The 5 components of Internal Control 2 / 2

Sample
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Question 18a

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 which help ensure that management directives are carried out.

Required:
Describe FOUR different types of control activities and, for each type, provide an example control a company may implement. (4 marks)

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Question 5a

You are an audit senior of Scarlet & Co and are in the process of reviewing the systems testing completed on the payroll cycle of Bronze Industries Co (Bronze), as well as preparing the audit programmes for the final audit.

Bronze operate several chemical processing factories across the country, it manufactures 24 hours a day, seven days a week and employees work a standard shift of eight hours and are paid for hours worked at an hourly rate. Factory employees are paid weekly, with approximately 80% being paid by bank transfer and 20% in cash; the different payment methods are due to employee preferences and Bronze has no plans to change these methods. The administration and sales teams are paid monthly by bank transfer.

Factory staff are each issued a sequentially numbered clock card which details their employee number and name. Employees swipe their cards at the beginning and end of the eight-hour shift and this process is not supervised. During the shift employees are entitled to a 30-minute paid break and employees do not need to clock out to access the dining area. Clock card data links into the payroll system, which automatically calculates gross and net pay along with any statutory deductions. The payroll supervisor for each payment run checks on a sample basis some of these calculations to ensure the system is operating effectively.

Bronze has a human resources department which is responsible for setting up new permanent employees and leavers. Appointments of temporary staff are made by factory production supervisors. Occasionally overtime is required of factory staff, usually to fill gaps caused by staff holidays. Overtime reports which detail the amount of overtime worked are sent out quarterly by the payroll department to production supervisors for their review.

To encourage staff to attend work on time for all shifts Bronze pays a discretionary bonus every six months to factory staff; the production supervisors determine the amounts to be paid. This is communicated in writing by the production supervisors to the payroll department and the bonus is input by a clerk into the system.

For employees paid by bank transfer, the payroll manager reviews the list of the payments and agrees to the payroll records prior to authorising the bank payment. If any changes are required, the payroll manager amends the records.

For employees paid in cash, the pay packets are prepared in the payroll department and a clerk distributes them to employees; as she knows most of these individuals she does not require proof of identity.

Required:
(a) Identify and explain FIVE internal control STRENGTHS in Bronze Industries Co’s payroll system. (5 marks)

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Question 2a

ISA 315 Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and Its Environment describes the five components of an entity’s internal control.

Required:
Identify and briefly explain the FIVE components of an entity’s internal control. (5 marks)

Specimen
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MC Question 4

Application controls are manual or automated procedures that operate over accounting applications to ensure that all transactions are complete and accurate

Which TWO of the following are application controls?

1 Password protection of programs
2 Batch controls
3 One for one checking
4 Regular back up of programs

A. 1 and 4
B. 3 and 4
C. 1 and 2
D. 2 and 3

Specimen
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MC Question 12

ISA 315 Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and Its Environment sets out the five components of internal control.

Which of the following is NOT set out as a component of internal control within ISA 315?

A. Control environment
B. The information system relevant to financial reporting
C. Human resource policies and practices

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Question 2a

ISA 315 Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and Its Environment requires auditors to understand the entity’s internal control. An entity’s internal control is made up of several components.

Required:

State the FIVE components of an entity’s internal control and give a brief explanation of each component. (5 marks)

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Question 4c

The EuKaRe charity was established in 1960. The charity’s aim is to provide support to children from disadvantaged backgrounds who wish to take part in sports such as tennis, badminton and football.

EuKaRe has a detailed constitution which explains how the charity’s income can be spent. The constitution also notes that administration expenditure cannot exceed 10% of income in any year.

The charity’s income is derived wholly from voluntary donations. Sources of donations include:

(i) Cash collected by volunteers asking the public for donations in shopping areas,
(ii) Cheques sent to the charity’s head office,
(iii) Donations from generous individuals. Some of these donations have specific clauses attached to them indicating that the initial amount donated (capital) cannot be spent and that the income (interest) from the donation must be spent on specific activities, for example, provision of sports equipment.

The rules regarding the taxation of charities in the country EuKaRe is based are complicated, with only certain expenditure being allowable for taxation purposes and donations of capital being treated as income in some situations.

Required:

Explain why the control environment may be weak at the charity EuKaRe. (4 marks)

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