5.

27 In the planning of the audit, there will be a greater focus on accounts

receivable and inventory due to the following.
 Accounts receivable—the higher than expected days outstanding indicates
possible bad or doubtful debts that may not be adequately provided for,
resulting in the risk of overstatement of accounts receivable.
 Inventory turnover—the discrepancy between the actual inventory turnover
figure and all the comparatives indicates that the auditor should investigate
inventory further. The increase in the inventory turnover may indicate to the
auditor that the inventory is being run down, with a risk of stock outs or that,
due to heavy discounting to sell the stock, inventory is valued above the lower
of cost and net realisable value.
There is also a risk that accounts receivable are overstated because of an
increase in sales. The risk is that sales are fictitious or revenue is
inappropriately recognised, contributing to the increase in days in
receivables discussed above. The auditor would look at the income
statement, compare sales to budget and investigate large fluctuations.
The current ratio is in line with budget, past experience, industry average
and the general rule of thumb benchmark of 2. The increase in accounts
receivable and the decrease in inventories seem to cancel each other out.
Therefore, based only on the preliminary analytical procedures, the auditors
would not focus greater attention on current assets or liabilities.
Similarly, the drop in the debt to equity ratio is probably not significant
enough to warrant special attention and its actual level of 0.36 does not
indicate a high dependence on debt.
5.29 The results of the ratio analysis undertaken as part of your analytical
procedures may include the following ratios:
Ratios 2013 2014 2015
Current ratio 2.7 2.2 1.8
Quick asset ratio 1.3 1.2 0.9
Receivables turnover ratio * 8.4 5.75
Days in receivables * 43.2 days 63.5 days
Inventory turnover ratio * 4 3.1
Return on total assets 0.44 0.43 0.31
Return on shareholders’ 1.6 2 2.5
equity
Debt/Equity 2 2.4 4
Gross profit ratio 0.47 0.47 0.43
Net profit ratio 0.27 0.26 0.22

* Turnover ratios have not been calculated for 2013, as opening balances are
not available to calculate average receivables or average inventory.
An analysis of these ratios indicates the following:
 The current ratio and quick asset ratio have decreased significantly and
are below the usual benchmarks of 2 for current ratio and 1 for quick
asset ratio. This indicates liquidity problems that may lead to going
concern problems as Meteor currently has insufficient liquid assets to
meet its current liabilities. In addition, these ratios may actually be worse
based on the possible overstatement of receivables and inventory
discussed below.
 The inventory turnover ratio is at a relatively low level and has
deteriorated, while sales have increased over the three years. The auditor
needs to investigate the reasons for this situation, which may indicate the
possibility of obsolete or slow-moving inventory. Given that sales and
inventory levels have increased and gross profit ratio has decreased,
there is also a possibility that some of the obsolete or slow-moving
inventory was cleared at discounted prices.
 The receivables turnover ratio has decreased significantly indicating
possible collection problems, resulting in bad or doubtful debts.
Correspondingly, the days in receivable, which has increased over the
two-year-period from 43.2 days to 63.5 days, needs to be compared to the
 company’s terms of trade and the cause of the deterioration in the
receivables turnover investigated.
 The debt/equity ratio has increased significantly and is now at a
dangerously high level, indicating the company’s very high reliance on
debt compared to equity. The cause for increased dependence on debt
and the company’s ability to repay the debt needs to be investigated, as it
may give rise to going concern problems.
 All profitability ratios, except the return on equity, have deteriorated over
the three years. The increase in return on equity is due to the company’s
higher reliance on debt compared to equity, as is evident from increased
debt/equity ratio.

7.17

(a) Internal control weakness (b) Internal control improvements

Other departments can raise
requisitions for goods and
services without proper
authorisation.
Pre-numbered requisitions orders
should be raised and signed by
authorised personnel. Requisitioning
authority should be related to authority
and function. A signed requisition order
should be required before raising
purchase orders.
Purchase orders are
unnumbered and unaccounted
for.
Purchasing department obtains
goods and services as soon as the
requisition is received, without
checking for the best deal.
Blank purchase orders are
accessible to all purchasing staff
and open to theft and
misappropriation.
Pre-numbered purchase orders should
be signed by an authorised purchasing
department staff member and a copy
forwarded to the requisitioner, goods
receiving and accounts departments.
Pre-numbered purchase orders should
ensure completeness.
Orders should be placed with approved
suppliers on the best terms and quality.
Blank purchase orders should be kept in
a secure place to avoid misuse and
should be accounted for; that is, checked
for sequential continuity.
7.18 (a) Strengths
 Orders are subject to various edit checks on the terminal. Only those
orders satisfying all edit criteria except the credit limit test are accepted.
 Credit limits on orders are reviewed by the credit control clerk for
approval. Data failing any other edit criteria is not accepted by the
system.
 Rejected orders are noted by the data entry clerk and passed to the
department’s supervisor for investigation.
 Segregation of duties in receiving, entering, checking and picking orders.
 The storeperson initials the picking slip prior to forwarding it together
with the goods to dispatch.
 The dispatch clerk agrees the picking slip to physical goods picked.
 The accounts receivable master file is updated daily.
(b) Weaknesses and consequences
 Sales orders via telephone are accepted without documentary evidence—
possibility of fictitious orders.
 The dispatch clerk agrees the picking slip with quantities noted to
physical goods picked—possibility of misappropriating any extra goods
picked or ticking quantities on the picking slip as correct without
counting goods picked physically.
 The dispatch clerk makes adjustments for stock-outs without verifying
the details—possibility of theft by the stockperson or someone else.
 Lack of segregation of duties—the dispatch clerk prints the invoice, not
someone in the accounts payable department, after verifying approved
sales order with goods dispatched. Delivery docket (invoice) endorsed by
the customer is given back to the dispatch department. Goods may be
sold to a related party of dispatch supervisor/clerk, who may then
destroy the picking slip and the returned delivery docket (invoice).
(c) The control risk relating to Acid’s sales system will be assessed as
medium, as there are some controls that may be able to be relied upon, but
also major weaknesses around the dispatch clerk.
7.19 (a) Strengths
 Payments are received by cheques and not cash.
 Cash receipts report is printed daily.
 All cheques are agreed to the cash receipts report.
 Cheques are deposited daily.
 Accounts receivable master file is updated daily.
(b) Weaknesses and consequences
 Sales representatives may obtain cheques directly from customers. Sales
representatives may pocket the cheques.
 Whoever opens the mail does not prepare a list of cheques received—
cheques may be misappropriated.
 If inadequate details are provided, the credit control clerk allocates the
receipts to the oldest balance first—oldest balance may be disputed.
 Lack of segregation of duties—the credit control clerk performs several
incompatible tasks, such as approving/reviewing the customer credit;
receiving and crossing cheques; recording; printing cash receipts report;
preparing bank deposit slip; and banking the cheques—high possibility of
misappropriation.
(c) The control risk relating to Cannon’s cash receipts system will be
assessed as high, due to the weaknesses in internal control.
7.20

A)

(i) Control activity (ii) Explanation (iii) Key

assertion
Segregation of duties in The segregation of duties Completeness of
recording and handling makes the theft of cash cash
cash receipts (one difficult (unless there is
employee compares the collusion). Comparing the
cheque with the cheque received with the
remittance advice and remittance advice ensures
forwards the cheque, a that payments are
different employee complete.
prepares a list of cash
receipts).
Monthly bank Prompt attention to Completeness of
reconciliations by an reconciliation of cash cash
employee who is not records makes detection of
responsible for receiving errors or frauds easier.
cash.
Authorisation of sales All sales returns and Occurrence of
returns and allowances allowances must be sales
authorised by a person who
has an appropriate level of
authority (i.e. the financial
controller).
Authorisation of bad debt Bad debts can be written off Valuation and
write-off only by the financial allocation of
controller after discussion accounts
with the credit manager. receivable and
occurrence of
bad debt
expense
B)

(i) Internal (ii) Account (iii) Assertion (iv) Justification

control balance at risk
weakness at risk
Sales orders Sales Occurrence There is no externally
may be generated
received orally. documentary
Accounts Existence
evidence of a
receivable
customer order.
Hence fictitious sales
may be generated.
There is no Accounts Valuation and Sales staff can
credit approval receivable allocation increase sales by
required for selling to customers
customers who may not be able
Provision for Completeness
prior to sales to pay their debts.
doubtful
being debts
processed.
Although sales Sales Completeness Accounting for a
orders are pre- sequence of sales
numbered, orders can ensure
there is no that records are
sequence check complete. Without
completed. this control, all sales
may not be recorded
in the accounts.
8.25 (a)
Control
Unit price is automatically
generated and cannot be
overridden by the purchasing
clerk.
Quantity of goods received cannot
be overridden by the purchasing
clerk.
Staff passwords must be changed
on first time log in and then every
90 days.
CAAT
Process a dummy (test transaction)
order and attempt to override the unit
purchase price.
Create a dummy (test transaction)
order and attempt to override the
quantity received.
Test security controls by selecting
random user profiles from the
spreadsheet and attempt to access the
system by using initially allocated
passwords.

(b) The documentation required in the working papers could include:

 CAATs objectives
 staffing to be used
 details of the tests performed
 audit findings
 audit conclusions.
8.26
Risk Assertion IT CAAT
at risk application
control
Possible Occurrence Authorised 1. Identify the access
existence users of the mechanism (security roles or
of ghost HRMIS are profiles) required to perform
(fictitious) segregated each of the functions that should
employees between those be segregated (in this case, the
who can ‘create new employee’ and
create ‘initiate/process pay-run’
employees, functions).
and those who 2. Get the computer to sort user
can initiate accounts by function into two
and process a separate lists (i.e. a ‘create new
pay-run. employee’ list and an
‘initiate/process pay-run’ list).
 3. Merge the lists to identify any
users who are present on both
lists (this would also include
identifying any training or
super-user logins that may exist
in the live system).

Incorrect Accuracy The HRMIS Create a dummy employee and

calculation automatically process to see if system
of calculates automatically calculates pay
payments employees’ correctly.
monthly
payments
based on
salary and tax
rates.