Endunamoo BCTA Support Course (BCTA2018)

Endunamoo BCTA Support Course (BCTA2018)

AUE3702: Formulating Substantive Procedures: CyclesKhanyisile Mthethwa

Introduction

The Audit Process

Preliminary engagement activities

Planning

Establish overall audit strategy

Develop an audit plan

Obtain audit evidence (the auditor’s response to

assessed risk)

Perform tests of control

Perform substantive procedures

Evaluation, concluding and reporting

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Acquisition & Payments Cycle

Recap

An audit (substantive) procedure should address the following:

• How: Applicable verb

• What: Source of evidence (Document)

• Why: Reason for the audit procedure which should address anassertion

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Goods and services are acquired by a business for resale or formanufacture of a product, so the consequences of a poor acquisitioncycle will have a negative effect on the business

Basic Functions of any acquisitions and payment cycle

• Ordering of goods

• Receiving of goods

• Recording of purchases (acquisition)

• Payment preparation

• Actual payment and recording of the payment

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Documentation used in the cycle includes:

• Requisition

• Purchase order form

• Suppliers delivery note

• Goods received note

• Purchase invoice

• Credit note

• Creditors Statements

• Remittance Advice

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Types of accounts found in this cycle ad their respective assertions

1. Purchases (Income Statement Account)

• Occurrence: Purchases has occurred and it pertains to that entity

• Accuracy: The Amount of the purchase has been recordedappropriately

• Cut-off: The purchase has been recorded in the correct accountingperiod

• Classification: The purchase has been recorded in the properaccounts

• Completeness: All purchases that should have been recorded havebeen recorded

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2. Payments (Income Statement Account)

• Occurrence

• Accuracy: The amount of the payment has been recordedappropriately

• Cut-off: The payment has been recorded in the proper accountingperiod

• Classification: The payment has been recorded in the properaccounts

• Completeness: All payments that should have been recorded havebeen recorded

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3. Trade Payables (Balance Sheet Account)

• Obligation: The trade payables represent obligations pertaining tothe company.

• Existence: Trade payables included in the balance actually exist,they are not fictitious.

• Valuation: Trade payables are included in the AFS at appropriateamounts and related disclosures have been appropriately measured.

• Completeness: All trade payables and accruals which should havebeen recorded have been recorded.

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Factors to be mindful of when required to perform substantiveprocedures using CAATS:

• The creditors masterlist can be cast to obtain total amount owing andthe detailed list of creditors and their balances can be printed out.

• The Masterfile can be scanned for error conditions i.e. blank fieldsand debit balances

• The Masterfile for the current year can be compared to the prior yearMasterfile to identify significantly reduced balances and creditors whono longer appear.

• The software can be used to extract samples i.e. amounts above acertain amount and nil balances.

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The software can be used to extract lists of any creditors which can beidentified by a particular field or code.

The creditors Masterfile will usually contain the following fields:

• Account number

• Name

• Address and contact details

• Total amount payables

• Aging of total amounts payables

• Payment and discount terms

Please study Chapter 11 of J&S

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Inventory & Production Cycle


The cycle is given a number of names such as the conversion cycle, theinventory and warehousing cycle.

The cycle deals with:

• The custody and safekeeping of inventory in whatever form it is i.e.goods held for resale or manufacture and finished goods.

• The recording of costs where a production/manufacturing processoccurs.

The beauty about this cycle is that is it integrates more than onesubject:

• Accounting IAS 2

• Management Accounting Standard Costing

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Basic Functions of any acquisitions and payment cycle

• Receiving

• Raw Material and component store

• Production

• Finished goods

• Goods for resale warehouse

• Despatch

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Documentation used in the cycle includes:

• Good received note

• Material (components) requisitions, material (components) issuesnote

• Manufacturing or production schedules

• Job cards

• Production report

• Costing schedule

• Transfer to finished goods note

• Picking slip and delivery notes

• Inventory sheet

• Inventory adjustment form

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Types of accounts found in this cycle ad their respective assertions

1. Inventory (Balance Sheet Account)

• Rights: The company holds or controls the rights to the inventory

• Existence: Inventory included in the statement of financial positionactually exists

• Completeness: All inventory which should have been recorded, hasbeen recorded

• Valuation: Inventory is included in the financial statements atappropriate amount

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Valuation

There are certain aspects of the valuation assertion that links to othersubjects:

• Arithmetic accuracy

• Pricing of inventory purchased locally

• Pricing imported inventory purchases

• Pricing manufacturing goods

• Lower of cost or net realisable value

• Inventory Obsolescence allowance

Therefore when required to give substantive procedures for theassertion valuation, do not panic but rather expand on the above.

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You are the audit manager of an existing client, Tiger Trailers (Pty)

Limited, which manufactures standard light duty trailers. The manufacturing of trailers is not a complex process and can be easily understood by observing the production process. The risk of material misstatement of inventory is at an acceptable level. You attended the client’s annual inventory count and are satisfied with the counting procedures. You made copies of the final inventory count sheets. The inventory count sheets are computerised and have the following columns: product code with a description, quantity, selling and cost price. The cost accountant gave you the formula costing records. This is a blueprint of a particular trailer with the exact specifications, product codes and costing. From these records the cost price of a particular trailer is determined. The cost price is then utilised to complete the inventory count sheets for each specific trailer indicated on the inventory count sheets.

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Cost is determined on the FIFO basis. Direct costs of manufacturing anda proportion of manufacturing overheads, based on normal operatingcapacity, are included in the cost of manufactured goods

Inventories at cost on 28 February 2013

2013 2012

R’000

Finished goods 4 280 3 845

Work-in-progress (70% complete) 1 190 1 084

Raw materials 995 799

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Required:

Describe the manual substantive procedures that you will perform to ensure that finished goods are accurate, correctly valued and allocated at year end.

Your answer should not deal with substantive procedures regarding the related disclosures of the finished goods balance.

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INVENTORY

Raw materials Obsolete Stock

Manufacturing overheads Finished goods

Labour costs


Inventory count sheets

1. Recalculate the value of individual items on the final inventory list by

multiplying the quantity with the unit price.

2. Cast the final inventory list.

3. Agree the total of the final inventory list (audited) to the balance ofthe inventory control account in the general ledger and the trialbalance.

4. Perform standard analytical tests, including comparisons withprevious years’ figures and calculating the inventory turnover and grossprofit percentages. Obtain acceptable explanations for deviationsidentified.

5. Perform an analytical procedure to identify slow moving stock bycomparing this year’s monthly purchases with this year’s monthly sales

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and in the months where the movement of purchases does not correlateto a similar movement in sales, perform a detailed analysis thereof.

6. Compare the selling price on the approved price list with cost priceon the inventory list to identify instances where the cost price is higherthan the selling price.

7. Determine through enquiries from management and the sales staff,as well as by inspection of the minutes and correspondence files,whether any of the inventory items are subject to special salesconditions/offers.

8. Confirm the selling prices by inspecting a number of sales invoicesbefore year end with the selling prices on invoices after year end todetermine that the selling prices did not drop.

9. Where selling prices are lower than cost prices, request managementto make the required adjustment to net realisable value (if material).

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10. Confirm through inspection of the previous year’s financialstatements that the accounting policy with regard to inventory isapplied consistently.

Production records

11. Obtain the production records and the formula for the finished goods. Match the formula with that of the previous year for consistency and obtain explanations for deviations.

12. Cast the formula costing records and agree the unit price of a trailer to the cost price reflected on the finished goods inventory list.

13. Perform the following test on the formula costing records:

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13.1 Raw material component:

• Compare the component codes and unit prices as reflected in the

formula costing records with the codes and unit prices reflected in

the raw material inventory list to ensure that they are the same.

• Trace unit price to the relevant supplier’s invoices to establish

whether the correct prices have been used in terms of the FIFO cost

formula.

13.2 Labour component

• Confirm the allocated labour costs with the approved wages

information received from the wages department.

• Agree the hourly rate in the formula costing records with the hourly

wage rate in the wage records and actually paid.

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13.3 Overheads

• Confirm the allocated manufacturing overheads with the approved

allocation basis and the use of accurate information pertaining to

normal operating capacity.

• Evaluate the manufacturing overheads allocation basis, including the

periodic changes to this basis, for reasonableness and discuss with

the financial manager if required.

14. Inspect the inventory count sheets and the inventory records for possible obsolete inventory. Discuss with management the possibility of a provision for obsolete inventory.

15. Obtain a management representation letter with regard to the inventory value as at year end.

Payroll & Personnel Cycle

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The payment of salaries and wages is an integral part of any business and as it isa cycle which results in an outflow of funds from the business, it is extremelyimportant that the accounting system and related internal control activities aresound.

The major differences between salaries and wages are:

• Salaries are fixed monthly amounts whilst wages are based on hoursworked

• Salaries earners are not usually paid for working overtime, whilst wageearners are usually paid overtime at an increased hourly rate.

• Salaries are usually paid by direct EFT into the bank accounts whilst wageearners in some situations are still paid in cash.

• Salaries are paid monthly whilst wages are paid weekly or every 2 weeks

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The basic functions for a payroll and personnel cycle are

• Personnel (Human Resources)

• Timekeeping

• Payroll preparation

• Payment preparation and pay-out

• Deductions: Payment and Recording

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Documentation used in this cycle

• Employment contracts /employee files

• Payroll amendment form

• List of employees

• Clock card

• Batch control sheet and batch register

• Deduction tables and returns

• Payroll (wage journals)

• Pay-packets, payslips, salary advice

• Unclaimed wage register

• Wage/Salary reconciliation

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Assertions and accounts specific to this cycle

1. Salaries and Wages expense (Income Statement Account)

• Occurrence: Total balance recorded for salaries and wages include onlyamounts paid to genuine employees in respect of genuine hours.

• Completeness: All salaries and wages paid or payable for the period, havebeen included in the account balance

• Accuracy: Amounts paid for salaries and wages and other related data havebeen recorded appropriately

• Cut-off: The payments have been recorded in the correct accounting period.

• Classification: The amounts have been recorded in the proper accounts

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The integration between the subject to this cycle is still relevant. Please alsoconsider the following sections when studying this cycle:

• Sec 30 of Companies Act (Auditing)

• The JSE Listing requirements (Finance) Mergers and Acquisitions Chapter

• The King IV Report and Corporate Governance

• IAS 1 – Presentation of Financial Statements

• IAS 19 – Employee Benefits

• IAS 24 – Related Party

• IAS 37 – Provisions, Contingent Liabilities and Contingent Assets

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ACTIVITY 3.4.1

Clothing-4-U Limited (C4U) is a company that manufactures clothing for all MrPrice outlets in South Africa. Over the past year the company has grownconstantly and currently has 600 permanent wage workers employed at itsfactory.

Your audit firm is appointed as the auditor of C4U, with you as audit senior incharge of auditing the payroll and personnel cycle. A major concern for you isthat you will fail to detect material overstatement of the salary and wageexpenses, mainly owing to the following:

• Inclusion of fictitious employees on the payroll

• Inclusion of time not worked (normal and overtime) in the salary and wage

calculations

• Calculation of wages at an incorrect wage rate

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The following information about the factory wage workers is available to you:

(1) C4U uses an automated salary and wage system.

(2) All staff are permanently employed and a complete personnel file containingall the necessary information about the employees is maintained in the humanresources department.

(3) Employees are paid a fixed hourly rate depending on their job grade. The jobgrade is determined on appointment and reviewed once a year based onexperience and years of service at the company.

(4) Overtime can only be worked if authorised by Mr Hat and may not exceed 30

hours per month.

(5) The rates per hour for the three different job grades are as follows:

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(6) Rates are increased annually at the beginning of the financial year by 12%.

(7) Wages are based on actual hours worked (normal and overtime) which are

determined by using a biometric reader access system that records the time of

entry and exit at the factory. Controls over the biometric reader access system

appear to be sound.

(8) Wages are paid directly into the employees’ bank account and are based on

the hours worked during the calendar week and are paid the following Friday.

(9) The employee master file contains the following information:

– employee name

– employee number

– employee identity number

– employee taxation number

– employee bank account number

– gender and race

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– address and contact information

– date of employment/dismissal/resignation

– job grade

– normal hours worked each month

– overtime hours worked each month

– rate of normal hours worked

– rate of overtime hours worked

– PAYE/SITE amount to be paid each month

– medical aid contribution to be paid each month

– net wages for each month

– net wages year to date

You have decided to use CAATs to perform substantive procedures.

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Required:

Formulate the substantive procedures that you will perform in the payroll and

personnel cycle of C4U to obtain evidence that no fictitious employees are being

paid and that employees are only paid for actual hours worked and at the correct

wage rate. Your answer should specifically deal with the occurrence and

accuracy assertions. Limit your answer to substantive procedures using CAATs.

Your answer should not deal with substantive procedures regarding the related

disclosures.

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Occurrence

1. Use CAATs to select a sample of employees from the employee master file of

C4U and follow up on differences with management (11⁄2 marks each):

• Verify all information against the personnel files kept in the humanresources department, for example inspect employee contracts, copies ofidentity documents, banking details and taxation numbers.

• Perform physical positive identification of the employees on a surprisebasis by inspecting the information on the staff card.

• Inspect the returns made to outside entities, for example SARS, to ensurethat the employees in the sample are included on the SARS return.

• Enquire with managers to whom the employee reports whether theemployee has been employed throughout the year.

2. Use CAATs to extract and compare a list of employees from the employee

master file of C4U for the prior year and for the current year in order to identifyadditions or removals of employees and compare the information withsupporting documents in the personnel files

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3. Use CAATs to extract a list of employees with information in the date of

employment/dismissal/resignation fields and compare the information with

the supporting documents in the personnel files (employee contract/resignation

letter, etc.).

4. Use CAATs to scan the employee master file of C4U for “error” conditions

and print an exception report to discuss these cases with management. For

example (11⁄2 marks each):

• Duplicated identity numbers or bank account numbers or employee

numbers or taxation numbers

• Where an employee has resigned or has been dismissed, but still has a

value in the net wages field after the date of resignation or dismissal

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Accuracy

1. Use CAATs to recalculate net wages to confirm the accuracy of net wages.

2. Use CAATs to compare total of the net wages in the master file with thebalance in the general ledger and trial balance.

3. Use CAATs to extract a sample of employees indicating the normal or overtimehours worked and compare with the hours logged by the biometric readeraccess system.

4.vUse CAATs to scan the employee master file for any job grade or rate changes

during the year and follow differences up with management. (There should beno changes because job grade and rate changes are only reviewed annually.)

5. Use CAATs to compare the rate of job grades A, B and C with applicable ratesfor normal hours and overtime hours in the master file of C4U and print anexception report whenever the wrong rate is used for a specified job grade.Follow exceptions up with management.

6. Use CAATs to extract a sample of employees reflecting the rate and job gradesand verify these details with details described in the personnel file in the

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human resources department. Follow up on any differences. Use CAATs

to extract a sample of employees indicating their deductions and inspect

whether all deductions are in accordance with appropriate tables and rules

by comparing these with supporting documentation

7 Use CAATs to extract a sample of employees indicating their deductions andrecalculate the deductions (PAYE, medical aid) to confirm that calculations areperformed correctly. Follow differences up with management.

8. Use CAATs to scan the employee master file of C4U for “error” conditions andprint an exception report to discuss these cases with management, i.e.

• Negative wages, hours worked, rates or deductions

• No amounts in the “net wages” field where an employee has been employed

• Net wages greater than gross earnings

• Overtime hours worked exceeding 30 hours per month

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Analytical procedures

1. Perform analytical procedures by using CAATs to compare the following:

• The total wage expense for the current year with the total wage expense forthe prior year. Follow up on any differences above or below the 12% increasewith management (accuracy/occurrence).

• Current year wage expense compared with the budget. Follow up on anydifferences with management (accuracy/occurrence).

• Compare the month to month wages and follow up on any materialdifferences (accuracy/occurrence).

2. By using CAATs and the fields available in the master file of C4U performanalytical procedures by comparing the total of the net wages value permonth for each employee with the total net wages year to date value for eachemployee. Follow differences up with management (accuracy).

3. Perform the following analytical procedures by using CAATs:

• Calculate the average wages per employee for each month

• Compare the number of employees of this year with the prior year

Finance & Investment Cycle

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The audit of the finance and investment cycle can be very difficult andwill require a technically proficient and experience member of the auditteam to be responsible for it.

This is the cycle where everything goes that was not classified underthe 4 cycles we have done thus far.

The following are examples of accounts you will find in the financecycle:

• Share Capital

• Debentures

• Long term loans

• Finance lease liability

• Provisions, Contingent Liabilities and Contingent Assets

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The following are examples of accounts you will find in the financecycle:

• Property, plant and equipment

• Investment in shares

• Long term loans made by the company

• Intangible assets

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Assertions which will affect the finance and investment cycle are bothfor the balance accounts and also the income statements accounts.

1. Assets/ Liabilities (Balance Sheet Accounts)

• Existence

• Rights and Obligation

• Completeness

• Valuation and Allocation

• Presentation and Disclosure

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1. Income/ Expenses (Income Statement Accounts)

• Occurrence

• Accuracy

• Completeness

• Cut off

• Classification

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End of the lecture

Any questions?

Thank you

Presenter’s detailsKhanyisile Mthethwa

Email: [email protected]

Cellphone number: 076 245 3559

BCTA2018 Administration

Rejoyce Mutengera

[email protected]

+2711 056 6359

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mailto:[email protected]

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Endunamoo BCTA Support Course (BCTA2018)

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