Question 7.

Compare the objectives of the internal control auditors with those of the independent auditor.

Question 7.2

What is a management letter? What is the letter’s significance?

Question 7.3

Management is responsible for establishing effective internal control for its organization, including
measures to prevent, deter and detect fraud.

What are the three major categories of antifraud measures and the measures that should be
established under each category?

Question 7.4

During your first audit of a medium-size manufacturing company, the owner, John Bell, explains that
in order to establish clear-cut lines of responsibility for various aspects of the business, he has made
one employee responsible for the purchasing, receiving, and storing of merchandise.

A second employee has full responsibility for maintenance of accounts receivable records and
collections from customers.

A third employee is responsible for personnel records, timekeeping, preparation of payrolls, and
distribution of payroll checks.

Bell asks your opinion concerning this plan of organization. Explain fully the reasons supporting your
opinion.

Question 7.5

Randall, Inc., is a private company that manufactures heavy machinery. The company has an active
audit committee and board of directors. The audit committee consists of two outside directors and
Howard Kress, the company chief financial officer. The audit committee meets quarterly to provide
oversight of financial reporting, including reviewing new accounting policies and unusual
transactions. Howard Kress personally reviews and approves any related party transactions. Internal
audits of operating units are performed by the internal auditor, who reports directly to Lara Howe,
the chief operating officer.

The company has a written code of conduct, and employees agree to adhere to the code when they
are hired. The company also has a hotline for confidential reporting of unethical behavior that is
staffed by the corporate controller. The audit committee reviews summaries of all incidents and
investigations performed.

Identify the weaknesses in Randall’s system of corporate governance and provide suggestions for
improvement in the system. Organize your answer as follows:
 Weakness Suggested Improvement

Question 7.6

You are performing an audit of Systex Corporation and evaluating various controls. Classify the
following controls as being primarily:

 Preventive
 detective
 corrective

Explain your answers.

a) Annual physical inventory.

b) Monthly reconciliation of bank accounts.
c) Segregation of duties over purchasing.
d) Supervisory approval of time cards.
e) Dual signatures for checks.
f) Adjustment of perpetual inventory records to physical counts.
g) Management review of budget/actual information.
h) Internal audits of payroll.

Question 7.7

Island Trading Co., a client of your CPA firm, has requested your advice on the following problem. It
has three clerical employees who must perform the following functions:

1) Maintain general ledger.

2) Maintain accounts payable ledger.
3) Maintain accounts receivable ledger.
4) Maintain cash disbursements journal and prepare checks for signature.
5) Issue credit memos on sales returns and allowances.
6) Reconcile the bank account.
7) Handle and deposit cash receipts.

Assuming that there is no problem as to the ability of any of the employees, the company requests
your advice on assigning the above functions to the three employees in such a manner as to achieve
the highest degree of internal control. It may be assumed that these employees will perform no
other accounting functions than the ones listed and that any accounting functions not listed will be
performed by persons other than these three employees.

a) List four possible unsatisfactory combinations of the above-listed functions.

b) State how you would recommend distributing the above functions among the three employees.
Assume that, with the exception of the nominal jobs of the bank reconciliation and the issuance
of credits on returns and allowances, all functions require an equal amount of time.

Wigley

Your audit client, Wigley is a retail department store that does not produce any products.
You are currently working on the inventory portion of the audit. In obtaining audit evidence
in support of financial statement assertions, the auditor develops specific audit objectives in
light of those assertions. Audit procedures are then selected to accomplish audit objectives.
For each specific inventory audit objective listed (Audit Objectives tab) select the most
closely related account balance financial statement assertion and the most appropriate audit
procedure. Financial statement assertions and audit procedures may be selected once, more
than once, or not at all.

Specific Audit Objective Financial statement Audit Procedure

assertion

The entity has legal title to C . Rights and obligation

inventories

A.Completeness H. select a sample of items

Recorded inventory quantities during the physical inventory
include all products on hand count and determine that
they have been includeed on
count sheets.
D. Valuation and allocation F.
Inventories are reduced, when
appropriate, to replacement costs or
net realizable value

D. Valuation and allocation I

Cost of inventories is properly
calculated

E G
The major categories of inventories
and their basis of valuation are
adequately reported in the financial
statements
Financial statement assertion
A Completeness
B Existence
C Rights and Obligations
D Valuation and Allocation
E Presentation and disclosure
Audit Procedure
F Examine current vendors’ price list
G Review drafts of the financial statement
H Select a sample of items during the
physical inventory count and determine that they
have been included on count sheets
I Select a sample of recorded items and
examine supporting vendors’ invoices and
contracts
J Select a sample of recorded items on count
sheets during the physical inventory count and
determine that items are on hand
K Test reasonableness of direct labor rates