CHAPTER 4 PART A

INTRODUCTION
TO INTERNAL CONTROLS

Nr Topic Comments
PART INTERNAL CONTROL
A
I.1 Internal control: theory and components
I.5 Internal control: control activity & control objective
I.6 Internal control: theory, control activity & control Progress
objective question:
see table
below
I.9 Internal control: control activity & control objective
I.15 Internal control: theory, control activity & control
objective
S1.19 Internal control: control activity & control objective
I.20 Internal control: control activity & control objective
Theory, Internal control objectives and internal control
l.22 ILP2
activities
Theory, Internal control objectives and internal control Class
I.24
activities question

Progress questions:

For the week ending Question:

23 February 2024 Question I.6

1
I.1

SECTION A 10 marks

Tjoepstil Limited’s new accounting assistant, who has recently graduated, mentioned
to the general manager that, according to him, the system of internal controls
contains weaknesses which can be rectified by segregation of duties (division of
work). The following procedures exist at Tjoepstil Limited:

(a) Management receives information from the external auditors regarding

weaknesses in the system of internal controls, together with proposed
improvements.

(b) Management have paid special attention to and investigated the risks that might
occur when using a computerized accounting system.

(c) A policy document and financial reporting manuals was developed and
implemented.

(d) Information systems management have developed controls to prevent

unauthorized use of information systems equipment and data files.

(e) Responsibility and authorization have been allocated in such a manner that
everyone knows how his/her activities integrate with those of others, in reaching
the company’s goals.

(f) Management are intent upon eliminating any incentives or temptations that may
lead to employees becoming involved in dishonest activities and fraud.

REQUIRED

1. According to the COSO model, a system of internal controls consists of five

components. Indicate to which of the five components of a system of internal
controls each of the above relates to. (6)

2. What is the objective of segregation of duties? (2)

3. Give three guidelines to achieve proper segregation of duties. (2)

2
I.5 12 marks

The following is an abstract from the internal control questionnaire that one of the
audit clerks completed on the Salaries and Wages cycle of LCD Limited.

WP REFERENCE: K2
CLIENT: LCD Limited YEAR END: 30 June 2021
PREPARED BY: Audit clerk REVIEWED BY: Myself
DATE: Today DATE: Later the same day

INTERNAL CONTROL QUESTIONNAIRE

SALARIES AND WAGES

QUESTION ANSWER COMMENTS

1. Are the appointment of new Yes It is done by the Head of

personnel, salaries and wages Human Resources
calculations and the payments division, Salaries and
thereof handled by different wage clerks and the
people? manager
2 Are the salary- and wage No
calculations checked and
approved by an independent
person?
3 Does a person on management Yes Mr Andas approved it
level approve all rate adjustments?
4 Do the authorised signatories of Yes Confirmed by enquiry
the on-line banking account of
LCD Limited compare the salary
EFT’s that are loaded for release,
to supporting documentation
before they release the EFT’s?

REQUIRED

1 Identify for each question listed on the above internal control questionnaire the
relevant internal control activity. (4)

2 Name the internal control objective(s) to be achieved for every question in the
above internal control questionnaire. (5)

3 Describe what the possible consequence(s) would be for every question in the
above internal control questionnaire for which the reply is “NO”. (1)

Presentation (2)

3
4
Question I.5 Internal Control Internal Control Consequences of
Activity Objective/s weaknesses in situations
where the answer is
“NO”.
1 Are the appointment of new Yes - It is done by the
personnel, salaries and wages Head of Human
calculations and the payments Resources division,
thereof handled by different Salaries and wage
people? clerks and the
manager

2 Are the salary- and wage No

calculations checked and
approved by an independent
person?

3 Does a person on Yes - Mr Andas

management level approve all approved it
rate adjustments?

4 Do the authorised signatories Yes - Confirmed by

of the on-line banking account enquiry
of LCD Limited compare the
salary EFT’s that are loaded
for release, to supporting
documentation before they
release the EFT’s?

1
I.6 25 marks

You are the auditor of Rosco Limited, an enterprise that manufactures and sells
refrigerators.

You and the audit team are currently busy with the planning stage of the 2022 audit
of the company and have already done the following:

□ acquired knowledge of the business, among other things through enquiry from
staff and visits to the premises;

□ preliminary evaluated inherent risk for the financial statements as a whole, as

low;

□ completed the standard internal control questionnaire of your firm with respect
to the “Overall Control Environment”.

The following internal controls were identified in the enterprise after completing an
internal control questionnaire on the purchases and payment cycle:

1. The purchase manager approves the purchase orders before the order is
placed.

2. Purchase orders are pre-numbered, the numerical sequence is checked and

outstanding or duplicate purchase orders are followed up on a regular basis.

3. Different people complete the purchase order, receive the goods and record
the transactions in the purchases journal.

4. A responsible official in the accounting division checks the calculations of

invoices received from creditors before invoices are sent through for
payment.

5. All documents are stamped “Paid” as soon as it is paid by EFT.

6. The accountant checks journal entries on a regular basis to ensure that

transactions were posted to the correct general ledger accounts.

7. The cashbook clerk does bank reconciliations on a monthly basis by

comparing the cashbook with the bank statement.

1
REQUIRED

1. Explain what the “control environment” is. Also name 3 factors that will characterise
a sound control environment and also indicate why the auditor will want to evaluate
the control environment. (5)

2. Identify for each of the above-mentioned internal controls the applicable internal
control activity. (8)

3. Name the internal control objective(s) to be achieved if the internal controls are
applied. (12)

Format for presentation of parts 2 & 3:

Number Internal Control Activity Internal Control

of the Objective
control

I.9 15 marks

You are an audit manager working for Zebra Incorporated, an audit firm in
Stellenbosch. For the past five years your firm has been the auditors of Kwekery Ltd
(“Kwekery”). You are currently planning the audit of Kwekery Ltd for the year ending
30 April 2022.

Kwekery is a large unlisted company with its head office in Cape Town that sells
indigenous plants and related products. The group manages various nurseries
spread all over South Africa. Each nursery is run as a separate wholly owned
subsidiary company that prepares its own annual financial statements which are then
again consolidated to prepare the group financial statements.

The following internal controls amongst others were identified after trainee
accountants completed an internal control questionnaire on the sales and receipts
cycle of Kwekery:

1. Returns received are appropriately approved by the credit department

manager.

2. Credit notes had been pre-printed and pre-numbered and appropriately

completed by the credit clerk. The number sequence is checked by the
credit department manager and outstanding numbers are followed up.

3. The write-off of bad debt is discussed and approved by the Credit

Committee.

4. The person handling the returns and the resulting credit note is not
responsible for orders as well.

2
 5. The security guard at the entrance of the nursery checks the goods
returned with the original invoice and marks them as returns with a
sticker.

6. Returns are compared with the client's copy of the invoice and checked
before taken back as inventory and preparing the returns voucher.

7. Bank reconciliations are done by the cash book clerk on a monthly

basis.

REQUIRED

Please note: Your answers to parts (a) and (b) must be in table format –
refer to format indicated under part (b).

(a) For each of the above-mentioned internal controls, identify the appropriate
internal control activity under discussion. (7)

(b) For each of the above-mentioned internal controls, mention the internal control
objective(s) to be achieved when the control is appropriately applied. (8)

Format for presentation of parts (a) and (b):

Number of internal Internal control Internal control

control measure activity objective(s)
1.
2.
Etc.

3
I.14 16 marks

You have recently been appointed as an internal control specialist at Cinnebon

(Proprietary) Limited (“Cinnebon”). Cinnebon manufactures and sells fresh pastries
and delicacies to several shops and deli’s in the Western Cape. The factory and
head office are situated in Stellenbosch, Western Cape. Cinnebon has become a
household name and the company is now selling branded products on a large scale.
This increase in sales and production has made Mr Bun, the managing director and
owner, realise that Cinnebon requires a capital injection to be able to expand. This,
he believes, will result in an increase of the production capacity of its business and
show a return within the next year. Mr Bun recently visited Cinnebon’s banker who
informed him that one of the loan requirements are audited financial statements of
the applicant. In response to this, Mr Bun recently appointed an auditor for Cinnebon.
At the first meeting with the auditor, Mr Bun realised that some of the internal controls
over credit sales and deliveries of sold goods are severely lacking. You have been
appointed to address these weaknesses.

Mr Bun requested that, rather than improving the weaker elements of the current
system, you design replacement internal controls that can be implemented going
forward. You may make use of any documents that you deem necessary. He has,
however, given you one cost constraint in that no new employees may be appointed
to implement and run the new internal control system that you propose.

As a starting point you gathered the following information regarding aspects of the
credit sales and deliveries system that are already functioning effectively and do not
require amendment:

• All new customers go through the necessary credit approval process before Mr
Bun sets credit limits based on the results of the credit checks. No sales are made
on a cash basis.

• To build good customer relationships and loyalty, each customer is allocated

to one of the sales clerks. Customers call the sales team each afternoon at four
o’clock to place their orders for the following day. Sales are made up of fresh pastries
and delicacies and only with the dedicated sales clerk allocated to each customer.
This ensures that only the freshest goods are sold to the public.

• Customers have agreed to a fixed daily time when freshly baked goods are
delivered to them. Cinnebon has the good reputation of always adhering to these
agreed delivery times. They have two delivery vehicles to ensure timeous delivery
and in case of a “cinne-ster” breakdown or fire.
• All products are sold at standard approved prices. Customers who have
purchased goods from Cinnabon for a period of more than one year are given a 10%
loyalty discount. This is the only discount granted by Cinnabon to customers.
• Refer to the organogram that follows for the organisational structure of
Cinnebon.

Organisational structure:

4
 Salesman 1
Sales manager
Mrs Whirl
Salesman 2

Owner/Managing director Storeman 1

Storeman 2
Inventory
foreman Driver 1
Mr Bun

Mr Frosting
Driver 2

Gate keeper

Invoicing clerk

Financial Credit mangement clerk - Debtors

manager
Mrs Chappel Inventory records clerk

Other - Not involved directly with sales and

debtors

PART A

In your meeting with Mr Bun to present the proposed system of internal control
regarding credit sales and deliveries of sold goods, Mr Bun requested that you
answer the following question regarding an audit and related matters.

REQUIRED

Mr Bun recently read an article in a management magazine regarding how control

objectives can be used to ensure that internal controls address the risks to which a
company is exposed. What are the control objectives for the recording of sales
invoices in the sales journal? (6)

PART B

The following internal controls were identified as a part of the inventory count
process:

5
 1. Access to the inventory warehouse will be limited during the inventory count.
2. The count sheet will be pre-numbered and missing numbers will be followed
up on.
3. All changes where physical inventory differs from the inventory records, must
be authorised by the supervisor.
4. Persons working in the inventory warehouse are not involved in the stocktake.
5. The count sheets are reconciled with inventory records and differences are
investigated.

REQUIRED

1. For each of the abovementioned internal controls, identify the relevant control
activities. (4)
2. For each of the internal controls, list the internal-control objective(s) that will be
met if the controls are applied correctly. (6)

Format of presentation for part 1and 2:

Number of controls Control activities Internal control

objectives
1.

I.15 24 marks

Choc-a-Lot Proprietary Limited (Choc-a-Lot) is a company that manufactures and

sells chocolate bars in South Africa. Choc-a-Lot started as a family run business that
has recently signed a large retail chain as its customer. Consequently, Choc-a-Lot
now has to increase production by 200% and requires your assistance in designing
and implementing a system of internal control to support this growth.

Up to this point the staff compliment of Choc-a-Lot has been relatively small and an
“all hands on deck” approach has been followed, meaning that everyone assists
where needed to get the job done. Kaylee Kabeljou (Kaylee), the operations
manager, informed you that until now she has trusted her team. However, as a large
number of additional staff will need to be appointed, she will no longer be able to build
the same relationships with them going forward. Consequently, Kaylee is aware that
she will need to have a sound system of internal control to maintain quality. To break
the ice Kaylee has requested that you meet with her and the other members of the
management team to discuss certain foundational concepts of internal control.

In preparation for the meeting you have identified the following aspects of internal
control that you would like to discuss at the first meeting:

1. The definition of internal control. (3)

6
2. The definition of risk assessment in a system of internal control. (3)

3. As segregation of duties is not always possible in a small business, you would

like to clearly explain what segregation of duties is and what, at a minimum,
the functions are that should be segregated in a generic transaction. (3)

4. As the approach up to this point has been all “hands on deck” you would like
to explain to the management team what the risks are if duties are not properly
segregated. (2)

5. Explain, through the use of examples of internal controls relating to sales

returns, the link between internal controls, as given in the table below, their
related control objectives and the relevant control activities. (12)
Table of example internal controls that has to be used for point 5 follows
on the next page.

7
 Number Internal control Control Internal
activity(ies) control
objective(s)
5.1 The financial manager, having
scrutinised supporting
documentation and company
policy, authorises a credit note by
signing it.
5.2 Debtors reconciliations are
performed on a monthly basis to
ensure correct posting to the
debtors ledger and general ledger
account.
5.3 A sequentially numbered goods
returned voucher is issued after
inspecting returned goods and a
sequence check is done by the
returns manager on a weekly basis
who follows up on missing
numbers.
5.4 The person who posts the credit
notes to the sales returns journal is
not the same person who receives
the physical goods returned.
5.5 Only authorised persons have
access to the inventory warehouse
where returned goods are stored.
5.6 A clerk re-performs calculations of
VAT on goods returned vouchers
and then checks accuracy of the
posting to the sales returns journal.

REQUIRED
Prepare for the meeting with the management of Choc-a-Lot Proprietary Limited by
explaining the aspects described in points 1 to 5 above. (23)

NOTE: You are required to answer point 5 in a tabular format, using only the
number, control activity(ies) and internal control objective(s).

Communications skills: Layout and structure (1)

8
S1.19 20 marks

You are the auditor of Table Topper Limited (‘Table Topper’), an enterprise that
manufactures and sells wooden furniture. Table Topper’s financial year-end is
31 March 2022.

You and the audit team are currently busy with the planning stage of the 2022 audit
of the company and have already performed the following:

□ obtained knowledge of the business through, inter alia, visits to the

premises and discussions with staff members and;
□ completed the standard internal control questionnaire of your firm with
respect to the ‘Overall Control Environment’.

The following internal controls were identified to be present in the enterprise after
completing the internal control questionnaire of the purchases and payment cycle:

1. The purchase manager approves the purchase orders before the order is
placed.
2. Purchase orders are pre-numbered, the number sequence is checked and
outstanding purchase orders are investigated and followed up on a regular
basis.
3. Different staff members complete the purchase order, receive the goods and
record the transactions in the purchases journal.
4. A designated staff member in the accounting division checks the
calculations on invoices received from creditors before invoices are
submitted for payment.
5. An independent accountant compares the invoice, order, and goods
received note with each other to ensure that all the details and amounts
agree before the relevant journal entry is made in the purchases journal,
creditors’ ledger and general ledger.
6. The accountant checks the journal entries on a regular basis to ensure that
transactions were posted to the correct general ledger accounts.
7. The creditors ledger is reconciled to the general ledger on a regular basis.
8. Bank reconciliations are performed on a monthly basis by comparing the
cashbook with the bank statement.

9
 REQUIRED

For each of the internal controls mentioned above:

1. Identify the applicable internal control activity (activities); and (9)

2. Name the internal control objective(s) to be achieved if the internal controls are
properly implemented.
(10)

Your answer should be presented in the following table format:

Number
Internal control
of the Internal control activity (ies)
objective(s)
control

Communications skills – layout and structure (1)

I.20 20 marks

Poppy’s Cupcakes and Rainbows Proprietary Limited (PC&R) is a company based in

Cape Town that bakes cakes and treats. PC&R has grown and are wanting to apply
for a bank loan to expand the bakery. The bank has prescribed that an audit be
conducted prior to the application process being finalised.

Your audit firm has been engaged to audit PC&R. Poppy, the owner and manager, is
expecting the audit to be finished in no time as she has not identified any fraud in her
business and all her employees are like family. Poppy recently read an article on the
elements of internal control and has requested that someone from your firm explain
the terms “control environment” and “risk assessment” to her. The partner in charge of
the audit has requested that you respond to Poppy’s request by having a meeting with
her. He has further tasked you with preparing a table that can be used to train the more
junior staff members of the audit team as to which control activities and objectives are
relevant to certain internal controls in the sales and receipts cycle of PC&R.

10
REQUIRED

For each of the internal controls implemented by Poppy’s Cupcakes and Rainbows
Proprietary Limited listed as a) to e) in the table that follows on the next page, identify
the applicable control activity(ies) and relevant control objective(s) that will be
achieved should the control be properly implemented. (12)

NOTE: You are required to answer in a tabular format, using only a)-e), control
activity(ies) and internal control objective(s) in your solution.

Communication skills: Layout and structure (1)

Internal controls implemented by Poppy’s Cupcakes and Rainbows Proprietary

Limited

# Internal control Control Internal control

activity(ies) objective(s)
a) All credit sales are subject to a pre-approval
process by the credit manager to ensure that
customers are creditworthy or have sufficient
credit available.
b) When cakes are collected by the customer the
cake decorator and the customer inspect that
the cake agrees to the approved order and the
customer signs the approved order before the
cake may leave the premises.
c) All cash received is locked away in the cash
register drawer and no cash may be accepted
unless a receipt is issued.
d) The debtors ledger is reconciled to the general
ledger on a monthly basis.
e) On a regular basis the financial manager
reviews the sales journal that has been
prepared by the accountant.

11
I.22 25 Marks
You are the new auditor of Trail-Run Funky Socks Limited (TRFS), a company with
a 28 February year-end. The company manufactures and only sells socks at its
warehouse. Sales are on cash and on credit. Due to significant growth experienced,
the company recently appointed a board of directors to assist with the corporate
governance of TRFS.

You and the audit team are currently involved in the planning stage of the 2021-
external audit of TRFS and have already done the following as part of the planning
process:
• acquired knowledge of the business, among other things, through enquiry from
staff and visits to the premises;
• evaluated overall preliminary inherent risk for the financial statements as low;
and
• completed the standard internal control questionnaire of your firm with respect
to
“The overall control environment of the client”.

The following internal controls were identified, amongst others, after trainee
accountants prepared the internal control questionnaire for the sales and receipts
cycle of TRFS.

# Internal Control Internal control Internal control

activity objective(s)

1. The financial manager, having scrutinised

supporting documentation and company
policy, authorises a credit note by signing it.
2. Credit notes are pre-printed and pre-
numbered. The number sequence is
checked and outstanding numbers are
followed up.
3. The person completing the resulting credit
note is not responsible for orders as well.
4. Unused credit notes are locked away in the
safe. Only the bookkeeper can gain access
to these credit notes.
5. A second clerk in the accounting department
reperforms calculations on credit notes and
checks the accuracy of the recording of
credit notes in the sales returns journal and
the posting thereof to the debtors’ ledger
accounts.
6. Debtors reconciliations are performed on a
monthly basis to ensure correct posting to
debtors’ ledger and general ledger
accounts.

12
REQUIRED

(a) Explain why an external audit can only provide reasonable assurance and
cannot provide absolute assurance. (6)

(b) For each of the internal controls referred to in the above- mentioned table:

(i) Identify the appropriate internal control activity under discussion. (6)

(ii) Name the internal control objective(s) that is addressed when the internal
control measure is appropriately applied. (6)

Provide your answer in the table format indicated below:

Number of internal control (i) Internal control (ii) Internal control

measure activity. objective(s)
1.
2.
Etc.

(c) Explain to the newly elected board of directors what the ‘control environment’ is
and list the factors that will characterise a sound control environment. (4)

(d) Explain what the risk assessment process in a system of internal control is.

(3)

I.24 20 marks

Wolfberg Limited (‘Wolfberg’) is a construction company that specialises in the

building of business parks and malls across South Africa. Wolfberg is a family-owned
business founded in 2001. Due to the increase in corporate scandals, the Board of
Directors of Wolfberg have started to place more focus on the internal control
systems (specifically the internal control environment and materials purchasing
process).

Internal control environment

Wolfberg’s management developed a Code of Conduct as part of project called

‘Fixit’, to guide employees on ethical values and behaviours. Project ‘Fixit’ is in the
process of being rolled out, and will also entail:
• The effectiveness of the internal control environment will be assessed under the
guidance of the Board of Directors.
• Review of processes that are in place to ensure that competent and skilled
employees are recruited and retained by the company.
13
Materials purchasing and returns process

Before the commencement of a project, Timothy Titan (‘Mr Titan’), the head engineer
will calculate and plan all material required to complete the build. The acquisition of
materials needed for these projects are driven by the engineering department. Prince
Hlube (‘Mr Hlube’), the project engineer, will prepare a pre-printed, sequentially
numbered purchase requisition, which is then shared with the purchase department.
Should Olivia Owen (‘Mrs Owen’), the senior engineer, be dissatisfied with the quality
of any of the material acquired from a supplier, a process to return the material is
initiated. Mrs Owen will complete a pre-printed, sequentially numbered goods
returned to supplier voucher. The goods returned to supplier voucher contains the
below information:
• Date;
• Supplier code;
• Item code of material returned;
• Quantity of material returned; and
• Reason for return.
Mr Titan will authorize the goods returned to supplier voucher after verifying the
above information.

Mr Gordan, the account payable clerk, will only create a debit note if supported by:
1. An authorised goods returned to supplier voucher, as well as a goods received note
(as evidence that the goods being returned were originally purchased).
2. The original supplier invoice the return relates to.

The following controls are in place:

3. Once Mr Gordan is satisfied that these items agree, he creates a debit note, which is
sent to Dorothy Dryer (‘Mrs Dryer'), the financial manager, for approval.
4. Mrs Dreyer will cast and recalculate the debit note once received. She also agrees
the quantity on the debit note to the quantity on the goods returned to supplier
voucher. She will sign the debit note as proof of review once she is satisfied that the
quantity agrees and the calculations are correct.

REQUIRED

a) According to ISA 315 (Revised), evaluation of the environment is important for the
auditor because an effective system of internal control is not possible if a favourable
control environment was not created. This helps us to assess the risk of material
misstatement of the financial statements. List the elements of the control environment
(as defined by COSO), and, for every element listed, give an example of the application
thereof by Wolfberg Limited from the scenario. (5)

b) With reference to the purchase returns controls, as discussed in the materials

purchasing and returns systems description above, for each of the controls listed:

1. Identify the appropriate internal control activity(ies) involved. (5)

14
1. List the internal control objective(s) that is(are) addressed when the internal control
measure is appropriately applied. (5)

Present your answer in the following format:

Number as per system (i) Internal control (ii) Internal control

description in activity(ies) objective(s)
scenario
1.
2.
Etc.

Communication skills: Using table format (1)

c) List four (4) inherent limitations of an external audit. (4)

15
16