Auditing and assurance revision question and answer

Auditing and Assurance Revision Questions and Answers

ISA 400 Risk Assessments and Internal Control deals with internal control objectives and internal controls. ISA 500
Audit Evidence deals with audit objectives and audit procedures. A proper understanding of internal controls is essential to auditors in order that they understand the business and are able to effectively plan and execute tests of controls and an appropriate level of substantive procedures.
You are the auditor of a small manufacturing company, that pays its staff in cash and bank transfer and Maintains its payroll on a small stand-alone computer.

Required:
(a) For the payroll department, describe the:
(i) Internal control objectives that should be in place; (4 marks)
(ii) Internal control environment and internal control procedures that should be in place to achieve the internal control objectives. (6 marks)
(b) For the payroll charges and payroll balances (including cash) in the financial statements:
(i) Describe the external auditor audit objectives; (4 marks)
(ii) List the tests of control and substantive procedures that will be applied in order to achieve the audit objectives identified in (b) (i) above. (6 marks)
(Total: 20 marks)

ANSWER
(a) (i) Internal control objectives

Control objectives include policies and procedures designed management to:

 Achieve the orderly and efficient running of the business including adherence to internal policies – this would include the regular, accurate processing and recording of payroll payments.
 Safeguard assets – this would include the physical safeguarding of cash and safeguarding money held in bank accounts means of other controls.
 Prevent and detect fraud and error – fraud and error would include incorrect payments or deductions from the payroll and payments of incorrect amounts for tax and NSSF, payments for work not performed and payments to dummy employees, for example.
 Achieve accuracy and completeness of the accounting records and timely preparation of reliable financial information; this would include making correct payments and deductions from the payroll, correct payments for tax and (NSSF, NHIF), and making payments for work performed only (not to dummy employees, for example), in order that quarterly or half-yearly accounts can be prepared (possibly), but in any case in order that annual accounts can be prepared within the time limits for small companies.

(ii) Internal control environment and control procedures

The control environment relates to:

 Management‘s overall style in encouraging awareness of the need for good controls, for example.

 The existence of organizational controls such as review of the payroll an independent person such as the managing director, and the rotation of payroll duties amongst staff responsible for processing it – this helps achieve all of the objectives set out above.

 Segregation of duties and supervisory controls to avoid the misappropriation of cash and to avoid fraudulent collusion to create, for example, dummy employees or to make inflated payments – this prevents the loss of assets and/or inaccurate records.
Internal control procedures include:

 Limiting direct physical access to the cash, such as the use of a security firm to deliver cash, locking doors to areas where cash is held, keeping cash in a fire-proof safe and the protection of the computer password controls – this will help safeguard assets and ensure the completeness and accuracy of the records and financial statements.

 Controls over computerized applications, checking the arithmetical accuracy of documents and the maintenance of control accounts – this can be achieved by, for example, the use of time sheets or clock cards, the use of reliable software with programmed controls for the calculation of deductions, and the use of batch and hash totals for information that is input into the computer system – this helps achieve the orderly and efficient running of the
business and the accuracy and completeness of records and financial statements.

 Approval and control of documents, such as the authorization of the payroll itself, and authorization for the bank to make transfers and to deliver cash.

(b) Audit objectives, tests of control and substantive procedures

Objectives Tests of control and substantive procedures
Existence: of assets and liabilities such as cash on hand and in the bank, and of the liability to pay staff and the associated tax and NSSF contributions. Testing controls over the security of cash to ensure that they are operating effectively throughout the period.

Performing cash counts, with reconciliations to the records and observing cash payments to staff, ensuring that appropriate signatures are obtained and that unclaimed cash is promptly re-banked, for example.

Making checks on the physical existence of staff to ensure that the related expenses and liabilities are genuine.

Checking after date payments to staff and for tax and NSSF contributions.

Occurrence: payroll transactions occurred during the relevant accounting period. Performing cut off tests to ensure that payroll costs incurred during the period have been recorded during the period examining entries in the payroll records just before and just after the period end and checking back to source documentation,

such as timesheets or clock cards

Completeness: there are no unrecorded assets or liabilities such as cash on hand and in the bank or transactions such as payroll payment. Performing starters and leavers tests to ensure that staff are not paid before they join the company and are not paid after they leave. This involves checking the payroll for two separate periods and examining entries relating to starters and leavers in the intervening period.

 

Manually checking the accuracy of payroll calculations to ensure that correct payments and deductions are being made in accordance with approved pay rates and approved deduction rates for tax and NSSF.

 

Reviewing evidence of authorisation controls

to ensure that the payroll has already been checked.

Measurement: transactions such as payroll payments are recorded at the correct amounts and are recorded in the correct

period.

Same as for completeness, above, and checking entries relating to hours or time worked    in    the    payroll    to    source

documentation.

Presentation and disclosure: an item is disclosed and described in accordance with accounting standards and legislation. Reviewing the financial statements with the aid of a disclosure checklist to ensure that disclosure requirements have been met. Reviewing the overall presentation of payroll

transactions and balances.



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