business strategy and the operations of the company. Eason purchased a new factory in March 2017, which was largely financed by increasing its overdraft facility with the bank. The company plans to expand the range of drinks under its own brand Sweety so as to increase its sales. Nonetheless, the company encountered many obstacles in the process of setting up the new factory. The draft financial statements reveal high level of finished goods inventory and significant losses attributed to substantial spending on branding and marketing. However, these branding and marketing campaign to boost the sales of Sweety have not seen positive results. The raw material of the juices is imported from Malaysia and priced in US dollars. The cost of raw materials has increased significant with the weakening of the local currency to US dollar. Eason also has to reduce its prices on supermarket branded products in view of heightened competition between supermarkets. In addition, the supermarkets are also delaying their payments to Eason. Required a) Explain the auditor’s responsibility in relation to the applicability of the going concern concept to the client. b) Critically assess any potential indicators that Eason is not a “going concern”.  c) Recommend the audit procedures that the auditor of Eason should perform in assessing whether the company is a going concern. 6 Question 6 You are the manager on the audit of Bowie PLC. You have left two audit juniors, William and Lola, in charge of auditing cash and bank. Lola lost the audit programme but decided to carry on with the audit anyway. On your review of the file you find out the following information: There was no letter sent to the bank, however Lola maintained that it did not matter because the bank statement was there, and the bank balance was small at the end of the year. She also noticed that there were a lot of differences on the bank reconciliation, because it had not been done for 4 months. She felt it would take too long to check them all, so she checked every 10th item, and they all seemed to be alright. a) What were the shortcomings of Lola’s work on the bank account?b) What is the purpose of bank letter and statement and discuss their merits.  c) What are the key assertions that should be tested in relation to cash and bank? Question 7 You are an audit senior planning the audit of Palo Plc. You are currently assessing the audit risk and setting the materiality level as part of your planning procedures. a) Describe the audit risk model, defining each component and explain the link between risk and the level of substantive testing carried out. b) In line with ISA 320 Materiality in planning and performing an audit, discuss the meaning of materiality and assess its impact on an audit.