Chapter 13 Q &A - ACTIVITIES PDF

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CHAPTER 13 REVIEW QUESTIONS AND EXERCISESQuestions 1. What is meant by the control environment? What are the factors the auditor must evaluate to understand it? -Control environment means the overall attitude, awareness and actions of directors and management regarding the internal control system an...

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CHAPTER 13 REVIEW QUESTIONS AND EXERCISES Questions 1. What is meant by the control environment? What are the factors the auditor must evaluate to understand it? -Control environment means the overall attitude, awareness and actions of directors and management regarding the internal control system and its importance in the entity. The auditor must evaluate the different factors such as: the function of the board of directors and its committees; the philosophy and operating style of management; the entity's organizational structure and methods of assigning authority and responsibility; and the control system of management. 2. What is the relationship among the five components of internal control? -They help ensure the organization to achieve its goals while avoiding complications along the way. They are crucial and important part of organization. 3.

The separation of operational responsibility from record keeping is meant to prevent different types of misstatements than the separation of the custody of assets from accounting. Explain the difference in the purposes of these two types of separation of duties. -Separation of operational responsibility from record keeping is intended to reduce the likelihood of operational personnel biasing the results of their performance by incorrectly recording information while separation of the custody of assets from accounting for

these assets is intended to prevent

misappropriation of assets and also to prevent fraud. 4. For each of the following, give an example of a physical control the client can use to protect the asset or record: a. Petty cash- Entity could keep it in a fireproof safe. b. Cash received by retail clerks- should be registered to cash register to record cash received.

c. Accounts receivable records- Entity could also use safe for these records and provide a computerized back up. d. Raw material inventory- Entrust it with reliable and competent employee and provide a locked storeroom. e. Perishable tools- Could be also kept in locked storeroom with reliable employee. f. Manufacturing equipment- Keep in area protected by burglar alarms and fire alarms. g. Marketable securities- Keep it in a safety deposit vault. Exercises Exercise 1

Each of the following internal controls has been taken from a standard internal control questionnaire for assessing control risk in the payroll and personnel cycle. Required A. For each internal control, identify a specific misstatement that is likely to be prevented if the control exists and is effective. B. For each control, list a specific misstatement that could result from the absence of the control C.For each control, identify one audit test that the auditor could use to uncover misstatements resulting from the absence of the control.

1. Approval of department heard or foreman on time cards is required before preparing payroll. a. An unauthorized or invalid time card turned in by an existing employee.The time card

may be for

an employee

who

formerly worked

for

the

company or one who is temporarily laid on. b. An

employee

could

be

claiming

too

many

hours

by

having

friend punch him or her in early, or by making manual changes on time cards.

a

c. Check to see that all employees that are punched in one day are physically present. 2. All pre-numbered time cards are accounted for before beginning data entry for preparation of checks. 3. The payroll accounting software application will not accept data input for an employee number not contained in the employee master file. 4. Persons preparing the payroll do not perform other payroll duties (timekeeping. distribution of checks) or have access to payroll data master files or cash. 5. The computer calculates gross and net pay based on hours inputted and information in employee master files, and payroll accounting personnel doublecheck the mathematical accuracy on a test basis. 6. All voided and spoiled payroll checks are properly mutilated and retained. a. Preparation of a check for an inappropriate person, the distribution of that check to that person, and the recording of that check in the cash disbursements journal as a voided check. b. An employee who is supposed to void a check could record it as voided on the books and cash the check. At month-end the amount of the check could be covered by adjusting the bank reconciliation. c. Test month-end bank reconciliations in detail

to determine that

the

account reconciles properly, that all supporting documents are proper, looking especially for a check that cleared and was supposed to be voided, and that no alterations have been made to the bank statement. 7. Personnel requires an investigation of an employment application from new employees. Investigation includes checking the employee's background, former employers, and references. a. Both errors and fraud are likely to be prevented if competent trustworthy employees are hired. Hiring honest employees minimizes likelihood

of

fraud.

Hiring competent employees minimizes the likelihood of unintentional errors.

b. Several types of intentional misstatements could occur if a dishonest person is hired. Similarly, several types of unintentional errors could occur if an incompetent person is hired. c. An examination of cancelled checks and supporting documents, including time cards and personnel records, is a test of the possibility of fraud. A test of

the

calculation of payroll is a test for an unintentional error caused by employees who are not competent. 8. Written termination notices, with properly documented reasons for termination, and approval of an appropriate official are required. a. The preparation of a payroll check for a former employee is prevented. b. A terminated employee could be continued on the payroll with someone else obtaining the paycheck. c. Perform a

surprise

pay

in

which

the

auditor

accounts

for

all

paychecks and distributes them to the employees, who must provide identification to receive their checks. 9. All checks not distributed to employees are returned to the treasurer for safekeeping. a. Checks prepared for nonexistent employees or employees on vacation, or absent for other reasons are controlled and safeguarded. b. Checks could be lost which are intended for absent employees or a check could be taken by the person responsible for distributing the checks. c. Examine cancelled checks to make certain that each check is properly endorsed, supported by a time card, and the person for whom the check is made out is still working in the company. 10.On-line ability to add employees or change pay rates to the payroll master file is restricted via passwords to certain human resource personnel. a.

Preparation of a check for a fictitious employee or preparation of checks

using an unapproved pay rate is prevented.

b.

A fictitious payroll check could be processed for a fictitious employee if

those with record keeping responsibilities are allowed to enter new employee numbers to the master file. Also, paychecks to valid employees could be overstated if unauthorized personnel have the ability to make changes to the pay rates in the master file. c.

Attempt to access the online payroll master file using a password that is

not allowed to access that master file Exercise 2

The division of the following is meant to provide for the best possible controls for the Meridian Paint Company, a small wholesale store. 1. Assemble Supporting documents for general and payroll cash disbursements.+ (Robert Cruz and James Santos) 2. Sign general cash disbursement checks.+ (Robert Cruz and James Santos) 3.

Input information to prepare checks for signature, record checks in the cash disbursements journal, and update the appropriate master files. + (Robert Cruz and James Santos)

4. Mail checks to suppliers and deliver checks to employees.+ (Robert Cruz and James Santos) 5. Cancel supporting documents to prevent their reuse. + (Robert Cruz and James Santos) 6. Approve credit for customers included in the customer credit master file.+ (Robert Cruz and James Santos) 7.

Input shipping and billing information to bill customers, record invoices in the sales journal, and update the accounts receivable master file. + (Robert Cruz and James Santos)

8. Open the mail and prepare a pre-listing of cash receipts. (Bill Reyes)

9. Enter cash receipts data to prepare the cash receipts journal and update the accounts receivable master file.+ (Robert Cruz and James Santos) 10.Prepare daily cash deposits.+ (Robert Cruz and James Santo 11. . Deliver daily cash deposits to the bank.+ (Robert Cruz and James Santos) 12.Assemble the payroll time cards and input the data to prepare payroll checks and update the payroll journal and payroll master files.+ (Robert Cruz and James Santos) 13.Sign payroll checks.+ (Robert Cruz and James Santos) 14.Update the general ledger at the end of each month and review all accounts for unexpected balances. (Bill Reyes) 15.Reconcile the accounts receivable master file with control account and review accounts outstanding more than 90 days. (Robert Cruz) 16. Prepare monthly statements for customers by printing the accounts receivable master file; then mail the statements to customers. (James Santos) 17.Reconcile the monthly statements from vendors with the accounts payable master file. (James Santos) 18.Reconcile the bank account. (Robert Cruz) Required: You are to divide the accounting-related duties 1 through 18 among Robert Cruz, James Santos and Bill Reyes. All of the responsibilities marked with a cross (+) are assumed to take about the same amount of time and must be divided equally between Robert and James. Both employees are equally competent. Bill, who is president of the company, Is not willing to perform any functions designated by a dagger and will perform only a maximum of two of the other functions.

Exercise 3

Recently, while eating lunch with your family at a local cafeteria, you observe a practice that is somewhat unusual. As you reach the end of the cafeteria line, an adding machine operator asks how many persons are in your party. He then totals the food

purchase on the trays for all of your family and writes the number of persons included in the group on the adding machine tape. He hands you the tape and asks you to pay when you finish eating. Near the end of the meal, you decide you want a piece of pie and coffee so you return to the line, select your food, and again go through the line. The adding machine operator goes through the same procedures, but this time he staples the second tape to the original and returns it to you. When you leave the cafeteria, you hand the stapled adding machine tapes to the cash register operator, who totals the two tapes, takes your money, and puts the tapes on a spindle.

Required: a. What internal controls has the cafeteria instituted for its operations? -They are focusing on their environment, risk assessment and information system. b. How can the manager of the cafeteria evaluate the effectiveness of the controls? -They can conduct survey or ask feedback from their customers to measure the effectiveness of their control. c. How do these controls differ from those used by most cafeterias? -These controls are not usually performed in other cafeterias and it is convenient to use and it ensures orderliness in the cafeteria. d. What are the costs and benefits of the cafeteria's system? - They are not costly but very beneficial to the company. This way enables them to gain customer support and loyalty.

Exercise 4

The following are partial descriptions of internal controls for companies engaged in the manufacturing business: 1. When Mr. Clark orders materials for his machine-rebuilding plant, he sends a duplicate purchase order to the receiving department. During the delivery of materials, Mr. Smith, the receiving clerk, records the receipt of shipment on this

purchase order. After recording, Mr. Smith sends the purchase order to the accounting department, where it is used to record materials purchased and accounts payable. The materials are transported to the storage area by forklifts. The additional purchased quantities are recorded on storage records. 2. Every day, hundreds of employees clock in using time cards at Generous Motors Corporation. The timekeepers collect these cards once on a week and deliver them to the computer department. There, the data on these time cards are entered into the computer. The information into the computer is used in the preparation of the labor cost distribution records, the payroll journal, and the payroll checks. The treasurer Mrs. Wan, compares the payroll journal with the payroll checks, signs the checks, and returns them to Mr. Santos, the superior of the computer department. The payroll checks are distributed to the employees by Mr. Santos. 3. The smallest branch of Super Fresh Cosmetics in Iloilo City employs Mary Santos, the branch manager, and her sales assistant, Jane Keyes. The branch uses as bank account in Iloilo City to pay expenses. The account Is kept in the name of "Super Fresh Cosmetics-Special Account”. To pay expenses, checks must be signed by Mary Santos or by the treasurer of Super Fresh Cosmetics, Juan Dy. Mary receives the cancelled checks and bank statements. She reconciles the branch account herself and files cancelled checks and bank statements in her records. She also periodically prepares reports of cash disbursements and sends them to the home office. Required: a. List the weaknesses in internal control for each of the above. To identify the weaknesses. b. For each weakness, state the type(s) of misstatement(s) that is (are) likely to result. Be as specific as possible. c. How would you improve internal controls for each of the three companies? ANSWERS: REQUIREMENT A:

1. - Purchase orders and other documents are sent to the accounting department for recording however, they doesn't any other copy and/or computerized back-up in case of loss. - The inventories are being kept in a storage room, however it is not stated if the storage room is being protected by alarms and if it is entrusted to reliable employee. Also, the company is relying only to records and documents for inventory count. 2. - The data entered into the computers from the time cards are not being checked. - There is no actual monitoring of employees performance. 3. - There is no counter signature needed to pay company's expenses. - Mary is the only one in-charge for the company's cash even in the bank reconciliation. REQUUREMENT B: 1. -Purchase checks are already recorded so they are not needed anymore. - There is not a need for a computerized back-up since it is in the hands of trusted employee. - The inventories are protected since they are kept in a storage room. 2. - All data recorded are assumed true and correct. - Employees are committed to the company. 3. - Mary could use company's fund to finance own expenses. - Mary is the company's manager so she can be trusted and no need to double check her works. REQUIREMENT C: 1. The company could provide computerized back-up and/or keep all records and documents in a protected safe and only allow reliable and trusted employees to have access in it. Install also alarms into the storage rooms of inventories to avoid theft and

robbery or any fortuitous event and have monitoring on these inventories to check its conditions. 2. Have an ocular inspection or surprised inspection to check wether employees are really doing and is committed to their works. The data should be checked and audited first before handling it preparing payroll checks . 3. Allow another person to counter sign checks needed to pay company's expenses and another one to do the bank reconciliation to avoid fraud and avoid future risks for the company. Exercise 5

The Art Appreciation Society operates a museum for the benefit and enjoyment of the community. When the museum is open to the public, two clerks who are positioned at the entrance collect a P50.00 admission fee from each nonmember patron. Members of the Art Appreciation Society are permitted to enter free of charge upon presentation of their membership cards. At the end of each day, one of the clerks delivers the proceeds to the treasurer. The treasurer counts the cash in the presence of the clerk and places it in a safe. Each Friday afternoon, the treasurer and one of the clerks deliver all cash held in the safe to the bank and receive an authenticated deposit slip that provides the basis for the weekly entry in the accounting records The Art Appreciation Society board of directors has identified a need to improve its internal controls over cash admission fees. The board has determined that the cost of installing turnstiles, sales booths, or otherwise altering the physical layout of the museum will greatly exceed any benefits. However, the board has agreed that the sale of admission tickets must be integral part of its improvement efforts.

Amparo Cruz has been asked by the board of directors of the Art Appreciation Society to review the internal control over cash admission fees and provide suggestions for improvements. Required: Indicate weakness in the existing internal controls over cash admission fees that Amparo Cruz should identify, and recommend one improvement for each of the weakness identified.

WEAKNESS

RECOMMENDATION

There is no basis for establishing the Pre-numbered admission tickets should documentation of the number of the

be issued upon payment of the admission

paying patrons.

fee.

There is only one person(Treasurer) who Do a ank reconciliation to avoid fraud. is trusted by the company to handle cash.

The work is done manually taking much time.

Allow

online

commerce.

reservation

and

online...