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Auditing study guide 2021
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BCOM IN ACCOUNTING
AUDITING 3A
STUDY GUIDE
2021
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Table of Contents
1.
About Brand........................................................................................................................... 6
2.
Our Teaching and Learning Methodology ............................................................................. 7
Icons......................................................................................................................................... 8
3.
Introduction to the Module................................................................................................... 9
Module Purpose ...................................................................................................................... 9
Outcomes .............................................................................................................................. 10
Assessment ............................................................................................................................ 12
Planning Your Studies ............................................................................................................ 13
4.
Prescribed Reading .............................................................................................................. 13
Prescribed Book ..................................................................................................................... 13
5.
Module Content .................................................................................................................. 14
Study Unit 1: Internal Control and Tests of Control .............................................................. 15
5.1.1 Introduction ......................................................................................................................... 15
5.1.2 The importance of internal controls in business ................................................................. 15
5.1.3 Definition of internal control and internal control systems ................................................ 16
5.1.4 Components of internal control .......................................................................................... 16
5.1.5 Tests of control .................................................................................................................... 19
5.1.6 Conclusion ........................................................................................................................... 20
5.1.7 Self-Evaluation Questions.................................................................................................... 20
Study Unit 2: Audit Risk and Substantive Procedures ........................................................... 23
5.2.1 Components of audit risk .................................................................................................... 23
5.2.2 Differences between audit risk and business risk ............................................................... 24
5.2.3 Identification and assessment of risk .................................................................................. 25
5.2.4 How to respond to risk at financial statement level and account balance level ................. 26
5.2.5 Nature, timing and extent of audit procedures................................................................... 27
5.2.6 Substantive procedures and tests of controls ..................................................................... 27
5.2.7 Formulating substantive procedures................................................................................... 29
5.2.8 Self-Evaluation Questions.................................................................................................... 30
Study Unit 3: Auditing Revenue Receipt Transactions and Balances .................................... 31
5.3.1 Sources of income and source documents.......................................................................... 31
5.3.2 Activities in accounting systems for sales, receipts and accounts receivables ................... 33
5.3.3 Internal control measures for the control of sales, receipts and accounts receivables ...... 33
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5.3.4 Assertions for the control of sales, receipts and accounts receivables .............................. 34
5.3.5 Tests of controls .................................................................................................................. 36
5.3.6 Audit objectives ................................................................................................................... 37
5.3.7 Substantive audit procedures for sales ............................................................................... 38
5.3.8 Debtors’ circularization ....................................................................................................... 40
5.3.9 Self-Evaluation Questions.................................................................................................... 41
Study Unit 4: Auditing Expenditure Transactions and Balances............................................ 43
5.4.1 Nature and type of activities in accounting system ............................................................ 43
5.4.2 Control measures ................................................................................................................ 46
5.4.3 Risks in the acquisition and payments cycle........................................................................ 46
5.4.4 Assertions and the acquisition and payments cycle............................................................ 47
5.4.5 Test of controls .................................................................................................................... 48
5.4.6 Substantive audit procedures for purchases ....................................................................... 49
5.4.7 Presentation and disclosure ................................................................................................ 52
5.4.8 Self-Evaluation Questions.................................................................................................... 52
Study Unit 5: Auditing Inventory and Production Cycle ........................................................ 54
5.5.1 Nature and activities in accounting system for trading inventory ...................................... 54
5.5.2 Risks in the inventory cycle ................................................................................................. 56
5.5.3 Control measures ................................................................................................................ 57
5.5.4 Financial statement assertions and the inventory and production cycle............................ 57
5.5.5 Test of controls .................................................................................................................... 58
5.5.6 Substantive procedures ....................................................................................................... 58
5.5.7 Presentation and disclosure ................................................................................................ 61
5.5.8 Self-Evaluation Questions.................................................................................................... 62
Study Unit 6: Auditing Payroll Transactions and Balances .................................................... 64
5.6.1 Nature and activities in accounting system for wages and salaries .................................... 64
5.6.2 Risks in the inventory cycle ................................................................................................. 66
5.6.3 Control measures ................................................................................................................ 67
5.6.4 Financial statement assertions and the payroll and personnel cycle.................................. 68
5.6.5 Substantive procedures ....................................................................................................... 68
5.6.6 Self-Evaluation Questions.................................................................................................... 71
Study Unit 7: Auditing Investing and Financing Balances ...................................................... 73
5.7.1 Nature and activities in accounting systems for investments and finance ......................... 74
5.7.2 Risks and control measures in investment and finance cycle ............................................. 75
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5.7.3 Financial statement assertions and audit objectives for non-current assets...................... 77
5.7.4 Tests of controls for non-current assets .............................................................................. 78
5.7.5 Substantive procedures for non-current assets .................................................................. 78
5.7.6 Substantive procedures for investment in shares ............................................................... 81
5.7.7 Financial statement assertions for non-current liabilities................................................... 81
5.7.8 Substantive procedures for non-current liabilities.............................................................. 82
5.7.9 Substantive procedures for finance lease liabilities ............................................................ 83
5.7.10 Self-Evaluation Questions.................................................................................................... 83
Study Unit 8: Auditing Investments and Cash Balances ........................................................ 85
5.8.1 Nature of cash and investments in a business .................................................................... 85
5.8.2 Source documents used in the cycle ................................................................................... 85
5.8.3 Risks in the cycle .................................................................................................................. 86
5.8.4 Activities in the payments cycle .......................................................................................... 87
5.8.5 Assertions and audit objectives for cash and bank balances .............................................. 87
5.8.6 Bank confirmations.............................................................................................................. 88
5.8.7 Auditing procedures for cash count and bank reconciliations ............................................ 88
5.8.8 Substantive audit procedures for bank and cash ................................................................ 89
5.8.9 Lapping and kiting................................................................................................................ 90
5.8.10 Self-Evaluation Questions.................................................................................................... 90
Study Unit 9: Audit Completion and The Auditor’s Report ................................................... 91
5.9.1 Subsequent events .............................................................................................................. 91
5.9.2 Audit procedures for subsequent events ............................................................................ 92
5.9.3 Going concern...................................................................................................................... 93
5.9.4 Responsibility of the auditor and management regarding going concern .......................... 94
5.9.5 Audit procedures in performing going concern reviews ..................................................... 95
5.9.6 Reporting implications on going concern ............................................................................ 96
5.9.7 Unmodified audit opinion ................................................................................................... 96
5.9.8 Modified audit opinion ........................................................................................................ 96
5.9.9 Emphasis of Matter paragraphs and other matter paragraphs .......................................... 97
5.9.10 Self-Evaluation Questions.................................................................................................... 98
6.
References ........................................................................................................................... 99
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1. About Brand
Damelin knows that you have dreams and ambitions. You’re thinking about the future, and how the
next chapter of your life is going to play out. Living the career you’ve always dreamed of takes some
planning and a little bit of elbow grease, but the good news is that Damelin will be there with you
every step of the way.
We’ve been helping young people to turn their dreams into reality for over 70 years, so rest assured,
you have our support.
As South Africa’s premier education institution, we’re dedicated to giving you the education
experience you need and have proven our commitment in this regard with a legacy of academic
excellence that’s produced over 500 000 world – class graduates! Damelin alumni are redefining
industry in fields ranging from Media to Accounting and Business, from Community Service to Sound
Engineering. We invite you to join this storied legacy and write your own chapter in Damelin’s history
of excellence in achievement.
A Higher Education and Training (HET) qualification provides you with the necessary step in the right
direction towards excellence in education and professional development.
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2. Our Teaching and Learning Methodology
Damelin strives to promote a learning-centred and knowledge-based teaching and learning
environment. Teaching and learning activities primarily take place within academic programmes and
guide students to attain specific outcomes.
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A learning-centred approach is one in which not only lecturers and students, but all sections and
activities of the institution work together in establishing a learning community that promotes a
deepening of insight and a broadening of perspective with regard to learning and the application
thereof.
An outcomes-oriented approach implies that the following categories of outcomes are embodied
in the academic programmes:
Culminating outcomes that are generic with specific reference to the critical cross-field outcomes
including problem identification and problem-solving, co-operation, self-organisation and selfmanagement, research skills, communication skills, entrepreneurship and the application of
science and technology.
Empowering outcomes that are specific, i.e. the context specific competencies students must
master within specific learning areas and at specific levels before they exit or move to a next level.
Discrete outcomes of community service learning to cultivate discipline-appropriate
competencies.
Damelin actively strives to promote a research culture within which a critical-analytical approach and
competencies can be developed in students at undergraduate level. Damelin accepts that students’
learning is influenced by a number of factors, including their previous educational experience, their
cultural background, their perceptions of particular learning tasks and assessments, as well as
discipline contexts.
Students learn better when they are actively engaged in their learning rather than when they are
passive recipients of transmitted information and/or knowledge. A learning-oriented culture that
acknowledges individual student learning styles and diversity and focuses on active learning and
student engagement, with the objective of achieving deep learning outcomes and preparing students
for lifelong learning, is seen as the ideal. These principles are supported through the use of an engaged
learning approach that involves interactive, reflective, cooperative, experiential, creative or
constructive learning, as well as conceptual learning via online-based tools.
Effective teaching-learning approaches are supported by:
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Well-designed and active learning tasks or opportunities to encourage a deep rather than
a surface approach to learning.
Content integration that entails the construction, contextualization and application of
knowledge, principles and theories rather than the memorisation and reproduction of
information.
Learning that involves students building knowledge by constructing meaning for
themselves.
The ability to apply what has been learnt in one context to another context or problem.
Knowledge acquisition at a higher level that requires self-insight, self-regulation and selfevaluation during the learning process.
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Collaborative learning in which students work together to reach a shared goal and
contribute to one another’s learning at a distance.
Community service learning that leads to collaborative and mutual acquisition of
competencies in order to ensure cross cultural interaction and societal development.
Provision of resources such as information technology and digital library facilities of a high
quality to support an engaged teaching-learning approach.
A commitment to give effect teaching-learning in innovative ways and the fostering of
digital literacy.
Establishing a culture of learning as an overarching and cohesive factor within institutional
diversity.
Teaching and learning that reflect the reality of diversity.
Taking multi culturality into account in a responsible manner that seeks to foster an
appreciation of diversity, build mutual respect and promote cross-cultural learning
experiences that encourage students to display insight into and appreciation of
differences.
Icons
The icons below act as markers, that will help you make your way through the study guide.
Additional information
Find the recommended information listed.
Case study/Caselet
Apply what you have learnt to the case study presented.
Example
Examples of how to perform a calculation or activity with the
solution / appropriate response.
Practice
Practice the skills you have learned.
Reading
Read the section(s) of the prescribed text listed.
Revision questions
Complete the compulsory revision questions at the end of each
unit.
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Self-check activity
Check your progress by completing the self-check activity.
Study group / Online forum discussion
Discuss the topic in your study group or online forum.
Think point
Reflect, analyse and discuss, journal or blog about the idea(s).
Video / audio
Access and watch/listen to the video/audio clip listed.
Vocabulary
Learn and apply these terms.
3. Introduction to the Module
Welcome to Auditing 3A. This module is a continuation of the principles and concepts that you have
already learnt in Auditing 2. Generally accepted auditing standards (GAAS) are a set of systematic
guidelines used by auditors when conducting audits on companies' financial records. GAAS helps to
ensure the accuracy, consistency, and verifiability of auditors' actions and reports.
Module Information
Qualification title
Module Title
NQF Level
Credits
Notional hours
Bachelor of Commerce: Accounting
Auditing 3A
7
10
100
Module Purpose
The purpose of this module is to provide students with the knowledge of internal control and tests of
control, detection of risk and the design of substantive procedures, auditing for
revenue receipt transactions & balances, expenditure transaction and balances, production /
inventory transaction balances, payroll transactions and balances, investing and financing transactions
and balances, investment and cash transactions and balances and the audit completion and the
auditor’s report. The module builds on Auditing 2B and concepts related to controls are covered in
more detail.
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Outcomes
By the end of this module, students will be able to:
• Identify controls;
• Perform tests of control;
• Asses control risk;
• Asses audit risk;
• Understand substantive procedures;
• Understand the nature, timing and extent of substantive procedures;
• Understand the nature, timing and extent of substantive procedures in a computer environment;
• Describe the sources of income;
• Describe the activities in accounting systems for credit sales, cash sales, receipts from trade accounts
receivable and other accounts receivables;
• Describe the internal control measures that could be introduced for the control of credit sales, cash
sales, receipts from trade accounts receivable and other accounts receivables;
• Formulate tests of control according to which internal control measures can be evaluated;
• Describe the audit objectives which the auditor aims to achieve by auditing credit sales, cash sales,
receipts from trade accounts receivable and other receipts;
• Formulate substantive procedures for auditing credit sales, cash Sales, receipts from trade accounts
receivables and other receipts;
• Describe all the procedures to circularise accounts receivable;
• Describe the nature and type of activities in accounting systems for credit purchases, cash purchases,
payments to trade accounts payable and other accounts payable;
• Describe the internal control measures that could be introduced for the control of credit purchases,
cash purchases, payments to trade accounts payable and other accounts payable;
• Understand the audit objectives for account transactions and balances;
• Asses the risk and inherent risks involved with expenditure;
• Asses effectiveness of the internal controls for credit purchases, cash purchases, payments to trade
accounts payable and other accounts payable;
• Discuss the functions relative to purchasing activities;
• Formulate tests of control according to which internal control measures can be evaluated;
• Formulate substantive procedures for auditing credit purchases, cash purchases, payments to trade
accounts payable and other creditors;
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• Formulate substantive procedures for auditing accounts payable balances and bills payable
balances;
• Presentation and disclosure of expenditure;
• Describe the activities in accounting systems for trading inventory;
• Describe the audit objectives of inventory;
• Know the examples of risk encountered;
• Describe the internal control measures that could be introduced for the control of trading inventory;
• Describe the internal control aspects of stock-taking;
• Explain the valuation concepts and principals of stockkeeping;
• Asses the effectiveness of the internal controls for trading inventory;
• Formulate tests of control according to which internal control measures can be evaluated;
• Formulate substantive procedures for auditing trading inventory;
• Presentation and disclosure aspects;
• Describe the activities in the accounting system for wages and salaries;
• Describe the audit objectives which the auditor aims to achieve by auditing wages
• Asses the risks of misstatements;
• Describe the internal controls that could be introduced for the control of wages and salaries;
• Formulate substantive procedures for auditing credit purchases, cash purchases, payments to trade
accounts payable and other creditors and wages;
• Describe the activities in the accounting system for income from investments, proceeds of sale of
asset and reserves;
• Describe the internal control measures for reserves, income from investments and proceeds from
sale of fixed assets;
• Describe the activities in the accounting system for purchase of non-current assets, investments and
granting of loans;
• Formulate tests of control for the purchase of non-current assets, investments and granting of loans;
• Describe the objectives an auditor wishes to achieve by auditing non-current assets (assertions);
• Formulate the substantive procedures for non-current asset balances;
• Formulate substantive procedures for the purchase of non-current assets, investments and granting
of loans;
• Describe the objectives an auditor wishes to achieve by auditing non-current liabilities (assertions);
• Formulate the substantive procedures for non-current liability balances;
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• Describe the accounting systems for Long-term loans;
• Describe the internal control measures for long-term liabilities;
• Describe the nature of cash and investments of a business;
• Describe the audit procedures for a cash count of cash balances or bank reconciliation;
• Describe audit objectives of cash and bank balances;
• Describe substantive procedures for cash and bank balances;
• Describe presentation and disclosure;
• Understand the terms lapping and kiting.
Assessment
You will be required to complete both formative and summative assessment activities.
Formative assessment:
These are activities you will do as you make your way through the course. They are designed to help
you learn about the concepts, theories and models in this module. This could be through case studies,
practice activities, self-check activities, study group / online forum discussions and think points.
You may also be asked to blog / post your responses online.
Summative assessment:
You are required to do one test, two assignments (one individual assignment and one group
assignment) and one final examination.
Mark allocation
The marks are derived as follows for this module:
Test
Assignments
Exam
TOTAL
20%
20%
60%
100%
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Planning Your Studies
You will have registered for one or more modules in the qualification and it is important that you plan
your time. To do this look at the modules and credits and units in each module.
Create a time table / diagram that will allow you to get through the course content, complete the
activities, and prepare for your tests, assignments and exams. Use the information provided above
(How long will it take me?) to do this.
What equipment will I need?
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Access to a personal computer and internet.
4. Prescribed Reading
Prescribed Book
Title: Auditing Fundamentals in a South African Context, Edition: 2019, Authors: Von Wielligh,
P. & Prinsloo, F. ISBN: 9780190749040
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5. Module Content
You are now ready to start your module! The following diagram indicates the topics that will be
covered. These topics will guide you in achieving the outcomes and the purpose of this module.
Please make sure you complete the assessments as they are specifically designed to build you in your
learning.
Unit 1INTERNAL CONTROL AND TESTS OF CONTROL
Unit 2: AUDIT RISK AND SUBSTANTIVE PROCEDURES
Unit 3: AUDITING REVENUE RECEIPT TRANSACTIONS AND BALANCES
Unit 4: AUDITING EXPENDITURE TRANSACTIONS AND BALANCES
Unit 5: AUDITING INVENTORY AND PRODUCTION CYCLE
Unit 6: AUDITING PAYROLL TRANSACTIONS AND BALANCES
Unit 7: AUDITING INVESTING AND FINANCING BALANCES
Unit 8: AUDITING INVESTMENTS AND CASH BALANCES
Unit 9: AUDIT COMPLETION AND THE AUDITOR’S REPORT
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Study Unit 1: Internal Control and Tests of Control
As stated in Jackson and Stent (2016:5/3), management is responsible for running all
aspects of the entity. The objectives of the business will be set, the risks relating to
achieving those objectives will be identified and suitable books, records and
documents, and policies and procedures will be put in place to address those risks. The
policies and procedures that are put in place will include the implementation of
Purpose
effective internal controls to ensure, amongst others, the efficient, effective and
economic operation of the business. The auditor generally seeks to rely on the internal
controls within the entity in order to reduce the amount of testing of final balance. In
this chapter we will look at some of the detailed requirements of ISA 315
with regard to internal controls.
After studying this unit, you should be able to:
• Explain the importance of internal controls
• Define internal controls
Learning
Outcomes • Identify controls;
• Describe and explain the 5 components of a system of internal control
• Perform tests of control
It will take you 2 hours to make your way through this unit.
Time
5.1.1 Introduction
As stated in Jackson and Stent (2016:5/3), management is responsible for running all aspects of the
entity. The objectives of the business will be set, the risks relating to achieving those objectives will
be identified and suitable books, records and documents, and policies and procedures will be put in
place to address those risks. The policies and procedures that are put in place will include the
implementation of effective internal controls to ensure, amongst others, the efficient, effective and
economic operation of the business. The auditor generally seeks to rely on the internal controls within
the entity in order to reduce the amount of testing of final balance. In this chapter we will look at
some of the detailed requirements of ISA 315 with regard to internal controls.
5.1.2 The importance of internal controls in business
• Safeguarding the assets of the business for example, inventory from theft or damage
• Preventing fraud
• Complying with the laws and regulations applicable to the entity
• Producing reliable financial information necessary to run the business and satisfy the financial
requirements, for example producing the annual financial statements
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• Operating the business efficiently and effectively
5.1.3 Definition of internal control and internal control systems
Internal control: According to ISA 315 (revised) para .4, “Internal control can be defined as the process
designed, implemented and maintained by those charged with governance, management and other
personnel to provide reasonable assurance about the achievement of an entity’s objectives with
regard to:
• The reporting of the entity’s financial reporting
• The effectiveness and efficiency of its operations and
• Its compliance with applicable laws”
The auditors must understand the accounting system and control environment in order to determine
their audit approach. An understanding of internal control will assist the auditor in identifying types
of potential misstatements and factors that affect the risks of material misstatement, and in designing
the nature, timing and extent of further audit procedures.
Initially, gaining an understanding of internal control helps auditors to determine which controls are
relevant to the audit. Having determined which controls are relevant, and are adequately designed to
aid in the prevention of material misstatements in the financial statements, the auditor can then
decide whether it is more efficient to seek reliance on those controls and perform tests of controls in
that area, or more efficient to perform substantive testing over the area.
5.1.4 Components of internal control
A system of internal control consists of five components which are:
i. Control environment
ii. Entity’s risk assessment process
iii. Information system, including the business processes relevant to financial reporting, and
communication
iv. Control activities
v. Monitoring of controls
1.4.1 Control environment (refer to ISA 315.A76-A77)
The control environment is the framework within which controls operate. The control environment is
determine by management and the governing body of an entity. The control environment includes
the governance and management functions and the attitudes, awareness and actions of those charged
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with governance and management concerning the entity’s internal control and its importance in the
entity.
Aspects of the control environment such as attitudes towards control will always be a significant factor
in determining how controls operate. Controls are more likely to operate well in an environment
where they are treated as being important therefore a strong control environment is a positive factor
whereas a weak control environment can undermine the effectiveness of controls.
The following table illustrates the elements of the control environment that may be relevant when
obtaining an understanding of the control environment.
Table 1: Elements of control environment
CONTROL
ENVIRONMENT
Communication
and
enforcement of
integrity
and ethical values
Commitment to
competence
Essential elements which influence the effectiveness of the design,
administration and monitoring of controls.
Management’s consideration of the competence levels for
particular jobs and how those levels translate into requisite skills
and knowledge
Participation by • Independence from management
those
• Experience and stature
charged with
• Extent of involvement and scrutiny of activities
governance
• Appropriateness of actions and interaction with internal
and external auditors
Management’s
• Approach to taking and managing business risks
• Attitudes and actions towards financial reporting
philosophy and
• Attitudes towards information processing and accounting
operating style
functions and personnel
Organisational
The framework within which an entity’s activities for achieving
structure
its objectives are planned, executed, controlled and reviewed.
Assignment
of How assignment and authority for operating activities are
authority
assigned and how reporting relationships and authorisation
and responsibility hierarchies are established
Recruitment, orientation, training, evaluating, counselling,
Human resource
policies
and promoting, compensation and remedial actions
practices
Source: Adapted from ACCA Audit and Assurance Study Text (2011) BPP Learning Media
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1.4.2 Entity’s risk assessment process
“An entity’s risk assessment process refers to the way in which the entity deals with the governance
of risk as set out in Chapter 4 of the King 3 Report. King 3 defines risk assessment as the “Overall
process of risk identification, risk quantification and risk evaluation in order to identify potential
opportunities that minimize loss” (Prinsloo, 2015).
ISA 315 says the auditor shall obtain an understanding of whether the entity has a process for:
• Identifying business risks relevant to financial reporting objectives
• Estimating the significance of the risks
• Assessing the likelihood of their occurrence
• Deciding upon actions to address those risks
1.4.3 Information system relevant to financial reporting
The information system relevant to financial reporting creates the audit trail of each transaction and
event to which the entity is party, and includes all the processes and activities of the entity involved
in preparing the financial information. The information system may be computerized consisting of
hardware, software, people, procedures and data necessary to produce the financial information.
“The information system relevant to financial reporting includes the accounting system and consists
of the procedures and records created as a transaction flows through the accounting system, as well
as the business processes that relate to the particular transaction” (Prinsloo,
2015)
“The accounting system documents the path that each transaction follows in the entity from where
the transaction is initiated to its ultimate inclusion in an amount or disclosure that appears in the
financial statements” (Prinsloo, 2015).
1.4.4 Control activities
According to ISA 315 (A96-A100), Control activities refer to those internal control measures, policies
and procedures that management designs and implements to ensure that their objectives are
achieved. According to Prinsloo (2015), control activities ensure that the identified risks do not
materialize and should they materialize, they are timeously detected and appropriately addressed.
Table 2: Examples of control activities
Examples
of
control
activities
Approval and control of
Transactions should be approved by an appropriate person.
documents
For example overtime should be approved by departmental
managers
Control over computerized
There should be controls on the computerized accounting system
applications
used for example controls over access to the system.
Checking the arithmetical
For example checking to see if individual invoices have been
accuracy of records
added up correctly
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Maintaining and reviewing
control accounts and trial
balance
Control accounts bring together transactions in individual ledgers.
Trial balances bring together unusual transactions for the
organization as a whole. Preparing these can highlight
unusual transactions or accounts
Reconciliations involve comparison of a specific balance in the
Reconciliations
accounting records with what another source says the balance
should be, for example, a bank reconciliation.
Difference between the two figures should only be
reconciling items
Source: Adapted from ACCA Audit and Assurance Study Text (2011) BPP Learning Media
ISA 315 states that the auditor shall obtain an understanding of control activities relevant to the audit
and how the entity has responded to risks arising from IT.
1.4.5 Monitoring of controls
Monitoring of controls is a process to assess the effectiveness of internal control performance over
time. It includes the design and operation of controls on a timely basis and taking necessary corrective
actions modified for changes in conditions.
The auditor shall obtain an understanding of the major activities that the entity uses to monitor
internal control over financial reporting including how the entity initiates corrective actions to
deficiencies in its controls. The auditor shall obtain an understanding of the sources of the information
used in the monitoring of activities and the basis upon which management considers it reliable.
Please refer to page 122 of the prescribed textbook and read “limitations of a
system of internal control” to understand the inherent limitations.
5.1.5 Tests of control
Tests of controls are tests performed to obtain audit evidence about the effectiveness of the:
• Design of the accounting and internal control systems, that is whether they are appropriately
designed to prevent, or detect and correct, material misstatement at the assertion level, and
• Operation of the internal controls throughout the period
Tests of controls are distinguished from substantive procedures which are designed to detect material
misstatements in the financial statements.
Tests of control may include the following
a) Inspection of documents supporting controls or events to gain audit evidence that internal controls
have operated properly, for example verifying that a transaction has been authorised
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b) Inquiries about internal controls which leave no audit trail, for example determining who actually
performs each function
c) Re-performance of control procedures for example reconciliation of bank accounts, to ensure
correct performance
d) Examination of evidence of management reviews for example minutes of management meetings
e) Testing of internal controls operating on computerised systems for example access controls
Observation of controls to consider the manner in which the control is operating
5.1.6 Conclusion
This chapter dealt with selected aspects of internal controls and tests of controls. In summary, the
auditors must understand the accounting system and control environment in order to determine their
audit approach. An auditor may choose to conduct test o controls to assess whether they can rely on
the controls.
5.1.7 Self-Evaluation Questions
Answer the following questions to check whether you have achieved all the set
outcomes:
I. Which of the following is not a test of control
A. Inspection of documents
B. Re-performance of control procedures
C. Observation of controls
D. Verification of value to invoice
II. Indicate whether the following statement is True/False: After the controls
have
been assessed, the audit plan may be modified.
III. Define internal control and explain the usefulness of internal controls?
IV. Describe the characteristics of an effective control environment?
V. Briefly explain the 5 components of internal control system?
VI. Describe the inherent limitations of internal controls?
Case Study/ Scenario Analysis
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You are a first year trainee accountant forming part of the audit team on the audit of Travel with Flair
(Pty) Limited (Travel with Flair) for the year ended 28 February 2016. The following information of the
company is available to you:
Background information
Travel with Flair is South Africa’s first fully automated online travel agency. Stephan Van
Eck launched Travel with Flair in 2010 after his first online travel agency in Switzerland,
Mr Jet, had proved to be very successful. Travel with Flair is a wholly-owned subsidiary of
Mr Jet and both companies have the same financial year end. The auditors of Mr Jet require the
audited financial statements of Travel with Flair within two weeks after year end in order to audit the
consolidated results in time. This is the first time that your audit firm is providing audit services to
Travel with Flair.
Travel with Flair operates its business from an office situated in Cape Town. Customers can make
bookings for flights, hotel accommodation and car rental with a variety of international and national
suppliers through Travel with Flair using the Internet. During the
2016 financial year Travel with Flair experienced rapid growth in its business. The company’s number
of bookings and revenue figures increased by more than 55% from the prior financial year. Two senior
executives are set to receive share options in Travel with
Flair based on reported profits.
Due to the rapid growth of the company Stephan Van Eck has a new vision for Travel with
Flair and plans to expand Travel with Flair’s business by opening ten new holiday resorts all over South
Africa. To finance this expansion, Travel with Flair has to apply for a bank loan. The approval of the
loan is dependent on the audited 2015 financial statements.
In May 2015, two key staff members in the accounting department went on maternity leave and the
chief financial officer (CFO) was fired. During the financial year the CFO has been in a major public
labour dispute with Travel with Flair. The dispute was settled in court during October 2015. The posts
of the two key staff members from the accounting department and the CFO’s post were filled by
temporary staff members who were on training for the first two months. These temporary staff
members were not performing at the optimal level after the period that they were on training.
Travel with Flair’s revenue comprises:
• Commission received from a variety of international and national suppliers with whom the bookings
for flights, hotel accommodation and car rental are made. Revenue from commission is recognised as
soon as the booking has been finalised. A booking is finalised as soon as the payment has been
received from the customer. Suppliers should pay the commission to Travel with Flair at the end of
the next month following the month in which a booking has been finalised. Commission is calculated
using the percentage as agreed with the supplier in the service level agreement.
• Service fees received are fees charged on every booking made for flights, hotel accommodation and
car rentals. Revenue from service fees is recognised as soon as a booking has been finalised. A booking
is finalised as soon as the payment has been received.
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Revenue system
Travel with Flair uses an automated revenue system. Customers can make bookings for flights, hotel
accommodation and car rentals through Travel with Flair using the Internet.
The revenue system is protected by means of firewalls. Travel with Flair’s website is directly linked to
the databases of all the suppliers with whom Travel with Flair has approved service level agreements.
Access to the suppliers’ databases is automatically gained through a special connection between
Travel with Flair and the supplier databases.
This allows Travel with Flair to provide customers with accurate and up-to-date information on its
services.
Travel with Flair can only enter into service level agreements with suppliers after the directors approve
the agreements annually at a directors’ meeting. A service level agreement contains the terms and
conditions of the agreement between the supplier and
Travel with Flair, a budget with special discounted prices and the commission percentage that Travel
with Flair earns when a supplier’s services are used. The commission is calculated using a percentage
and is based on the price of the services booked.
Commission is paid to Travel with Flair at the end of the next month following the month in which a
booking has been finalised.
Required
With reference to the revenue system of Travel with Flair, formulate the tests of controls that you will
perform to test the manual and automated internal controls of the revenue system. If you make use
of audit procedures using test data to test the automated controls, limit your answer to invalid test
data. (20marks) Model answers are in the workbook.
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Study Unit 2: Audit Risk and Substantive Procedures
Purpose
Learning
Outcomes
Time
This chapter covers the aspects of audit risk and the designing of substantive
audit procedures. Firstly we introduce the concept of audit risk and look into
detail at detection risk and how audit risk is managed by the auditor. At the
end we look at substantive procedures and the various types of substantive
procedures.
After studying this unit, you should be able to:
• Define and explain the components of audit risk
• Explain the differences between audit risk and business risk
• Identify and assess audit risk at both financial statement level and account
balance/ class of transactions level.
• Explain how to respond to risk at financial statement level and account
balance level.
• Explain the nature, timing and extent of audit procedures
• Explain the types of substantive procedures
• Formulating substantive procedures
It will take you 2 hours to make your way through this unit.
5.2.1 Components of audit risk
Audit risk is the risk that an auditor expresses an inappropriate audit opinion when the financial
statements are materially misstated. There are three components of audit risk which are:
a) Inherent risk: “Is defined in ISA 200 as the susceptibility of an assertion to material misstatement
before considering internal control” (Prinsloo et al, 2015 page 500). Inherent risk is the risk that items
will be misstated due to the characteristics of those items, such as the fact that they are estimates or
that they are important items in the accounts. Inherent risk is intrinsic to the entity and arises from
the very nature of the entity itself and its business dealings. Inherent risk cannot be changed by the
auditor but can only be assessed and then responded to it. Inherent risk is affected by the nature of
the entity, for example the industry it is in and the regulations it falls under, and also the nature of the
strategies it adopts.
b) Control risk: “Is defined in ISA 200 as being the risk that a material misstatement that could occur
in the financial statements is neither prevented, nor detected and corrected, on a timely basis by an
entity’s system of internal control. Control risk is also intrinsic to the entity and arises due to the nature
of the controls in the entity itself. Control risk cannot be changed by the auditor but can only be
assessed by the auditor and responded to.
Control risk in other words is the risk that internal controls will fail to prevent or detect and correct
material misstatements. An entity with more strong internal controls is more likely to prevent, detect
and correct material misstatements affecting the financial statements.’’
(Prinsloo et al, 2015 page 502)
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C) Detection Risk: Detection risk is defined in ISA 200 as “’the risk that the auditor’s procedures,
performed to reduce audit risk to acceptable low levels, will fail to detect material misstatements.’’
Prinsloo et al (2015), stated that detection risk arises through the performance of inappropriate or
inadequate audit procedures which are matters that the auditor should be in control of. If an auditor’s
procedures are inadequate, there is increased likelihood that misstatements will not be detected and
therefore that audit risk will increase.
If risk is too high to be tolerated, the auditors can carry out more work to reduce this aspect of the
audit risk, and therefore audit risk as a whole. Sampling risk and non-sampling risk are components of
detection risk.
Management of audit risk
ISA 200 states that “ to obtain reasonable assurance, the auditor shall obtain sufficient appropriate
audit evidence to reduce audit risk to an acceptably low level and thereby enable the auditor to draw
reasonable conclusions on which to base the auditor’s opinion’’
Auditors will want their overall audit risk to be at an acceptable level, or it will not be worth them
carrying out the audit. In other words, if the chance of them giving an inappropriate opinion and being
sued is high, it might be better not to do the audit at all. The auditor will manage audit risk by
manipulating detection risk, the only element of audit risk they have control over. This is because the
more work the auditor does the lower the detection risk, although it cannot be entirely eliminated
due to inherent limitations of audit. The auditors will determine the level of audit work so that
detection risk is as low as possible.
5.2.2 Differences between audit risk and business risk
Study prescribed and recommended text book
• Page 505 of the Prescribed text book Auditing Fundamentals (Prinsloo et al,
2015)
• Auditing Notes For South African Students, Jackson & Stent (7/4- 7/13), 10th
edition.
Explain the differences between audit risk and business risk providing
examples?
Feedback on Activity
Jackson & Stent defines audit risk as the risk that the auditor will express an inappropriate opinion
when the financial statements are materially misstated (see Jackson & Stent 2017:7/4).
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Figure 1: Diagram illustrating Audit Risk
Jackson & Stent (7/13) defines business risk as the term used to describe those conditions, events,
circumstances, actions or inactions which threaten the company’s achievement of the objectives it
has set and its ability to achieve those objectives. Business risk includes risks other than the risk of
material misstatement. An example of a business risk is making sales on credit to customers who will
not pay.
5.2.3 Identification and assessment of risk
Auditors usually follow a risk based approach to auditing as required by ISAs. In this approach, auditors
analyse the risks associated with the client’s business, transactions and systems which could lead to
misstatements in the financial statements, and direct their testing to risky areas.
In the examination, you can be asked to identify and explain audit risks (risks
of material misstatements) based on a scenario. In order to score well in such
questions, you should state the assertion which is at risk and the element of
financial statement which is at risk.
Just explaining the fact from the scenario without stating which element of
financial statements is impacted and which assertion will significantly limit the
number of marks you can obtain.
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5.2.4 How to respond to risk at financial statement level and account balance
level
Study prescribed and recommended text book
• Page 520- 525 of the Prescribed text book Auditing Fundamentals (Prinsloo
et al, 2015)
• ISA 330, the auditor’s responses to assessed risk. SAICA Handbook Volume 2
Having assessed the risks of material misstatement, the auditor shall
respond accordingly.
What is the auditor’s responses at financial statements level and at
the assertion level?
Feedback on activity
Responses to address the risks of material misstatements at financial statements level
These include:
• Emphasising to audit staff the need to maintain professional scepticism
• Assigning additional or more experienced staff to the audit team
• Providing more supervision on the audit
• Incorporating more unpredictability in the audit procedures
• Change the degree of audit partner involvement
• Making general changes to the nature, timing or extent of audit procedures
Page 521-522 of the prescribed text book Auditing Fundamentals
Responses to address the risks of material misstatements at assertion level
The auditor shall design and perform further audit procedures whose nature, timing and extent are
based on and are responsive to the assessed risks of material misstatement at the assertion level.
Nature refers to the purpose and the type of test that is carried out, which include:
• Tests of controls and
• Substantive tests
Auditing Notes for South African Students, 2017. Jackson& Stent (5/25-5/29)
ISA 330 & 500 (SAICA Handbook Volume 2)
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5.2.5 Nature, timing and extent of audit procedures
ISA 330 (SAICA Handbook Vol 2) says the auditor shall design and perform further audit procedures
whose nature, timing and extent are based on and are responsive to the assessed risks of material
misstatement at the assertion level.
Nature of audit procedures
The nature of the audit procedures refers to its purpose, (that is, tests of control or substantive
procedures) and its type (that is inspection, observation, inquiry, confirmation, recalculation,
reperformance or analytical procedure).
Timing of audit procedures
Timing of audit procedures refers to when it is performed, or the period or date to which the audit
evidence applies. Matters to consider include whether interim audits will be conducted, time for
inventory counts, reporting deadlines, audit committee meetings, early verification of year end
balances
Extent of audit procedures
Extent of audit procedures refers to the quantity to be performed, specifically how much testing is to
be done. For example, a sample size or the number of observations of a control activity.
Jackson & Stent, Auditing notes for South African students 10th Edition, 6/19
1SA 330 & 500, SAICA Handbook Volume 2
5.2.6 Substantive procedures and tests of controls
As indicated by ISA 500 (Jackson & Stent 5/25), further audit procedures comprise of
• Tests of controls and
• Substantive tests, both tests of detail and analytical procedures
Study Jackson & Stent, Auditing notes for South African students 10th Edition,
5/27.
Study 1SA 330 & 500, SAICA Handbook Volume 2
Explain the differences between tests of controls and substantive procedures?
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Feedback on activity
Tests of controls
• Are audit procedures designed to evaluate the operating effectiveness of controls in preventing, or
detecting and correcting material misstatements at the assertion level?
• Tests of controls also involves testing the accounting system and related control activities to
determine whether they produce reliable balances and totals.
• When the auditor’s risk assessment includes an expectation that controls are operating effectively,
the auditor shall design and perform tests of controls to obtain sufficient appropriate evidence that
the controls were operating
• In carrying out tests of controls, auditors shall use inquiry, but shall also use other procedures like
re-performance, inspection and others (Refer to Jackson & Stent,
Auditor’s tool box 5/25)
• If the tests of controls provide sufficient appropriate evidence that the controls are operating
effectively, the auditor will be more confident that the balances and totals produced by the system
are valid, accurate and complete, and hence he will need to spend less time on conducting substantive
tests.
Substantive audit procedures
• Are audit procedures designed to detect material misstatements at the assertion level?
They consists of tests of details of classes of transactions, account balances and disclosures, and
substantive procedures.
• The ISA 330 says that the auditor shall design and perform substantive procedures for each material
class of transactions, account balances and disclosure.
• When conducting tests of detail, the auditor carries out procedures on specific detail of a
transaction, account balance or disclosure. Tests of detail may be appropriate in gaining information
about account balances like inventory, accounts receivable etc.
• When conducting analytical procedures the auditor evaluates financial information through analysis
of plausible relationships among both financial and non-financial data, for example comparison of
sales year to year.
• These analytical procedure might provide the auditor with general idea as to whether sales have
been overstated or not.
• When performing substantive procedures the auditor is interested in the following assertions:
✓ Balances- completeness, existence, valuation, rights and obligation, presentation and disclosure
✓ Transactions- completeness, occurrence, accuracy, cut-off, classification and, presentation and
disclosures
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✓ Disclosures- occurrence and rights and obligations, completeness, classification and
understandability, accuracy and valuation
Jackson & Stent, 2017 (5/27-5/28)
5.2.7 Formulating substantive procedures
Study Jackson & Stent, Auditing notes for South African students 10th Edition,
5/27.
Study 1SA 330 & 500, SAICA Handbook Volume 2
Explain the procedures that can be used for carrying out risk assessment
procedures, tests of control and substantive tests?
Feedback to activity
The procedures which the auditor carries out during risk assessment or when testing controls or
performing substantive tests are described as follows:
✓ Inspection: involves examining records or documents, whether internal or external, in paper form,
electronic form or other media, or a physical examination of an asset.
✓ Observation: consists of looking at a process or procedure being performed by others, or at the
performance of control activities.
✓ External confirmation: obtaining a direct written response from a third party to a request/query
from the auditor to that third party in paper form or by electronic or other medium.
✓ Recalculation: consists of checking manually or electronically, the mathematical accuracy of
documents or records.
✓ Reperformance: involves the auditor’s independent execution of procedures or controls that were
originally performed as part of the entity’s internal control.
✓ Analytical procedures: evaluating financial information through analysis of plausible relationships
among financial and non-financial information.
✓ Inquiry: seeking information of knowledgeable persons, both financial and nonfinancial, within the
entity or outside the entity.
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It is not possible to categorise each of the above procedures as simply a risk assessment procedure, a
test of controls procedure or a substantive procedure. The procedure will be categorised in terms of
what the auditor is trying to achieve, therefore, the objective.
5.2.8 Self-Evaluation Questions
Answer the following questions to check whether you have achieved all the set
outcome
1. Is it acceptable for the “further audit procedures” to consist only of tests of
controls?
2. Explain tests of controls and substantive procedures as further audit
procedures.
3. What is the auditor’s objective when carrying out risk assessment
procedures?
4. Explain briefly the components of audit risk.
5. Explain the procedures that an auditor may use in gaining an understanding
of the entity.
Study the case study/scenario below and answer the questions that follow
Stone Holidays is an independent travel agency. It does not operate holidays itself. It takes commission
on holidays sold to customers through its chain of high street shops. Staff are partly paid on
commission basis. Well established tour operators run the holidays that Stone Holidays sells. The
networked reservations system through which holidays are booked and the computerised accounting
system are both well-established systems used by many independent travel agencies.
Payments by customers including deposits, are accepted in cash and by debit order and credit card.
Stone holidays is legally required to pay an amount of money (based on its total sales for the year)
into a central fund maintained to compensate customers if the agency should cease operations.
Required
a). Describe the nature of the risks to which Stone holidays is subject arising from fraud and error.
b). Explain the responsibilities of external auditors in respect of the risk of fraud and error in an audit
of financial statements. (20marks)
(Refer to workbook for model answers)
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Study Unit 3: Auditing Revenue Receipt Transactions and
Balances
The purpose of this topic is to introduce the student to the revenue
and receipts cycle and to the internal controls of the revenue and
Purpose
receipts cycle. The student is expected to understand the tests of
control and substantive procedures carried by the auditor on revenue
receipt an accounts receivable transactions.
After studying this unit, you should be able to:
• Describe the sources of income;
• Describe the activities in accounting systems for credit sales, cash
sales, receipts from trade accounts receivable and other accounts
receivables;
• Describe the internal control measures that could be introduced for
the control of credit sales, cash sales, receipts from trade accounts
Learning
receivable and other accounts receivables;
Outcomes • Formulate tests of control according to which internal control
measures can be evaluated;
• Describe the audit objectives which the auditor aims to achieve by
auditing credit sales, cash sales, receipts from trade accounts
receivable and other receipts;
• Formulate substantive procedures for auditing credit sales, cash
Sales, receipts from trade accounts receivables and other receipts;
• Describe all the procedures to circularise accounts receivable;
It will take you 4 hours to make your way through this unit.
Time
5.3.1 Sources of income and source documents
In your earlier accounting modules you learnt how to account for revenue and receipts and how the
balance between those two accounts are actually reflected in the trade receivable account. You also
learnt how to perform a bank reconciliation. This knowledge is very important for auditing because
this allows you to visualize the accounting process of transactions and balances. Your degree must be
seen as an integrated unit of knowledge and not as separate compartment .You must break any
barriers that prevent integration and lateral thinking. To break that mental block that many students
have, remember that auditing is not a rocket science. If you are able to visualize the cycle, then you
the auditor, must just collect evidence based on this cycle.
Therefore, before you can audit revenue cycle you must first be able to name the sources of income
and source documents and envisage the business environment and the transaction flow from
initiation of the transaction through to recording it in the accounting books and general ledger and
the presentation and disclosure thereof in the AFS.
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Forms of revenue from sale of goods and rendering of services
Examples of various forms of sales and services include:
• A retail entity (retailer) selling goods directly to the public e.g. clothing
• A wholesale entity selling goods selling goods to retailers e.g. bulk food products
• A manufacturing entity selling goods it has produced to wholesalers or retailers
• A resource entity selling minerals it has mined to a metal refinery
• A services entity rendering its services to other entities or to the public
• A municipality providing utilities to town residents, such as water and electricity
Revenue and receipts cycle
Figure 2: A typical transaction in revenue and receipts cycle
Source: Prinsloo et al. 2015. Auditing Fundamentals page 187
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5.3.2 Activities in accounting systems for sales, receipts and accounts
receivables
Study Auditing Fundamentals (2015) page 189- 192
Study Auditing Notes for South African students (2017) page 10/2-10/10
What functional areas and activities exist in the sales and receipts cycle?
Feedback on self-evaluation question
Figure 3: Functional areas and activities by department
Sales and credit department
1. Credit management
2. Receiving orders
from customers
3. Authorization of
sales orders
10. Processing returns
and other sales adjustments
Warehouse
4. Picking of goods
from warehouse
5. Dispatch and
delivery of goods to
customers
10. Processing of
returns and other sales
adjustments
Accounting department
6. Invoicing
7. Recording of sales in
the accounting
records
8. Receipt of cash from
customers
9. Recording of
receipts in the
accounting records
10. Recording of returns
and other sales
adjustments
Source: Prinsloo et al. 2015. Auditing Fundamentals page 191
5.3.3 Internal control measures for the control of sales, receipts and accounts
receivables
Study Auditing Fundamentals, Prinsloo et al. (2015). Page 212-216
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What are the controls in the sales and receipts cycle (manual and
computerized)?
Feedback on the self-evaluation activity
• All documentation relating to the cycle should be properly designed, placed under proper stationery
control and used in conjunction with a proper chart of accounts for the transaction related
• Authorization and approval is required each time a customer is awarded the right to purchase on
credit from the entity, a sales order is processed and a credit adjustment is made to a customer’s
account such as for a sales return.
• Segregation of duties: Initiation of a transaction, execution of a transaction, approval of a
transaction, custody of the asset underlying the transaction and recording of the transaction should
be performed by different staff or departments in the cycle.
• Access controls to protect against misappropriation of assets or damage to goods should apply
whenever the entity picks goods for dispatch from the warehouse and dispatches the goods to a
customer, goods are returned from a customer and cash is received from a customer and kept secure
until banked.
• Independent checks and reconciliations: Examples of verification checks include checking the
quantities and description of goods on sale orders and on picking slips for accuracy and completeness,
checking physical goods being dispatched to customers to supporting documentation, checking the
sequential number order of supporting documentation such as delivery notes, matching of source
document with each other such as invoice and delivery notes, performing debtors reconciliations and
bank reconciliations.
5.3.4 Assertions for the control of sales, receipts and accounts receivables
Study page 10/54 Jackson & Stent, 10th Edition, Auditing notes for South
African students.
What are the financial statements assertions that apply to the revenue,
receipts and receivables?
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Feedback to activity
Sales
• Occurrence: Recorded sales actually occurred and they pertain to the entity
• Accuracy: Sales are recorded at the correct amount
• Cut-off: Sales are allocated to the proper accounting period
• Completeness: All sales have been recorded
• Classification: Sales are recorded in the proper accounts
Receipts
• Occurrence: Receipts were actually received for amounts owed to the entity
• Accuracy: The receipts are recorded at the correct amount
• Cut-off: Receipts are allocated to the proper accounting period
• Completeness: All receipts have been recorded
• Classification: Sales are recorded in the proper accounts
Trade and other receivables
• Existence: Trade receivables actually existed at reporting date
• Rights: The Company had the rights to trade receivables
• Completeness: All trade receivables are included
• Valuation: Trade receivables have been included in financial statements at the appropriate value
Assertions about presentation and disclosure
• Occurrence, rights and obligations: All disclosed events relating to receivables have occurred and
pertain to the entity
• Completeness: All disclosures required have been included
• Classification and understandability: Financial information is appropriately presented and described
and disclosures clearly expressed
• Accuracy and valuation: Financial and other information is disclosed fairly and at appropriate
amounts.
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5.3.5 Tests of controls
Table 3: Test of controls
Assertion
Occurrence and
existence
Controls
• Segregation of duties
• Sales recorded only with
approved customer order
form and delivery note
• Accounting for numerical
sequence of invoices
• Monthly customer
statements sent out and
customer queries and
complaints handled
independently
• Authorization of credit
terms to customers
(senior staff
authorization, credit
checks for new
customers, regular
review of credit limits)
• Authorization by senior
staff required for
changes in other
customer data such as
address
• Orders not accepted
unless credit limit
reviewed first
• Authorized price lists and
specified terms of trade
in place
Completeness
• Accounting for numerical
sequence of invoices
• Delivery notes are
matched to invoices
• Sales invoices are
reconciled to the daily
sales report
Tests of controls
• Observe and evaluate whether
proper segregation of duties is
operating
• Test a sample of sales invoices for
authorized customer order form and
delivery note
• Examine application controls for
authorization
• Review and test entity’s procedures
for accounting for numerical
sequences of invoices
• Review entity’s procedures for
sending out monthly statements and
dealing with customer queries and
complaints.
• Review entity’s procedures for
granting credit to customers
• Examine a sample of customer
orders for evidence of proper credit
approval by the appropriate senior
staff member
• Examine application controls for
credit limits
• Review all new customer files to
ensure satisfactory credit references
have been obtained
• Compare prices and terms on a
sample of sales invoices to the
authorized price list and terms of
trade.
• Examine application controls for
authorized prices and terms
• Review and test entity’s procedures for
accounting for numerical sequences of
invoices
• Trace a sample of delivery notes to the
sales invoices and ledger
• Review a sample of reconciliations
performed
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• Sales invoices and
matching documents
including delivery notes,
customer’s order forms
etc. required for all
entries
• All delivery notes are
forwarded to the
invoicing section on a
daily basis
• Select a random sample of recorded
sales and vouch the recorded sales to
supporting documents.
• Compare dates on sales invoices
with dates of corresponding delivery
notes
• At year end obtain the document
numbers of the last documents used in the
financial year such as sales invoices,
dispatch notes and agree this to the last
entry in the sales journal.
Classification
• Chart of accounts is in
• Review sales ledger for proper
place
classification
• Codes in place for
• Examine a sample of sales invoices for
different types of
proper classification
products or services
• Test application controls for proper
codes
Source: Adapted from ACCA Audit and Assurance Study Text (2011) BPP Learning Media
Cut-off
5.3.6 Audit objectives
Study page 547. Auditing Fundamentals, Prinsloo et al
What are audit objectives?
Feedback to self-evaluation question
The auditor’s objective with audit procedures is to gather sufficient appropriate audit evidence that
each assertion made by management is true and that is free from material misstatement
One can therefore formulate audit objectives as follows: The auditor’s objective is to test that… (E.g.
all sales transactions have been completely recorded in the accounting records and none have been
omitted). Audit objectives are derived from assertions. Once the auditor has formulated audit
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objectives for material class of transactions, account balances and disclosure, the auditor can then
formulate the audit procedures required to achieve the audit objective.
5.3.7 Substantive audit procedures for sales
Table 4: Substantive procedures for sales
Assertion
Occurrence
Substantive audit procedures
• For a sample of sales transactions recorded in the ledger, vouch the sales invoice
back to customer orders and dispatch note
• Trace each sale in the sample through to the cash receipt journal/bank statement
and customer remittance advice and by inspection determine whether a payment
of the correct amount for each invoice was received. If the payment is not received
the auditor would trace it to the debtors’ ledger.
• For a sample of sales invoices, compare the prices and terms to the authorized
Accuracy
price list and terms of trade documentation
• Confirm the mathematical accuracy of the invoice b recalculating all extensions,
casts, discounts and VA calculations.
• Confirm that the invoice is a valid tax invoice such as VAT registration number is
included
• Agree the quantity and description of the goods invoiced to the quantity and
description of the goods on the dispatch note.
• At year end the auditor should obtain the document numbers of the last
Cut-off
documents used in the financial year such as sales invoices, dispatch notes
• At a later stage agree this number to the last entry in the sales journal and
sequence test say the last two weeks before year end for any missing invoice
numbers
• Scrutinize the subsequent month’s sales journal for any invoice numbers lower
than the cut-off number (none should be found)
• Select say the first 20 invoices entered in the sales journal for the month after
year end and trace them to supporting dispatch notes and by inspecting dates on
the documents confirm that the goods were not actually delivered prior to year
end
• Select say the last 20 dispatch notes prior to the year-end cut-off dispatch note
number and by inspection of the sales journal, confirm that the corresponding sale
was raised prior to year end
Completeness • Compare the gross profit % by product line with the previous year and industry
data
• Compare the sales/debtors to prior year periods
• Compare the sales ratios to prior periods such as sales commission to sales.
Classification • Take a sample of sales invoices and examine proper classification into revenue
accounts
• Inspect the revenue account for the inclusion of any amounts which are included
as revenue but do not constitute sales such as interest, dividend income
Source: Adapted from ACCA Audit and Assurance Study Text (2011) BPP Learning Media
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Substantive audit procedures for trade receivables
Assertion
Rights
Existence
Valuation and
allocation
Substantive audit procedures
• By inspection of prior year work papers, minutes of directors’ meetings, loan
agreements, bank confirmations and by enquiry of management, determine
whether receivables have been factored, ceded or encumbered in any way
• Perform a receivables circularization on a sample of year end receivables
• Follow up all balance disagreements and non replies to the receivables’
confirmation
• Perform alternative procedures for any exceptions and non replies to the
receivables confirmation such as
• Review after date cash receipts by inspecting bank statements and cash receipts
documentation
• Examine the customer’s account and customer’s correspondence to assess
whether the balance outstanding represents specific invoices and confirm their
validity
• Examine the underlying documentation (purchase order dispatch note, duplicate
sales invoices).
• Inquire from management explanations for invoices remaining unpaid after
subsequent ones have been paid
• Observe whether the balance on the account is grown and if so, find out why by
discussing with management.
• Compare receivables’ turnover and receivables’ days to the previous year and or
industry data
• Compare the aged analysis of receivables from the aged trial balance to the
previous year
• If comparison of the debtors list (per debtors’ ledger) to the balance in the
debtors control account reveals that there are reconciling items, the auditor should
follow up on reconciling items.
• The debtors control account in the general ledger should be reviewed for unusual
entries such as debits arising from journal entries at year end, and followed up.
• The debtors list should be reviewed for credit balances and these should be
followed up and reversed if necessary.
• Enquiry should be made of the method and procedures adopted by management
to estimate the allowance for bad debts.
• Compare the bad debt expense as a % of sales to previous year and or industry
data
• For a sample of old debts on the aged trial balance, obtain further information
regarding their recoverability by discussing with management and review of
customer correspondence Study Jackson & Stent 10/64- 10/65
Completeness • Reconcile the balance from the individuals sales ledger accounts to the aged
receivables’ listing and vice versa
• Match the total of the aged receivables listing to the sales ledger control account.
• Trace a sample of the delivery notes to sales invoices and into the sales ledger.
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• Complete disclosure checklist to ensure that all disclosure relevant to receivables
have been made
• Compare the gross profit % by product line with the previous year and industry
data.
• Compare the level of prepayments to the previous year to ensure the figure is
materially correct and complete
The auditor must inspect the financial statement disclosures and consider whether
• Disclosures are complete in terms of applicable
accounting framework such as the balance is included in current assets
• Amounts, facts, details are accurate and agree with evidence gathered
• Any classification of the information disclosed is appropriate
• The wording of the disclosures is clear and understandable such as the
accounting policy and the explanation of any encumbrances.
5.3.8 Debtors’ circularization
The auditor selects a sample of statements for circularization to ensure that a statement has been
produced for each debtor and there is a debtor recorded for each statement.
Two different types of confirmations may be used by the auditor:
• A positive confirmation requests that the debtor confirms with the auditor whether the balance on
the statement is correct or not
• A negative confirmation requests that the debtor confirms with the auditor only if the balance on
the statement is not correct.
The positive confirmation is therefore preferred because it provides better evidence supporting the
existence assertion e.g. if a negative circularization letter is not returned it could mean that:
• The debtor’s balance is correct or
• That it went to a fictitious debtor or
• That the debtor’s balance is incorrect but in favour of the debtor
The point is very little evidence is provided by negative circularization.
The auditor then monitors all replies to the circularization, following up all disagreements and
addresses unknown and no replies so as to collect evidence relating to existence and to a lesser extent
valuation.
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5.3.9 Self-Evaluation Questions
Answer the following questions to check whether you have achieved all the set
outcomes:
1. Identify and describe the documents and records, both manual and
computerised, utilised in the cycle and describe the purpose of each?
2. Identify and describe the risks of misstatement affecting account balances,
classes of transactions and events in the financial statements
3. Describe how internal controls may assist in achieving the control objectives
in the cycle and how these control objectives relate to management’s assertion
in the financial statements.
4. Explain the assertions and test of controls that applies to sales and account
receivables.
5. Explain the substantive procedures that should be formulated by an auditor
when auditing sales and accounts receivables.
Study the case study/scenario below and answer the questions that follow
You have carried out your interim audit in respect of the year ending 31 December 20x0 which
included a circularization of 80 trade accounts receivable as at 30 September 20x0 selected from a
total credit customer list of 1000. Replies were received from all customers circularized.
The interim audit work disclosed the following:
a) Of the 80 customer’s accounts circularized, 8 disagreed but could be reconciled by
bringing into account payments stated by the customers concerned to have been made before 30
September 20x0 but which in each case were recorded in Bright Sparks’ books between 14 and 18
days after the dates stated by the customers as the date of payment.
b) Your tests suggested that some 25% of credit customers were allowed settlement discounts of 2.5%
although payments were consistently received after the latest date eligible for discount.
c) A large number of credit notes were raised representing approximately 12% of the total number of
invoices raised. A review of the copy credit notes indicated that they usually arose from arithmetical
and pricing errors on invoices raised.
You are required to explain the conclusions you would draw as a result of the interim audit and
describe the work you would plan to carry out at the final audit on trade receivables at 31 December
20x0 based upon those conclusions. (20 marks)
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Study the Independent Regulatory Board of Auditors on page 6
of the prescribed textbook.
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Study Unit 4: Auditing Expenditure Transactions and Balances
This chapter covers expenditure transactions and balances. This chapter
explains the accounting and control activities in the cycle, risks involved with
expenditure and assertions and the acquisition and payments cycle. At the end
Purpose
we will look at the test of controls and substantive procedures for trade and
other payables.
After studying this unit, you should be able to:
• Describe the nature and type of activities in accounting systems for credit
purchases, cash purchases, payments to trade accounts payable and other
accounts payable;
• Describe the internal control measures that could be introduced for the
control of credit purchases, cash purchases, payments to trade accounts
payable and other accounts payable;
• Understand the audit objectives for account transactions and balances;
• Asses the risk and inherent risks involved with expenditure;
Learning
• Assess effectiveness of the internal controls for credit purchases, cash
Outcomes
purchases, payments to trade accounts payable and other accounts payable;
• Discuss the functions relative to purchasing activities;
• Formulate tests of control according to which internal control measures can
be evaluated;
• Formulate substantive procedures for auditing credit purchases, cash
purchases, payments to trade accounts payable and other creditors;
• Formulate substantive procedures for auditing accounts payable balances and
bills payable balances;
• Presentation and disclosure of expenditure;
It will take you 4 hours to make your way through this unit.
Time
5.4.1 Nature and type of activities in accounting system
The purchases and payments cycle relates to an entity’s acquisition of goods and services from
suppliers, and payments to suppliers in exchange.
How transactions in the cycle are initiated
• For a purchase transaction to commence, an internal purchase requisition should be issued by the
department in the entity that requires the goods and services. This action will in turn lead to an order
being submitted to a supplier.
• For a payment transaction to commence, an invoice should become payable within agreed payment
terms.
Functional areas that exist for any acquisition and payments cycle
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a. Ordering of goods: There must be a section/department which initiates the placing of orders for
goods or services with suppliers and these requests comes from departments like warehouse
department, finance department etc.
b. Receiving of goods: Receiving of goods ordered from suppliers and acknowledging the company’s
acceptance of the goods
c. Recording of purchases (acquisition): To ensure that all valid purchases made are accurately
accounted for in the entity’s financial records, and in a timely manner.
d. Payment preparation: This function will be responsible for determining the amount to be paid to
the creditor, confirming that the payment is valid and preparing any documentation required for the
payment to be authorized and initiated.
e. Actual payment and recording the payment: This function will be responsible for preparing the
means of payment, e.g. Cheque or electronic funds transfer, authorizing it and carrying out the
payment timeously. The function will also be responsible for recording the payment in the accounting
records.
f. Returning goods and recording a purchase adjustment: This function is responsible for returning
unsatisfactory goods previously purchased and to record the transaction as a purchase return, to
record other adjustments to supplier accounts, such as where incorrect prices or item quantities have
been invoiced by a supplier.
Study Prinsloo et al (2015) Auditing fundamentals, page 262-263
Study Jackson & Stent (2017) Auditing notes for South African
students page 11/2-11/3.
Documents used in the cycle
Study Prinsloo et al (2015) Auditing Fundamentals, page 264-268
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Explain why there is a need in the purchase and payment cycle to
prepare each of the source documents referred below?
• Goods received note
• Supplier delivery note
• Purchase invoice
• Quotation
• Receipt
• Cheque requisition
• Master file amendment form
• Credit note
Feedback to self-evaluation question
Source document
Goods received note
Why is there a need to prepare a source document?
This document is completed by the purchasing company when the
goods are delivered by the supplier. It records the actual goods received
and will be cross referenced to the suppliers delivery note.
Supplier delivery note This document is made out by the supplier and details the goods which
are being supplied. It will be cross referenced to the purchasing
company’s order form and on delivery of the goods, will be signed by
the purchasing company to acknowledge the receipt of the goods.
This document is sent by the supplier to the purchasing company to
Purchase invoice
inform them of goods for which it is being charged, the price, any
discounts and value added tax
(VAT).
Quotation
A quotation prescribes the best price of the goods and services needed
by the entity. Department requisitioning the goods and services may
have to obtain one or more quotations from suppliers and comparison
is made and the best quotation is accepted.
Receipt
A document provided by the supplier to acknowledge that a payment of
Rx has been received.
Cheque requisition
A form completed by the creditors section of the purchasing company
requesting that a cheque be made out for a particular creditor. Details
of the creditors and amount to be paid will be shown on the requisition.
Master
file A master file amendment form is completed in a computerized system
amendment form
each time a creditor’s details are to be changed on the creditor’s master
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file. The creditor master file represents the creditor’s ledger in a
computerized system.
This is a supplier document which records any credits to the purchasing
company’s account other than a payment that is when incorrect,
damaged or unwanted goods are returned by the purchasing company.
5.4.2 Control measures
Proper control activities have to be implemented in the cycle to ensure that the entity achieves its
control objectives of validity, accuracy and completeness of financial information.
Study Jackson & Stent (2017) Auditing notes for South African students,
page11/7-11/30.
Study Prinsloo et al (2015), Auditing fundamentals page 280-301
Explain the control activities in each of the following functions of the
acquisition and payments cycle?
• Ordering of goods
• Receiving of goods
• Recording of purchases
• Payment preparation
• Actual payment and recording
5.4.3 Risks in the acquisition and payments cycle
Study Jackson & Stent (2017) Auditing notes for South African students,
page11/7-11/13
Explain the control risks that could exist in a payment department?
Feedback on self-evaluation question
• Payment to fictitious creditors
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• Payment of incorrect amounts
• Unauthorised payments
• Discounts lost due to late payments
• Cheques may be incorrectly made out e.g. wrong payee, wrong amount
• Payments may be recorded inaccurately or may be intentionally misstated to hide fraud.
5.4.4 Assertions and the acquisition and payments cycle
Purchase transactions:
• Occurrence: purchases recorded actually occurred, they are not fictitious and they pertain to the
entity.
• Accuracy: purchases have been recorded appropriately that is at the correct amount
• Cut-off: Purchases have been recorded in the correct accounting period
• Classification: Purchases have been recorded in the proper accounts and
• Completeness: All purchases that should have been recorded have been recorded.
Payment transactions:
• Occurrence: Payments recorded actually occurred (not fictitious), and pertain to the entity
• Accuracy: the payments have been recorded appropriately that is at the correct amount
• Cut-off: Payments have been recorded in the correct accounting period
• Classification: Payments have been recorded in the proper account
• Completeness: All payments to creditors that should have been recorded have been recorded.
Trade payables
• Existence: Creditors actually existed at the reporting date, they are not fictitious
• Obligation: All creditors included in the balance represent obligations of the company
• Completeness: All creditors that should have been recorded at reporting date have been included.
• Valuation: Creditors have been reflected at the appropriate amount.
Presentation and disclosure
In addition to the assertions above, the directors also assert that the presentation and disclosure of
all matters pertaining to the balance and transactions in the cycle are complete in terms of the chosen
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accounting framework, have been correctly classified and accurately presented and disclosed in an
understandable manner.
Jackson & Stent (2017) Auditing notes for South African students,
10th edition page 11/42.
5.4.5 Test of controls
The auditor tests a control to determine whether the control has been effective in achieving the
objective for which it has been implemented in the first place.
Assertion
Occurrence and
existence
Controls
• Authorisation procedures and policies in
place for ordering goods and services
• Segregation of duties
• Purchase orders raised for each purchase
and authorised by appropriate senior
personnel
• Approved purchase order for each
receipt of goods.
• Staff receiving goods verify them to the
purchase order.
• Purchase orders and GRNs are matched
with the supplier’s invoices
Completeness
• Purchase orders and GRNs are matched
with the supplier’s invoices
• Periodic accounting for
pre-numbered GRN’s and purchase orders
• Independent verification of amount
recorded in the
purchase journal
Tests of controls
• Inspect policies and procedures
and enquire about them
• Observe
and
evaluate
segregation of duties
• Examine a sample of purchase
orders to ensure they have been
appropriately authorised.
• For a sample of orders, examine
the goods received note (GRN)
and match it to the order.
• Observe receipt of goods by
staff to confirm whether the
verification of e.g. quantity, size
is done
• Examine supporting documents
for a sample of invoices with a
view to determine the validity of
purchases and trade payables
amount
• Examine supporting documents
for a sample of invoices and
trace them to creditors’ ledger
with a view to determine if all
were recorded
• Review entity’s procedures for
accounting for pre-numbered
documents
• Examine application controls
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• Examine documentation for
evidence of this verification
•Examine
supporting
Rights and
• Purchase orders and GRN’s are matched
documentation for a sample of
obligations
with the supplier’s invoices
invoices with a view to determine
if an entity has an obligation to
pay
Accuracy,
• Purchase orders and GRN’s are matched
•Examine
supporting
classification
with supplier’s invoices
documentation for a sample of
and valuation
• Mathematical accuracy of the supplier’s
invoices with a view to
invoice is verified
determine the accuracy of
• Amount posted to general ledger is
purchases and trade payables
amount
reconciled to the
• Recalculate the mathematical
purchase ledger
accuracy of a sample of supplier’s
• Chart of accounts
invoices
• Review reconciliations for
evidence of this verification
process
• Review purchases journal and
general ledger for reasonableness
• Procedures in place that require
• Compare dates on vouchers
Cut-off
recording of purchases as soon as possible
with dates they were recorded in
after goods/services received
the purchases journal with a view
to determine if they were
recorded
in
the
correct
accounting period and at the
appropriate time
Source: Adapted from ACCA Audit and Assurance Study Text (2011) BPP Learning Media
5.4.6 Substantive audit procedures for purchases
Assertion
Occurrence
Accuracy
Substantive audit procedures
• Inspect the supporting documentation (purchase order, supplier
delivery note, GRN and invoice to confirm that the external documents are made
out to the entity and are from approved supplier, all documents are correctly
cross-referenced to each other, each document is signed by the designated
authority and the goods purchased are of a type used by the company.
• Inspect the cash payment records/ EFT schedules/ bank statements to confirm
that the goods were appropriately paid for, payment authorised, correct payee
and correct amount.
• Confirm the mathematical accuracy of the invoice by recalculating all
extensions (quantity x price), casts and discounts
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• Tally the quantity of items charged on the invoice, against the quantity on the
goods received note
• Confirm prices and trade discounts used on the invoice by inspection of the
order or purchase contract
• Recalculate VAT, and by inspection of the invoice, confirm that discounts are
taken into account prior to the calculation of VAT
• By inspection, confirm that the VAT number and details of the supplier as well
as the supplier’s VAT number are clearly presented on the supplier’s tax invoice.
• Inspect the dates on the supplier delivery note, goods received note and
invoice to confirm that the goods were received during the accounting period
under audit.
• Inspect the purchase order to determine the expense or asset account to
which the purchase should be allocated and posted and trace the posting from
the purchase journal to designated expense or asset account in the general
ledger.
• Establish the description of the goods purchased to confirm that the
classification of the purchase is appropriate e.g. the purchase of a non-current
asset has not been written-off as an expense
• Inspect the purchase journal and invoice to confirm that VAT has been
correctly allocated and posted
• Inspect the supplier’s account in the creditors ledger to confirm that the
purchase was correctly posted from the purchase journal
• Select a sample of GRN’s and trace them through to the corresponding
invoices, if there was no corresponding invoice, the purchase may not have been
recorded.
Substantive audit procedures on the trade and other payables balance
Assertion
Obligation
Existence
Valuation
Substantive procedures
• Inspect the supporting documentation, statements, invoices etc. to confirm
that they are made out in the name of the company and in respect of purchase
of goods or services which are used by the company
• Vouch selected amounts from the trade accounts payables listing and accruals
listing to supporting documentation such as purchase orders and supplier’s
invoices
• Obtain selected supplier’s statements and reconcile these to the relevant
supplier’s accounts
• Perform analytical procedures comparing current year balances to the
previous year to confirm reasonableness, and also calculating payables turnover
and comparing to the previous year.
• Perform a confirmation of accounts payables
• Agree the list of individual creditor’s balances to the balance on the creditors
control account
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• Agree a sample of individual creditor’s balances on the list to the individual
creditor’s account in the creditors’ ledger
• Agree the total of the accrual and creditors control accounts in the general
ledger to the trial balance
• Re-perform casts of the creditors control account and the creditors list
• Identify any debit balances on the creditors list, establish the reason with the
purchase manager and consider whether the balances should be transferred to
debtors
• Select a sample of creditors from the creditors list and obtain the year-end
creditors reconciliations performed by the creditors clerk and re-perform the
casts of the reconciliation, agree balances on the reconciliation to the creditors
statement and creditors listing
• If applicable, select a sample of foreign creditors from the creditors list and by
scrutiny of the supporting documentation (invoices), determine the amount
owed to the creditor in the foreign currency denominated currency.
• Compare current year balances for trade accounts payables and accruals to
previous year
• Compare the payables’ turnover and payables days to the previous year and
industry data.
• Compare the list of creditors at the current year-end to the previous year-end,
to identify creditors on the previous list who do not appear on the current list
and creditors balances which are significantly smaller at the current year-end
and by enquiry determine the reason
• Inspect the creditor’s correspondence file for correspondence relating to
unsettled disputes with suppliers, and by discussion with management,
determine whether any adjustments to creditors are required.
• If available, inspect the list of GRNs which were unmatched to invoices at yearend. Confirm by inspection, that a journal entry raising the corresponding
creditors at year end, has been passed, and that the amounts raised are correctly
computed by obtaining the price of the goods received
• Select a sample of material purchases from the purchase journal for the month
following the year-end and trace to the goods received note applicable to the
purchase, to confirm that the GRN number is greater than the GRN “cut-off”
number.
Select a sample of large payments from the cash payments journal for the month
after the financial year-end and by inspection of the GRN and delivery note,
confirm that if the payment relates to goods or services received prior to
yearend and the corresponding creditor had been raised at yearend.
• Perform analytical procedures and follow up on material fluctuations e.g.
current year creditors and accruals at year end to prior years
Refer to Jackson & Stent page 11/51
The auditor must inspect the disclosures and consider whether
• They are complete in terms of the applicable reporting framework
• The disclosures are consistent with evidence gathered on the audit
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• Amounts, facts, details etc. are accurate and agreed with the evidence
gathered
• Any classification of the information disclosed is appropriate
• The wording of the disclosures is clear and understandable
5.4.7 Presentation and disclosure
The auditor must inspect the disclosures and consider whether
• They are complete in terms of the applicable reporting framework, e.g. the balance is included in
current liabilities as part of accounts payable
• The disclosures are consistent with evidence gathered on the audit
• Amounts, facts, details etc. are accurate and agreed with the evidence gathered
• Any classification of the information disclosed is appropriate
• The wording of the disclosures is clear and understandable
5.4.8 Self-Evaluation Questions
Answer the compulsory revision questions below.
1. Describe the functional areas that exist for an acquisition and payments
cycle?
2. Identify and describe the risks of misstatement affecting account balances,
classes of transactions and events in the financial statements
3. Describe the internal control measures that could be introduced for the
control of credit purchases, cash purchases, payments to trade accounts
payable and other accounts payable
4. Explain the assertions and test of controls that applies to purchases and
accounts payables.
5. Explain the substantive procedures that should be formulated by an auditor
when auditing purchases and accounts payables
Study the case study/scenario below and answer the questions that follow
Fox Industries Co (Fox) manufactures engineering parts. It has one operating site and a customer base
spread across Europe. The company’s year-end was 30 April 2013.
Below is a description of the purchasing and payments system.
Purchasing system
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Whenever production materials are required, the relevant department sends a requisition form to the
ordering department. An order clerk raises a purchase order and contacts a number of suppliers to
see which can despatch the goods first. This supplier is then chosen. The order clerk sends out the
purchase order. This is not sequentially numbered and only orders above
$5,000 require authorisation.
Purchase invoices are input daily by the purchase ledger clerk, who has been in the role for many years
and, as an experienced team member, he does not apply any application controls over the input
process. Every week the purchase day book automatically updates the purchase ledger, the purchase
ledger is then posted manually to the general ledger by the purchase ledger clerk.
Payments system
Fox maintains a current account and a number of saving (deposit) accounts. The current account is
reconciled weekly but the saving (deposit) accounts are only reconciled every two months. In order to
maximise their cash and bank balance, Fox has a policy of delaying payments to all suppliers for as
long as possible. Suppliers are paid by a bank transfer. The finance director is given the total amount
of the payments list, which he authorises and then processes the bank payments.
Required
a) As the external auditors of Fox Industries Co, write a report to management in respect of the
purchasing and payments system described above which:
(i) Identifies and explains FOUR deficiencies in the system; and (8 Marks)
(ii) Explains the possible implication of each deficiency; and (10 Marks)
(iii) Provides a recommendation to address each deficiency. (10 Marks)
b) Identify and explain FOUR application controls that should be adopted by Fox Industries
Co to ensure the completeness and accuracy of the input of purchase invoices. (10 marks)
c) Describe substantive procedures the auditor should perform to confirm the bank and cash balance
of Fox Industries Co at the year-end. (10 marks)
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Study Unit 5: Auditing Inventory and Production Cycle
This chapter covers inventory and production cycle. This chapter explains the
accounting and control activities in the cycle, risks involved with inventory
and assertions and the inventory and production cycle. At the end we look at
Purpose
the test of controls and substantive procedures for inventory and production
cycle.
After studying this unit, you should be able to:
• Describe the activities in accounting systems for trading inventory;
• Describe the audit objectives of inventory;
• Know the examples of risk encountered
• Describe the internal control measures that could be introduced for the
control of trading inventory;
Learning
• Describe the internal control aspects of stock-taking;
Outcomes
• Explain the valuation concepts and principles of stock- keeping;
• Asses the effectiveness of the internal controls for trading inventory;
• Formulate tests of control according to which internal control measures
can be evaluated;
• Formulate substantive procedures for auditing trading inventory;
• Presentation and disclosure aspects;
It will take you 4 hours to make your way through this unit.
Time
5.5.1 Nature and activities in accounting system for trading inventory
The inventory and production cycle relates to an entity’s function of managing and safeguarding its
inventory and, and in the case of a manufacturing entity, controlling the production process. Therefore
this cycle is applicable to an entity trading or manufacturing goods. Inventory is usually the major
component in the calculation of cost of sales, gross profit and net profit. It plays a prominent role in
the fair presentation of the financial statements and for this reason material misstatement in
inventory, in whatever form, will often be pervasive to the financial statements. For this reason, the
accounting system and related control activities within the cycle must be well designed and strictly
adhered to, e.g. a strong control environment must be maintained and physical access controls must
be in place.
Purpose of inventory and production cycle in an entity:
• Safeguard inventory against theft and damage
• Control the movement of inventory (raw-material, work in progress and finished goods) during the
production process and
• Control the production process itself (e.g. what and how many to manufacture, spillage during the
production process and quality of the manufactured goods)
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Movement of inventory in retail and manufacturing entity
Figure 4: Movement of inventory
Source: Adapted from Auditing Notes for South African Students, 10th edition, page 12/4
The diagram above represents the inventory and production cycle in a simple format. It illustrates that
goods received from suppliers follow one of two paths, namely, to the raw material and component
store, on to production and into finished goods warehouse, or direct to the “goods for resale”
warehouse. The diagram also indicates where a transfer takes place (arrow head) and where physical
controls over inventory are required (C).
Study Jackson & Stent (2017) Auditing notes for South African students,
page12/4-12/5.
Study Prinsloo et al (2015), Auditing fundamentals page 323-329
Explain the reasons for preparing the following source documents in the
inventory cycle?
• Goods received note
• Materials requisition, materials issue note
• Job cards
• Inventory sheet
• Inventory adjustment form
Feedback to self-evaluation question
Source
document
Why there is need to prepare the source document
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Goods
received
note
Materials
requisition,
materials
issue note
Job cards
On transfer of inventory items (of whatever kind) from the goods
receiving bay into the warehouse, the warehouse clerk will sign the
goods received note which was made out when the goods were
delivered by the supplier.
A materials requisition is a documented request to the warehouse
to release materials to the production section, and a materials issue
note records the issue of materials to production
Tracks the stages of production for a specific job. As costs are
accumulated, e.g. raw materials used, labour hours expended, they
are recorded on the job card. At a later stage, an overhead allocation
can be made to arrive at the total cost of production.
Inventory
A document which is used during an inventory count. The inventory
sheet
sheet will usually contain a description of each item of inventory, its
location in the warehouse and a column into which the quantity of
items actually counted, can be entered.
Inventory
Is a sequenced document which is used to record adjustments which
adjustment must be made to correct the perpetual inventory records when actual
form
inventory and theoretical inventory (per perpetual inventory records)
do not agree?
5.5.2 Risks in the inventory cycle
Study Jackson & Stent (2017) Auditing notes for South African students,
page12/6-12/8
Study Prinsloo et al (2015) Auditing fundamentals, page 333.
Explain the risks that could exist in the inventory and production cycle?
Feedback on self-evaluation question
• Goods received from suppliers are not transferred into the warehouse timeously or at all (stolen)
• Inventory in whatever form is stolen or lost
• Inventory deteriorates in value due to inadequate physical controls and its nature e.g. foodstuffs
• No record is created of goods or components physically moved
• The goods or components issued are incorrect resulting in lost sales or production delays
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• Inventory shortages (including theft) are concealed.
• Unauthorised requisitioning or issue of materials (theft)
• Requisitioning or issue of incorrect materials resulting in losses from wastage/delays
• Failure to budget costs properly resulting in selling prices which are too low and subsequent losses
• Failure to monitor actual expenditure and identify variances between actual and
Budget
• Failure to control the transfer of finished goods to finished goods store (manufactured items stolen,
damaged or lost).
5.5.3 Control measures
Proper control activities have to be implemented in the cycle to ensure that the entity achieves its
control objectives of validity, accuracy and completeness of financial information.
Study Jackson & Stent (2017) Auditing notes for South African students,
page12/6-12/9.
Study Prinsloo et al (2015), Auditing fundamentals page 333- 349.
Explain the control activities in each of the following functions of the inventory
cycle?
• Warehousing
• Production
5.5.4 Financial statement assertions and the inventory and production cycle
The assertions which apply to inventory account balances are as follows:
a) Rights: the company holds or control the rights to all inventory reflected in the financial statements
b) Existence: All inventory included in the account balance actually existed at the reporting date
(inventory is not overstated by inclusion of fictitious items)
c) Completeness: All inventory to which the company has the rights of ownership, is included in the
financial statements. All inventory that should have been recorded has been recorded.
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d) Valuation and allocation: Inventory is reflected in the financial statements at an appropriate
amount (carrying value) (this means that appropriate adjustments have been made to comply with
the IAS 2 requirement that inventory be presented at the lower of cost or net realizable value).
Assertions pertaining to presentation and disclosure
In addition to the assertions applicable to the inventory balance identified above, the directors are
also asserting that the presentation and disclosure of all matters pertaining to the balances in this
cycle are complete in terms of the applicable financial reporting framework, e.g. IFRS have been
correctly classified and accurately presented and disclosed in an understandable manner.
5.5.5 Test of controls
The auditor tests a control to determine whether the control has been effective in achieving the
objective for which it has been implemented in the first place.
The auditor’s main focus is normally on substantive testing of the inventory balance.
However, some tests of controls will be carried out and will centre on the following:
• Observation of the inventory count
• Inspection of reconciliations and cycle count amendment forms for cycle counts carried out during
the year, to determine frequency and materiality of discrepancies and how they were resolved and
for authorising signatories.
• Observation of warehouse controls to determine the effectiveness of
✓ Access controls (custody and safe keeping) and
✓ Controlling inventory movement
• Inspection of records controlling inventory movement’s e.g.
✓ a sample of requisitions and materials issue notes for authorising signatures and cross referencing
to job cards
✓ a sample of inventory movements per the perpetual inventory records to “transfers to finished
goods notes”.
• Enquiry of production and warehousing as to what control procedures they actually perform.
5.5.6 Substantive procedures
The performance of year-end substantive procedures is usually broken down into two distinct phases,
namely:
• Attendance at the year-end inventory count (mainly existence, but some evidence of completeness
and valuation is gathered)
• The subsequent audit of the carrying value (valuation, rights to the inventory and presentation and
disclosure of inventory)
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Inventory count attendance
Prior to the inventory count the auditor should:
• Liaise with the client about date and times of the inventory count
• Confirm all locations at which the client holds inventory and if necessary visit the locations
• Perform administrative planning e.g. organise audit staff to attend.
• Obtain and review a copy of the written instructions given to the client’s count teams
• Enquire whether the client has any inventory which should not be included in the count e.g.
consignment inventory, inventory already invoiced but not yet delivered
• Brief the audit staff allocated to the count on their responsibilities
During the count the auditor should
• Observe inventory taking procedures to ensure that the client’s written instructions are adhered to.
• Walk through the warehouse and identify inventory which is obsolete or damaged or appears to be
slow moving e.g. dusty, old packaging etc. Trace these items to the inventory sheets to confirm that
these items have been marked as damaged/obsolete
• Conduct test counts on the inventory in the warehouse in both directions making sure all sections
and categories are tested:
✓ from inventory sheets to physical inventory (existence)
✓ from physical inventory to inventory sheets (completeness)
• Resolve discrepancies in test counts before conclusion of the count by recounting with client staff
and confirming that amendments are made to the inventory sheets where necessary
• Test the numerical sequence of the inventory sheets both before and at the conclusion of the count
to ensure that all inventory sheets are accounted for
• Confirm by enquiry of inventory counters and inspection of inventory sheets that inventory which
should not be included in the client’s inventory, has been excluded.
At the conclusion of the count, the auditor should
• Inspect the inventory sheets to confirm that:
✓ Lines have been drawn through blank spaces (so that items cannot be added)
✓ Alterations/corrections have been signed, and
✓ Inventory sheets have been signed by the counters responsible
• Create audit records in respect of the inventory count attendance by:
✓ Taking copies of all inventory sheets (hardcopy and digital)
✓ Recording observations as to the client’s count procedures
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✓ Recording results of all test counts performed by the audit team
✓ recording any damaged. Obsolete or slow moving inventory
• Record cut-off numbers for all documents used in the inventory and production cycle.
Post inventory count procedures
Assertion-rights- the company has the right or controls the right to inventory
• Enquire of management as to whether any inventory is held on consignment for other parties
• Obtain a listing of inventory of goods in transit at the financial year-end and inspect relevant
orders/contracts to determine whether ownership has passed to the client by scrutiny of the terms of
purchase e.g. FOB, CIF
• Establish whether inventory is in any way encumbered (e.g. offered as security) by
✓ Discussion with management
✓ Inspection of bank confirmations
✓ Review of directors’ minutes
✓ Review of correspondence/contracts with suppliers and credit providers
• Inspect invoices whether they would have been made out to the client.
Assertion- valuation and allocation- inventory is included in the financial statements at appropriate
amounts
To establish the value of inventory, the client will have to multiply the quantities confirmed at the
inventory count by the cost price of the item, using the correct cost formula. Once this is done the
allowance for inventory obsolescence must be established.
• Compare the quantities of inventory items on the auditor’s copies of the inventory sheets to the
client’s priced inventory sheets to confirm that the client has not yet altered the quantities
• Test the arithmetical accuracy of the inventory sheets by re-performing all extensions (quantity x
cost) and casting the extension column (total inventory value)
• Review inventory sheets for any negative ‘’inventory item values’’
• Compare the total inventory value per the inventory sheets to the general ledger and trial balance.
• Using the sample selected for inventory items which were test counted at the inventory count trace
to relevant suppliers invoices to establish whether the correct purchase prices have been used in
obtaining the cost in terms of the cost formula.
• Re-perform the weighted average calculation and compare results to the weighted average price
used by the client.
• By enquiry of the costing clerk and inspection of invoices from transporters, establish that relevant
carriage costs have been included in unit cost calculations
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• For a sample of imported high value items, obtain the relevant suppliers invoices/ shipping contracts
and costing schedule, and re-perform the unit cost calculations for a sample of imported items and
verify that the correct exchange rate was used.
• For pricing of manufactured goods enquire of appropriate personnel and inspect documentation
used in the costing exercise to gain an understanding of the costing method used.
• For pricing of manufactured goods where a standard costing system is used determine the
appropriateness of the standard setting process by discussion with management and inspection of
budgets and historical records
• Discuss with management the process used to determine the obsolescence allowance and evaluate
the process for reasonableness and consistency with prior years.
• Confirm with management any procedures in place for the approval of the final allowance, e.g. is
the allowance approved by the Finance Director.
General- all assertions
• Perform an overall analytical view of inventory by comparing current year figures and ratios with the
corresponding figures of prior year e.g.:
✓ Total inventory
✓ Total inventory by category or location or source
✓ Inventory as a % of current assets/total assets
• Include reference to inventory, particularly the allowance for obsolescence, in the management
representation letter.
5.5.7 Presentation and disclosure
The auditor must inspect the financial statement disclosures and consider whether
• They are complete in terms of the relevant reporting framework e.g.
✓ Encumbrances on inventory (security)
✓ accounting policies
✓ Cost formula
✓ Cost of goods sold
• They are consistent with evidence gathered on the audit
• Amounts, facts, details etc. are accurate and agree with the evidence gathered
• Any classification of the information disclosed is appropriate e.g. W.I.P, finished goods, raw materials
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• The wording of the disclosures is clear and understandable e.g. the circumstances that led to a
reversal of impairment of inventory
5.5.8 Self-Evaluation Questions
Answer the compulsory revision questions below.
1. Describe the activities in accounting systems for trading inventory
2. Identify and describe the risks of misstatements affecting inventory account
balance, in the financial statements
3. Describe the internal control measures that could be introduced for the
control of inventory
4. Explain the assertions and test of controls that applies to inventory
5. Explain the substantive procedures that should be formulated by an auditor
when auditing inventory account balance
6. Explain the audit procedures that are carried out by an auditor before, during
and after inventory count.
Study the case study/scenario below and answer the questions that
follow
You are the audit senior in charge of the audit of CompTech Limited (CompTech). The trainee
accountants working on the audit of CompTech prepared the following working paper.
Client: CompTech
Year end: 30 September
20xx
Date: 17 October 20xx
Prepared by: Innocent
Mutaki
Reviewed by: Munyaradzi
Dera
A1
Subject: Inventory
CompTech uses an automated (computerised) inventory system and performs regular physical
inventory test counts. All inventories are issued directly to customers from the warehouse at the head
office in Sandton.
Inventories are measured at the lower of cost or net realisable value. The cost price is determined in
terms of the first-in-first-out cost formula.
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Pre-numbered goods received notes are used to record receipts of inventory, while prenumbered
delivery notes are used to record the issue of goods to customers.
Because of the effective working of the inventory system and internal controls in the inventory cycle,
no other adjustments due to theft or damages were made to the closing balance of inventory.
The inventory balance will be audited using data CAATs.
The inventory master file contains the following fields:
• Inventory item number
• Inventory item description
• Date of last purchase per item
• Date of last sale per item
• Quantity on hand at the beginning of the financial year
• Year-to-date sales quantity
• Year-to-date purchase quantity
• Quantity on hand at the end of the financial year
• Unit selling price at year end
• Unit purchase price at year end
• Value of the inventory at the end of the financial year
Required
Refer to working paper A1 entitled “Inventory”. Describe the substantive procedures that you will
perform on the valuation of inventory using data CAATs. You are not required to deal with substantive
procedures relating to consignment inventory. (20marks)
(Refer to Workbook for model answers)
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Study Unit 6: Auditing Payroll Transactions and Balances
This chapter covers payroll and personnel cycle. This chapter explains the accounting
and control activities in the cycle, risks involved with payroll and assertions and the
Purpose
payroll and personnel cycle. At the end we look at the test of controls and substantive
procedures for payroll and personnel cycle.
After studying this unit, you should be able to:
• Describe the activities in the accounting system for wages and salaries;
• Describe the audit objectives which the auditor aims to achieve by auditing wages
• Asses the risks to misstatement;
Learning
Outcomes • Describe the internal controls that could be introduced for the control of wages and
salaries;
• Formulate substantive procedures for auditing credit purchases, cash purchases,
payments to trade accounts payable and other creditors and wages;
It will take you 4 hours to make your way through this unit.
Time
5.6.1 Nature and activities in accounting system for wages and salaries
The payroll and personnel cycle relates to the paying of salaries and wages to employees of the
company and related expenses (e.g. UIF, medical aid contributions), which results in outflow of funds
from the company. Expenses paid for salaries and wages are often a material expense for
organizations and cash could also be involved where wages are paid to employees in cash rather than
into their bank accounts. This cycle is at risk contributing to material misstatements in the financial
statements for possible fraud (misappropriation of assets), firstly as remuneration could be paid in
cash (necessitating cash on hand on the premises), and secondly for the creation of fictitious (or ghost)
employees. Salaries and wages are usually a major expense for most entities, which increases the risks
of material misstatements arising as a result of the large numbers involved.
Purpose of payroll and personnel cycle in an entity is to address:
• Appointment of personnel, authorization of any changes to salaries and wages rates and deductions,
and maintaining personnel records
• Time keeping and control over hours worked
• The preparation of salary and wage transactions and the recording of these transactions
• Preparation of salaries and wages to be paid
• Payment of salaries and wages
• Paying over of deductions to the relevant parties (e.g. SARS)
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How transactions in the cycle are triggered (initiated)
• A typical wage transaction in the human resource cycle will originate from the appointment of an
employee. Then a wage rate has to be set, deductions have to be authorized and a record of the time
worked has to be kept.
• For a salary transaction to commence, a salaried employee has to be appointed, a monthly salary
rate has to be set, and the deductions have to be authorized.
• Deduction transactions commence when the employee is to be paid for the first time and part of
the remuneration is due to 3rd parties (e.g. medical aid, pension fund contributions, SARS)
The cycle ends when the salaries and wages have been paid over and recorded in the accounting
records, and when deductions are paid over to the 3rd parties.
Summary of functional areas by department
Table 5: Functional areas in payroll and personnel
Human
resources Payroll division
division
(administrative)
1. Personnel
2. Time keeping
Payroll Division
Accounting
department
5. Payment of
deductions
6. Recording of
salary and
wage
transactions
in the
accounting
records
3. Calculation
and
recording of
salaries and
wages
4. Payment
preparation
and payment
of salaries
and wages
Source: Adapted from Adopted from Auditing fundamentals, Prinsloo at al, 2015 page 372
Study Jackson & Stent (2016) Auditing notes for South African students, page
13/5-13/6
Study Prinsloo et al (2015), Auditing fundamentals page 374
Explain the reasons for preparing the following source documents in the payroll
and personnel cycle?
• Unclaimed wage register
• Payroll amendment form
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• Payroll (wage) journal
• Logs and variance reports
• Employment contracts
Feedback on self-evaluation question
Source document
Unclaimed
wage
register
Payroll
amendment
form
Payroll (wage journal)
Logs and
reports
variance
Employment contracts
Why is there a need to prepare this source document?
This is the book/journal used to record details of employees who have not
collected their pay-packets. Does not apply if there is no wage pay-out.
This document is used to detail and authorize changes made in
the employee register which affect the workforce, e.g. new appointments,
dismissals, promotions to higher grades, changes to pay rates. In a
computerized system these will be master file
amendments to the employee master file
This document (journal) is a spreadsheet which lists employees’ names,
their work section or cost centre, their overtime and normal hours
worked, their gross pay, deductions and net pay.
In a computerized system a computer can be programmed to compile
logs, variance reports, etc. A log is simply a record of an
activity that has taken place on the computer, e.g. if a Masterfile
amendment is made, the computer will automatically “store’’ the activity,
who did it, when it was done, what the amendment was.
This document formalizes the terms and conditions of employment. A
copy is kept by the personnel department in the employee’s personnel file
and or could be stored electronically.
5.6.2 Risks in the inventory cycle
Study Jackson & Stent (2017) Auditing notes for South African
students, page13/9-13/14
Study Prinsloo et al (2015) Auditing fundamentals, page 384.
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Explain the risks that could exist in the payroll
and personnel cycle?
Feedback on self-evaluation question
• Recruiting or retaining unsatisfactory or unnecessary employees.
• Incorrect dismissal procedures
• Unauthorised amendments to employee records that id fictitious additions and unauthorised
changes in wage rates
• Inaccurate or incomplete records
• Invalid hours recorded by for example an employee clocking for an absent fellow employee or
employees clocking in and leaving the premises
• Hours on clock card incorrectly calculated for normal and/ or overtime
• Inclusion of fictitious (ghost) employees
• Use of incorrect or unauthorised pay rates, hours or deduction tables
• Misappropriation of unclaimed wages
• Errors or theft of cash during drawing of cash and at pay-out
• Criminal or civil charges due to non-payment of salaries, statutory payments and other employee
contributions
• Penalties due to non-payment, late payment or underpayment of statutory payments e.g. PAYE
• Incomplete or inaccurate amounts paid over.
5.6.3 Control measures
Proper control activities have to be implemented in the cycle to ensure that the entity achieves its
control objectives of validity, accuracy and completeness of financial information. The major control
activities particular to the human resource cycle are performed either manually or by a computer
system
Study Jackson & Stent (2017) Auditing notes for South African
students, page13/9-13/14.
Study Prinsloo et al (2015), Auditing fundamentals page 390392.
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Explain the control activities in each of the following
functions of the payroll and personnel cycle?
• Personnel
• Payroll
• Accounting
5.6.4 Financial statement assertions and the payroll and personnel cycle
The assertions which apply to wages and salaries are as follows:
a) Occurrence: the totals (account balances) recorded for salaries and wages include only amounts
paid to genuine employees in respect of genuine hours worked.
b) Completeness: All salaries and wages paid or payable for the period, have been included in the
account balance. The risk of material misstatement arising from the omission of salaries or wage
payments is not anything other than low.
c) Accuracy, cut-off and classification: Amounts paid for salaries and wages and other related data
have been recorded appropriately, the payments have been recorded in the correct accounting
period, and the amounts have been recorded in proper accounts.
d) Presentation: The risk of material misstatements in the disclosure of directors’ and prescribed
officer’s emoluments may be reasonably high. The auditor is most likely to be concerned with the
following assertions:
✓ Completeness: Have all disclosures about directors been included
✓ Classification and understandability: Does the disclosure classify the type of remuneration as
required e.g. salary, compensation for loss of office and have disclosures been expressed clearly
✓ Accuracy and valuation, e.g. are the details of the disclosures and related amounts accurate and
fair
5.6.5 Substantive procedures
Procedures to confirm that employees on the payroll are not fictitious
The approach will be to extract a sample of employees from the payroll selected, and
• Inspect the documentation in the employee’s personal file, e.g. signed employment contract,
identity details, tax registration forms, etc. and tally it to the payroll
• Perform a positive physical identification of the employee where possible, this would involve visiting
the employee at his workplace during working hours and inspecting his personal identity document
or staff identity tag
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• Enquire of senior personnel to confirm (in writing) that specified individuals are employed in their
section or division
• Inspect returns to outside entities for the inclusion of employees selected in the sample, e.g. PAYE
reconciliations submitted to SARS, or medical aid contribution returns
• Use audit software to scan the employee Masterfile for “error conditions” which may indicate
fictitious employee’s e.g.
✓ Duplicated or missing identity numbers
✓ Duplicated or missing tax reference numbers
✓ Duplicated bank accounts
✓ Duplicated staff employee numbers
• By discussion with staff in the personnel department and examination of the employment and
dismissal/resignation documentation, confirm that employees are put onto or removed from the
Masterfile on the correct date.
Detailed testing of inventory
To conduct detailed tests on the payroll, the auditor should
• Confirm that the gross salary used in the payroll is authorised in terms of the company’s
remuneration policies and signed salary notifications in the employee’s personal file.
• Trace any additional amounts paid to the employee to source documentation and
✓ Inspect the source documentation for a valid authorising signature, e.g. the finance director
approving the payment of incentive bonus or the sales manager authorising commission.
✓ Re-perform any calculations
✓ Confirm by enquiry and inspection, that the payment is valid in terms of company policy
• For hourly paid employees, confirm that the hourly wage rate used for the employee is in accordance
with the wage rate for that level of employee and is authorised in terms of a notification in the
employee’s personnel file.
• For hourly paid employees, inspect any overtime reports signed by the foreman or production
manager for the period selected, and confirm that the rate used for the overtime complied with the
company policy and labour requirements.
• Compare all deductions, e.g. PAYE, pension, medical aid, to the appropriate tables/rules to confirm
that the correct amounts were deducted
• Trace amounts posted form the selected payroll to the relevant accounts in the general ledger
Analytical procedures
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Where the risk of material misstatement is assessed as low, the auditor may simply decide to conduct
analytical procedures and follow up on any fluctuations revealed by the analysis. Analytical procedures
will include:
• Comparisons
✓ Salaries: month to month by division, department or section
✓ Wages: period to period by cost centre
✓ Salaries and wages to the prior year corresponding period
✓ Deductions paid over to 3rd parties, monthly
• Ratio and trend analysis, e.g.
✓ Salaries as a % of total expenses
✓ Wages as a % of production costs
✓ Wages in relation to production (output)
• Inspect monthly reconciliations for salaries and period to period reconciliation for wages, follow up
fluctuations by inspecting supporting documentation e.g. inspecting signed master file amendments
in the event of salary increases
Presentation and disclosure
The presentation and disclosure of information pertaining to the payroll cycle will be governed by
• The requirement of Section 30 of the Companies Act of 2008
• The JSE listing requirements
• The King IV Report on Corporate Governance
• A number of accounting standards, e.g. IAS1, IAS19, IAS24, IAS37
Usually the client will provide detailed workings/schedules to support the actual disclosures in the
financial statements and a senior member of the audit team will:
• By enquiry and inspection, evaluate the company’s processes for gathering this information
• By inquiry of senior personnel, inspection of internal and external documentary evidence, recomputation of calculations, etc.
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5.6.6 Self-Evaluation Questions
Answer the compulsory revision questions below.
1. Describe the activities in accounting systems for payroll and
personnel cycle
2. Identify and describe the risks of misstatement affecting payroll
transactions , in the financial statements
3. Describe the internal control measures that could be introduced for
the control of payroll transactions
4. Explain the assertions and test of controls that applies to payroll
and personnel cycle
5. Explain the substantive procedures that should be formulated by an
auditor when auditing payroll transactions
Case study
Study the case study/scenario below and answer the questions that
follow
Times (Pty) Ltd is a manufacturer of timing devices. In addition to a large salaried staff, the company
employs about 100 skilled and semi-skilled wage earners. As part of the planning for the audit, you
obtained the following information:
1. The 100 employees are spread evenly over three sections
2. Each section is headed by a foreman. The foreman reports to Reagon Seconds the factory manager.
3. The three sections are located in a single factory building and to enter or leave the building, hourly
paid employees must pass a clock card through a clocking machine to record the their time of entry
or exit and to activate the control gate. The clock is located at the control gate. There is only one point
of entry/exit.
4. The clocking procedure is observed by Ben Bigg the factory administration clerk
5. Employees work Monday to Friday and are required to “clock-in” by 7 am and “clock out” at 4pm.
Any additional time worked is regarded as overtime. Overtime work is carefully planned and scheduled
by the section foreman. Reagon Seconds authorises the schedule of overtime.
6. Wages are paid every two weeks and the clock cards for each wage period are prepared in the
human resources department and sent to Ben Bigg with a listing of each employee for whom there is
a card. Ben Bigg agrees the cards to the listing, signs the list and retains a copy.
7. The wage period runs from Thursday morning until Wednesday afternoon two weeks later. Early on
Thursday morning Ben Bigg collects all the clock cards for the wage period just completed from the
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racks next to the clocking machine, and replace them with the clock cards for the two week wage
period commencing that morning.
8. Once the previous period’s cards have been collected, various batch controls and other procedures
are carried out before the clock cads are taken to the wage office by Ben Big
9. The wage office is staffed by the paymaster, Jerome, and his assistant, Preston Ngo.
10. The wages are processed using application software developed and maintained by the company
itself. Enhancements to the software are made from time to time by
Times (Pty) Ltd’s small information technology (IT) section to keep the application up to date with tax
requirements and to provide management with better information for controlling wages, which is a
major expense. The company runs all of its accounting applications on a local area network and the IT
department is headed by Shakira
Maharaj.
11. Preston Ngo is responsible for preparing the payroll. Once he has received the clock cards, he
selects the “enter ours worked” module and then captures the employee number, as well as the
normal and overtime hours from each clock card. Once he is satisfied that the hours captured are
accurate and complete, he selects the “process payroll” option to effect the processing of the payroll.
The software is well designed and includes a number of programmes (automated) controls to provide
valid, accurate and complete capture and processing of data.
Required
a) Explain the internal control objectives of validity, accuracy and completeness in the context of the
payroll cycle. [10 Marks]
b) Describe the batch controls and other procedures which should be in place from the time Bin Bigg
collects the completed wage period’s clock cards from the racks, to the time Preston Ngo accepts the
clock cards from Br Bigg. [15 Marks]
c) Identity and explain the controls which should be in place to prevent unauthorised access to the
wage application and its various modules on Times (Pty) Ltd’s local area network. [10 Marks]
d) Briefly explain the following programme control and give an example of how each control could be
used to assist Preston Ngo in capturing valid, accurate and complete data
• Mandatory field check
• Verification check
• Limit check
e) Describe the internal controls which should be implemented over enhancements to the wage
application software. [9 Marks]
(Refer to Workbook for answers)
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Study Unit 7: Auditing Investing and Financing Balances
This chapter covers finance and investment cycle. This chapter explains the
accounting and control activities in the cycle, risks involved with finance
Purpose
and investment, and assertions and the finance and investment cycle. At
the end of the chapter, we look at the test of controls and substantive
procedures for finance and investment cycle.
After studying this unit, you should be able to:
• Describe the activities in the accounting system for income from
investments, proceeds of sale of asset and reserves;
• Describe the internal control measures for reserves, income from
investments and proceeds from sale of fixed assets;
• Describe the activities in the accounting system for purchase of noncurrent assets, investments and granting of loans;
• Formulate tests of control for the purchase of non-current assets,
investments and granting of loans;
• Describe the objectives an auditor wishes to achieve by auditing noncurrent assets (assertions);
Learning
Outcomes • Formulate substantive procedures for non-current asset balances;
• Formulate substantive procedures for the purchase of non-current
assets, investments and granting of loans;
• Describe the objectives an auditor wishes to achieve by auditing noncurrent liabilities (assertions);
• Formulate the substantive procedures for non-current liability balances;
• Describe accounting systems for Long-term loans;
• Describe internal control measures for long-term liabilities;
Time
It will take you 4 hours to make your way through this unit.
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5.7.1 Nature and activities in accounting systems for investments and finance
The investments and financing activities pertains to an entity’s acquisition of capital assets and raising
of funds, the subsequent payment thereof, as well as handling and accounting for related investment
and financing income and expenditure.
Investments transactions
• The acquisition and disposal of tangible non-current assets, as well as financial instrument
investments
• The acquisition, internal generation and disposal of intangible assets
• The receipt and accrual of interest income and dividends received on investments
• Accounting for the use of and changes in the value of intangible assets through:
✓ Depreciation/amortisation over the asset’s useful life
✓ Revaluations and other fair value adjustments
✓ Impairment and write-downs and
✓ Profits/losses on disposal (through sale, retirement or exchange)
Financing transactions
• The issue of shares and the repurchase or cancellation of issued shares
• The receipt of loan funding and the subsequent repayment thereof,
• The issue of debentures and subsequent repayments
• The handling of and accounting of the obligations that arise from financing, including
✓ Dividends declared and paid in relation to shares in issue
✓ Finance charges paid and accrued in relation to loans outstanding and
✓ Finance charges and accounting adjustments in relation to debentures in
Issue
Study Jackson & Stent (2016) Auditing notes for South African students, page
14/4-14/25
Study Prinsloo et al (2015), Auditing fundamentals page 449-450
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Explain the reasons for preparing the following source documents in the
investments and finance cycle?
• Asset requisition
• Capital budget
• Minutes of board meetings
• Share certificates
• Fixed asset register
• Master file amendment forms
Feedback on self-evaluation questions
Source document
Asset requisition
Capital budget
Minutes of board
minutes
Share certificates
Fixed asset
register
Master file
amendment file
Why is there a need to prepare this source document?
Is completed by an employee usually management, setting out the
requirements of the asset and requesting that it be purchased
Caters for items of capital nature, such as property, plant and equipment to
be acquired during the year. Capital budgets should be
approved by the board of directors prior to commencement of
financial year
The minutes reflect the resolution of the board of directors to
authorise the acquisition of items of property, plant and equipment
Certificates are issued to the entity on the purchase or subscription
of shares for investment purposes in another company
Is a register detailing all assets on hand, includes information like
serial number, description of an asset, the location of the asset, the
original cost price, carrying amount etc.
Is a form that is completed in a computerised system each time a new asset
is purchased or disposed or a change is made to a related accounting policy
e.g. a change in depreciation method?
5.7.2 Risks and control measures in investment and finance cycle
Proper control activities have to be implemented in the cycle to ensure that the entity achieves its
control objectives of validity, accuracy and completeness of financial information. In this cycle there
are often non-standard, non-routine internal controls, and thus record keeping processes and financial
reporting may differ substantially from entity to entity.
Study Jackson & Stent (2017) Auditing notes for South African students,
page13/9-13/14.
Study Prinsloo et al (2015), Auditing fundamentals page 446-449.
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Explain the risks and control activities in the investments and finance cycle?
Feedback on self-evaluation question
KEY RISKS
FINANCING ACTIVITIES
Invalid issue(repurchase) of
shares my occur- that are not
in line with the requirements
of the Companies Act or the
Memorandum
of
Incorporation
Invalid dividends that are not
in line with the requirements
of the Companies Act or the
company’s Memorandum of
Incorporation and invalid/ or
inaccurate payments made
Invalid loan financing may be
obtain by the entity
Invalid, incomplete and or
inaccurate fiancé charges
EXAMPLES OF CONTROLS TO BE IMPLEMENTED
• Specific high level authorization and approval for all share issue
or repurchase decisions. This is by way of resolutions of e board
directors.
• Before the resolution is passed, specific consideration must be
given to the requirements of the Companies Act, company
policies and Memorandum of Incorporation
• All statutory and governance requirements that have to be met
for a decision must be adequately minuted
• Specific high-level authorization and approval is required for all
dividends declared – authorization by board of directors after
considering the solvency and liquidity of the company and other
statutory requirements. The minutes must reflect the board
resolution and the fact that these requirements were considered
and satisfied
• The updated securities register should be used to by the
accounting department to calculate dividends
• The necessary controls over payments should be in place with
regard to the dividend payments
Decisions to initiate and obtain financing re processed specific
control activities which may include, among others the following:
• Specific high level authorization and approval are required for
all financing decisions. This should be by way of resolution by
board of directors and evidenced in the minutes of those
meetings
• Before the resolution is passed, specific consideration must be
given to the requirements of the Companies Act, the company’s
policies, Memorandum of Incorporation and cash budgets.
• Legal advice should be obtained to consider the implications for
the entity before concluding any material agreement
• Properly signed agreement should be entered into and should
include all relevant terms and conditions
• All calculations of finance charges and capital
repayments must be made based on properly signed loan
agreements that include all relevant terms and
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and
or
repayment conditions
transactions
may
be
recorded and aid
Source: Adapted from Adopted from Auditing fundamentals, Prinsloo at al, 2015 page 449
KEY RISKS
INVESTMENT ACTIVITIES
• Assets purchased may be
invalid e.g. or employees’
personal use and thus result
in
Unnecessary purchases or
even fraud as a result of nonlegitimate payments.
• Investment decisions and
purchases
may
place
financial strain on the entity
and not be in line with the
entity’s budgets
• Once a tangible asset is on
hand, it may be lost, stolen,
damaged and therefore
inappropriately recorded in
the entity’s financial records
• Assets may be incorrectly
valued through the invalid,
inaccurate or incomplete
recording of depreciation,
amortization, impairments
and
revaluations
EXAMPLES OF CONTROLS TO BE IMPEMENTED
• Adequate segregation of duties is necessary that is one individual
should not be responsible for initiating and approval of capital
asset purchase transaction.
• Large capital asset purchases may be subject to specific control
activities such as
✓ Specific high-level authorisation and approval should be
obtained for non-current asset purchases
✓ Adequate controls over purchases such as obtaining multiple
quotes from preapproved suppliers before entering into a
purchase transaction
• All material tangible assets should be physically secured by
security guards, cameras and locks to
avoid theft of assets and loss to the entity
• A detailed fixed asset register should be kept
• A detailed fixed asset master file should be kept and
continuously updated
• Qualified personnel who understand the requirements of the
applicable accounting standards should calculate the relevant
estimates e.g. useful lives, residual values
• Detailed depreciation/amortization calculation schedules must
be prepared and kept up to date
• Where appropriate exerts should be contracted to assist with the
determination of the appropriate asset values
Source: Adapted from Adopted from Auditing fundamentals, Prinsloo at al, 2015 page 450
5.7.3 Financial statement assertions and audit objectives for non-current assets
Table 6: Assertions and audit objectives in non-current assets
Financial statement assertion Audit objective
Existence and occurrence
• Additions represent assets acquired in the year and disposal
represent assets sold or scrapped in the year
• Recorded assets represent those in use at the year end
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• All additions and disposals that happened during the year have
been recorded
• Balances represent assets in use at year end
Rights and obligations
• The entity has rights to the assets purchased and those recorded
at year end
Accuracy, classification and • Non-current assets are correctly stated at cost less accumulated
valuation
depreciation
• Additions and disposals are correctly recorded
Assertions
relating
to • Disclosure relating to cost, additions and disposals, depreciation
presentation and disclosure policies, useful lives and assets held under finance leases are
(Occurrence and rights and adequate and in accordance with accounting standards
obligations, completeness,
classification
and
understandability, accuracy
and valuation)
Completeness
5.7.4 Tests of controls for non-current assets
The auditor tests a control to determine whether the control has been effective in achieving the
objective for which it has been implemented in the first place.
Study Jackson & Stent (2017) Auditing notes for South African students,
page14/19-14/25
Study Prinsloo et al (2015) Auditing fundamentals, page 423-440
Explain the tests of controls that an external auditor should perform on
tangible non-current assets?
5.7.5 Substantive procedures for non-current assets
Property, plant and equipment
Existence
• Extract a sample of assets from the fixed asset register, which includes additions for the year. If the
client’s fixed asset register is computerised, audit software can perform this task
• Physically inspect the assets selected, matching them to the description e.g. serial numbers obtained
from the asset register
• If an asset cannot be physically verified for existence e.g. it is a large piece of mobile equipment
being used in a remote area, seek corroborating evidence e.g. repairs and maintenance records
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• Conduct a search of unrecorded disposals (mainly for plant and equipment)
✓ Analyse the sundry revenue account/cash receipts journal for cash receipts from disposals of fixed
assets, confirm that the item for which the cash has been received, is included on the list of disposals.
✓ Enquire of senior personnel whether major equipment acquired has replaced old equipment if so,
follow up to determine whether old equipment was disposed of and recorded as a disposal.
• Reconcile disposals per the capital budget with client’s list of disposals
Completeness
• Inspect repairs and maintenance and similar accounts for material items which may represent
acquisition of plant and equipment, but which may have been erroneously charged as an expense
• When physically verifying the assets for existence, select a sample of fixed assets and trace to the
fixed asset register agreeing description, asset number etc.
• Review payments for fixed asset purchases and confirm that they are recorded as fixed assets in the
register
• Review all lease agreements and enquire of senior personnel for evidence of any assets which have
been leased in terms of finance leases, but which have not been capitalised.
Rights
• For assets owned at the beginning of year (opening balance), determine whether there has been
any change in the rights to the asset, e.g. sale and leaseback, by
✓ Enquiry of management
✓ Inspection of directors’ minutes
• For additions, inspect purchase documentation and documents of title, to confirm that they are in
the name of the client:
✓ for motor vehicles, inspect the registration document and licence renewal receipt to confirm that
they are in the name of the client.
✓ for land inspect the title deeds/deeds of transfer, mortgage bonds and sale agreements
✓ for other assets inspect sales agreements and invoices
• Where leased assets have been capitalised, inspect the lease agreements to ensure that the risks
and rewards of ownership have been effectively passed to your client.
Accuracy, valuation and allocation
• Agree the opening balances on the summary schedules to prior year working papers/ general ledger
• Re-perform all casts and extensions in the fixed asset register, the summary schedules and the
supporting lists of additions and disposals
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• Re-perform the reconciliation of the fixed asset register to the fixed asset accounts and accumulated
depreciation accounts in the general ledger, following up on all reconciling items
• Agree by inspection, the closing balances on the summary schedules to the general ledger and
financial statements.
Cost of additions
• Select a sample of additions from the fixed asset register and trace them to capital budget, minutes
of directors’ meetings and purchase requisitions for evidence of authority for the acquisition.
• Inspect payment records to confirm that payment was made for the asset
• By inspection of the purchase documentation, confirm that the cost of the asset includes:
✓ The correct cost price
✓ Correct shipping charges, import duties, insurance (if applicable)
✓ Costs of installation and commissioning
Disposal
• Inspect the supporting documentation used to approve disposal for authorising signature
• By reference to the capital budget, confirm authority for the disposal
• Trace the proceeds of the sale to the receipts records
Valuation- depreciation allowance
• Confirm by enquiry of the directors that the accounting policy for depreciation is consistent with
prior years
• Obtain a written representation letter from management, confirming that they have reassessed the
useful life and residual value of the assets
• When physically inspecting assets inspect for, and enquire about, any damaged or not in use assets
and establish whether such assets should be written down
• Re-perform the depreciation calculations for the year to ensure accuracy and compliance with the
depreciation policy and amounts correctly posted.
Valuation- impairment
• Evaluate the process by which the company itself identifies and quantifies impairments
• Inspect and evaluate any documents which might support the directors on impairments with regard
to assumptions made, method and rates or % used.
• Discuss with management any assets whose market value has declined significantly more than would
be expected as a result of passage of time or normal use.
• Discuss with management any evidence of obsolescence, physical damage to assets and assets lying
idle with plans to discontinue certain operations
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Assertion- Presentation and disclosure
• The auditor must inspect the financial statements to confirm that
✓ Property, plant and equipment are reflected as a separate line item on the face of the statement of
financial position under non-current assets
✓ Depreciation, impairment losses and losses on disposals are reflected in the statement of
comprehensive income.
5.7.6 Substantive procedures for investment in shares
This section deals with the audit of investments of shares in listed and non-listed companies.
The major risk will be overstatement of investment account either by inclusion of fictitious
investments or overstatement of the value of the investment.
Study Jackson & Stent (2017) Auditing notes for South African
students, page14/26-14/28
Study Prinsloo et al (2015) Auditing fundamentals, page 423-440
Explain the substantive procedures that an external auditor
should carry out on investments in shares under the following
assertions:
• Rights and existence
• Accuracy, valuation and allocation
• Completeness and classification
• Presentation
5.7.7 Financial statement assertions for non-current liabilities
Non-current liabilities are usually authorised by the board and should be well documented.
Our focus is on non-current liabilities comprising of long-term loan, debentures and other loans
repayable at a date more than one year after year end.
Auditors seeks evidence about the assertions relating to the balance on the long-term liabilities
account and its related disclosures, the assertions which are:
• Obligation- whether an entity has an obligation to pay liabilities
• Existence- whether the liability exist as at the balance sheet date
• Accuracy, valuation and allocation- whether interest payable has been calculated correctly and
included in the correct accounting period
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• Classification and completeness- whether all non-current liabilities have been correctly disclosed
• Presentation- whether long-term loans have been disclosed in accordance with accounting
regulatory framework
5.7.8 Substantive procedures for non-current liabilities
The substantive procedures below are for non-current liabilities in the statement of financial position
and the related interest charge in the statement of comprehensive income
Opening balance:
• Inspect prior year working papers and prior year financial statements to confirm that the opening
balance agree with the prior year closing balance of long-term loans/debentures
Occurrence/existence
• Inspect the memorandum of incorporation to determine whether
✓ The Company is authorised to issue debentures
✓ The issue is in any way contravened the company’s borrowing powers, e.g. authority requirements
• Inspect the minutes of the meeting of directors at which the decision to issue debentures was taken
and note
✓ to whom the issue was to be made
✓ the number and amount of debentures to be issued
✓ the interest rate, date and manner of payment
Accuracy, cut-off, classification
• Re-perform the calculations and casts to confirm that the cash received from the issue of
debentures/ from long-term loan is in accordance with the debenture agreement or loan agreement
• Trace the receipt of cash from the cash receipts journal to the general ledger to confirm that it has
been posted to debenture liability account/ long-term loan account.
• Inspect the dates on all documentation to confirm that they fall within the accounting period under
audit (cut-off)
• Inspect the journal entry raising the finance cost and increasing the debenture account/ long-term
loan account and agree the amount to the amortisation calculation
Completeness
• Confirm by enquiry of the directors and scrutiny of the minutes that no other debentures issued/
long-term loan was raised during the year
• Obtain a written representation that all long-term loans have been included
• Review financial records, minutes of directors’ meetings, audit committee and capital expenditure
committee meetings and correspondence for evidence of unrecorded loans.
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• Perform analytical review e.g. compare current year balances on loan accounts and interest paid to
the prior year.
Closing balance
• Agree the closing balance on the debenture account/ long-term loan account to the trial balance
5.7.9 Substantive procedures for finance lease liabilities
The audit of a finance lease is far more difficult and requires that both the asset raised and the
corresponding liability be audited. The auditor must be aware of guidance contained in
IAS 17- Leases.
Study Jackson & Stent (2017) Auditing notes for South African students,
page14/12-14/14
Study Prinsloo et al (2015) Auditing fundamentals, page 423-440
Explain the substantive procedures that an external auditor should carry out
on finance lease liabilities under the following assertions:
• Occurrence/obligation and existence
• Completeness
• Accuracy, cut-off, classification
• Presentation
5.7.10Self-Evaluation Questions
Answer the compulsory revision questions below.
1. Describe the activities in accounting systems for finance and
investment cycle
2. Identify and describe the risks of misstatements affecting finance and
investment transactions , in the financial statements
3. Describe the internal control measures that could be introduced for
the control of finance and investment transactions
4. Explain the assertions and test of controls that applies to finance and
investment cycle
5. Explain the substantive procedures that should be formulated by an
auditor when auditing property, plant and equipment balance.
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Study the case study/scenario below and answer the questions that
follow
Property, plant and equipment
Client: Orange Limited
Year end: 30 September 2017
Prepared by: Innocent Mutaki
Preparation date:15 August 2017
Reviewed by: Munyaradzi Dera
Review date: 1 October 2017
Subject: Property, plant and equipment- Computer and network equipment
Computer and network equipment make up 40% of total value of Orange Limited’s total assets. This
equipment is used to run the day to day activities of Orange Limited. Computer equipment is carried
at cost less accumulated depreciation and accumulated impairment losses in terms of IAS 16,
Property, plant and equipment.
Depreciation is charged on a straight line basis over the estimated useful life (3years) of these items.
There were no changes to the accounting policy during the financial year and no impairment testing
was performed during the year ended 30 September 2014.
There were no additions and disposals of computer and network equipment during the financial year.
All items of property, plant and equipment are paid for in cash.
Louis Zaka provided the following
• Fixed asset register
• Depreciation calculation
• Accounting policy relating to fixed assets
Required
Formulate the substantive procedures that you will carry out to audit the existence and valuation of
computer and network equipment at year end.
(Refer to the workbook for model answer)
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Study Unit 8: Auditing Investments and Cash Balances
This chapter covers auditing of investments and cash transaction and
balances. This chapter explains the accounting and control activities in the
cycle, risks involved with investments and cash, and assertions for
Purpose
investments and cash. At the end of the chapter we look at lapping and kiting,
and substantive procedures for cash balances.
After studying this unit, you should be able to:
• Describe the nature of cash and investments of a business;
• Describe the audit procedures for a cash count of cash balances or bank
reconciliation;
Learning
Outcomes • Describe audit objectives of cash and bank balances;
• Describe substantive procedures for cash and bank balances;
• Describe presentation and disclosure;
• Understand the terms lapping and kiting.
It will take you 4 hours to make your way through this unit.
Time
5.8.1 Nature of cash and investments in a business
“Cash” in the financial statements represents cash in hand and cash on deposit in bank accounts. Most
accounting transactions pass through the cash account so cash is affected by all of the entity’s business
processes, and is specifically impacted by the sales and purchases processes.
5.8.2 Source documents used in the cycle
Study Jackson & Stent (2016) Auditing notes for South African students, page
10/6-10/8
Study Prinsloo et al (2015), Auditing fundamentals page 195
Explain why there is a need in the receiving and recording payments from
debtors function to prepare each of the following source documents:
• Receipt
• Deposit slip
Hint: Use the following table format in answering this question
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Source document
Why is there a need to prepare this source
document?
Feedback on self-evaluation questions
Source document
Receipt
Deposit slip
Why is there a need to prepare this source
document?
The receipt records details of payments received from
Customers
This is a bank document which is filled in by the company to
record the deposit of payments received from the customer, into
the bank.
5.8.3 Risks in the cycle
Study Jackson & Stent (2016) Auditing notes for South African students, page
10/17
Study Prinsloo et al (2015), Auditing fundamentals page 201
Explain the major reporting risks affecting cash and cash equivalents reported
in the financial statements?
Feedback on self-evaluation questions
The following risks may affect cash and bank balances reported in financial statements:
• Bank and cash balances are overstated owing to fictitious receipts having been recorded in the
financial records which may also be due to fictitious sales.
• The non-recording of cash receipts or deposits where sales which were made for cash are not
recorded in the cash book e.g. due to theft by the entity’s staff, resulting in decrease in the revenue
figure.
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5.8.4 Activities in the payments cycle
Study Jackson & Stent (2016) Auditing notes for South African students, page
11/4-11/5
Study Prinsloo et al (2015), Auditing fundamentals page 254
Briefly explain the main activities within the actual payments and recording of
payments in the acquisition and payment cycle?
Feedback on self-evaluation questions
In order to check the actual balance of the cash receipts and payments journal (cash book), it will be
necessary to check both the receipts and the payments. When a bank reconciliation is carried out,
amounts deposited and paid out as shown in the cash receipts and payments journal are agreed with
the particulars shown on the bank statement(s).
One way of reducing risk in bank transactions is to perform regular bank reconciliations. A bank
reconciliation is carried out to compare the entries in the cash receipts and payments journal to the
items on the bank statement. The auditor should ascertain whether the accounting treatment of the
transactions has been correct, especially with regard to balancing, outstanding deposits, outstanding
cheques and other reconciling items. The reconciliation statement should be carefully followed up and
the reconciliation items traced to the bank statements of the next period.
5.8.5 Assertions and audit objectives for cash and bank balances
The following table demonstrates the audit objectives for cash balances and how these are related to
the financial statement assertions relevant to cash and bank account.
Table 7: Assertions for cash and bank cycle
Financial statement assertion Audit objectives
Existence
Recorded cash balance exist as at end of year
Completeness
Recorded cash balances include the effects of all transactions
that have occurred
Rights and obligations
The entity has legal title to all cash balances shown at year end
Valuation
Recorded cash balances are realisable at the amounts stated
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Assertions
relating
to Disclosures relating to cash are adequate and in accordance
presentation and disclosure with accounting standards and legislation
(classification
and
understandability,
occurrence and rights and
obligations, accuracy and
valuation, completeness)
Source: Adapted from Adopted from ACCA Auditing and Assurance Study Text (2011) BPP Leaning
Media, page 256
5.8.6 Bank confirmations
Bank balances are usually confirmed directly with the bank in question. The audit of bank balances
will need to cover completeness, existence, rights and obligations and valuation. All these assertions
can be audited directly by obtaining third party confirmations from the client’s banks and reconciling
these with the accounting records.
This type of audit evidence is valuable because it comes directly from an independent source and
therefore provide greater assurance of reliability than that obtained solely from the client’s own
records. The bank letter is mentioned as a source of external third party evidence in ISA 505 External
confirmations
The bank confirmation letter can be used to ask a variety of questions, including queries about
outstanding interests, contingent liabilities and guarantees. The auditor has to decide from which bank
or banks to request confirmation, having regard to such matters as size of the balance, volume of
activity, degree of reliance on internal control, and materiality within the context of the financial
statements
5.8.7 Auditing procedures for cash count and bank reconciliations
Cash balances/floats are often individually immaterial but they may require some audit emphasis
because of the opportunities for fraud that could exist where internal control is weak and because
they may be material in total.
Where auditors determine that cash balances are potentially material they may conduct cash count,
ideally at year end. The conduct of the count falls into three phases which are: planning, the count
itself and follow up procedures.
Audit plan: Cash count and follow up procedures
• Count cash balances held and agree to petty cash book or other record
✓ Count all balances simultaneously
✓ All counting to be done in the presence of the individuals responsible
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• Confirm that bank and cash balances as reconciled above are correctly stated in the financial
statements.
• Verify unbanked cheques/ cash receipts have subsequently been paid in and agree to the bank
reconciliation by inspection of the relevant documentation
5.8.8 Substantive audit procedures for bank and cash
Assertion: Rights, existence and completeness
• Obtain a schedule of all bank accounts held by the company at year end
✓ Compare the accounts listed on the schedule to the prior year schedule and note any changes
• Obtain a bank confirmation from the bank.
Assertion: Accuracy and valuation
• Agree the balances on the reconciliation to the cash book, bank statement and bank confirmation
balances respectively
• Agree the balances for each bank account on the schedule to the balances in the general ledger and
cash book(s)
• Re-perform the casts on the reconciliation and at the same time, test the logic of the reconciliation
• Trace reconciling items through to the cash book prior to year-end, and agree the amount and dates
• Trace the reconciling items through to the post year end bank statement to confirm that they went
through the bank and were not cancelled
• Obtain satisfactory explanations for all items in the cash book for which there are no corresponding
entries in the bank statement and vice versa by discussing with finance staff.
• Verify contra items appearing in the cash book with original entry
• Inspect the cash book and bank statement before and after the year end for exceptional entries or
transfers which have a material effect on the balance shown to be on hand Presentation and disclosure
The disclosure of bank balances and cash on hand is stated below
• The total should be shown on the face of the statement of financial position under current assets
under the heading “cash and cash equivalents”
• This should be followed by a note which distinguishes between the different categories e.g. cash on
hand, current account balances and call account balances
• The details of any pledges, security, etc. offered, attached to a bank overdraft will also be disclosed
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5.8.9 Lapping and kiting
“Cheque kiting is a technique whereby an entity makes use of the time it takes to clear cheque
payments between two banks for fraudulent purposes. The purpose of kiting is to fraudulently
overstate the bank and cash balance in the financial statements and by doing so convey a more
favourable net asset position for the entity” Prinsloo et al, 2015.
“Lapping occurs where a cashier takes cash paid by a debtor to the entity, and covers the shortfall
using a subsequent debtor’s cheque or cash receipt. This practice is also called cash rolling” Prinsloo
et al, 2015.
5.8.10Self-Evaluation Questions
Answer the compulsory revision questions below.
1. Describe the activities in accounting systems for cash and bank cycle
2. Identify and describe the risks of misstatement affecting cash and bank
transactions , in the financial statements
3. Describe the internal control measures that could be introduced for the
control of cash and bank transactions
4. Explain the assertions that applies to cash and bank cycle
5. Explain the substantive procedures that should be formulated by an auditor
when auditing cash and bank balance.
6. Explain the following terms which are used in window dressing and
misappropriation of cash: kiting and lapping.
7. Explain the purpose and importance of a bank reconciliation statement.
Case Study
Study the case study that follows and answer the question that follows:
You are the auditor responsible for cash and bank portfolio. You have been given the bank
reconciliation statements, bank statements, cash deposit slips, EFT confirmation slips, cheque stubs
and cash register roll. You audit senior has so much confidence in you since you have done auditing
and passed with a distinction. He has asked you to audit the bank balance
Required
Formulate substantive procedures to audit year end bank balance (10 marks)
(Refer to workbook for answers)
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Study Unit 9: Audit Completion and The Auditor’s Report
This chapter covers audit completion and the auditor’s report. This chapter will
consider reviews that take place during the completion stage of the audit, which
include subsequent events and going concern. These are both important
disclosure issues in the financial statements, because if disclosures are not
Purpose
correct, this will impact on the auditor’s report. At the end of this chapter. We
look at the auditor’s report. An auditor’s report is the means by which the
external auditors express their opinion on the truth and fairness of a company’s
financial statements.
After studying this unit, you should be able to:
• Define subsequent events
• Distinguish adjusting and non-adjusting subsequent events
• Discuss the procedures to be undertaken in performing a subsequent events
review
• Explain the going concern assumption used in the preparation of financial
Learning
statements
Outcomes • Explain the audit procedures to be undertaken by an auditor when performing
going concern reviews
• Explain the reporting implications when faced with scenarios in which a
company has going concern problems
• Describe unmodified reports
• Describe modified reports
• Explain emphasis of matter paragraphs and other matter paragraphs
It will take you 4 hours to make your way through this unit.
Time
5.9.1 Subsequent events
ISAs refer to “Subsequent events” whereas IAS 10 refers to “Events after the reporting period”.
The ISAs cover the auditor’s responsibility with regard to these events even after the date of the audit
report. IAS10, Events after the reporting period does not cover the auditor’s responsibility after the
audit report has been issued.
Subsequent events are events occurring between the date of the financial statements and the date of
the auditor’s report, and facts that become known to the auditor after the date of the auditor’s report.
IAS 10, Events after the reporting period deals with the accounting treatment in the financial
statements of events, both favourable and unfavourable, occurring after the period-end. There are
types of event defined by IAS 10:
• Adjusting events: those events that provide evidence of conditions that existed at the end of
reporting period. These conditions may require adjustments to be made in the financial statements.
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• Non-adjusting events: those that are indicative of conditions that arose after the reporting period.
These events do not require adjustments to be made to the financial statements, but may require
disclosure to the users.
Study Jackson & Stent (2017) Auditing notes for South African students,
page17/6-17/7.
Study Prinsloo et al (2015), Auditing fundamentals page 653-655.
What are the examples of adjusting and non-adjusting events, provide at least
3 examples of each
Adjusting events
Non-adjusting events
Settlement of court case
Dividends declared after the year-end
Sale of inventory after year-end providing Fire causing destruction of major plant
evidence of its NRV at year-end
Fraud or error showing the accounts are Announcement of a major restructuring
incorrect
Source: Adapted from Adopted from ACCA Auditing and Assurance Study Text (2011) BPP
Learning Media page 299
5.9.2 Audit procedures for subsequent events
Inquiries
of • About the status of items involving subjective judgement
management
• About status of items accounted for using preliminary or inconclusive data
• If there are any new commitments, borrowings or guarantees
• If there have been any:
✓ Sales or destruction of assets
✓ Issues of shares or debentures or changes in business structure
✓ Developments involving risk areas, provisions and contingencies
✓ Unusual accounting adjustments
✓ Major events (e.g. going concern problems) affecting appropriateness of
accounting policies for estimates
Other
procedures
✓ Litigation or claims
• Review management procedures for identifying subsequent
events to ensure that such events are identified
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• Read minutes of general board/committee meetings and enquire about
unusual items
• Review latest available interim financial statements and budgets, cash flow
forecasts and other management reports
• Obtain any evidence concerning any litigation or claims from the company’s
solicitors with client’s permission
• Obtain a written representation that all events occurring subsequent to the
period-end which need adjustment or disclosure have been adjusted or disclosed
Source: Adapted from Adopted from ACCA Auditing and Assurance Study Text (2011) BPP Learning
Media page 300
5.9.3 Going concern
Under the going concern assumption, an entity is viewed as continuing in business for the foreseeable
future. When the use of the going concern assumption is appropriate, assets and liabilities are
recorded on the basis that the entity will be able to realise its assets and discharge its liabilities in the
normal course of the business.
The financial statements should be prepared on the going concern basis unless management either
intends to liquidate the entity or has no realistic alternative but to do so. If the going concern basis is
not appropriate then the financial statements are prepared using on a break up basis. Asset values
will need to be stated at their realizable value as they are no longer to be used in an ongoing business.
The going concern has such significance that it has its own standard International Standard on
Auditing, ISA 570 Going concern.
Study Jackson & Stent (2017) Auditing notes for South African students,
page15/4-15/5.
Study Prinsloo et al (2015), Auditing fundamentals page 653-657.
What are the events or conditions that may suggest that going concern is at
risk?
Feedback on self-evaluation questions
Table 8: Indications of going concern at risk
Events or conditions that may suggest that going concern is at risk
Financial
• The entity is in net liability or net current liability
• Fixed term borrowings are approaching maturity without realistic prospects of
renewal or repayment
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• Excessive reliance on short term borrowings to finance long term assets
• Withdrawal of financial support by creditors and other suppliers
• Negative operating cashflows
• Adverse key financial ratios
• Substantial operating losses or significant deterioration in the value of assets
used to generate cash flows
• Arrears or discontinuance of dividends
• Inability to pay creditors on due dates
• Inability to comply with terms of loan agreements
• Change from credit to cash on delivery transactions with suppliers
• Inability to obtain financing for essential new product development or other
essential investments
Operating
• Management intentions to liquidate or cease operations
• Loss of key management without replacement
• Loss of major market, key customers, licence, or principal suppliers
• Labour difficulties e.g. strikes, lack of skills
• Shortages of important supplies e.g. raw materials
• Technological obsolescence of products
• Threats from cheap imported goods
• Emergence of a highly successful competitor
• Non-compliance with capital or other statutory
Other
requirements
• Pending legal proceedings against the entity which may, if successful, result in
judgments which cannot be met, e.g. extensive damages awarded against the
client
• Changes in law or regulations that may adversely affect the entity e.g.
withdrawal of tax concessions
• Uninsured or under-insured catastrophes when they occur
• Negative perceptions about the company’s product in the market place
(reputational damage)
• Failure to satisfy Black Economic Empowerment requirements leading to loss
of contracts
Source: Adapted from Adopted from ACCA Auditing and Assurance Study Text (2011) BPP Learning
Media page 302
5.9.4 Responsibility of the auditor and management regarding going concern
IAS 1, Presentation of financial statements and IAS 10, Events after the reporting period requires
management to make an assessment of an entity’s ability to continue as a going concern in the
preparation of financial statements. The assessment involves making a judgement about uncertain
future outcomes of events or conditions.
The auditor’s responsibilities with regard to the use of the going concern assumption are as follows:
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• Perform risk assessment procedures to consider whether there are events or conditions that may
cast significant doubt on the entity’s ability to continue as a going concern
• Discuss with management their formal assessment of the entity’s ability to continue as a going
concern
• If there is a risk that the going concern assumption may be inappropriately applied in the financial
statements, evaluate management’s assessment
• Remain alert throughout the audit for audit evidence of events or conditions that may cast doubt
on entity’s ability to continue as a going concern
5.9.5 Audit procedures in performing going concern reviews
Study Jackson & Stent (2017) Auditing notes for South African students, page17/617/8.
Study Prinsloo et al (2015), Auditing fundamentals page 659-660.
What are the audit procedures to be performed by an auditor when evaluating the
ability of the entity to continue as a going concern?
Feedback on self-evaluation questions
• Analyze and discuss cash flow, profit and other relevant forecasts with management
• Analyze and discuss the entity’s latest available interim financial statements
• Review the terms of debentures and loan agreements and determine whether they have been
breached
• Read minutes of the meetings of shareholders, the board of directors and important committees for
referencing to financing difficulties
• Enquire of the entity’s lawyers regarding litigation and claims, and the reasonableness of
management’s assessment of any financial implications for the company
• Confirm the existence, legality and enforceability of arrangements to provide or maintain financial
support with related and third parties and assess the financial ability of such parties to provide
additional funds
• Consider the entity’s position concerning unfilled customer contracts/orders e.g. penalties for failure
to perform
• Confirm the state of the relationship of the company with its bankers/borrowings providers
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• Obtain and review reports of any regulatory actions, e.g. SARS investigation, investigations by
industry controlling bodies
• Review events after year end for transactions or events which either mitigate or aggravate
conditions affecting the entity’s ability to continue as a going concern
Jackson & Stent, (2016), Auditing notes for South African Students, Lexis Nexis
5.9.6 Reporting implications on going concern
The following table summarizes the possible scenarios that could arise following the auditor’s review
of going concern.
Table 9: Impact of going concern scenarios on audit opinion
Impact on auditor’s report
Unmodified
opinion
and
explanatory
emphasis of matter paragraph
Qualified or adverse opinion
(modified
opinion)
Use of going concern assumption inappropriate Adverse opinion
Management unwilling to make or extend its
Qualified or Disclaimer of
assessment
opinion (modified opinion)
Source: Adapted from Adopted from ACCA Auditing and Assurance Study Text (2011) BPP Learning
Media page 304
Scenario
Going concern assumption appropriate but
material uncertainty which is adequately
disclosed
Going concern assumption appropriate but
material uncertainty is not adequately disclosed
5.9.7 Unmodified audit opinion
An unmodified opinion is the opinion expressed by the auditor when the auditor concludes that the
financial statements are prepared, in all material respects, in accordance with the applicable financial
reporting framework. ISA 700 states that an auditor shall express an unmodified opinion when the
auditor concludes that the financial statements are prepared, in all material respects, in accordance
with the applicable financial reporting framework.
Study Prinsloo et al, Auditing fundamentals page 668 for further details
5.9.8 Modified audit opinion
ISA 705 Modifications to the opinion in the independent auditor’s report sets out the different types
of modified opinions that can result. It identifies 3 possible types of modifications which are:
• A qualified opinion
• An adverse opinion
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• A disclaimer of opinion
Table 10: Nature of matter and effect on audit opinion
Nature of matter
Auditor’s judgement about the pervasiveness of the
giving
effects or possible effects on the financial statements
rise
to
the Material but not pervasive Material and pervasive
modification
Financial
Qualified opinion
Adverse opinion
statements are
materially misstated
(Disagreement)
Inability to obtain
Qualified opinion
Disclaimer of opinion
sufficient,
appropriate audit
evidence
(scope limitation)
Source: Adapted from Jackson & Stent (2017) Auditing notes for South African students, page 18/12
Study Jackson & Stent (2017) Auditing notes for South African students, page17/617/7.
Study Prinsloo et al (2015), Auditing fundamentals page 653-655.
Briefly explain the above terms qualified audit opinion, adverse audit opinion and a
disclaimer of opinion?
5.9.9 Emphasis of Matter paragraphs and other matter paragraphs
“An Emphasis of Matter paragraph is inserted in the audit report immediately after the opinion
paragraph when the auditor wants to draw user’s attention to a matter adequately presented or
disclosed in the financial statements, but which the auditor considers important and fundamental to
the users’ understanding of the financial statements” Prinsloo et al (2015)
Other matter paragraphs
“ISA 706 (Revised) also allows for what are termed “other matter paragraphs” to be included in an
audit report. An “other matter” paragraph will be included if the auditor considers it necessary to
communicate a matter other than those that are presented or disclosed in the financial statements
that, in the auditor’s judgement, is relevant to users’ understanding of the audit, the auditor’s
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responsibilities or the auditor’s report. An example is that the auditor may wish to convey to the users
that the prior period’s financial statements were audited by another auditor” Jackson & Stent (2016)
5.9.10Self-Evaluation Questions
Answer the compulsory revision questions below.
1. Distinguish between adjusting and non-adjusting subsequent events
2. Explain management’s responsibilities with regard to subsequent events
3. Formulate the audit procedures that the auditor will perform with regard to
subsequent events
4. Describe the structure and content of ab audit report
5. Distinguish between the types of audit opinions and reports
6. Explain the going concern assumption and provide indicators of going concern risk
and also mitigating factor
Case study
Study the case study below and answer the questions that follow
During the audit of Hiki (Pty) Ltd for the year ending 31 December 201X you discovered that
Hiki (Pty) Ltd is factually insolvent (i.e. liabilities exceed assets, fairly valued). The managing director is
confident that the company will return to profitability in the new financial year as certain large new
contracts have been secured. Management is unable to satisfy you (as the auditor) that Hiki (Pty) Ltd
will restore its solvency in the foreseeable future.
Required:
State, giving reasons, what actions you would take given the circumstances that management is
unable to satisfy you that Hiki (Pty) (Ltd) will restore its solvency in the foreseeable future. Your answer
should include a discussion of
• Sections 1 and 45 of the Auditing Profession Act 2005
• Section 22 of the Companies Act 2008
• Common law fraud
• The considerations to formulate an audit opinion on the company’s financial statements
(20marks)
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6. References
Prinsloo et al, (2015). Auditing fundamentals in South Africa. 1st ed. Oxford University Press
Jackson & Stent, (2017). Auditing Notes for South African Students. 10th Ed. Lexis Nexis
SAICA, (2016/2017). SAICA Auditing student’s handbook. Vol 2. Lexis Nexis
BPP learning Media (2015), Auditing and Assurance Study Text, BPP learning Media
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