Paper F8 (INT)

ALL FIVE questions are compulsory and MUST be attempted
1 Introduction
TinkerbellToys Co (Tinkerbell) is a manufacturer of children’s building blocktoys; they have been trading for over 35 years and they sell to a widevariety of customers including large and small toy retailers across thecountry. The company’s year end is 31 May 2011.
The company has alarge manufacturing plant, four large warehouses and a head office. Uponmanufacture, the toys are stored in one of the warehouses until theyare despatched to customers. The company does not have an internal auditdepartment.
Sales ordering, goods despatched and invoicing
Eachcustomer has a unique customer account number and this is used to entersales orders when they are received in writing from customers. Theorders are entered by an order clerk and the system automatically checksthat the goods are available and that the order will not take thecustomer over their credit limit. For new customers, a sales managercompletes a credit application; this is checked through a credit agencyand a credit limit entered into the system by the credit controller. Thecompany has a price list, which is updated twice a year. Largercustomers are entitled to a discount; this is agreed by the salesdirector and set up within the customer master file.
Once the orderis entered an acceptance is automatically sent to the customer bymail/email confirming the goods ordered and a likely despatch date. Theorder is then sorted by address of customer. The warehouse closest tothe customer receives the order electronically and a despatch list andsequentially numbered goods despatch notes (GDNs) are automaticallygenerated. The warehouse team pack the goods from the despatch list and,before they are sent out, a second member of the team double checks thedespatch list to the GDN, which accompanies the goods.
Oncedespatched, a copy of the GDN is sent to the accounts team at headoffice and a sequentially numbered sales invoice is raised and checkedto the GDN. Periodically a computer sequence check is performed for anymissing sales invoice numbers.

Fraud
During the year a material fraud was uncovered. It involved cash/cheque receipts from customers being diverted into employees’ personal accounts. In order to cover up the fraud, receipts from subsequent unrelated customers would then be recorded against the earlier outstanding receivable balances and this cycle of fraud would continue.

The fraud occurred because two members of staff ‘who were related’ colluded. One processed cash receipts and prepared the weekly bank reconciliation; the other employee recorded customer receipts in the sales ledger. An unrelated sales ledger clerk was supposed to send out monthly customer statements but this was not performed. The bank reconciliations each had a small unreconciled amount but no-one reviewed the reconciliations after they were prepared. The fraud was only uncovered when the two employees went on holiday at the same time and it was discovered that cash receipts from different customers were being applied to older receivable balances to hide the earlier sums stolen.
Required:

(a) Recommend SIX tests of controls the auditor would normally carry out on the sales system of Tinkerbell, and explain the objective for each test. (12 marks)
(b) Describe substantive procedures the auditor should perform to confirm Tinkerbell’s year-end receivables balance. (8 marks)
(c) Identify and explain controls Tinkerbell should implement to reduce the risk of fraud occurring again and, for each control, describe how it would mitigate the risk. (6 marks)
(d) Describe substantive procedures the auditor should perform to confirm Tinkerbell’s revenue. (4 marks)
(30 marks)

2 (a) Auditors are required to document their understanding of the client’s internal controls. There are various options available for recording the internal control system. Two of these options are narrative notes and internal control questionnaires.
Required:
Describe the advantages and disadvantages to the auditor of narrative notes and internal control questionnaires as methods for documenting the system. (6 marks)
(b) ISA 210 Agreeing the Terms of Audit Engagements provides guidance on the content of engagement letters and deals with the auditor’s responsibilities in agreeing the terms of the audit engagement with management.
Required:
(i) State the purpose of an engagement letter. (1 mark)
(ii) List SIX matters that should be included within an audit engagement letter. (3 marks)
(10 marks)

3 (a) The auditor has a responsibility to design audit procedures to obtain sufficient and appropriate evidence. There are various audit procedures for obtaining evidence, such as external confirmation.
Required:
Apart from external confirmation:
(i) State and explain FIVE procedures for obtaining evidence and;
(ii) For each procedure, describe an example relevant to the audit of purchases and other expenses. (10 marks)
(b) Donald Co operates an airline business. The company’s year end is 31 July 2011.

You are the audit senior and you have started planning the audit. Your manager has asked you to have a meeting with the client and to identify any relevant audit risks so that the audit plan can be completed. From your meeting you ascertain the following:
In order to expand their flight network, Donald Co will need to acquire more airplanes; they have placed orders for another six planes at an estimated total cost of $20m and the company is not sure whether these planes will be received by the year end. In addition the company has spent an estimated $15m on refurbishing their existing planes. In order to fund the expansion Donald Co has applied for a loan of $25m. It has yet to hear from the bank as to whether it will lend them the money.

The company receives bookings from travel agents as well as directly via their website. The travel agents are given a 90-day credit period to pay Donald Co, however, due to difficult trading conditions a number of the receivables are struggling to pay. The website was launched in 2010 and has consistently encountered difficulties with customer complaints that tickets have been booked and paid for online but Donald Co has no record of them and hence has sold the seat to another customer.
Donald Co used to sell tickets via a large call centre located near to their head office. However, in May they closed it down and made the large workforce redundant.

Required:
Using the information provided, describe FIVE audit risks and explain the auditor’s response to each risk in planning the audit of Donald Co. (10 marks)
(20 marks)

4 You are an audit manager in NAB ; Co, a large audit firm which specialises in the audit of retailers. The firm currently audits Goofy Co, a food retailer, but Goofy Co’s main competitor, Mickey Co, has approached the audit firm to act as auditors. Both companies are highly competitive and Goofy Co is concerned that if NAB ; Co audits both companies then confidential information could pass across to Mickey Co.
Required:
(a) Explain the safeguards that your firm should implement to ensure that this conflict of interest is properly managed. (4 marks)