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AUD 610











CASE 1 a. List FIVE sources of information that would be of use in gaining an understanding of Sunny Stores, and for each source describe what you would expect to gain. (5 marks)

1. Previous Auditors The interviews with previous partners and audit staff to learn of their experiences when auditing Sunny Stores can help us to gain the information and data of the business. It helps us to get information regarding any disputes with management and the quality of the clients controls over its operations. However, Sunny Stores permission is required before we can meet with the previous auditor and interviewed them because of the confidentiality of the information.

2. Annual report and annual return An annual report is a comprehensive report on a company's activities that had been publicized to the public throughout the preceding year. Annual reports are intended to give shareholders and other interested people e.g the public, information about the company's activities and financial performance. Most jurisdictions require companies to prepare and disclose annual reports, and many require the annual report to be filed at the company's registry due to public concern regarding management of companys funds and transparency of the companys affairs. Information we get are CSR activities, future plans, internal control activities, compliance information and core business activities of Sunny Stores. 3. Preliminary interviews with management and employees These interviews can be helpful in understanding the operational

management of Sunny Stores. Personal interviews can also be helpful in analyzing the frankness or evasiveness of management in dealing with important company issues affecting their performance. Information we get from internal people include operational knowledge on how to run Sunny Stores daily, employees benefit and their job description at Sunny Stores. 4. News media and Web searches Information about the company and its management may be available in financial journals, magazines, industry trade magazines, or more importantly

on the Web. Sunny Stores surely provide lots of input in their website to attract potential investor for the expansion of business e.g share price, dividends distributed, profit earning after tax, MOU with suppliers, new product launch and R&D activities.

5. Public databases Computerized databases can be searched for public documents dealing with management or any articles on the company. Similarly, public databases can be searched for the existence of legal proceedings against the company or key members of management. The public document might have information about level of management integrity or managements involvement in potential illegal activities. 6. Independent Sources of Information. The sources include Independent, private investigations, e.g., those done by a private investigation firm used when low level of transparency of business activities adopted by the company. Past filings with regulatory agencies such as the SEC and CCM provide information on business activities and their financial performance. Inquiries of federal regulatory agencies although this is not a primary source of information, the auditor may have reason to make inquiries of specific regulatory agencies regarding pending actions against the company or the history of regulatory actions taken with respect to the company, Sunny Stores and its management.

b. Using the information provided, describe FIVE audit risks and why it posed a risk to Sunny Stores. (10 marks) 1. Treatment of capital and revenue expenditure The risk here could relate to existence of property, plant, and equipment if capital expenditure has been expensed rather than capitalized in the statement of financial position. When this happened, it will overstated the expenses and affect the financial statement materially e.g refurbishment programme expenditure. 2. Valuation of inventory It become the risk for Sunny Stores when, for example, there are considerable levels of aged inventory and incorrect valuation of inventory basis used to record it. Wrong basis to value of inventory recorded affect the financial position of Sunny Stores.

3. The integrity of employees Sunny Stores will be performing a year-end inventory count at the central warehouse as well as at all 22 supermarkets it own. Integrity of the employees in stock count become the risk to Sunny Stores because with big amount of inventory Sunny Stores have, its employees will sometimes take shortcut to count the inventory thus resulted with incorrect amount of stock reported. Therefore, underestimated amount of inventory will materially affect the financial statement. 4. Employees experience and knowledge possessed For example, the inexperience of key employees may affect the preparation of the financial statements of the entity. Less experience staff at the finance department might having problem to maintain the financial records effectively e.g unrecorded transaction, omission of records, wrongly recorded account but correct amount and etc. 5. Unusual pressures on employees For example, circumstances that might predispose employees to misstate the financial statements, such as the entity that lacks sufficient human capital to continue operations and work overloaded that face by Sunnys Stores employees at the head office. The increased workload will demotivate employees and unable to completed their job especially the financial records thoroughly due to job redundancy. Thus, it will result with incomplete financial transaction records by the employees at finance department that will affect the financial statement of Sunny Stores.

6. The nature of the entity's business, for example, the potential obsolescence of its inventory, the significance of related parties and the number of locations and geographical spread of its production facilities.

c. Explain the auditors response (what would the auditor do in response to the risk) to each risk in planning the audit of Sunny Stores. (10 marks) Auditors responses should focus on how the team will obtain evidence to reduce the risks identified to an acceptable level. Their objective is confirming whether the financial statement assertions have been adhered to, and whether the financial statements are true and fair. Responses are not as detailed as audit procedures; instead they relate to the approach the auditor will adopt to confirm whether the transactions or balances are materially misstated. 1. Treatment of capital and revenue expenditure recognized the expenditure on the basis of Financial Reporting Standards that has been approved by the board 2. Valuation of inventory comparing market price with real allowable cost that incurred 3. The integrity of employees physical visit at the central warehouse and supermarkets during the stock count day, re-calculate the actual records and comparing with the physical balances of inventory 4. Employees experience and knowledge recommend training and seminar on new financial reporting standards, workshop done by experienced accountant and auditor 5. Unusual pressures on employees segregation of duties and recommend for increase number of employees at finance department of the head office 6. The nature of the entity's business regular monitoring and inspection of inventory and limiting access to physical assets at the warehouse

d. The finance director of Sunny Stores is considering establishing an internal audit department. Describe the factors the finance director should consider before establishing an internal audit department. (5 marks) 1. Increasing risk, such as complex or highly regulated transactions This might trigger the finance director of Sunny Stores the need for the IA control to be deployed. For example you would therefore, expect banks to have IA departments since some of the transactions they handle are complex (accounting for financial instruments) and they operate in a regulated industry. This might happened with Sunny stores after the expansion plans completed. 2. Number of employees

For example, one factor the number of employees might indicate risks directly (a large volume of payroll transactions to process) but, more significantly, it indicates size and complexity, so perhaps widespread locations with complex reporting lines and less shared culture (of risk awareness, or of integrity). 3. Scale, diversity and complexity of the companys operations The presence of diversified and complex operation of Sunny Stores after expansion plans is the finance director concern due to fraud and error might happen. Internal auditor can help to reviews companys activities continually and is directly concerned with the prevention of fraud in any form of activity reviewed by them. 4. Cost-benefit considerations The cost of introducing the internal audit function will become the utmost concern of the finance director due to the usage of financial resources to hire the internal auditor. The benefit from this function must over shadow the cost of financial resources used e.g improved operational performance, reduction of waste and idle time in production, boosting inventory management, confirmation on accomplishment of Sunny Stores objectives and goals in the future and effective internal control of management of financial activities. Therefore, the qualitative benefits might affect the judgment of the finance director to come out with decision.

5. Problems with internal control systems Finance director can introduce internal audit function with basis of it helps Sunny Stores to accomplish its objectives by bringing a systematic, disciplined approach to evaluate and improve the effectiveness of risk management, internal control and corporate governance. Internal reviews of accounting controls are important and the presence of internal audit help to strengthened the management controls over financial activities. 6. Changes in organizational structure, changes in key risks and increased number of unexplained or unacceptable events