M08-1 Workshop Solutions

10.13 Why do auditors want to rely on internal controls wherever possible?
In order to arrive at an audit opinion an auditor must obtain sufficient appropriate

evidence that the financial statements are free from material misstatement. This
evidence comes from two sources: test of control and substantive tests. Where the
internal control system can be relied upon by the auditor, having performed tests of
control, will be able to reduce the amount of substantive testing that would be
required if these tests had not been performed.
The auditor will generally perform tests of control whenever possible as they usually
take less time to perform than the substantive tests they replace (it should be noted
that some substantive tests will always be required given the inherent limitations of
internal control systems).
10.15 What is the difference between a walk-through review test and a test of controls?
A walk-through test is used when obtaining an understanding of the internal controls
of an entity. A representative transaction from a class of transactions is traced through
all the processing steps as a way of confirming the understanding of system obtained
through questionnaires or flowcharts.
Tests of control are designed to give the auditor evidence about the effective design
and operation of internal controls. The objective being to establish the extent to which
internal controls can be relied upon for evidence that the financial statements are free
from material error. Where internal controls are found to be effective the level of
substantive testing can be reduced. Where internal controls are not found to be
effective all the audit evidence needed to support the audit opinion will be received
from performing substantive tests.
10.19 What is the difference between test data and integrated test facility?
Under the test data approach, dummy transactions are prepared by the auditor and
processed under auditor control by the client’s computer program. This is often
performed during a time when the auditor can take full control over the client’s
computer operations.
In an integrated tests facility approach the auditor does not control computer
operations and dummy transactions are processed simultaneously with real
transactions. This usually requires the creation of a small subsystem (a mini-company)
within the regular IT system. It may be accomplished by creating dummy master files
or appending dummy master records to existing client files. Test data, specially coded
to correspond to the dummy master files, are introduced into the system together
with actual transactions.
10.23 Potential misstatements 

Your firm has been engaged to audit the financial report of Pellerton Ltd. In
obtaining an understanding of internal control relating to purchases, the following
questionnaire is used:
1. Are all purchase orders supported by an authorised purchase requisition?
2. Are deliveries received checked to ensure all goods on the delivery have been
received in good condition?
3. Is the goods delivery note validated against the approved order?
4. When goods are received is the inventory system amended to reflect the new
delivery?
5. Are purchase invoices validated against delivery notes?
6. Are mathematical checks performed on purchase invoices before they are
processed?
7. Are payments made only after receiving and reconciling supplier statements?
8. Are all payments requested supported by authorised invoices?
9. Are all amendments to purchase ledger accounts authorised by the purchase
ledger supervisor?
Required
Identify a potential misstatement that could occur, assuming a No answer to each
question.
a. Unauthorized purchases could be made, creating unauthorized liabilities for
Pellerton
b. Acceptance of the delivery note assumes acceptance of the liability for those
goods, if the goods actually received are different to what is on the delivery note
then it is possible that a liability is accepted for goods that were not received, or
for goods that were received but they were damaged
c. Accepting a liability for goods that were not ordered
d. Goods could be accepted without being recorded, creating a risk that these goods
could be misappropriated without detection
e. The delivery note is a record of what was received and if the invoice is charging for
different items there is a risk of paying for goods not received
f. If invoices are not checked then invoicing errors will not be picked up leading to a
risk of paying incorrect amounts
g. Without supplier statements the company cannot be sure that all invoices and
credit notes have been correctly recorded in the purchase ledger which could give
rise to paying the incorrect amount
h. There is a risk that payments are made where no liability exists or a payment is
made for the wrong amount
i. Unauthorised amendments to purchase ledger accounts can be used for
fraudulent purposes.
10.31 Introduction – audit firm 

You are an audit senior in Brennon & Co., a firm providing audit and assurance
services. At the request of an audit partner, you are preparing the audit program for
the income and receivables systems of Seeley Co.
Audit documentation is available from the previous year’s audit, including internal
control questionnaires and audit programmes for the despatch and sales system.
The audit approach last year did not involve the use of computer-assisted audit
techniques (CAATs) the same approach will be taken this year. As far as you are
aware, Seeley’s system of internal control has not changed in the last year.
Client background — sales system
Seeley Co is a wholesaler of electrical goods such as kettles, televisions, MP3 players,
etc. The company maintains one large warehouse in a major city. Seeley customers
are always owners of small retail shops, where electrical goods are sold to members
of the public. Seeley only sells to authorised customers and, following appropriate
credit checks, each customer is given a Seeley identification card to confirm their
status. The card must be used to obtain goods from the warehouse.
Despatch and sales system
The despatch and sales system operate as follows.
1. Customers visit Seeley’s warehouse and load the goods they require into their
vans after showing their Seeley identification card to the despatch staff.
2. A pre-numbered goods despatch note (GDN) is produced and signed by the
customer and a member of Seeley’s despatch staff confirming goods taken.
3. One copy of the GDN is sent to the accounts department, the second copy is
retained in the despatch department.
4. Accounts staff enter goods despatch information onto the computerised sales
system. The GDN is signed.
5. The computer system produces the sales invoice, with reference to the inventory
master file for product details and prices, maintains the sales day book and also
the receivables ledger. The receivables control account is balanced by the
computer.
6. Invoices are printed out and sent to each customer in the post with paper copies
maintained in the accounts department. Invoices are compared to GDNs by
accounts staff and signed.
7. Paper copies of the receivables ledger control account and list of aged
receivables are also available.
8. Error reports are produced showing breaks in the GDN sequence.
Required
a. Explain the steps necessary to check the accuracy of the previous year’s internal
control questionnaires.
b. Using information from the scenario, list six tests of control that an auditor
would normally carry out on the dispatch and sales system at Seeley Co, and
explain the reason for each test.
a.
 Obtain the audit file from last year’s audit. Ensure that the documentation on
the sales system is complete. Review the audit file for indications of
weaknesses in the sales system and note these for investigation this year.
 Obtain system documentation from the client. Review this to identify any
changes made in the last 12 months.
 Interview client staff to ascertain whether systems have changed this year
and to ensure that the internal control questionnaires produced last year are
correct.
 Perform walk-through checks. Trace a few transactions through the sales
system to ensure that the internal control questionnaires on the audit file are
accurate and can be relied upon to produce the audit programmes for this
year.
 During walk-through checks, ensure that the controls documented in the
system notes are actually working, for example, verifying that documents are
signed as indicated in the notes.
b.
Test of control Reason for test
Review a sample of goods despatch notes Ensures that the goods despatched are
(GDN) for signatures of the goods despatch correctly recorded on the GDNs.
staff and customer.
Review a sample of GDNs for signature of Ensures that the GDN details have been
the accounts staff. entered onto the computer system.
Observe despatch system ensuring Seeley Ensures that goods are only despatched to
staff have seen the customers’ authorised customers.
identification card prior to goods being
loaded into customers’ vans.
Review the error report on numeric Ensures that the sequence of GDNs is
sequence of GDNs produced in the complete.
accounts department and enquire action
taken regarding omissions.
Observe despatch process to ensure that Ensures that goods are not despatched to
the customers’ credit limit is reviewed prior poor/bad credit risks.
to goods being despatched. Note: reviewing credit limits is not specifically
stated in the scenario; however, most
despatch/
sales systems will have this control.
Review a selection of invoices ensuring Ensures the accurate transfer of goods

they have been signed by accounts staff. despatched information from the GDN to the
invoice.

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What are the main steps in an auditor obtaining an understanding of a client's internal controls?

What is the difference between a walk-through review test and a test of controls?

10.13 Why do auditors want to rely on internal controls wherever possible?

In order to arrive at an audit opinion an auditor must obtain sufficient appropriate

10.23 Potential misstatements 

10.31 Introduction – audit firm 

Test of control Reason for test

Review a selection of invoices ensuring Ensures the accurate transfer of goods

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