Question Tag: Deficiencies

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  • 6 Marks

AA – Dec 2022 – L2 – Q5d – Audit and Assurance Risk Environment

States the auditor's responsibilities when significant deficiencies in internal control are identified during an audit.

A significant deficiency in internal control is one which merits the attention of those charged with governance.

Required:
State THREE (3) requirements of an Auditor when there are deficiencies in internal control of a client.

Requirements of an auditor when deficiencies in internal control are identified:

  • The auditor must determine whether the identified deficiencies are significant individually or in combination with others.
  • The auditor must communicate in writing significant deficiencies to those charged with governance on a timely basis.
  • The auditor must communicate to management any other deficiencies that have not been communicated by other parties, if deemed important enough to warrant attention.
  • 12 Marks

AA – Nov 2015 – L2 – Q1a – Audit and Assurance Risk Environment, Planning and Approach for Audit and Assurance Engagements

This question addresses identifying deficiencies in an inventory count, implications, and recommendations.

Your firm is the external auditor of The Ceramicz Company, and you recently attended the year-end inventory count at the company’s warehouse. The company manufactures high-quality tableware (plates, cups, and saucers, etc.) and maintains an integrated computerised system that shows the inventory held at any point in time.

At the year-end inventory count, reports showing the various categories of inventories (but not the quantities) are printed off the system, and the quantities of inventories actually counted are inserted manually by the counters. Later, the quantities are compared with those per the computer system.

The count instructions were received by both you and the counters the day before the count was due to take place. The instructions consisted of the following five points:

Counters must arrive at 8 am on the morning of the count.
They will work in teams of two people.
Each team will be assigned a specific area of the warehouse to count. They will receive inventory sheets listing the products to be found in their area.
The inventory sheets are pre-numbered.
Once the counters have finished the inventory count, the inventory sheets must be handed to the warehouse manager.
Your notes from the attendance at the count include the following observations:

Many areas in which the count took place were untidy, and inventory was sometimes difficult to find because it was not in the allocated area. The same categories of inventories were sometimes found in several different areas, and some inventory was incorrectly labelled.
The count was conducted in a hurry in order to close the warehouse before a public holiday, and there were insufficient counters to conduct the count properly in the time available. The issue and receipt of inventory sheets (on which the quantities were recorded by counters) were not properly controlled. It was difficult to reconcile the inventory quantities recorded at the count to the computerised records, and some significant differences remain outstanding.
Although no finished goods were dispatched during the inventory count, a large delivery of raw materials was received into the warehouse.
Required:

a) For the inventory count conducted by the Ceramicz Company:
i. Identify and explain FOUR (4) deficiencies in the count.
ii. Explain the possible implication of each deficiency and
iii. Provide a recommendation to address each deficiency.
(12 marks)

Deficiency Implication Recommendation
Planning: The inventory count was poorly planned as there were insufficient counters, inventory was untidy, inventory was not in its allocated area and was sometimes incorrectly labelled. If the inventory count is not conducted in an organised way, then inventories could be omitted from the count or items counted twice. Items could also be recorded as the wrong product line if different products are mixed up in the same location. If the inventory is not organised, then it may be difficult to identify obsolete or damaged inventory. These factors mean that when the quantities are compared to the computerised records, adjustment could be made unnecessarily. This would lead to incorrect quantities of items being recorded both in management’s inventory records and the financial statements. This could lead the business to hold too much/too little of certain inventory lines or to have a material error in their financial statements. In future, the inventory count should be properly planned and organised. Management should carry out a review of the warehouse a few days before the count is scheduled to ensure that the warehouse is tidy, inventory lines are stored together, and obsolete or damaged inventory is segregated. Staff should be advised that they should communicate any problems with the inventory count to the manager in charge as soon as they are identified. If there is significant concern over the accuracy of the year-end count, then the auditor may need to request that the warehouse is organised and a second count carried out at a later date, and a roll-back reconciliation performed.
Inventory count sheets: The inventory count sheets were not properly controlled. Employees were not required to sign for them and records were not kept of who was working from which sheet. Inventory sheets may be lost or not used in the count. This could result in inventories being counted and not recorded in the final inventory count, or not counted at all. This means that inventories may be understated in the financial statements. The pre-numbered inventory sheets should be signed in and out by the manager responsible for overseeing the inventory counts. A record should be kept as to which employees have which inventory sheet. At the end of the count, a sequence check of inventory sheets should be made to ensure they are complete.
Segregation of duties: There is a lack of segregation of duties concerning the responsibility for the count, as the inventory counters must hand the inventory sheets to the warehouse manager at the end of the count. The warehouse manager has day-to-day responsibility for the inventory and also has control over the inventory count, which is the most important procedure to determine the accuracy of the quantity of inventory at the year-end. If there are significant differences between the quantity counted and recorded on the inventory sheets and the quantity recorded in the computerised inventory records, then the warehouse manager has the opportunity to conceal these errors. This could lead to inaccurate information regarding inventory quantities and/or fraud going undetected. Someone other than the warehouse manager should have overall responsibility for the inventory count, for example, a supervisor or manager from the finance department. Once the count is completed, the inventory sheets should be reviewed and photocopied by this member of staff before being handed back to the warehouse manager. This will enable any subsequent changes to the inventory sheets to be monitored.
Procedures over the movement of inventory: There are no formal procedures regarding the control of inventory movements whilst the count is being conducted. There were no goods dispatched during the count, but goods were received while the count was ongoing. It is not clear whether these items were included in the count or not. If there is no stipulation made regarding the cut-off of inventory, then inventory could be recorded in the wrong accounting period. Ideally, there would be no movements of inventory in and out of the warehouse whilst the count is being conducted. However, if goods must be dispatched during the count, then they should be separated from the other inventory lines and not included in the year-end count. Goods received during the count should also be segregated and recorded in the year-end count. This process should be overseen by the finance supervisor/manager.
  • 15 Marks

AA – May 2018 – L2 – Q2b – Audit and Assurance Risk Environment

Identifies deficiencies in a company's wages system and provides recommendations to prevent misstatements in financial statements.

Third Floor Ltd is a construction company with many contracts being executed concurrently. A large number of workers are on various construction sites. Third Floor Ltd has an internal audit department, and the team is currently reviewing cash wages systems within the company.

The following information is available concerning the wages systems:

  • Workers on each site are controlled by a foreman. The foreman has a record of all employee numbers and can issue temporary numbers for new employees.
  • Any overtime is calculated by the computerised wages system and added to the standard pay.
  • The two staff in the wages department make amendments to the computerised wages system in respect of employee leave, illness, as well as setting up and maintaining all employee records.
  • The computerised wages system calculates deductions from gross pay, such as employee taxes (PAYE), and other statutory deductions.
  • Finally, a list of net cash payments for each employee is produced. Cash is delivered to the wages office by secure courier. The two staff place cash into wages envelopes for each employee along with a handwritten note of gross pay, deductions, and net pay. The envelopes are given to the foreman for distribution to the individual employees.

Required:
Identify and explain FIVE deficiencies in Third Floor Ltd’s system of internal control over the wages system that could lead to misstatements in the financial statements, and, for each deficiency, suggest an internal control to overcome that deficiency. (15 marks)

  1. Deficiency: The foreman has the authority to issue temporary employee numbers, which allows the possibility of creating fictitious employees and misappropriating wages.
    Recommendation: The issuance of new employee numbers should require authorization from a manager and must be supported by formal documentation, such as an employment contract.
  2. Deficiency: The two wages department staff are responsible for both setting up and maintaining employee records, including amendments for leave and illness. This creates the risk of collusion and unauthorized modifications.
    Recommendation: A segregation of duties should be implemented, where one person maintains employee records and another authorizes any amendments. All changes should be reviewed and authorized by a manager.
  3. Deficiency: Handwritten notes of gross pay, deductions, and net pay are included in wage envelopes, which increases the risk of errors in pay calculation and distribution.
    Recommendation: Computer-generated payslips should be produced and included in the wage envelopes to ensure accuracy and consistency between the calculated wages and the actual cash distributed.
  4. Deficiency: The foreman distributes the cash wages to employees, allowing for the possibility of wage misappropriation or failure to return unclaimed wages.
    Recommendation: Another manager should oversee the distribution of wages, and any unclaimed wages should be recorded and returned to the wages department for safekeeping.
  5. Deficiency: There is no check to verify the amount of cash delivered to the wages office by the secure courier, creating the risk of cash shortages.
    Recommendation: The cash delivered should be counted and verified in the presence of two staff members, and both should sign a receipt acknowledging the amount received from the courier.

(Total: 15 marks)

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