ACCA AA Syllabus B. Planning And Risk Assessment - Fraud & Misstatement Effects - Past Papers ^{2 / 6}

You are the audit senior in charge of the audit of Swandive Co (Swandive), and have been informed by your audit manager that during the year a fraud occurred at the client. A payroll clerk set up fictitious employees and the wages were paid into the clerk’s own bank account. This clerk has subsequently left the company, but the audit manager is concerned that additional frauds have taken place in the wages department.

Required:
Describe procedures which should be undertaken during the audit of wages as a result of the manager’s assessment of the increased risk of fraud. (5 marks)

Jackdaw Motor Cars Co (Jackdaw) manufactures a range of motor cars and its year end is 31 January 2015. You are the audit supervisor of Puffin & Co and are currently preparing the audit programmes for the year-end audit of Jackdaw. You have had a meeting with your audit manager and he has notified you of a number of issues identified during the audit risk assessment process.

Land and buildings
Jackdaw have a policy of revaluing land and buildings, this is undertaken on a rolling basis over a five-year period.

During the year Jackdaw requested an external valuer to revalue a number of properties, including a warehouse purchased in May 2014. Depreciation is charged on a pro rata basis.

Work in progress
Jackdaw undertakes continuous production of cars, 24 hours a day, seven days a week. An inventory count is to be undertaken at the year end and Puffin & Co will attend. You are responsible for the audit of work in progress (WIP) and will be part of the team attending the count as well as the final audit. WIP constitutes the partly assembled cars at the year end and this balance is likely to be material. Jackdaw values WIP according to percentage of completion, and standard costs are then applied to these percentages.

During the audit, your team has identified an error in the valuation of work in progress, as a number of the assumptions contain out of date information. The directors of Jackdaw have indicated that they do not wish to amend the financial statements.

Required:
Explain the steps Puffin & Co should now take and the impact on the audit report in relation to the directors’ refusal to amend the financial statements. (5 marks)

Bush-Baby Hotels Co operates a chain of 18 hotels located across the country. Each hotel has bedrooms, a restaurant and leisure club facilities. Most visitors to the restaurant and leisure club are hotel guests; however, these facilities are open to the public as well. Hotel guests generally charge any costs to their room but other visitors must make payment directly to the hotel staff.

During the year, senior management noticed an increased level of cash discrepancies and inventory discrepancies, and they suspect that some employees have been stealing cash and goods from the hotels. They are keen to prevent this from reoccurring and are considering establishing an internal audit department to undertake a fraud investigation.

Required:

Explain how the new internal audit department of Bush-Baby Hotels Co could assist the directors in preventing and detecting fraud and error. (3 marks)

ISA 315 Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and Its Environment requires auditors to obtain an understanding of control activities relevant to the audit.

Control activities are the policies and procedures that help ensure that management directives are carried out; and which are designed to prevent and detect fraud and error occurring. An example of a control activity is the maintenance of a control account.

Required:

Apart from maintenance of a control account, explain FOUR control activities a company may undertake to prevent and detect fraud and error. (4 marks)

Explain the external auditors’ responsibilities in relation to the prevention and detection of fraud and error. (4 marks)

Introduction

Tinkerbell Toys Co (Tinkerbell) is a manufacturer of children’s building block toys; they have been trading for over 35 years and they sell to a wide variety of customers including large and small toy retailers across the country. The company’s year end is 31 May 2011.

The company has a large manufacturing plant, four large warehouses and a head office. Upon manufacture, the toys are stored in one of the warehouses until they are despatched to customers. The company does not have an internal audit department.

Sales ordering, goods despatched and invoicing

Each customer has a unique customer account number and this is used to enter sales orders when they are received in writing from customers. The orders are entered by an order clerk and the system automatically checks that the goods are available and that the order will not take the customer over their credit limit.

For new customers, a sales manager completes a credit application; this is checked through a credit agency and a credit limit entered into the system by the credit controller. The company has a price list, which is updated twice a year. Larger customers are entitled to a discount; this is agreed by the sales director and set up within the customer master file.

Once the order is entered an acceptance is automatically sent to the customer by mail/email confirming the goods ordered and a likely despatch date. The order is then sorted by address of customer. The warehouse closest to the customer receives the order electronically and a despatch list and sequentially numbered goods despatch notes (GDNs) are automatically generated.

The warehouse team pack the goods from the despatch list and, before they are sent out, a second member of the team double checks the despatch list to the GDN, which accompanies the goods.

Once despatched, a copy of the GDN is sent to the accounts team at head office and a sequentially numbered sales invoice is raised and checked to the GDN. Periodically a computer sequence check is performed for any missing sales invoice numbers.

Fraud

During the year a material fraud was uncovered. It involved cash/cheque receipts from customers being diverted into employees’ personal accounts. In order to cover up the fraud, receipts from subsequent unrelated customers would then be recorded against the earlier outstanding receivable balances and this cycle of fraud would continue.

The fraud occurred because two members of staff ‘who were related’ colluded. One processed cash receipts and prepared the weekly bank reconciliation; the other employee recorded customer receipts in the sales ledger.

An unrelated sales ledger clerk was supposed to send out monthly customer statements but this was not performed. The bank reconciliations each had a small unreconciled amount but no-one reviewed the reconciliations after they were prepared.

The fraud was only uncovered when the two employees went on holiday at the same time and it was
discovered that cash receipts from different customers were being applied to older receivable balances to hide the earlier sums stolen.

Required:

Identify and explain controls Tinkerbell should implement to reduce the risk of fraud occurring again and, for each control, describe how it would mitigate the risk. (6 marks)

One of your audit clients is Tye Co a company providing petrol, aviation fuel and similar oil based products to the government of the country it is based in. Although the company is not listed on any stock exchange, it does follow best practice regarding corporate governance regulations. The audit work for this year is complete, apart from the matter referred to below.

As part of Tye Co’s service contract with the government, it is required to hold an emergency inventory reserve of 6,000 barrels of aviation fuel. The inventory is to be used if the supply of aviation fuel is interrupted due to unforeseen events such as natural disaster or terrorist activity.

This fuel has in the past been valued at its cost price of $15 a barrel. The current value of aviation fuel is $120 a barrel. Although the audit work is complete, as noted above, the directors of Tye Co have now decided to show the ‘real’ value of this closing inventory in the financial statements by valuing closing inventory of fuel at market value, which does not comply with relevant accounting standards. The draft financial statements of Tye Co currently show a profit of approximately $500,000 with net assets of $170 million.

Assume that the directors have agreed to value inventory at $15/barrel.

Having investigated the matter in part (a) above, the directors present you with an amended set of financial statements showing the emergency reserve stated not at 6,000 barrels, but reported as 60,000 barrels.

The final financial statements now show a profit following the inclusion of another 54,000 barrels of oil in inventory. When queried about the change from 6,000 to 60,000 barrels of inventory, the finance director stated that this change was made to meet expected amendments to emergency reserve requirements to be published in about six months time.

The inventory will be purchased this year, and no liability will be shown in the financial statements for this future purchase. The finance director also pointed out that part of Tye Co’s contract with the government requires Tye Co to disclose an annual profit and that a review of bank loans is due in three months.

Finally the finance director stated that if your audit firm qualifies the financial statements in respect of the increase in inventory, they will not be recommended for re-appointment at the annual general meeting. The finance director refuses to amend the financial statements to remove this ‘fictitious’ inventory.

Required:

(i) State the external auditor’s responsibilities regarding the detection of fraud; (4 marks)

(ii) Discuss to which groups the auditors of Tye Co could report the ‘fictitious’ aviation fuel inventory; 
(6 marks)

SouthLea Co is a construction company (building houses, offices and hotels) employing a large number of workers on various construction sites. The internal audit department of SouthLea Co is currently reviewing cash wages systems within the company.

The following information is available concerning the wages systems:

(i) Hours worked are recorded using a clocking in/out system. On arriving for work and at the end of each days work, each worker enters their unique employee number on a keypad.

(ii) 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.

(iii) Any overtime is calculated by the computerised wages system and added to the standard pay.

(iv) The two staff in the wages department make amendments to the computerised wages system in respect of employee holidays, illness, as well as setting up and maintaining all employee records.

(v) The computerised wages system calculates deductions from gross pay, such as employee taxes, and net pay. Finally a list of net cash payments for each employee is produced.

(vi) Cash is delivered to the wages office by secure courier.

(vii) The two staff place cash into wages packets for each employee along with a handwritten note of gross pay, deductions and net pay. The packets are given to the foreman for distribution to the individual employees.

Required:

Compare the responsibilities of the external and internal auditors to detect fraud. (6 Marks)