April, 2010 [CAT PAPER 8 IMPLEMENTING AUDIT PROCEDURE

Class exercise for Session 8

Exercise 1- Non-current Assets
Ruby Co produces kitchen units from factory premises, and prepares annual
financial statements to 31 December. Its board comprises four directors, there
being a managing director and directors of sales, production and finance &
administration. The company employs only one buyer who reports directly to the
managing director. Ruby Co exercises the following controls over the acquisition
of tangible non-current assets:

1. In October, the directors and the buyer meet to discuss the tangible non-
current asset requirements of each functional area. At the end of the meeting an
agreed list of acquisitions is approved and a copy is retained by all attendees.

2. The buyer is then required to contact potential suppliers of the approved

acquisitions to obtain confirmation of availability, and the lowest price for
inclusion in the company’s tangible non-current assets expenditure budget for the
forthcoming year.

3. In December, the directors and the buyer meet again to formalise and approve
the tangible non-current asset expenditure budget. Following the meeting, a
schedule is produced detailing approved acquisitions by category, expected
month of purchase and budgeted cost as obtained by the buyer. The schedule
then forms the basis of the tangible non-current assets expenditure budget of
Ruby Co for the forthcoming year.

4. Throughout the new year, on a monthly basis, without prior consultation the
buyer places orders with suppliers ensuring that assets are acquired in the month
as budgeted. As part of his remuneration package, the buyer is entitled to bonus
payments equating to 10% of any saving he can negotiate on budgeted costs.
Consequently assets may not necessarily be purchased from the suppliers
contacted by the buyer for budgeting purposes.

5. The buyer normally places orders to purchase by a simple e-mail message.

However where required by suppliers he provides orders by way of a letter,
which he signs.

Nguyen Thu Hang (BCom, CPA Aus ASA) Page 1

 April, 2010 [CAT PAPER 8 IMPLEMENTING AUDIT PROCEDURE

6. Having placed an order, the buyer calculates his bonus entitlement and
forwards a copy of the calculation together with a copy of the order
documentation to the managing director. He reviews this against his copy of the
budget, prior to authorising as appropriate and forwarding to the accounts
department for payment of the bonus as part of the buyer’s monthly salary.

Required:

(a) State FOUR objectives of the internal controls that should be exercised over
the acquisition of tangible non-current assets. (4 marks)

(b) With regard to the tangible non-current assets acquisition system of Ruby Co:

(i) Identify FOUR weaknesses in the system; (4 marks)

(ii) Describe the implications of each weakness identified; and (6 marks)

(iii) Recommend improvements to address the weaknesses. (6 marks)

(c) Explain the purpose of a tangible non-current assets register, describe its
contents and state how it should be used by a company. (5 marks)

(Extracted from Past paper Dec 2008)

Nguyen Thu Hang (BCom, CPA Aus ASA) Page 2

 April, 2010 [CAT PAPER 8 IMPLEMENTING AUDIT PROCEDURE

Exercise 2-Inventory
Starling Co manufactures a range of vacuum cleaners, operates from large
factory premises and prepares its annual financial statements to 31 January. It
has a stores area from which raw materials and parts are issued to production,
and a finished goods store. In recent months the company has encountered
severe difficulties in controlling its inventory resulting in losses, stopped
production due to the shortage of parts and incorrect valuation of inventory.

The company has been using a system of continuous inventory checking (also
known as a ‘perpetual inventory system’) as a means of control, but the directors
recognise that the system has failed during the current year.

Consequently they have agreed that company employees will carry out a
physical inventory count as at 31 January 2008, as a basis for valuing inventory
for inclusion in the company’s annual financial statements. The directors have
also agreed to seek advice from your audit firm in connection with the
introduction of a satisfactory system of continuous inventory checking to be
introduced from February 2008 and also in connection with the valuation of
inventory.

Required:

(a) State FIVE objectives of the internal controls that should be exercised over
inventory, including inventory records. (5 marks)

(b) State FIVE procedures that Starling Co will need to incorporate in its revised
continuous inventory checking system, if it is to be relied upon by the company’s
auditors. (5 marks)

(Extracted from Past paper Dec 2007)

Nguyen Thu Hang (BCom, CPA Aus ASA) Page 3

 April, 2010 [CAT PAPER 8 IMPLEMENTING AUDIT PROCEDURE

Exercise 3
Righton Knitwear Co sells knitwear products of all types to shops. You are taking
part in the audit for the year ended 31 December 20X6 and you have been asked
to consider the audit work which should be performed on the company’s sales
system. Although most sales are on credit, there are some customers who are
too small and whose purchases are too infrequent to have a sales ledger account
with Righton. They are able therefore to order goods and pay in cash for the
goods when they collect them.

You have ascertained the following system for credit sales and cash sales

Credit sales

(a) Cash and cheques for credit sales are received in the post, which is
opened by two people. They make a record of all the cheques and cash
received, which are then handed over to the cashier.

(b) The cashier records the moneys received in the cash book, banks them
and reports them to the sales accounts department

(c) The sales accounts department posts the cash and cheques received to
the sales ledger

(d) Credit notes are sent to customers and posted to the sales ledger only
after thay have been authorised

Cash sales

(a) The customer places an order with the sales department; the sales
department prepares a pre-numbered multi-copy advice note

(b) The order is put together by the despatch department and this is handed
over to the customer along with a copy of the advice note

(c) The customer submits the advice note to the cashier; the cashier prepares
a sales invoice by hand.

(d) The cashier receives payment from the customer by cheque or in cash

(e) The monnies are recorded and banked by the cashier

Nguyen Thu Hang (BCom, CPA Aus ASA) Page 4

 April, 2010 [CAT PAPER 8 IMPLEMENTING AUDIT PROCEDURE

Required:

(a) (i) Consider why 2 people should open mail containing cash and cheques
from customer

(ii) State the audit procedures you would undertake while atttending the mail
opening and follow up of the cheque banking (7 marks)

(b) (i) What are the main reasons for the issue of credit notes?

(ii) How would you go about testing whether all credit notes had been issued
for a valid reason and had been authorised? (9 marks)

(c) (i) Point out the weakness in the cash sales system described above

(ii) In order to check that there is no material fraud or error in operation, what
audit tests would you perform on this system?. (9 marks)

(Extracted from Exam question Bank)

Nguyen Thu Hang (BCom, CPA Aus ASA) Page 5

 April, 2010 [CAT PAPER 8 IMPLEMENTING AUDIT PROCEDURE

Exercise 4- Non-current assets

Recruitment Co is a limited liability company which operates as a prestigious,
executive recruitment agency. Its most recent financial statements are those for
the year ended 31 March 2005. The directors of the company have developed a
strong control environment in the company and have introduced effective internal
controls. These include the review of monthly management accounts at formal
monthly board meetings and the use of a non-current assets register.

The company has 36 employees, most of whom are provided with an executive
type of company car. It is company policy to purchase only new cars and to
replace them when they are two years old. Employees are allowed to purchase
replaced cars, and they do so by forwarding sealed bids to the company as and
when replaced cars become available.

To protect the company from receiving only low bids from employees, sealed
bids are also received from independent motor car dealers.

During the year ended 31 March 2005 the company purchased large quantities of
office furniture, as part of an ongoing expansion programme. This included
$30,000 of furniture which was ordered on 18 February 2005 but in respect of
which the company had not been invoiced by 31 March 2005. The company’s
accounting records show that the furniture was delivered on 31 March 2005 and
that the associated supplier invoice was received on 31 May 2005, some two
weeks after the company’s financial statements were presented for audit.

Required:

(a) State FOUR objectives of the internal controls that should be exercised over
non-current assets. (4 marks)

(b) Explain how Recruitment Co’s non-current assets register, if properly

maintained, may be used by the company to facilitate control over non-current
assets. (4 marks)

(c) (i) Explain why it is particularly important that there should be strong internal
controls over the disposal of cars by Recruitment Co; (3 marks)

Nguyen Thu Hang (BCom, CPA Aus ASA) Page 6

 April, 2010 [CAT PAPER 8 IMPLEMENTING AUDIT PROCEDURE

(ii) Suggest FIVE internal controls that Recruitment Co should employ over the
disposal of cars. (10 marks)

(d) With regard to the delivery of office furniture to Recruitment Co on 31 March

2005:

(i) State how Recruitment Co should have reflected the transaction in its
accounting records; (2 marks)

(ii) Briefly describe TWO procedures the company’s auditors should carry out to
verify that the delivery occurred on that date. (2 marks)

(Extracted from past exams paper June 2005)

Nguyen Thu Hang (BCom, CPA Aus ASA) Page 7