Question 67

(a)
ISA 265 includes the examples of matters to consider in determining whether a deficiency in
internal controls is significant. These include:
 The prospect of the internal control deficiencies resulting in material
misstatements in the financial statements in the future.
 The quantity exposed to the internal control deficiencies
 The importance of the particular internal controls to the financial reporting
process
 The responsiveness to fraud or loss of the related asset or liability in the
particular internal control
 The interconnection of the deficiency with other deficiencies in internal
control
(b)

ABC & Co
Certified
Accountants
29 High Street

The Board of Directors

Greystone Co
15 Low Street

8 December 20X0 (after the year end

date)

Members of the board,

Financial statements for the year ended 30 September 20X0
We start out in this letter about deficiencies in the purchases system which arose as a result of
our review of the accounting systems and procedures operated by your company during our
recent audit. The matters dealt with in this letter came to our notice during the conduct of our
normal audit procedures which are designed primarily for the purpose of expressing our
opinion on the financial statements.
Determination of inventory levels
(i) Deficiency
In your company system, it is the purchasing manager who determines store inventory levels,
without consulting the store or sales managers, who are at the best place to judge the local
market.
(ii) Implication
Without the knowledge of the situation of the local market, certain clothes and accessories
might be over-ordered and might need to be sold at reduced price when the trend has gone.
This may cause in overvalued of inventory if the inventories are held at cost in the
management accounts and results in inaccurate figure in the financial statements. Some
inventory may not be ordered in sufficient amount to meet the market needs and it may affect
the reputation of Greystone.
(iii) Recommendation
The purchasing manager should regularly hold a meeting to consult the store managers and
make a joint decision that based on the initial inventory levels to be ordered for clothes and
accessories.
Re-ordering
(i) Deficiency
The store managers are in charged in re-ordering through the purchase manager and this can
take four weeks for goods to be received.

(ii) Implication
In this system, it requires the store managers to be determine the potential stock out products
and be proactive to re-order four weeks before the stock out. Without doing so they may
order too late and inventory may run out for a period of up to four weeks, and this could
cause in revenue lost.
(iii) Recommendation
New re-order levels should be introduced in the inventory system. When the inventory has
fall to the pre-determined level, the purchasing manager should be prompted to raise a
purchase order. For example, the system may generate automatic re-order request to be
emailed to the purchasing manager.
Internal ordering
(i) Deficiency
It is not possible to order goods from other branches of stores as all ordering must be
undertaken through the purchasing manager. Stores cannot transfer goods between each other
to meet demand. Customers are asked to try other stores or the website when an item of
clothing is sold out.
(ii) Implication
The system is inconvenient for the customers, which would result in the customers do not
follow up at other stores. The customers might have purchased if the goods were available in
their local store, and thus results in revenue lost. Besides, this makes customers perceive
there is a lack of customer service and the store’s reputation may suffer.
(iii) Recommendation
An internal ordering system should be set up which allows for the transfer of goods between
stores. Stores with low inventory levels should be able to obtain excess inventories from
those with high levels to meet demand while goods are re-ordered.
Checking of goods received
(i) Deficiency
Goods received in the stores are not checked against purchase orders.
(ii) Implication
Goods which were not ordered in the first place could be received. Once received, it may be
difficult to return these goods and they may need to be paid for and thus there is a potential
unnecessary administrative cost. Besides, some goods ordered may not be received resulting
to insufficient inventory levels revenue lost.
(iii) Recommendation
A copy of authorised orders should be kept at the relevant store and checked against goods
received notes. The order should be marked completed and sent to head office if all details
are correct. The purchasing clerk should review the purchase orders regularly for incomplete
items and investigate the reason they are not completed.
This letter has been produced for the sole use of your company. It must not be disclosed to a
third party, or quoted or referred to, without our written consent. No responsibility is assumed
by us to any other person.
We should like to take this opportunity of thanking your staff for their cooperation and
assistance during the course of our audit.
Yours faithfully
ABC & Co
(c)
- Compare the list of trade payables with the previous year's to identify any potentially
significant omissions.
- Review the bank statements or cash books after the end of the year for payments to find any
existence of unrecorded trade payables.
- Review the financial statements and make sure that trade payables are classified as current
liabilities in the financial statements.
- Compare the payables turnover and payables days to the previous year and industry data
- Reconcile a sample of payables balances with supplier statements and investigate
differences which could indicate a significant misstatement.

Question 69
(a)
Test of Control Test Objective
For a sample of invoices, compare the To ensure that goods are sold at authorised
invoices with the prices shown on the current prices to customers.
price list to ensure that the current prices have
been used.

Review the sample of orders and making sure To make sure that all orders are recorded
that an order acceptance email or letter was accurately and completely.
generated.
Visit one of the warehouses to observe To ensure that goods are despatched correctly
whether all goods are double checked against to customers.
the goods despatch notes and despatch list
before sending out.
Enter an order for a fake customer account To make sure that the system only accepts and
number and ensure the system does not accept process orders for valid customers.
it.
Examine a sample of processed creditTo make sure that the company only supply
applications from the credit agency and make goods to customers with acceptable credit
sure the same credit limit appears in the sales ratings.
system.
Review a sample of invoices showing To make sure that the company only provides
discounts, agree the discount terms back to the sales discount to those customers the sales
customer master file information. director has authorised.

(b)
- Review cash receipts after the year-end with the pre-year-end receivable balances to
identify if anything is still outstanding. Investigate whether allowance is needed for the
unpaid amounts.
- Review the previous receivables report to find any old balances. After that, discuss the
probability of recovery with the credit controller to assess whether allowance is needed.
- Review the reconciliation of the sales ledger control account to the sales ledger balances
and examine any unusual reconciling items.
- Compare the average receivable days with prior year’s and expectations, find out the reason
if there is any significant differences.
- Review the previous receivables ledger to find whether there is any credit balances and ask
management whether these should be reclassified as payables.
- Review the sample of goods despatched notes to make sure that the related invoices are
recorded in the correct accounting period.
- Review the board minutes to examine whether there is any material disputed receivables.
- Review a sample of year-end receivable balances with a sales order and a valid goods
despatched notes to ensure existence.

(c)
Control Explanation on how it would mitigate the risk
Staff within the finance department should Rotation will act as a deterrent to fraud.
rotate duties on a regular basis. Rotation increase risk for staff to commit
fraudulent activities and thus this may reduce
the probability of staffs committing fraud.
The receivables ledger supervisor should When the customers receive statements, they
make sure that customer statements have been may notice abnormalities in the allocation of
sent to all customers in each month. payments in terms of amount of timing. They
may inform the company, and this can bring
attention to the company about any potential
fraud.
An appropriate level manager, who is not Any material balances will be discovered by
involved in the process of preparation, should reviewing the bank reconciliation and fraud
review the bank reconciliation regularly. The can be discovered on time.
unreconciled amounts detected must be
examined and resolved at the time of review.

(d)
- Compare the calculated total revenue with the previous year’s and the budgeted revenue.
Examine if there is any significant changes.
- Review a sample of sales invoices of larger customers, and then recalculate the discount
allowed for larger customer and make sure that the discount given are accurate.
- Review a sample of customer orders with the related despatch notes and sales invoices,
tracing the details and ensure that there is a sale recorded.
- Obtain a sales analysis by major categories of toys manufactured from the management,
compare this analysis to the previous year’s analysis. Inform and discuss with the
management if any unusual movements are detected.