Topic 9: Systems

| ACCA F8 113

Topic 9: Systems

The Audit Process

Plan Audit

Understand the systems and controls

Confirm the operation of the system

Components

Activities / systems

System notes

CRIME

APIPS

Testing controls

Report on the deficiencies

| ACCA F8 114

Purpose and Importance of Internal Control

Internal controls are the policies and procedures used by directors and managers to help ensure the effective and efficient conduct of the business;

The safeguard of assets

Regulatory compliance

The prevention and detection of fraud and error

The accuracy and completeness of accounting records

The time preparation of reliable financial information

The importance of internal control is quite simply to manage problems that could prevent an organization from achieving its objectives.

| ACCA F8 115

System notes Narrative Notes

This is a document that describes and explains the system

Advantages Disadvantages

The main advantage of narrative notes is that they are simple to record, after discussion with the company these discussions are easily written up as notes.

Additionally, as the notes are simple to record, this can facilitate understanding by all members of the team, especially more junior members who might find alternative methods too complex.

Narrative notes may prove to be too cumbersome, especially if the system is complex.

This method can make it more difficult to identify missing internal controls as the notes record the detail but do not identify control exceptions clearly.

Questionnaires

Internal control questionnaires are used to assess whether controls exist which meet specific objectives or prevent or detect errors and omissions.

Internal control Evaluation questionnaires which lists the objectives, and asks the client how they meet that objective.


Questionnaires are quick to prepare, which means they are a cost effective method for recording the system.

They ensure that all controls present within the system are considered and recorded; hence missing controls or deficiencies are clearly highlighted.

Questionnaires are simple to complete and therefore any members of the team can complete them and they are easy to use and understand.

It can be easy for the company to overstate the level of the controls present as they are asked a series of questions relating to potential controls.

Without careful tailoring of the questionnaire to make it company specific, there is a risk that controls may be misunderstood and unusual controls missed.

| ACCA F8 116

Flow charts

A pictorial of how the system works


Can be prepared quickly. Tend to be easily followed and understood.

Eliminates the need for detailed narrative notes.

It’s difficult to show a graphic illustration for unusual transactions, and narrative notes tend to be better, due to the uniqueness. Major amendments are difficult without a complete redraw.

To validate the system notes the auditor would perform procedures on the documents

Procedures being:

Walk through tests Observations Test data (CAAT’S)

| ACCA F8 117

Internal control components

ISA 315 Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and Its Environment considers the components of an entity’s internal control. It identifies the following components:

C R I M E

Control activities relevant to the audit

Control activities are the policies and procedures that help ensure that management directives are carried out. Control activities, whether within information technology or manual systems, have various objectives and are applied at various organisational and functional levels.

Authorisation

Performance review

Information processing

Physical controls

Segregation of duties

| ACCA F8 118

IT activities

Document counts Sequence checks Arithmetic checks Range checks Batch reconciliations

Systems networked Software update Software and hardware

maintenance Passwords and restricted access Backup

Entity’s risk assessment process

For financial reporting purposes, the entity’s risk assessment process includes how management identifies business risks relevant to the preparation of financial statements in accordance with the entity’s applicable financial reporting framework.

It estimates their significance, assesses the likelihood of their occurrence, and decides upon actions to respond to and manage them and the results thereof.

Information system, including the related business processes, relevant to financial reporting, and communication

The information system relevant to financial reporting objectives, which includes:

accounting system consists of the procedures and records designed and established to initiate records process of information and report entity transactions

Application controls General controls

| ACCA F8 119

Monitoring of controls

Monitoring of controls is a process to assess the effectiveness of internal control performance over time.

It involves assessing the effectiveness of controls on a timely basis and taking necessary remedial actions.

Management accomplishes the monitoring of controls through on going activities, separate evaluations, or a combination of the two.

On-going monitoring activities are often built into the normal recurring activities of an entity and include regular management and supervisory activities.

Control environment

The control environment includes the governance and management functions and the:

Attitudes Awareness Actions

of those charged with governance and management concerning the entity’s internal control and its importance in the entity.

The control environment sets the tone of an organisation, influencing the control consciousness of its people.

The control environment has many elements such as communication and enforcement of integrity and ethical values, commitment to competence, participation of those charged with governance, management’s philosophy and operating style, organisational structure, assignment of authority and responsibility and human resource policies and practices.

| ACCA F8 120

Objective to why we have a system

Objectives of a

system

Revenue

Purchases

Wages

Bank

To ensure

Sales are made to valid customers Sales are recorded accurately All sales recorded Cash collected and allocated on a

timely manner

To ensure

Order are made for a valid purchase

Cost effective Purchases are recorded

accurately All purchases recorded Cash paid and allocated on

a timely manner

To ensure

Cash is safeguarded Minimal cash held on site Payments for authorised business

expenditure only

To ensure

Pay the right people The right wage rate Paid for hours worked Taxes calculated correctly

| ACCA F8 121

Revenue System

Cust

omer

Order Received

Goods Despatched Department

Accounts Department

Copy of pre-numbered order sent to dept.

Weekly order check Order signed by inventory

picker GDN raised and matched

to order signed

Confirm orders in writing Carry out credit checks Establish limits Pre-number orders Exception reports Check inventory levels

before acceptance Discount authorised Standard price list Approval of order

Writing Email Fax Telephone Online

Customer signs GDN to agree goods delivered

Sequentially numbered GDN, review for missing GDN

When happy: right goods, right quality

Invoice Raised

Invoice matched to order and GDN

Unmatched GDN to be reviewed

Invoices signed as agreed to PO, GDN, price list

Recalculation

Invoice sent to Customer

Credit Note Raised If goods were damaged or incorrect

Authorised Tied to invoice Ensure valid Check for sequence

Recorded

Cash Received Cash Recorded Customer happy with goods and invoice paid

Agreed back to invoice Double count Review aged listing Debt chasing

Monthly statements sent out Bank reconciliation Regular banking Segregation of duties

Review receivables for credit balances

Agree back to invoices

Reconciliation Send out customer statements

Copy of order to go to Accounts Dept

When order authorised, it is sent to

Copy of signed GDN sent to Accounts Dept

| ACCA F8 122

Warwick Garden centre Co supplies a wide range of garden products to trade and domestic customers. The company has 7 divisions, with each division specialising in the sale of specific products, for example, seeds, garden furniture, etc... The company has an internal audit department which provides audit reports to the audit committee on each division on a rotational basis.

Products in the seed division are offered for sale to domestic customers via an Internet site. Customers review the product list on the Internet and place orders for packets of seeds using specific product codes, along with their credit card details, onto Warwick Garden centre Co’s secure server. Order quantities are normally between one and three packets for each type of seed. Order details are transferred manually onto the company’s internal inventory control and sales system, and a two part packing list is printed in the seed warehouse. Each order and packing list is given a random alphabetical code based on the name of the employee inputting the order, the date, and the products being ordered.

In the seed warehouse, the packets of seeds for each order are taken from specific bins and despatched to the customer with one copy of the packing list. The second copy of the packing list is sent to the accounts department where the inventory and sales computer is updated to show that the order has been despatched. The customer’s credit card is then charged by the inventory control and sales computer. Bad debts in Warwick Garden centre are currently 5% of total sales.

Finally, the computer system checks that for each charge made to a customer’s credit card account, the order details are on file to prove that the charge was made correctly. The order file is marked as completed confirming that the order has been despatched and payment obtained.

Required:

In respect of sales in the seeds division Warwick Garden centre Co

(a) identify and explain the deficiencies in the sales system

(b) provide a recommendation to alleviate each deficiency

(12 marks)

Apply Your Knowledge 1

| ACCA F8 123

Bank System

Bank

Receive Cash Check for counterfeit Sign it in Deposit in a secure place

Safe Strongroom Locked cashbook

Security locks Swipe cards Night safe Regular banking but not in a pattern

Bank

To be posted in the bank

Receipts Payments

Agreed back to sales invoice documents

Bank regular Review and authorised

Authorised payments Agree back to relevant

documentation

Review from management for reasonableness Segregation of duties Bank reconciliations Customer statement reconciliation Supplier statement reconciliation

Recording

| ACCA F8 124

Purchase system Requisition raised

All requisitions authorised Central purchasing department Review inventory levels first Sequentially numbers requisition pad

Order placed

When authorised, an order is raised

A note internally to an authorised manager asking if an order can be raised

Supp

lier

Order sent to the supplier Requisition note attached and agreed to order Request order confirmation in writing Preferred supplier list Agree quoted price against supplier list

Receipts

Accounts Department

A copy of the order sent to warehouse

Suppliers sends goods

One secure area Update inventory records Review quantity, quality and agree GRN

Copy of GRN signed sent to accounts dept

Invoice received Credit Note Issued

Match invoice to requisition order, GRN

If no GRN ask for proof of delivery

Match to invoice, GRN, order

Recorded

Batch controls on input Recalculate invoice, sign authorise Reconcile to monthly statements

If discrepancies

Cash paid Cash recorded

Stamp invoice to say paid Separate file for paid / unpaid Authorise payments Authorise invoices for

payments

Agree payment back to invoice Allocate to specific invoice Bank reconciliations Supplier statement

reconciliation

Sent from supplier

When happy the invoice is correct and the company have received the goods; cash to be paid

| ACCA F8 125

Apple International Co (Apple) is a manufacturer of mobile phones. It has factories across the country and its customer base includes retailers as well as individuals, to whom direct sales are made through their website. The company’s year end is 30 June 20X3. You are an audit supervisor of Apple & Co and are currently reviewing documentation of Apple’s internal control in preparation for the interim audit.

Apple’s website allows individuals to order goods directly, and full payment is taken in advance. Currently the website is not integrated into the inventory system and inventory levels are not checked at the time when orders are placed.

Goods are despatched via local couriers; however, they do not always record customer signatures as proof that the customer has received the goods. Over the past 12 months there have been customer complaints about the delay between sales orders and receipt of goods. Apple has investigated these and found that, in each case, the sales order had been entered into the sales system correctly but was not forwarded to the despatch department for fulfilling.

Apple’s retail customers undergo credit checks prior to being accepted and credit limits are set accordingly by sales ledger clerks. These customers place their orders through one of the sales team, who decides on sales discount levels.

Raw materials used in the manufacturing process are purchased from a wide range of suppliers. As a result of staff changes in the purchase ledger department, supplier statement reconciliations are no longer performed. Additionally, changes to supplier details in the purchase ledger master file can be undertaken by purchase ledger clerks as well as supervisors.

In the past six months Apple has changed part of its manufacturing process and as a result some new equipment has been purchased, however, there are considerable levels of plant and equipment which are now surplus to requirement. Purchase requisitions for all new equipment have been authorised by production supervisors and little has been done to reduce the surplus of old equipment.

Required:

In respect of the internal control of Apple International Co:

i. Identify and explain FIVE deficiencies; ii. Recommend a control to address each of these deficiencies; and

iii. Describe a test of control Apple & Co would perform to assess if each of these controls is operating effectively.

(15 marks)

ACCA ©Q1 June 12


| ACCA F8 126

Wage system

When company are happy hours marked have been paid at the right rate

New staff, change in details need to update

Do the work; submit Timesheets

Empl

oyee

s

Supervise clock in and clock out Head count Registers Authorisation of timesheet

Accounts Department

When timesheets authorised, they are sent to

Standing data input Processing the wage

Monthly print of changes reviewed and authorised by management

Data about employees printed and reviewed on a regular basis

Password, restricted access to the data

Complete a joiners / leavers form

Recalculate wages Recalculate tax deductions Exception reports Review and authorisation from

management

Recorded

Wage clerk signs print out that double entry has been done Check the amounts agree Sign amendment sheets when updated on accounting system Management review for reasonableness

Standing data input

Cash 2 people present Employees signs receipt of cash Agree back to wage accounts Wage control account

BACS / Cheque Authorised signatory Agree back to wage accounts Wage control account

| ACCA F8 127

Introduction and client background

You are the audit senior of Chartwells & Co and your team has just completed the interim audit of Witch Industries Co, whose year end is 31 March 20X3. You are in the process of reviewing the systems testing completed on the payroll cycle, as well as preparing the audit programmes for the final audit.

Witch Industries Co manufactures circuit boards and the manufacturing process is predominantly automated; however there is a workforce of 50 employees, who monitor the machines, as well as approximately 35 employees who work in sales and administration. The company manufactures 24 hours a day seven days a week.

Below is a description of the payroll system along with deficiencies identified by the audit team:

Factory workforce

The company operates three shifts every day with employees working eight hours each. They are required to clock in and out using an employee swipe card, which identifies the employee number and links into the hours worked report produced by the computerised payroll system. Employees are paid on an hourly basis for each hour worked. There is no monitoring/supervision of the clocking in/out process and an employee has witnessed employees using their employee swipe cards.

The payroll department calculates on a weekly basis the cash wages to be paid to the workforce, based on the hours worked report multiplied by the hourly wage rate, with appropriate tax deductions. These calculations are not checked by anyone as they are generated by the payroll system. During the year the hourly wage was increased by the Human Resources (HR) department and this was notified to the payroll department verbally.

Each Friday, the payroll department prepares the pay packets and physically hands these out to the workforce, who operate the morning and late afternoon shifts, upon production of identification. However, for the night shift workers, the pay packets are given to the factory supervisor to distribute. If any night shift employees are absent on pay day then the factory supervisor keeps these wages and returns them to the payroll department on Monday.

Sales and administration staff

The sales and administration staff are paid monthly by bank transfer. Employee numbers do fluctuate and during August, two administration staff joined; however, due to staff holidays in the HR department, they delayed informing the payroll department, resulting in incorrect salaries being paid out.

Required:

For the deficiencies already identified in the payroll system of Witch Industries Co:

i. explain the possible implications of these; and ii. suggest a recommendation to address each deficiency.

(12 marks)


| ACCA F8 128

Inventory

Supplier Returned Goods

Sent to separate

area

Goods received

Set location Signed for by manager Agree quantity and quality to order

Warehouse

Goods coming in accepted

If damaged goods

Standing data input Organised Security / Reg

Rotation Bins Shelves

Sprinklers Fire alarms CCTV Restricted access Temp regulations

Staff count in pairs Inventory sheets pre-

numbered Signed Close down warehouse for

count Mark inventory when

counted Write in pen Random second counts Staff don’t count area they

are responsible for

Good

stor

ed

Goes into production

Requisitions requested

The right quality and quantity

Agree to requisition Customer

GDN agree items to order Signed by authorised person Sequentially numbered order pads

Good despatched Customer signs for receipt

of goods

Goods of a good quality and right quantity

| ACCA F8 129

On the day of the inventory count, you attended depot nine at Zeeshan. You observed the following activities:

1. Prenumbered count sheets were being issued to client’s staff carrying out the count. The count sheets showed the inventory ledger balances for checking against physical inventory.

2. All count staff were drawn from the inventory warehouse and were counting in teams of two.

3. Three counting teams were allocated to each area of the stores to count, although the teams were allowed to decide which pair of staff counted which inventory within each area. Staff were warned that they had to remember which inventory had been counted.

4. Information was recorded on the count sheets in pencil so amendments could be made easily as required.

5. Any inventory not located on the pre-numbered inventory sheets was recorded on separate inventory sheets which were numbered by staff as they were used.

6. At the end of the count, all count sheets were collected and the numeric sequence of the sheets checked the sheets were not signed.

Required:

i. List Four deficiencies in the control system for counting inventory at depot nine. ii. For each deficiency, explain why it is a deficiency and state how that deficiency can be overcome.

(8 marks)


| ACCA F8 130

Reporting to those charged with governance

The Auditors will communicate deficiencies in the internal controls to those charged with governance and management.

This will be communicated via a management letter or report to management.

Auditors Address

Client Address

Dear Sirs

Please find enclosed an appendix of the deficiencies highlighted on the audit, the potential impact of those deficiencies and recommendations to manage these deficiencies.

If you should have any questions please do not hesitate to contact me.

Yours sincerely

Auditor

Report to management

To:

From:

Date:

Heading:

This report details the deficiencies found while on the audit of XYZ Ltd, the impact the deficiencies may have on the business and recommendations to improve the internal controls

Letter

| ACCA F8 131

Identify Deficiency Impact / why / consequence Recommendation

The question will tell you the issue, or it may be that the system is lacking a control that should be there Lack of authorisation Lack of review Lack of segregation on duties

Poor systems will lead to errors in the financial statement, errors regarding customers and suppliers which could lead to loss of goodwill and therefore revenue and discounts Risk of misappropriation of assets

Authorisation Performance review Information processing Physical controls Segregation of duties

Topic 9: Systems

Documents

Transcript of Topic 9: Systems