“An understanding of the client’s internal control will assist the auditor to understand and identify potential misstatements and factors that affect the risks of material misstatements as well as in designing the nature, timing and extent of the audit procedures to be used in the audit.” You have been assigned to audit a supermarket in a rural town.
A. Explain TWO (2) limitations of internal control systems that are at the client’s organization. (4 marks)
B. Describe FOUR (4) methods of documenting the accounting and control systems at the supermarket. (12 marks)
C. Summarize how the following would be applied at the supermarket:
i. Segregation of duties
ii. Physical controls
iii. Authorization and approval
iv. Management controls (4 marks)
(Total 20 marks)
SECTION B
One of your clients is Hotel Rio Jenuvo, a small hotel on the north coast. There are three main operating departments in the hotel: Rooms, Food & Beverage and Corporate Events. As part of the audit procedures, you are assessing the controls surrounding payroll. Based on last years’ audit file, the following information was noted:
i. Both full time and part time staff are employed. Most of the work is done on shifts due to the nature of the business. All staff are paid on a monthly basis.
ii. When new staff joins the hotel, they are each given an electronic identification card by the personnel department on the first day of work.
iii. This ID card is used to clock in and out to record the hours worked.
iv. The information recorded on the system regarding hours worked is automatically sent to the payroll department at the end of each week and also to each of the heads of the three operating departments.
v. Each department’s head must reply to the payroll department by email to authorise the hours worked by the respective staff.
vi. The payroll clerk then collates the authorised information and then input the data into a standardised computerised payroll package.
vii. The computerised system is password protected using an alphanumerical password that only the payroll clerk and the finance manager knows.
viii. The gross pay is calculated automatically to include statutory and any other non-statutory deductions.
ix. A payroll report is then produced and printed and sent to the finance manager for review. This is compared with the previous month’s data for consistency and variances as well as for any follow up that is necessary.
x. When he is satisfied, the payroll report is signed and returned to the payroll clerk who then submits the data.
xi. Payslips are sent to home addresses and payment is made by bank transfer.
A. Explain FOUR (4) strengths of the internal control system at the hotel with regards to the payroll. ` (8 marks)
B. For each of the strengths identified above, state ONE (1) test of control the auditor could perform to assess if the controls are operating effectively. (4 marks)
C. Outline FOUR (4) control activities (internal control principles) that are evident in the processing of payroll at Hotel Rio Jenuvo. (8 marks)
-
Management Override: Senior management can intentionally bypass established controls for personal gain or to manipulate financial results (e.g., the store manager forcing inventory records to match a desired profit target). The control system is generally designed to be effective against typical employee risks, not against the intentional acts of those in authority.
B. Methods of Documenting Accounting and Control Systems (12 marks)
Auditors need to document their understanding of the client's accounting and internal control systems. Four primary methods used to document the system at the supermarket are:
Narrative Records:
Description: A written description of the system, procedures, and flow of transactions. It details who performs what, when, where, and what documents are used.
Application: For the supermarket's sales process, the narrative would describe steps like: "The cashier scans the item (Source Document), the POS system calculates the total, the customer pays (Cash/Card), the cashier issues a receipt, and the transaction is recorded in the daily sales ledger (Accounting Record)."
Flowcharts:
Description: A diagrammatic representation of the sequence of activities and documents in a system. They use standardized symbols (e.g., diamonds for decisions, rectangles for processing, arrows for flow) to visually depict the system.
Application: A flowchart could illustrate the entire inventory purchasing cycle, starting with the store manager identifying low stock, generating a purchase order, receiving goods, and ultimately updating the perpetual inventory system. This visually highlights segregation of duties and control points (like required approvals).
Internal Control Questionnaires (ICQs):
Description: A series of questions designed to determine whether specific control activities exist and are operating. They usually require "Yes/No/N/A" answers, with "No" answers indicating a potential control weakness.
Application: Questions would focus on key control areas: "Is the petty cash box counted and reconciled daily?" "Are all credit notes/refunds approved by a supervisor?" "Does the POS system restrict cashiers from editing prices manually?"
Checklists (or Decision Tables):
Description: A structured list of internal controls relevant to specific transaction types or system components. They are used to confirm the presence of controls. Decision tables document the logical conditions and actions that should occur within a system, especially for complex processes.
Sample Answer
Part A: Supermarket Internal Control System
A. Limitations of Internal Control Systems (4 marks)
Internal control systems, no matter how well-designed, have inherent limitations that can restrict an organization from achieving its objectives perfectly. Two common limitations applicable to a supermarket are:
Human Error and Misunderstanding: Controls rely on staff performing procedures correctly. However, errors can arise from carelessness, fatigue, distraction, or simply misunderstanding instructions. For example, a cashier might accidentally enter the wrong price or quantity of an item, or a stock clerk might miscount inventory. In a busy supermarket, the pressure and volume of transactions increase the likelihood of such errors.
Collusion and Management Override:
Collusion: When two or more employees conspire to circumvent controls (e.g., a cashier and a customer service representative agree to process a fraudulent refund and split the cash). This is particularly difficult to detect because the control itself is being deliberately bypassed.