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ATC
INTERNATIONAL
(a)
Management and those charged with governance are responsible for the establishing
systems and controls to prevent and detect fraud and error.
The duties of internal auditors are generally determined by the organisation that has
set up the internal audit department and employs the internal auditors. Internal
auditors normally have a general responsibility to perform their work and their
reviews of systems with the possibility of fraud and error in mind.
This means that when they review the structure and operation of systems they have
regard to strengths in the system that will prevent or detect fraud and error and
weaknesses that will facilitate fraud and error.
It can be difficult in practice for internal auditors to deal with actual or suspected
management fraud. But the Rules of Professional Conduct do not permit auditors
to remain silent on the subject.
If an audit committee is established within the organisation, then they would be the
body to whom the internal auditor should report.
There is no general duty to report fraud or error outside the organisation and internal
auditors, like other employees, have a duty of confidentiality to the organisation
they work for.
External auditors are not, and cannot, be held responsible for the prevention and
detection of fraud and error that is the responsibility of management.
External auditors plan and perform their work with an attitude of professional
scepticism. ISA 240 Fraud and Error states that the audit is designed to detect
material errors, which may be due to fraud or error, but this does not mean that the
audit can be guaranteed to detect material fraud or error.
The external auditor must consider the risk of material misstatement arising from
fraud and error when:
(b)
The external auditor should plan and perform the audit with an attitude of
professional scepticism, recognizing that conditions or events may be found that
indicate that fraud or error may exist.
As part of their planning procedures, the external auditor must discuss the
susceptibility of their clients financial statements to material misstatement caused
by fraud.
Corporate governance
The objectives of good corporate governance include: the proper constitution of the
board, proper arrangements for the remuneration of directors, proper mechanisms
for shareholder relations, and proper accountability and audit.
Internal audits role in the context of these objectives includes assisting management
by suggesting ways in which these objectives can be achieved, and by monitoring
progress.
The internal auditors can recommend to the board those areas in which structural
changes need to be made in order to comply with codes of corporate governance,
such as those issued by the OECD and the World Bank. They can recommend
processes for setting objectives and targets, and for measuring their achievement.
(ii)
Risk management
Internal audit has a particular interest in investigating and evaluating the companys
risk management structures. Internal audit can manage the provision of the basic
data which management can use in order to identify, prioritise and manage the risks
facing the company.
Internal audit can also help by developing models and techniques for identifying,
prioritising and managing risk.
The management of risk depends on the business objectives, short and long term,
strategic and operational, and conflicts between objectives. These objectives
include, for example, the need to provide a return to investors, the need for longterm investment, and the need to produce a quality product. Internal audit can help
classify those risks.
(iii)
Organisational control
(c)
When computer systems are designed, internal audit can ensure that the appropriate
development controls are implemented and tested.
The costs of out-sourcing the function, including the internal administrative costs
and the costs of managing the function. These may be more or less than internal
costs, and a cost-benefit analysis will help establish the likely financial implications.
Out-sourcing the internal audit function probably means a loss of control, whilst the
responsibility for the function will remain with the company.
Change management issues have to be addressed which can be time consuming and
expensive. Existing staff have to be re-deployed (perhaps to the company to which
the function is out-sourced) and there may be resentment of the new internal
auditors and deliberate attempts to frustrate them.
MICROPRODS
(a)
(b)
Audit working papers from year-end physical count identifying obsolete, damaged,
returned or otherwise slow-moving inventory.
After date selling prices, especially of laptops identified at year-end physical count
as returns/damaged etc.
Order book to ascertain whether advertising campaign has had any appreciable
effect on level of demand for notebooks.
Clients schedule (if any) comparing costs and NRVs of all obsolete, damaged or
otherwise slow-moving items.
(c)
Warranty expense
Cr Materials (replacement components etc.)
Cr Labour (+ overheads)
At the financial year end, management has to estimate a provision for warranty work to be
done in the future (therefore uncertain) in respect of sales already made.
The clients system for recording computers returned and authorising rectification
work under the terms of warranty.
A schedule of claims received (including those notified after the end of the reporting
period) identifying those rejected (e.g. due to breach of warranty conditions).
Rectification cost records and related general ledger accounts showing cost of
replacement components.
Schedule of current year costs incurred under warranty agreements charged against
the warranty provision made in prior year.
Terms and conditions of notebook purchases from Far Eastern supplier (e.g. whether
any recourse or counter-claim provisions).
PHOENIX
(1)
Trade investment
(2)
(i)
Matters
Assuming that Pegasus is insolvent (e.g. a receiver or liquidator has been appointed)
this is an adjusting event after the reporting period (IAS 10).
The total expense of $95,000 represents 56% of draft profit before tax and may be
material. Consideration should be given to whether or not it is material to the
statement of financial position.
(ii)
Audit evidence
The audited accounts of Pegasus for the year ended 30 September showing whether
there are assets with market values in excess of book values.
Written management representation confirming that there have been no events since
the end of the reporting period other than Pegasuss insolvency.
Future maintenance
(i)
Matters
However, blast furnaces are of a type of plant and equipment that require relining
after a specified period. The components (blast furnace interiors) which require
replacement are separate assets that should be depreciated over the replacement
cycle. To the extent that the $500k includes the cost of replacing separate assets, it
represents future capital cost.
Prudence does not permit the creation of hidden reserves and excessive provisions.
This provision does not therefore meet the IAS 37 definition:
(3)
This is the first time that the blast furnaces need this form of maintenance. IAS 37
has been in issue since 1999 and its requirements should be well understood
(ii)
Audit evidence
Discussion with senior management their reasons for having made the provision this
year (but not in previous years) and whether any costs have been contracted for to
identify any elements that cannot be escaped, e.g. cancellation clauses.
Rework from facts obtained of what auditors believe provision should be and
compare to clients schedule showing make-up of provision.
The trade investment write off ($80,000) represents 4.7% of profit before tax and
may be considered, on its own, as not being material. Add to that the connected
dividend of $15,000, then the overall impact becomes 5.6%.
Whilst both may still not be considered as material, it does seem odd for the
management to wish to carry an investment that would be disclosed in the notes
when that investment no longer exists.
The provision represents 29% of draft profit before tax and is therefore material. If
the provision is not reversed the audit opinion should be qualified except for on
grounds of non-compliance with IAS 37.
Draft profit before tax ($17m) shows a 13% increase on the previous year. If
adjustments are made for points (1) and (2) , profit will be increased by at least
$400,000 (i.e. (1) $95k decrease plus (2) $500k increase). Profit before tax of
$21m would be a 40% increase on the prior year.
Marking Scheme
For most questions the marking scheme suggests you award 1 mark a point. However, the mark you
award for each point will depend on its relevance and the depth of the students discussion. So, a brief
point may be worth 1/2 mark or less while a point with a longer and deeper discussion could be worth 2
marks.
Also, marks are not allocated to specific points, as the student may mention a valid point which is not
given in the model answer obviously the student should be given credit for the point.
Many questions require the students to include a range of points in their answer, so an answer which
concentrates on one (or a few) points should normally be given a lower mark than one which considers
a range of points.
Marks
1
(a)
(b)
1 mark a point to max of 2 marks for (i) and (ii) and max of 1 for (iii).
PLUS 1 mark for each example (1 example per element only)
(c)
7
max 8
5
__
20
MICROPRODS
(a)
(b)
(c)
____
15
PHOENIX
(a)
Matters
Generally 1 mark a point up to a maximum of 4 for each element
Audit evidence
Generally 1 mark a point up to a maximum of 4 per element
max 7
max 7
__
max 12
(b)
3
__
max 15