AUE3761/104/0/2024

Tutorial Letter 104/0/2024

The audit process

AUE3761

Year module

Department of Auditing

This tutorial letter contains important information about your module.

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 CONTENTS
Page

1 INTRODUCTION .......................................................................................................................... 4
2 IMPORTANT INFORMATION REGARDING THIS TUTORIAL LETTER .................................... 4
2.1 DUE DATE ...................................................................................................................................... 4
2.2 LECTURERS AND CONTACT DETAILS ....................................................................................... 4
2.3 METHOD OF STUDY FOR THIS TUTORIAL LETTER .................................................................. 5
2.4 STUDY PROGRAMME ................................................................................................................... 5
3 LESSONS TO STUDY FOR THIS MODULE ............................................................................... 6
LESSON 8: SUBSTANTIVE PROCEDURES - THE CONCEPTS .......................................................... 8
Lesson 8.1 Principles in formulating substantive procedures ..................................................................... 9
Lesson 8.2 Substantive procedures with assistance of CAATs ................................................................ 19
Lesson 8.3 Analytical procedures ............................................................................................................. 24
LESSON 9: Formulating the substantive procedures for business processes.............................. 29
Lesson 9.1 Revenue and receipts business process ............................................................................... 30
Lesson 9.2 Acquisitions and payments business process ........................................................................ 39
Lesson 9.3 Inventory and production business process ........................................................................... 55
Lesson 9.4 Payroll and personnel business process ................................................................................ 74
Lesson 9.5 Finance and investment business process ............................................................................ 89
LESSON 10: OTHER CONSIDERATIONS ........................................................................................... 97
Lesson 10.1 Relying on information produced by a management’s expert (ISA 500) .............................. 98
Lesson 10.2 Using the work of an auditor’s expert (ISA 620) ................................................................. 101
Lesson 10.3 Auditing accounting estimates and related disclosures (ISA 540 (Revised)) ..................... 105
Lesson 10.4 External confirmations (ISA 505) ....................................................................................... 110
Lesson 10.5 Written representations (ISA 580) ...................................................................................... 114
Lesson 10.6 Related parties (ISA 550) ................................................................................................... 117
4 SELF-ASSESSMENT QUESTIONS......................................................................................... 124
4.1 Introduction ................................................................................................................................. 124
4.2 Important principles to remember when answering a question ................................................... 124
4.3 Questions to be attempted as part of your preparation for the examination ............................... 131
4.3.1 Non-integrated questions ............................................................................................................ 131
4.3.2 Integrated questions ................................................................................................................... 142

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5 SELF-ASSESSMENT SOLUTIONS ......................................................................................... 152
5.1 Introduction ................................................................................................................................. 152
5.2 Important principles to remember before you work through the solutions .................................. 152
5.3 Suggested solutions to the self-assessment questions .............................................................. 153
5.3.1 Non-integrated solutions ................................................................................................................ 153
5.3.2 Integrated solutions ....................................................................................................................... 167

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 1 INTRODUCTION
Congratulations on making it thus far in your AUE3761 studies. We trust that you are already familiar
with the contents of tutorial letter 101, 102 and 103. The purpose of this tutorial letter is for students
to gain knowledge, skills and competence in formulating appropriate substantive audit procedures
and, and responding to additional considerations arising on the audit. TL 104 has been based on
the International Standards on Auditing (ISAs) and the academic training requirements formulated in
terms of the SAICA Competency Framework.

2 IMPORTANT INFORMATION REGARDING THIS TUTORIAL LETTER

2.1 DUE DATE

The due date of this tutorial letter is on: 29 July 2024

This due date implies that you need study the content of all the lessons provided to you in this tutorial
letter (section 3), do the questions (section 4), assess your answers to the questions (section 5) and
finally write your next test. Remember to also revise previous tutorial letters.

2.2 LECTURERS AND CONTACT DETAILS

The lecturers responsible for this module, and to whom you should direct your enquiries, is:

Lecturer Telephone number

Mrs S Abed 012 429 4544

Mrs A Botha 012 429 6147
Mr T Diale 012 429 8497

If you would like to send an e-mail with your query about the content of this tutorial letter you
may send an e-mail to: AUE3761@unisa.ac.za.

All the lecturers on this module have access to this mailbox and will gladly assist you with your
query. However, please note that if your query is of an administrative nature you must direct
your e-mail to the relevant e-mail address as provided to you in tutorial letter 101.

PLEASE NOTE: Virtual consultations should be arranged beforehand. Come prepared and
ensure that you have worked through your study material when organizing a virtual consultation
with us.

Always have your student number ready when you contact your lecturers. When sending an e-mail,
make sure that you do so by using your Unisa myLife e-mail address.

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2.3 METHOD OF STUDY FOR THIS TUTORIAL LETTER

You should start off your studies by referring to the lessons in section 3 of this tutorial letter. Read
through the lessons, make sure that you understand the learning outcomes, study the relevant
sources provided and do the activities. You should also refer to myUnisa for additional activities,
videos or important announcements. After studying each of the lessons, consider whether you can
achieve the learning outcomes of each of the lessons before continuing. If you are still unsure or
need more guidance after this process, contact the lecturer for a virtual consultation.

Our aim is to focus on you as an active and constructive learner and not as a passive learner who
memorises content and forgets it after the examination. Therefore, we suggest that perform all the
activities and save them on your computer. We will provide feedback on certain activities in this
tutorial letter; however, other activities are for your own learning purposes and you must refer to the
study references supplied to ensure that you understand the relevant concepts. You will benefit from
the above approach because it will help you to cover the syllabus appropriately, at the right level of
knowledge and consistently throughout the year. Besides being an active learner, as lecturers we
will be able to know whether you are working consistently because cramming the learning material
before the examination date, in this module, will be impossible. Knowledge gained through surface
learning unfortunately does not develop your intellectual ability and you will forget it just as fast as
you think you learnt it. You must engage with the learning material and construct new meaning. After
completion of the lessons, you should attempt the self-assessment questions provided in section 4
of this tutorial letter. You should then mark your answers by referring to the self-assessment
solutions in section 5 of this tutorial letter to make sure that you have mastered the concepts studied
in this tutorial letter.

2.4 STUDY PROGRAMME

The following study programme is an example of how you could plan your studies:

Lesson to study Time frame

Lessons 8.1, 8.2 and 8.3 Week 1

Lesson 9.1 Week 2

Lessons 9.2 Week 3

Study Lessons 9.3, 9.4 and 9.5 Week 4

Study Lessons 10.1 until 10.6 Week 5

Revision and prepare for Test 3 Week 6

Write online Test 3 (40 marks) Monday, 29 July 2024, 11:00 – 13:00

Refer to the Study Plan and Lecture Schedule uploaded on myUnisa for your scheduled lectures in
respect of this tutorial letter. Check myUnisa announcements weekly for any changes or updates
to the Study Plan and Lecture Schedule.

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 3 LESSONS TO STUDY FOR THIS MODULE
The content that you need to study for this tutorial letter is set out in the lessons 8 to 10.
You will know by now that there are four stages in the audit process. Just as with tutorial letter
103, we are still focussed on stage 3 of the audit process as illustrated in figure 1.1

The following is a schematic representation of the stages of the audit process.

FIGURE 1:1 The stages of the audit process

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Tutorial letter 104 Lessons

The auditor’s further responses to risk
Substantive procedures
• How to formulate general procedures • ISAs 315, 330, 500, 501, 505, 520, 540,
• How to formulate substantive 550, 580, 620.
procedures in respect of different • All ISAs above must be considered in
business processes. the testing of all business processes.
• What are the other considerations
around audit evidence, when
formulating substantive procedures

The lessons in tutorial letter 104 will integrate your knowledge of TL102 and TL103 with substantive
audit procedures. In addition, we will look at the different forms of audit evidence and other
considerations: for example, evidence produced by experts, evidence required for accounting
estimates made by management, external confirmations, written representations and related parties.
TL 104 will culminate in the formulation of substantive audit procedures and provide integrated
questions to enhance your understanding of all business processes. Although you are studying on
your own, please contact your e-tutor and lecturer where you need help. We urge you to participate
in the e-tutor discussion forums and activities.

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LESSON 8: SUBSTANTIVE PROCEDURES - THE CONCEPTS

Overview
This is a very important lesson and if you master the principles in this lesson you will be able to
formulate audit procedures. In this lesson we are going to learn about the principles and concepts
involved in formulating substantive procedures, including those performed by making use of CAATs.
Substantive procedures are audit procedures designed to detect material misstatements at the
assertion level. Substantive procedures branch out into two components, namely tests of detail
(classes of transactions, account balances and related disclosures) and analytical procedures.
With this knowledge we will be able to apply these principles in formulating the substantive
procedures for all the business processes as dealt with in lesson 9.
This lesson is divided into the following lessons.

Lesson Title

8.1 Principles in formulating substantive procedures

8.2 Substantive procedures with assistance of CAATs

8.3 Analytical review procedures

Learning outcomes

At the end of the lesson, you should be able to

• evaluate the underlying principles in formulating substantive procedures with

and/or without Computer Assisted Auditing Techniques (CAATs).
• evaluate the underlying principles in formulating analytical procedures.

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Lesson 8.1 Principles in formulating substantive procedures

Learning outcomes

After having worked through this lesson you must be able to

• Understand the reasons for formulating substantive procedures.

• Understand overstatement and understatement.

• Understand the verbs used in formulating substantive procedures.

• Understand the sources of reliable evidence.

• Understand the need for general procedures.

INTRODUCTION
In tutorial letter 103 you learnt to formulate tests of controls. In this lesson we are going to learn the
principles needed to formulate sound substantive procedures. In lesson 9 of the study material you
will learn how to apply these principles to each business process. You must see this lesson similarly
to building a house – your house. If the foundation is nice and strong then we won't sit with cracks
and unnecessary repairs at a later stage – or walls collapsing on you while you think you're protected
from the elements! This lesson comprises a lot of theory and principles that you need to master.

REASONS FOR FORMULATING SUBSTANTIVE PROCEDURES

In lesson 5.1 of this module we spent a great deal of time on audit evidence. Remember that the
aim of the auditor is to express an audit opinion on the annual financial statements – but to do that,
the auditor must be able to support or substantiate his or her findings with audit evidence.
Remember from the audit risk model that detection risk is that part of the equation that the auditor
can control to balance the equation? The objective of substantive procedures is to reduce detection
risk to an acceptable level. To this end, substantive procedures are performed to obtain evidence to
determine whether the amounts, and related disclosures in the financial statements are free from
material misstatements. Substantive procedures comprise of tests of detail and analytical
procedures. The auditor will first perform risk assessment procedures and then relate these risks
to what can go wrong at assertion level. If the internal controls at the client are designed to reduce
errors that affect the identified risk areas and furthermore, through tests of controls, the auditor is
able to obtain evidence that the controls are indeed working, then one can argue that it is acceptable
to perform less extensive substantive procedures (because the control risk is low, and a higher
detection risk will be acceptable). However, if the tests of controls indicate that the internal controls
are not working as intended by management, then the auditor must gather more persuasive audit
evidence (to balance the equation) through extensive substantive procedures to support his or her
audit opinion (because the control risk is high).

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UNDERSTATEMENT VERSUS OVERSTATEMENT
We are concerned with overstatements or understatements because both will affect the direction of
our testing. For example, auditors usually test accounts like debtors for overstatement and creditors
for understatement as management could manipulate these accounts in this way to improve liquidity
ratios.

Reflect on the following statements

• Existence/occurrence ensures that the client is not recording things that they should
not be recording (if wrong, the result is overstatement).
• Completeness ensures that the client is not leaving anything out (if wrong, it results
in understatement).
• Identifying the direction of the misstatement becomes critical when designing
procedures to try and pick up the misstatement.
• Overstatement – must select from what has been recorded (internal records) to be
able to see if it does in fact belong in the records (existence/occurrence tests).
• Understatement – must select from external documents or initiating event (what
should have been recorded) to see if it was actually recorded (completeness tests).

ORIENTATION
When planning to write your substantive procedures from a case study scenario you must bear the
following in mind:

• the business process that you are dealing with.

• the category of financial information that should be dealt with (i.e. classes of transactions
and related disclosures or account balances and related disclosures)

• the assertion(s) to be focused on and the direction of testing

• use of analytical procedures if appropriate

• audit procedures already performed (given in the scenario of the exam) and auditor's
findings based on these

• the documents involved and books of entry

• wording the procedure as an instruction

• Companies Act requirements that may be applicable

• financial accounting standards that might be applicable

• awareness of the need for integration of taxation and/or management accounting

principles when designing the substantive procedures

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Verbs and relevant and reliable sources of audit evidence
To formulate the substantive procedures for all the business processes you must understand
(visualise) how the business processes operate and all the documents pertaining to them. In your
second level, you mastered the business processes, the accounts for the Statement of Financial
Position and the classes of transactions for the Statement of Comprehensive Income. This
knowledge is fundamental to being able to formulate a proper substantive procedure because this
is where you are going to look for the evidence. In order to write a good audit procedure you have
to know which verbs to use to begin your sentence. The source of evidence will also help you when
you write a procedure. Study the following summary of verbs and examples of sources of evidence:

Verbs Sources of evidence

Inspection Documented evidence:

(ISA 500, pars A18 to A20): – Cash receipts/payment
journals
• Inspect –Invoices
– Journals
• Examine –Goodsreceived vouchers
– Ledgers (GRVs)
• Trace
– Financial statements –Registers
• Scrutinise
– Management reports –Stock sheets
• Compare
– Written representation –Minutes of meetings
• Review
– Previous audit working –Correspondence
papers
–Third party
– Budgets
–Certificates
– Client working papers
–Monthly statements
– Reconciliations
–Agreements
– Tax computations
–Contracts
– Orders
–Scripts
– Deposit books
–Licences

–Insurance policies
–Bank statements

Observation (ISA 500, par A21: Procedures:

• Observe • Inventory count

• Wages pay-out

Enquiry and external

confirmation

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 Verbs Sources of evidence

(ISA 500, pars A22 and A26 - – Formal, written:

A29):
• Bank confirmation letters
• Enquire and confirm
• Enquiries from attorneys
• Discuss with and
confirm • Debtors and creditors confirmations

• Request • Enquiries from third parties (who are involved,

e.g. government institutions, trade unions,
• Obtain through SARS)
discussion/
confirmation – Informal, oral:

(Remember that enquiries of • Documenting of enquiries from board of directors

management may not be used
on its own as audit evidence.
These must be followed up
and substantiated.)

Re-calculation – Calculations on any of the abovementioned source

documents and accounting records
(ISA 500, par A23:

Analytical procedures
(ISA 500, par A25: – Past:

• Calculate ratios Compare previous years' financial statements, budgets,

projections, management reports, etc, with present
• Compare years.
• Analyse – Present:
• Predict (trends) Compare current year's management's reports with
financial statements of other enterprises in the same
(Remember that analytical operating sector
procedures can only be
applied to recurring, routine – Future:
transactions, balances,
where a trend is expected.) • Budgets

• Cash flow projections

• Profit forecasts

• Other operating projections

Re-performance
(ISA 500, par A24: –Calculations composed by the client/third
parties/experts
• Re-perform
– Client's debtors age analysis

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STRUCTURE OF A SUBSTANTIVE PROCEDURE
How, what and why
An audit procedure should include how, what and why questions:

• How: Requires the use of an applicable verb which should describe the action.
• What: A reference to a relevant and reliable source of evidence is required here.
• Why: Setting out the reason for the audit procedure with regard to the assertion being
tested and the risk that is responded to.

• Example of a badly worded procedure:

Check minutes to see if transactions were approved by management.

• Example of a well-worded procedure:

Inspect(1) minutes of directors' meetings(2) to confirm that the purchase of motor vehicles
was authorised.(3)
(1) verb (how)
(2) source (what)
(3) reason with regard to the assertion (why)

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Examples of audit procedures for obtaining audit evidence
The following table sets out some assertions and examples of audit procedures to test whether these
assertions are met.

Account balances and related Examples of audit procedures to test assertions (not
disclosures complete procedures in all instances)
Audit assertion

Existence Attend stock count to confirm existence of stock.

Physically inspect fixed assets selected from the fixed
asset register to confirm existence.
If physical inspection of assets is not possible, inspect,
for instance– insurance portfolio
– income generated by the asset
– valuation by a third party

Rights/Obligations Inspect title deeds.

Inspect licenses and registration documents.
Inspect insurance portfolio.
Inspect bank confirmations.

Completeness Creditors – select goods received notes issued close to

year end and trace to creditors listing to ensure all
creditors are recorded.
Inspect the financial statements and accounting policies
and confirm that they are in agreement with IAS/IFRS
statements and the Companies Act and that all
disclosures that should have been included in the
financial statements, have been included.

Accuracy, valuation and Inspect valuer's report.

Allocation Compare unit cost prices on stock sheets with prices on
recent suppliers' invoices/authorised standard selling
prices.
Inspect the financial statements and accounting policies
and confirm that they are in agreement with IAS/IFRS
statements and the Companies Act and that all
disclosures have been appropriately measured and
described.

Classification Obtain the journal entry to account for provisions.

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Account balances and related Examples of audit procedures to test assertions (not
disclosures complete procedures in all instances)
Audit assertion

Inspect the general ledger to agree that the journal entry

has been recorded in the proper accounts (e.g.
Provisions and expenses).

Presentation Inspect the financial statements and confirm that assets,

liabilities and equity interests are appropriately
aggregated or disaggregated and clearly described, and
related disclosures are relevant and understandable in
the context of the requirements of the applicable financial
reporting framework.

Classes of transactions/events Examples of audit procedures to test assertions (not

complete procedures in all instances)
and related disclosures
Audit assertion

Accuracy Recalculate suppliers' invoices and follow amount

through to purchases journal. Compare the cost of the
property with the purchase agreement and the statement
from the attorney to verify the cost of acquisition and
transfer of the property.
Inspect the financial statements and accounting policies
and confirm that they are in agreement with IAS/IFRS
statements and the Companies Act and that all
disclosures were appropriately measured and described.

Classification Scrutinise the repairs and maintenance account to

confirm that no capital items were included.

Cut-off Note the last delivery note number for the year. Confirm
by means of inspection that the 10 delivery notes before
year end are included in the current year's debtors
journal.
Confirm by means of inspection that the 10 delivery
notes after year end are excluded from the current year's
debtors journal.

Completeness Trace sales transactions from the goods delivery notes

to the sales invoices/sales journal to establish that all
sales transactions have been included. (Note: direction
of testing)
Inspect the financial statements and accounting policies
and confirm that they are in agreement with IAS/IFRS
statements and the Companies Act and that all

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Account balances and related Examples of audit procedures to test assertions (not
disclosures complete procedures in all instances)
Audit assertion

disclosures that should have been included in the

financial statements, have been included.

Occurrence Trace a sample of recorded sales transactions through

to there origin and inspect the supporting documentation
of invoices to confirm that the order was received from
an approved client.

Presentation Inspect the financial statements and confirm that

transactions and events are appropriately aggregated or
disaggregated and clearly described, and related
disclosures are relevant and understandable in the
context of the requirements of the applicable financial
reporting framework.

By simply knowing the assertions, the verbs, sources of evidence and the types of procedures to
obtain the evidence you are so close to formulating a good substantive procedure! Let's refine this
knowledge so that you can formulate these procedures correctly in the examination.

GENERAL PROCEDURES
In formulating substantive procedures, your starting point is general procedures. In some cases they
may not be applicable, however in general they are your starting point. They are listed below, and
you will see the effect that they have in your formulation of substantive procedures, in lesson 9.
Lesson 9 will teach you how to apply these general procedures within various business processes.
Remember that although these are general procedures, they must be applied to the specific scenario
you are provided with.

• Recalculate castings and calculations of general ledger accounts, annual financial

statements, documentary evidence, reconciliations, etc. Agree opening balances with
closing balances on previous year's working papers and audited financial statements.
• Follow applicable procedures when using the work of an expert.
• Test postings from the subsidiary ledgers to the general ledger.
• Agree the totals of lists (e.g. debtors age analysis or list of creditors) with the general ledger
account.
• Agree the balance of the general ledger account with the trial balance and annual financial
statements.
• Inspect minutes of meetings (management, board of directors, and shareholders) for
decisions taken, authorisation, etc.
• Perform analytical procedures: give examples of ratios to be used.
• Refer to IAS statements regarding the accounting treatment, where possible.
• Obtain/request from management:
- a signed written representation on the matter being audited
- attorney's letter
- bank confirmation letter
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• For a first audit request access to the predecessor auditor's working papers (with the
client's permission) in respect of opening balances.
• Do overall review for abnormal items/exceptions in general ledger accounts, subsidiary
ledgers, etc
• Presentation and disclosure – inspect for compliance with IASs, IFRSs and accounting
policies

SUMMARY
In this lesson you mastered the principles to formulate substantive procedures and all the caveats
that you must avoid when formulating substantive procedures. You will apply this knowledge in the
next lesson of this module where we are going to formulate the substantive procedures for each
business process, based on these principles.

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 REFLECT
Before moving on to the next lesson, check yourself against the learning outcomes formulated at
the beginning of this lesson and make sure that you are able to meet them.

SELF-ASSESSMENT
After having worked through the lesson and the references to the prescribed study material,
determine if you are able to answer the following questions:

1. Can you state the difference between assertions for transactions and account
balances?
2. Can you estate reasons for formulating substantive procedures?
3. Do you understand direction of testing, the verbs to be used in formulating
substantive procedures and the sources of reliable evidence?
4. Do you understand what general procedures are?

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Lesson 8.2 Substantive procedures with assistance of CAATs

Learning outcomes

After having worked through this lesson you must be able to

• Understand the reasons for formulating substantive procedures with CAATS.

• Understand and formulate substantive procedures with the assistance of CAATs

INTRODUCTION
The previous lesson explained how substantive procedures are formulated without the use of
computer-assisted audit techniques (CAATs). The aim of this lesson is to explain how substantive
procedures are formulated with the assistance of CAATs. Even though the use of CAATs sounds
very complicated, it is not. The only change when you formulate substantive procedures using
CAATs is that you should use the computer to perform substantive procedures. This is easy! We
will explain more later in this lesson.
Before we continue with further explanations about formulating substantive procedures using
CAATs, study a few theoretical concepts which will help you to apply your knowledge.

Study
Study the relevant sections under the heading “Computer assisted audit techniques (CAATs)”,
namely “Data-orientated CAATs” and “Audit functions which can be performed using data orientated
CAATs” – Auditing Notes chapter 9. “System-orientated CAATs” and “Factors which will influence
the decision to use CAATs” were referred to in lesson 5.4 in TL 103. Please revise those sections
to refresh your memory.

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 How should you formulate a substantive procedure using CAATs?

How should substantive procedures using CAATs be formulated?

A substantive procedure using CAATs should deal with the following:

- HOW: This is about the verb that describes the action to be performed. The
how in a substantive procedure using CAATs includes doing the following:

• Use CAATs to recalculate ...

• Use CAATs to select a sample ...

• Use CAATs to compare ...

• Use CAATs to perform analytical procedures ...

• Use CAATs to scan a file for “error” conditions for example ... and to print
an exception report

• Use CAATs to extract a summary of ...

• Use CAATs to sort ...

- WHAT: Here you should make reference to what relevant source of

evidence is required. For example:

Use CAATs to recalculate the net wages ...

Use CAATs to select a sample of employees ...

Use CAATs to compare net wage totals ...

- WHY: This is about the reason for the audit procedure with regard to the
assertion being tested and the risk that is being responded to. For example:

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

Use CAATs to select a sample of employees and perform physical positive

identification to confirm that employees are employed (i.e. no fictitious
employees).

Use CAATs to compare net wages totals in the master file with net wages totals
in the general ledger and trial balance to confirm accuracy.

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The following are examples of badly worded substantive procedures using CAATs
in common mistakes made by students:
Example 1:
Use CAATs to physically verify an employee.
Comment: Can CAATs be used to verify an employee? No, they cannot. However,
you can use CAATs to select a sample of employees that you can perform
corroborative procedures and thereby verify physically the employee.

Example 2:
Use CAATs to print an exception report.
Comment: Why and of what? The substantive procedure is not properly formulated
in terms of how, what and why.
Other common mistakes that students make, include the following:

• Substantive procedures are often too generic, and students do not

apply their substantive procedures to the information provided in the
scenario.

• Students do not know their business processes and therefore find it

difficult to identify all the relevant issues for which they should perform
substantive procedures.

• Students struggle to link their substantive procedures with assertions.

• Students do not manage their time according to the marks allocated and
therefore do not formulate all the relevant substantive procedures.

Now that you have a better understanding of how substantive procedures using CAATs should be
formulated, do the self-reflection activity 8.2.1 Remember the elements expected from a self-
reflection activity (your attempt, your mark allocation and your feedback in identifying your errors
with a plan to remedy the errors).

ACTIVITY 8.2.1- SELF-REFLECTIVE ACTIVITY

(1) List the audit functions that can be performed using data CAATs.
(2) For each audit function, provide an example of a substantive procedure that
can be performed with the use of data CAATs in the payroll and personnel
business process (refer to Auditing Notes chapter 13 for examples of
substantive procedures that you can use in order to formulate CAATs-specific
procedures).

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 FEEDBACK ON ACTIVITY 8.2.1

(1) Audit functions using (2) Examples of a substantive procedure using data
data CAATs CAATs in the payroll and personnel business
process

Re-perform casts and Use CAATs to recalculate total net wages in the
calculations. employee master file to confirm accuracy of wages.

Determine sample size and Use CAATs to select a sample of employees from the
select certain items. employee master file in order to perform physical positive
identification of the employees to confirm that employees
are employed by the company.

Compare data on separate Use CAATs to compare the total wage balance in the
files. master file with the total wage balance in the trial balance
and general ledger to confirm accuracy.

Perform analytical Use CAATs to perform analytical procedures on wages

procedures. by comparing the total wages balance of the current year
with the total wages balance in the previous year.

Discover missing data on file Use CAATs to scan the employee master file for “error”
(examining inconsistencies conditions (e.g. no amounts in the net wages field
and exception reporting).
where an employee has been employed) and print an
exception report to discuss with management.

Discover duplication Use CAATs to scan the employee master file for “error”
(examining inconsistencies conditions (e.g. duplicated employee numbers) and print
and exception reporting). an exception report to discuss with management.

Extract summaries. Use CAATs to extract the PAYE/UIF totals in the

employee master file and compare with totals on tax
returns submitted to SARS.

Sort. Use CAATs to sort employees according to their job

grades in the employee master file, compare the job grade
and rate with documentation in the personnel file.

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SUMMARY
This lesson explained how substantive procedures are formulated with the assistance of CAATs. By
using the knowledge that you obtained in this lesson and in the previous lesson, we will require you
to formulate substantive procedures for each of the different business processes in the next lesson
of this module.

SELF-ASSESSMENT
After having worked through the lesson and the references to the prescribed study material,
determine if you are able to answer the following questions:

1. Do you understand reasons for formulating substantive procedures with CAATS?

2. What types of procedures can CAATs perform?

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Lesson 8.3 Analytical procedures

Learning outcomes

After having worked through this lesson you must be able to

• Understand the reasons for using analytical procedures.

• Understand and formulate analytical procedures that the auditor could perform
during an audit.

INTRODUCTION
ISA 520 - Analytical procedures deals with the auditor's use of analytical procedures as substantive
procedures

Study
Study risk assessment procedures, including performing analytical procedures: Study ISA 520,
paragraph 01.
Study ISA 315, paragraphs 14(b) and A27 to A31.

Study
Study ISA 330, paragraph 4(a), and ISA 500, paragraph A21.
Note that analytical procedures are classified as substantive procedures.

Hint: If we require you to formulate substantive procedures, you should include

analytical procedures in your answer. However, the question can sometimes
specifically request you to exclude analytical procedures. Therefore, make sure
that you read the required part of the question very carefully so that you
understand what is required of you.

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Study
Study ISA 520 paragraphs 04, A1 to A3.

SELF-ASSESSMENT ACTIVITY
Define analytical procedures and provide examples.

FEEDBACK ON SELF-ASSESSMENT ACTIVITY

Refer to ISA 520 paragraphs 04, A1 to A3.
In summary, analytical procedures can include the following:
• Comparisons of the entity's financial information to, for example
– prior periods
– anticipated results of the entity, such as budgets and forecasts or expectations
of the auditor
– similar industry information
• Consideration of relationships, for example
– in the entity's financial information, such as the gross profit percentage (ratios)
– between financial information and non-financial information, such as payroll costs
to the number of employees

Study
Study the requirements applicable to designing and performing analytical procedures in ISA 520,
paragraphs 05, A4 to A16.
Study ISA 520, paragraphs 06, A17 to A19, and note that the auditor should design and perform
analytical procedures near the end of the audit to assist when forming an overall conclusion.
Study ISA 520, paragraphs 07, A20 to A21, and note that the auditor should investigate the results
of analytical procedures.

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 ACTIVITY 8.3.1- SELF-REFLECTIVE ACTIVITY
CompTech Limited's main business involves the sale of computer equipment to various
clients all over South Africa. You are the audit senior in charge of the audit of CompTech
Limited (CompTech).
CompTech uses an automated sales system. Based on your identification and
assessment of risk in the planning stage of the audit of CompTech, you decided to use a
combination of tests of details and substantive analytical procedures to obtain audit
evidence of CompTech's sales total during the current financial year.
The financial manager of CompTech provided you with the following information:

• financial statements and trial balance for the current and prior financial year end

• budget for the current financial year end

• financial statements of other enterprises in the same operating sector with a similar
clientele
Required:
Describe the analytical procedures that you will perform on the sales of CompTech.

FEEDBACK ON ACTIVITY 8.3.1

Analytical procedures on the sales value of CompTech:

• Inspect the financial statements and trial balance and compare the sales total of this
year with the sales total of the prior year. Investigate significant fluctuations.

• Inspect the current financial year end's financial statements and trial balance and
compare the sales total with the budgeted sales total. Investigate inconsistent
fluctuations.

• Inspect the sales total in the financial statements of the current year and compare to
the sales total in financial statements of other enterprises in the same operating
sector. Investigate inconsistent fluctuations.

• Calculate the gross profit margin of the current financial year and compare it to the
gross profit margin of the prior financial year. Follow up on significant differences.

• Calculate the gross profit margin of the current financial year and compare it to the
budgeted gross profit margin. Follow up on inconsistent fluctuations.

• Compare the increase or decrease in sales with the increase or decrease in debtors.
If debtors increase and sales decrease, follow up with management.
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If you are provided with the general ledger indicating the monthly sales, you may
also perform the following analytical procedure:

• Compare the sales on a monthly basis to the monthly budgeted prediction of sales.
Identify significant differences and follow up with management.

Comments or additional notes

• Analytical procedures are a form of substantive procedures. Therefore,

when you are required to describe substantive procedures, remember to
include the analytical procedures that you will perform with your other
substantive procedures (ISA 520, pars .05, A4 to A16).

• Analytical procedures can include the following (ISA 520, pars .04, A1 to
A3):
- Comparisons of the entity's financial information to, for example
* with prior periods
* with anticipated results of the entity, such as budgets and forecasts or
expectations of the auditor
* with similar industry information
- Consideration of relationships, for example
* in the entity's financial information, such as the gross profit percentage
(ratios)
* between financial information and non-financial information, such as
payroll costs to the number of employees

• An auditor may decide to perform analytical procedures at the beginning

of the audit as part of the risk assessment procedures and the auditor may
also perform analytical procedures when obtaining audit evidence in each
of the different business processes of an entity. The auditor may also
perform analytical procedures near the end of the audit to assist when
forming an overall conclusion of the audit (ISA 520, pars .06, A17 to A19).

• Remember that the success of analytical procedures depends on the

effective identification of significant fluctuations and inconsistencies and
their investigation. The investigation of the results of analytical procedures
includes (ISA 520, pars .07, A20 to A21):
– enquiring of management and following up on management's responses
by obtaining the appropriate audit evidence
– performing other necessary audit procedures

• Analytical procedures do not include, for example

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 – comparing the current year's opening balances with the prior year's
closing balances or
– comparing the total sales value in the trial balance with the total sales
value in the financial statements
These are examples of substantive procedures and not analytical procedures.

• Analytical procedures can also be performed with the use of computer

assisted audit techniques (CAATs). CAATs were covered in lesson 8.2.
Even though you learnt how to formulate substantive procedures using
CAATs, we want to refer you to a quick example.
Example of an analytical procedure without using CAATs:
Inspect the financial statements and compare the sales total of this year with
the sales total of the prior year. Investigate unreasonable fluctuations.
Example of the same analytical procedure with the assistance of CAATs:
Use CAATs to compare the sales total in the trial balance of this year with the
sales total in the trial balance of the prior year. Investigate unreasonable
fluctuations.

ACTIVITY 8.3.2- SELF-REFLECTIVE ACTIVITY

Please refer to activity 9.4.1 for practice on how we integrate CAATS analytical procedures
questions into the business processes.

SUMMARY
In this lesson we explained the auditor's use of analytical procedures. An important reminder that
analytical procedures are substantive procedures. This means that where questions require you to
formulate substantive procedures, you must include analytical procedures if they are applicable.

SELF-ASSESSMENT
After having worked through this lesson and the references to the prescribed study material, find out
whether you feel comfortable about doing the following:

1. Define, understand and formulate analytical procedures that the auditor could perform
during an audit.

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LESSON 9: Formulating the substantive procedures for business processes

Overview
In this lesson we are going to apply the principles of formulating substantive procedures (including
analytical review) as set out in lesson 8 to all the business processes.
The stance followed in the lesson is that you must first understand the business processes (visualise
these as if they are part of your own business) and identify the source documents and accounting
records and accounting treatment for presentation and disclosure purposes. This knowledge was
acquired by you in financial accounting modules. There are also process flow diagrams in Auditing
Notes, to help you visualise the process. The next step is to examine a set of annual financial
statements (AFS). Refer to any example of a set of AFS. The items on these AFS are assertions
made by management. What you are going to learn in this lesson is to formulate the substantive
procedures for each business process so that you are able to collect sufficient appropriate evidence
to support the opinion on the AFS. This requires you to consider the risk of material misstatement
and the material you have mastered in TL 102 and 103.

This lesson is divided into the following lessons.

Lesson Title

9.1 Revenue and receipts business process

9.2 Acquisition and payments business process

9.3 Inventory and production business process

9.4 Payroll and personnel business process

9.5 Finance and investment business process

LEARNING OUTCOMES

At the end of the lesson, you should be able to

• Understand the specific risks related to each business processes
• Formulate the substantive procedures for the revenue and receipts business
process; acquisition and payments business process; inventory business process;
payroll and personnel business process, and the finance and investment business
process.

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Lesson 9.1 Revenue and receipts business process

Learning outcomes

After having worked through this lesson you must be able to

• Formulate the assertions and substantive procedures for revenue, receipts and
trade receivables.

INTRODUCTION
We have all sold something to someone, be it silkworms during your primary school days or more
recently you may have sold something on “Gumtree” or “OLX”. The point I wish to make is that you
wanted to convert a commodity item into cash, but usually with a profit motive. The profit motive
allows you to buy something better in its place (investment business process). From the outset I
want you to realise that auditing the revenue and receipts business process is not something
abstract because we are exposed to it in our own revenue and receipts business process in our daily
lives. In this lesson we are going to teach you how to formulate the substantive procedures for the
revenue and receipts business process for a business. In lesson 8 you mastered the principles of
formulating substantive procedures (with or without CAATs) (and remember that substantive
procedures include analytical procedures), therefore you need to consider and apply those
principles.

IDENTIFY THE SOURCE DOCUMENTS

During your studies, you learnt how to account for revenue and receipts and how the balance
between those two accounts are reflected in the trade receivable account (if sold on credit). You
also learnt how to perform a bank reconciliation. This knowledge is very important for auditing
because this allows you to visualise the accounting process of transactions and balances. Your
degree must be seen as an integrated unit of knowledge and not as separate compartments. You
must break any barriers that prevent integration and lateral thinking. To break that mental block that
many students have. If you are able to visualise the business process (a man-made invention) then
you, as the auditor, must just collect evidence based on this business process.
Therefore, before you can audit a business process you must first be able to name the source
documents and envisage the business environment and the transaction flow from initiation of the
transaction through to recording it in the accounting books and general ledger and the presentation
and disclosure thereof in the AFS. Revise the following lessons just to refresh your memory. If you
already know the answers to the activity, then you may skip it.

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SELF-ASSESSMENT ACTIVITY

• Identify the Statement of Financial Position account balances and related

disclosures and Statement of Comprehensive Income classes of transactions and
related disclosures for the revenue and receipts business process.
• Describe credit sales transactions by explaining the activities, functions and risks
associated with credit sales.
• Describe cash sales transactions by explaining the activities, functions and risks
associated with cash sales.
• Explain the accounting processes involved to reflect the balances of the accounts
receivable and cash and cash equivalents accounts in the general ledger.

FUNCTIONING OF THE REVENUE AND RECEIPTS BUSINESS PROCESS

The next step is to understand how all of the above documents and accounting records function. In
other words, we want to visualise the clients accounting system and transaction flow (many of you
may not have practical experience). In practice, such a description will form part of the auditor's
working papers to evidence the understanding of the business. Therefore, as a trainee accountant
at an auditing firm, you may be allocated the task of compiling a systems description of a client. An
example of such a description is found in the next study activity. You are merely required to read it
and form a picture of the transaction flow and accounting system in your mind.

Study
Refer to your prescribed book Auditing Notes chapter 10 under the heading NARRATIVE
DESCRIPTION OF THE REVENUE AND RECEIPTS CYCLE AT PRORIDE (PTY) LTD.
Are you able to visualise ProRide (Pty) Ltd's transaction flow and accounting system?
In the examinations you will be provided with a case study (scenario/s) that require quite a lot of
reading. Besides understanding the accounting treatment and transaction flow of a revenue and
receipts business process, reading the above study reference will assist you in developing reading
and comprehension skills that are crucial.

AUDITING THE REVENUE AND RECEIPTS BUSINESS PROCESS

In lesson 5.1 you learnt that audit evidence must be relevant. Being relevant means that the audit
procedure must be spot on the target; anything that misses the target will waste time and therefore
cost money. You don't want to lose your clients due to an excessive audit fee attributed to trainee
accountants who performed irrelevant procedures! To be relevant you must identify the risks
embedded in the assertions.

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 Reflect and discuss
You own a business and through your hard work it has grown (you are making money – you picture
how the profits are going to pay for that Mauritius holiday). You were able to sell the product and
collect what was due to you, but the business has grown so rapidly that you can no longer perform
all these tasks yourself anymore. You start appointing people to handle the revenue and receipts
business process on your behalf.
Reflect and discuss what risks (including the possibility of fraud) the revenue and receipts business
process potentially holds for you, as the business owner, now that others are doing some of the
work on your behalf.
Example
Dispatching the wrong goods; money collected is not banked; certain customers should not have
been provided with a credit facility because they will not pay their accounts, etc.
Do you see why it is important to identify these risks? As the auditor of a client, you don't want your
client to be losing money! Imagine being your client: what if it was your business and what would
you be expecting from your auditors?
Your primary task as auditor is to provide the shareholders with assurance that the AFS are a fair
representation of their business. Financial statements are management's assertions.
Therefore, in designing your substantive procedures your aim is to reduce the risk of material
misstatements in the AFS knowing that the AFS are management's assertions. The auditor has to
consider risks at financial statement level, at account balance level and at transaction level and then
design the audit procedures to target risks of material misstatement to be in a position to express
an opinion of the AFS in spite of the business risks. Do you see why assertions are so important in
studying auditing?
Assertions for the revenue and receipts business process

Study
Refer to Auditing Notes chapter 10 under the heading AUDITING THE CYCLE and the sub-heading
FINANCIAL STATEMENT ASSERTIONS AND THE REVENUE AND RECEIPTS CYCLE). It is very
important to notice that there are assertions for transactions (revenue and receipts) and related
disclosures and for balances (trade receivables) and related disclosures. Transactions begin
with matching (corresponding) the relevant source documents pertaining to a specific transaction
with each other, e.g. the order, picking slip, delivery note and invoice, and then vouching these
matched source documents to the recorded amounts in the sales journal and receipts to the receipts
journal or vice versa. Assertions for balances refer to the aggregate effect of transactions as
reflected in an ending balance (accounts receivable). Therefore, when auditing balances one begins
with the ending balance reflected in the general ledger (also the balance as reflected in the
Statement of Financial Position). Related disclosure refers to the notes and disclosures reflected in
the AFS in terms of IAS.
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SELF-ASSESSMENT ACTIVITY 9.1.1

Describe the risks for sales transactions, receipt transactions and trade receivables and their
related disclosures. Link these risks to their related assertions. Show your answer in the following
format:

Risk Assertion

Understanding these concepts is crucial to formulating relevant (on target) substantive procedures.
Refer to the “Flow charts” section and the “Auditing the cycle” in Auditing Notes chapter 10, for
the answers.
FORMULATE SUBSTANTIVE PROCEDURES
Now that you have learnt the assertions for this business process, we are ready to formulate the
substantive procedures for transactions, balances and related disclosures. Remember transactions
are vouched (throughout the year) but a balance (at year end) is verified. Transactions are like a
movie while a balance is like a snapshot.
Revenue and receipts (transactions)

Study
Refer to Auditing Notes chapter 10 under the heading SUBSTANTIVE TESTING OF SALES.
Note the following while studying the substantive procedures for sales:

• They are formulated as an instruction.

• The documents to be inspected are named.
• The accounting records to be inspected are named.
• Occurrence – the transaction recorded occurred and relates to the client. This requires
selecting entries and examining them against all the relevant source documents.
• Accuracy – the transaction has been recorded at the correct amounts (values). Therefore
calculations (price x quantity) and additions (cast) are important when examining
accuracy.
• Cut-off – the transaction is accounted for in the correct financial year (dates of
transactions). By fiddling with cut-off dates management can, for example, understate (to
pay less tax) or overstate profits (bonuses).
• Classification – the transactions have been posted to the correct accounts. Again, you
need to examine the source documents and trace them to the sales journal and then to
the general ledger accounts.
• Completeness – nothing has been left out. Have all the invoices and dispatch notes been
recorded?

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 • Presentation – the transactions and events are appropriately aggregated or disaggregated
and clearly described, and related disclosures are relevant, understandable and in terms
of the applicable financial reporting framework.
• Analytical review procedures – by comparing monthly and yearly trends and ratios you
can highlight errors.

You can apply the above framework to receipts too. As soon as you understand the assertions,
envisage the source documents, books of primary entry and the general ledger account you can
formulate the substantive procedures for transactions.

SELF-ASSESSMENT ACTIVITY 9.1.2

You are the audit manager and the audit partner has allocated you to the client ExWhy (Pty)
Ltd. You intend to formulate the substantive procedures for revenue in such a way that a
junior member on your audit team will be able to understand them and therefore execute
them correctly.
Required part 1:
Based on the risks identified in activity 9.1.1 for sales transactions, formulate all the
substantive procedures to audit (vouch) revenue (sales transactions) for the year under
audit. Your answer must reflect the assertion applicable to the risk and the substantive
procedure, as follows:

Risk Assertion Substantive procedure

Make sure that you can successfully complete the activity. I could also have required you
to formulate the substantive procedures for a specific assertion e.g. “Formulate the
substantive procedures to test (vouch) the accuracy of sales for the year under audit”.
Therefore, read your questions very carefully in the examinations.
You must answer what the examiner requested, in other words, your procedures must be
relevant. If in the scenario reference was made to the fact that the auditor wishes to use
CAATs, then just incorporate the principles of lesson 8.2 into your solution. CAATs help
you to extract the information quickly and efficiently.
Required part 2:
Discuss whether the substantive procedures you described in part 1 are performed
because of:
• the assertions applicable to classes of transactions, or
• based on the risk identified.
Note: Fully substantiate your reasoning.
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Trade receivables (balances at year end)

Remember, when we verify balances at year end we do not go back and vouch the
transactions, because we have already done that when we audited the revenue and receipts.
That is why the assertions for balances are different to the assertions for transactions:

• Existence – the balance existed at year end – therefore the procedures will start with
trade receivables balance.
• Rights – the company has a right to the amount owed by a debtor.
• Completeness – all the debtors are included at year end and the related
disclosures that should have been included in the AFS, have been included.
• Accuracy, valuation and allocation – the balances are stated at a correct value (not
over- nor understated) and any valuation and allocation adjustments have been
appropriately recorded, and related disclosures have been appropriately measured
and described.
• Classification – debtors are recorded in the proper accounts (i.e. General ledger).
• Presentation – debtors are appropriately aggregated, and clearly described, and
related disclosures are relevant and understandable in the context of the requirements
of the applicable financial reporting framework.

Study
Refer to Auditing Notes chapter 10 under the heading SUBSTANTIVE PROCEDURES FOR THE
AUDIT OF TRADE RECEIVABLES and do the next activity.

ACTIVITY 9.1.3
You are the audit manager and the audit partner has allocated you to the client ExWhy
(Pty) Ltd. You want to formulate the substantive procedures to audit the trade receivables
balance of R18 152 112 at year end.
Required:
Formulate all the substantive procedures to audit (verify) trade receivables at year end.
Make sure that you can successfully complete the activity. I could also have required you
to formulate the substantive procedures for a specific assertion, e.g. “formulate the
substantive procedures to verify the accuracy, valuation and allocation of trade
receivables at year end”. Therefore, read your questions very carefully in the
examinations.

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Substantive procedures for the audit of bank and cash
You must also be able to audit the bank account. You could be asked to audit the bank reconciliation
or to formulate the audit procedures to audit the bank balance at year end.

Study
Study Auditing Notes chapter 10 under the heading SUBSTANTIVE TESTING FOR THE AUDIT OF
BANK AND CASH. Make sure that you can formulate the substantive procedures to audit the bank
balance at year end.

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DIAGRAMMATIC SUMMARY
POSSIBLE RISKS IN THE REVENUE AND RECEIPTS BUSINESS PROCESS.

Customer
order

Warehouse Risks
- Valid picking slips may not be acted upon
- Goods may be picked from inventory for
Recording of Revenue Warehouse/ fictitious/ unauthorised sales
sales Despatch - Incorrect items and quantities may be picked
(per functional area) - Inaccurate and incomplete delivery notes
may be made out
- “Out of stock” items may not be identified on
the picking slip
- Customer not notified of “out of stock” items
resulting in loss of the sale and customer
goodwill”
Despatch Risks
Invoicing Risks - Theft
- Goods despatched may not
Invoicing
- Despatch errors (incorrect quantity or goods,
be invoiced and/or delivered to incorrect customer)
- Invoices may be - Customers can deny receipt of goods
inaccurately prepared/ - Goods released from warehouse are not
misstated (prices/ despatched
quantities/ descriptions,
discounts, VAT)

Receipt Risks
Receipt of cash - Amounts received may not be banked due to carelessness or
theft

Receipts Recording of Recording of receipt Risks

Credit - Deposits may never be recorded/ not
management (per functional area) receipts recorded timeously
- Recorded deposits may be inaccurate
(errors), overstated (fictitious deposits) or
credited to the wrong debtor
Credit management
Risks
- Debtors may not pay at Goods returned by customer Risks
all or pay late - Description and quantity of goods returned may be incorrect (therefore
- Debtors are prematurely Goods incorrect credit note)
or inappropriately written returned - Credit note may be passed for goods not returned
off - Credit notes may be incorrectly recorded to the incorrect debtor
- Debtors are written off
without authority

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For every functional area in a business process, you are expected to understand the following at
this point:

- The risks of material misstatement.

- The relevant assertion related to the risk of material misstatement.
- The controls that should be implemented to address these risks and assertions.
- How to assess this risk as high, medium or low
- Designing appropriate substantive audit procedure to address the above.

SUMMARY
In this lesson we identified the source documents, books of prime entry and accounts that are
relevant to the revenue and receipts business process (including the bank). We also looked at the
accounting flow of transactions and balances for this business process. We identified the assertions,
but also noted that the assertions for transactions and balances are different. Finally, we formulated
the substantive procedures for revenue and receipt transactions and trade receivables and bank
(balances).

SELF-ASSESSMENT
After having worked through the lesson and the references to the prescribed study material,
determine if you are able to answer the following question.

1. Formulate the assertions and substantive procedures for classes of transactions and
account balances (e.g. revenue, receipts and trade receivables) in the revenue and
receipts business process.

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Lesson 9.2 Acquisitions and payments business process

Learning outcomes

After having worked through this lesson you must be able to

• Formulate the assertions and substantive procedures for purchases, payments

and trade payables.

INTRODUCTION
Many of us like to buy things – ladies often shop for beautiful clothes, gentlemen may like to buy fast
cars, perhaps? When you shop you have a perceived need for something and then you will look at
the price – you want value for your money and then you pay for the item. We are exposed to our
own acquisition and payment processes in our daily lives. In this lesson you will learn how to
formulate the substantive procedures for the acquisition and payment business process of a
business. Again, remember to rely on the knowledge that you acquired in lesson 8.

IDENTIFY THE SOURCE DOCUMENTS

During your studies, you learnt how to account for acquisitions (purchases) and payments and how
the balance between these two accounts was reflected in the trade payables balance – you even
learnt how to do a creditors reconciliation. This knowledge is very important for this lesson because
you are then able to visualise the accounting process of transactions and balances.
Break the “silo thinking” mentality and use and apply what you have learnt in other modules!
Before you can audit a business process, you must first be able to name the source documents and
envisage the business environment and the transaction flow, from initiation of the transaction
through to recording it in the accounting books and general ledger and its presentation and
disclosure in the AFS. Do the following self-assessment activity to refresh your memory.

SELF-ASSESSMENT ACTIVITY

• Identify the Statement of Financial Position account balances and related

disclosures and Statement of Comprehensive Income classes of transactions and
related disclosures for the acquisitions and payments business process.
• Identify the stages of the acquisition and payment business process and list all
the source documents and the accounting records.
• Describe credit purchases transactions by explaining the activities, functions and
risks associated with credit purchases.
• Describe cash purchases transactions by explaining the activities, functions and
risks associated with cash purchases.

39
 • Explain the accounting processes involved to reflect the balances of the accounts
payable and cash and cash equivalents accounts in the general ledger.

Refer to Auditing Notes Chapter 11 under “Documents used in the cycle” to answer this question.

FUNCTIONING OF THE ACQUISITIONS AND PAYMENTS BUSINESS PROCESS

The next step is to understand how all of the above documents and accounting records function. In
other words, we want to obtain an understanding of the client's accounting system and transaction
flow. If you can see the picture in your mind, then you can audit it. I bet you never thought that
auditors are supposed to be creative! In practice such a description will form part of the auditor's
working papers to demonstrate the understanding of the business. Therefore, as a trainee
accountant at an auditing firm, you may be allocated the task of compiling a systems description of
a client. An example of such a description is found in the next study activity.

Study

Refer to Auditing Notes chapter 11 under the heading THE ACQUISITIONS AND PAYMENTS
CYCLE AT PRORIDE (PTY) LTD.
Are you able to visualise ProRide (Pty) Ltd's transaction flow and accounting system?
Remember what we said in the previous lesson. In the examinations you will be provided with a
case study (scenario) that requires quite a lot of reading. Besides understanding the accounting
treatment and transaction flow of the acquisition and payments business process, reading the above
study reference will help you develop the reading and comprehension skills that are so crucial in the
examinations.

AUDITING THE ACQUISITION AND PAYMENTS BUSINESS PROCESS

Remember the principle of relevance? This means that the audit procedure must be right on target
and anything that misses the target will waste time and cost money.
You don't want to lose your clients because of an excessive audit fee caused by trainee accountants'
irrelevant audit procedures! To be relevant you must identify the risks embedded in the assertions.

Reflect and discuss

You own a business that has grown through your hard work and you are making money. You used
to be able to order and pay for goods yourself, but the business has grown so rapidly that you can
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no longer perform all these tasks yourself anymore. You started appointing people to handle the
acquisition and payments business process on your behalf.
Reflect and discuss what risks (including the possibility of fraud) the purchases and acquisition
business process potentially holds for you, the business owner.
Example
Buying more than is needed (overstocking) or paying excessive prices for acquisitions.
Do you see why it is important to identify these risks? Just as you will not like your employees
wasting money or even stealing your money from your business, so too will your clients not like that
happening in their business.
Your primary task is to provide the shareholders with assurance that the AFS is a fair representation
of their business.
Therefore, designing substantive procedures to target risks and examining the assertions makes
good sense – but the auditor will not always know where all the risks are hidden until some testing
is done. The auditor has to consider risks at financial statement level, at account balance level and
at transaction level and then design the audit procedures to target those risks to be able to express
an opinion of the AFS in spite of the risks. The AFS are a collection of management's assertions.
Do you see why assertions are so important in studying auditing?
ASSERTIONS FOR THE ACQUISITION AND PAYMENTS BUSINESS PROCESS

Study
Refer to Auditing Notes chapter 11 under the heading ASSERTIONS AND THE ACQUISITION AND
PAYMENTS CYCLE. It is very important that you notice there are assertions for transactions and
related disclosures (acquisitions and payments) and for balances and related disclosures (trade
payables).
Transactions begin with approval or authorisation of the transaction, matching (corresponding) the
relevant source documents pertaining to a specific transaction with each other, e.g. the order, goods
received note (GRN), supplier delivery note and invoice, focusing on details and then vouching these
matched source documents to the recorded amounts in the purchases journal and payments to the
payments journal or vice versa. Assertions for balances refer to the aggregate effect of transactions
as reflected in an ending balance (accounts payable). Therefore, when auditing balances one begins
with the ending balance reflected in the general ledger (also the balance as reflected in the
Statement of Financial Position). Related disclosure refers to the notes and disclosures reflected in
the AFS in terms of IAS.

ACTIVITY 9.2.1

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 Describe the risks for acquisitions (purchase) transactions, payment transactions and
trade payables and their related disclosures. Link these risks to their related assertions.
Show your answer in the following format:

Risk Assertion

Understanding these concepts is crucial to formulating relevant (on target) substantive

procedures.

FEEDBACK ON ACTIVITY 9.2.1

Risks Assertion

Order forms misused/ unauthorised e.g. for private Occurrence

purchases

Acceptance of short deliveries as full deliveries, Accuracy/Occurrence

broken items, incorrect items

Goods received note not made out at all Completeness

Goods received note not made out accurately Accuracy

Collusion with supplier delivery personnel e.g. theft Accuracy/Occurrence

Recording of incorrect amounts from incorrect Accuracy

invoices

Raising of fictitious purchases for which goods are Occurrence

never ordered

Delays, misallocation and posting errors resulting Accuracy

reconciliation problems

Payment to fictitious creditors Occurrence

Payment of incorrect amounts Accuracy

Unauthorised payments Occurrence

Use of incorrect foreign exchange rates (foreign Accuracy

transactions)

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FORMULATE SUBSTANTIVE PROCEDURES
Now that you have learnt the assertions for this business process, we are ready to formulate the
substantive procedures for transactions, balances and related disclosures. Remember transactions
are vouched (throughout the year) but a balance (at year end) is verified. Transactions are like a
video while a balance is like a snapshot.

Purchases and payments (transactions)

Study
Refer to Auditing Notes chapter 11 under the heading SUBSTANTIVE TESTING OF
TRANSACTIONS IN THIS CYCLE.
Note the following while studying the substantive procedures for purchases:

• They are formulated as an instruction.

• The documents to be inspected are named.

• The accounting records to be inspected are named.

• Occurrence – the transaction recorded and disclosed, occurred and relates to the client.
This requires selecting entries and examining them against all the relevant source
documents.

• Accuracy – the transaction has been recorded at the correct amounts (values) and related
disclosures was appropriately measured and described. Therefore calculations (price x
quantity) and additions (cast) are important when examining accuracy.

• Cut-off – the transaction is accounted for in the correct financial year (dates of
transactions). By fiddling with cut-off dates management can for example understate (to
pay less tax) or overstate your profits (bonuses).

• Classification – the transactions have been posted to the correct accounts. Again, you
need to examine the source documents and trace them to the purchases journal and
then to the general ledger accounts.

• Completeness – nothing has been left out and all the related disclosures that should have
been included in the financial statements have been included. Have all the GRNs been
recorded?

• Presentation – the transactions are appropriately aggregated or disaggregated and

related disclosures are relevant, understandable and in terms of the applicable financial
reporting framework.

• Analytical review procedures – by comparing monthly and yearly trends and ratios you
can highlight errors.

43
You can apply the above framework to payments too. As soon as you understand the assertions,
envisage the source documents, books of primary entry and the general ledger account you can
formulate the substantive procedures for transactions and related disclosures.

ACTIVITY 9.2.2
You are the audit manager and the audit partner has allocated you to the client ExWhy
(Pty) Ltd. You intend to formulate the substantive procedures for acquisitions (purchases)
in such a way that a junior member on your audit team will be able to understand them and
therefore execute them correctly.
Required part 1:
Based on the risks identified in activity 9.2.1 for acquisition (purchase) transactions,
formulate all the substantive procedures to audit (vouch) acquisitions (purchase
transactions) for the year under audit. Your answer must reflect the assertion applicable to
the risk and the substantive procedure, as follows:

Risk Assertion Substantive procedure

Make sure that you can successfully complete the activity. I could also have required you
to formulate the substantive procedures for a specific assertion e.g. “Formulate the
substantive procedures to test (vouch) the accuracy of purchases for the year under
audit”. Therefore, read your questions very carefully in the examinations.
You must answer what the examiner requested, in other words, your procedures must be
relevant. If in the scenario reference was made to the fact that the auditor wishes to use
CAATs, then just incorporate the principles of that lesson into your solution. CAATs help
you to extract the information quickly and efficiently.

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Required part 2:
Discuss whether the substantive procedures you described in part 1 are performed
because of:

• the assertions applicable to classes of transactions, or

• based on the risk identified.

Fully substantiate your reasoning.

FEEDBACK ON ACTIVITY 9.2.2

Risks Assertion Substantive procedures

Order forms misused/ Occurrence Inspect supporting documents are

unauthorised e.g. for private
- signed designated authority e.g.
purchases
chief buyer
- goods purchased are of a type used
by the company

Acceptance of short deliveries as Accuracy/Occur Inspect delivery note and cross reference
full deliveries, broken items, rence to purchase order (PO) to ensure
incorrect items quantities agree

Goods received note not made Completeness For approved purchase orders, test a
out at all sequence of POs and trace them to GRNs.
Investigate all POs that have no
corresponding GRNs

Good received note not made Accuracy Compare GRNs to supplier delivery notes
out accurately and purchase orders to ensure quantities
agree

Collusion with supplier delivery Accuracy/ Cross reference all supporting documents
personnel e.g. theft (PO, DN, GRN) to ensure proper authority
Occurrence
of purchase as well receipt of the correct
goods

Recording of incorrect amounts Accuracy Reperform casts and calculations on

from incorrect invoices invoices
Agree quantity per the invoice to GRN

45
 Recalculate VAT and confirm discounts
are taken into account prior to calculation
of VAT

Raising of fictitious purchases for Occurrence For a sample of recorded invoices cross
which goods are never ordered reference to supporting documents
(purchase order, supplier delivery note and
goods received note)

Delays, misallocation and Accuracy Confirm mathematical accuracy of invoice

posting errors resulting by recalculating all extensions, casts and
reconciliation problems discounts

Payment to fictitious creditors Occurrence Inspect supporting documents and ensure

that all documents are made to ExWhy
(Pty) Ltd and are from an approved
supplier

Payment of incorrect amounts Accuracy Agree the amount per the invoice to the
payment in the cash payment journal

Unathorised payments Occurrence Inspect authority of payment e.g.

- approved PO, GRN
- approved expenditure requisition
- approved payment requisition

Use of incorrect foreign Accuracy For a sample of foreign transactions agree

exchange rates (foreign the rate used to spot rate obtained from
transactions) reputable financial services institution

Trade payables (balances at year end)

Remember, when we verify balances at year end we do not go back and vouch the transactions
because we do this when we audit the acquisitions and payments. That is why the assertions for
balances are different to the assertions for transactions.

• Existence – the balance existed at year end.

• Obligation – their company has an obligation to pay the amounts owing to its creditors.

• Completeness – all the creditors are included at year end and all the related disclosures that
should have been included in the financial statements have been included.

• Accuracy, valuation and allocation – the balances are stated at the correct carrying value (not
over- nor understated) and any valuation and allocation adjustments have been
appropriately recorded, and related disclosures have been appropriately measured and
described.

• Classification – creditors are recorded in the proper accounts (i.e. General ledger).

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• Presentation – debtors are appropriately aggregated, and clearly described, and related
disclosures are relevant and understandable in the context of the requirements of the
applicable financial reporting framework.

Study
Refer to Auditing Notes chapter 11 under the heading SUBSTANTIVE PROCEDURES ON THE
TRADE AND OTHER PAYABLES BALANCE.

ACTIVITY 9.2.3
You are the audit manager and the audit partner has allocated you to the client ExWhy
(Pty) Ltd. You want to formulate the substantive procedures to audit the trade payables
balance of R18 152 112 at year end.
Required:
Formulate all the substantive procedures necessary to audit (verify) trade payables at
year end.
Make sure that you can successfully complete this activity. I could also have asked you
to formulate the substantive procedures for a specific assertion, for example, to formulate
the substantive procedures to verify the completeness of trade payables at year end.
Therefore, read your questions very carefully in the examinations.

FEEDBACK ON ACTIVITY 9.2.3

Assertion: Obligation (Does the company have a duty to settle the trade payable at year-end?)

• For year-end trade payable balances inspect supporting documents (invoices, supplier
statements) to confirm:
o they are in the name of the company.
o in respect of goods and services used by the company
Assertion: Existence (Do trade payable actually exist at year end?)

• Test that trade payables have not been overstated or recorded prematurely by:
o Inspect the purchases recorded close to year end correspond to GRNs dated before
year end.

47
Assertion: Accuracy, valuation and allocation (Are the trade payables valued at the correct
amount?)

• Agree the list of creditor’s balances to the balance per the creditor’s control account.
• Agree the balance per the creditor’s control to the annual financial statements.
• Cast and cross cast the creditor’s list and creditor’s control account
• Enquire from management regarding any debit balances on the creditor’s list and consider
whether any should be transferred to the debtor’s ledger.
• For a sample of creditors included in the year end trade payables account obtain creditors
reconciliation and perform the following:
o Cast the reconciliation for mathematical accuracy.
o Agree balances per the reconciliation to creditors statement.
o Agree amounts per the reconciliation to supporting documentation.

Assertion: Completeness (Has the company recorded all existing trade payables at year end?)

• Compare the list of creditors at current year end to the previous year end
o Identify creditors from prior year who do not exist in current year or have reduced
significantly in value.
o Inspect supporting documents to corroborate reasons for movement.
• Inspect creditor’s correspondence file for any amounts requiring adjustments as result of
disputes with creditors. This may result in the client not raising liabilities for such disputes.
• Inspect a list of GRNs not matched to invoices at year end
o Inspect that a journal entry has been passed to raise the corresponding liability.
o Recalculate the amount by agreeing the price of the goods to the purchase order or
most recent pricelist.
• Select purchases recorded in the month following year end
o Confirm that the GRNs do not relate to the current year end.
• Select a sample of large payments made immediately after year end (unrecorded liabilities)
o Confirm that payments relate to goods and services receives received prior to
yearend by inspecting corresponding GRN and delivery note.
o Confirm that a corresponding liability was raised at year end.

Assertion: Classification (have the trade payables been recorded in the correct accounts?)

• Scrutinise the trade payable listing with reference to existing audit evidence.
o Inspect that only amounts payable to trade creditors within twelve months have been
included.
o Inspect that amounts that should not be included e.g. short-term loans have not been
included

Assertion: Presentation (are the trade payable disclosures in terms of applicable IFRS?)

• Inspect notes to the annual financial statements and confirm:

o Disclosures are in terms of applicable IFRS.
o Disclosures are consistent with audit evidence.

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DIAGRAMMATIC SUMMARY
POSSIBLE RISKS OF THE ACQUISITIONS AND PAYMENTS BUSINESS PROCESS

Ordering risks
- Ordering of incorrect goods
- Ordering of unauthorised goods
- Requisitions not acted upon timeously
Ordering of - Inferior quality goods
goods - Paying high prices
- Order forms misused

Receiving of goods risks

- Acceptance of short, damaged, not ordered
Recording of Acquisition Receiving the items
purchases (per functional area) goods - Goods received notes not made out
accurately
- No goods received note made out
- Theft by employees or outside parties

Invoicing Risks
Receiving of - Recording of incorrect
invoice amounts
- Raising of fictitious
purchases
- Delays and posting errors

Payment Payment preparation Risks

- Payment to fictitious creditors
preparation
- Payment of incorrect amounts
- Unauthorised payments
- Discounts lost due to late payment

Payments Actual Actual payment Risks

- Payees made out incorrectly
(per functional area) payment - Invalid payments

Recording of Recording of payment Risks

payment - Payment may be recorded incorrectly
- Payment may be misstated to hide fraud

For every functional area in a business process, you are expected to understand the same points
listed in the diagram under possible risks in the revenue and receipts business process earlier.
INTERGRATED QUESTION
[This question includes concepts from previous tutorial letters, and is at the level that you can
expect for the exam]
49
You are the auditor of Roska Mine (Pty) Ltd, a subsidiary of a listed mining company.
The company owns the rights to mine coal on various properties. The coal is mined using an
open-cast mining which entails digging up a section of land to a certain depth, removing the coal
and restoring the environment thereafter.
Roska Mine (Pty) Ltd holds significant quantities of spare parts stock for its mining equipment.
These spare parts are accounted for at standard cost using a computerised stock recording
system.
Your trainee accountant has confirmed that the system for the purchase of spare parts operates
as follows:
1. Details of new spare parts are added to the master file by the store’s manager after
obtaining approval of the purchasing manager.
2. All orders are automatically generated by a computer program. Every evening the system
identifies spare part stock items to be re-ordered. Items are identified by comparing
quantities on hand to the minimum re-order levels indicated in the master file. A pre-
numbered order in duplicate is generated automatically by the system. All orders are sent
to the purchasing department the following morning. The purchasing and stores managers
each receive a daily listing of all orders generated by the system.
3. The store’s manager reviews all orders on the daily listing and authorises the order of the
items. The original order is dispatched by the purchasing clerk to the relevant supplier. The
copy of the order is sent to the creditor’s clerk. The creditors clerk changes the status on
the computer, of each order authorised to “pending”.
4. On receipt of the spare parts, the receiving clerk in the store enters the spare part number
into the computer system using an online terminal.
All orders with a pending status for the relevant spare part are displayed on the terminal,
showing the following fields:

• Part Number
• Order Number
• Name of the supplier
• Quantity ordered
• Description

The receiving clerk selects the order relating to the delivery and records the quantity
received. The computer prints a pre-numbered goods received note (GRN) in duplicate for
all recorded receipts. Details of the prices are not reflected on this document.
The original GRN is sent to the supplier and the copy is sent to the creditor’s clerk.
If the total quantity ordered has been received, the computer automatically changes the
status of the order to “complete”. The system automatically updates the record of stock
quantity on hand and total standard cost of stock.
5. The creditor’s clerk files the copy of the order and the GRN in alphabetical order in a
temporary file. On receipt of the invoice from the supplier the creditor’s clerk records the
order number on the system. If the status of the relevant orders reads “complete”, details
of the GRNs together with the price(s) are displayed on the screen. Details of the quantities
and prices as displayed on the screen are compared with the invoice and GRN by the
creditor’s clerk. If the unit price on the invoice differs from that of the order, the creditor’s

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clerk may change the order price on the system to agree with that on the invoice. The
prices of orders which have been changed in this manner are printed out daily for approval
by the purchasing manager.
After price change approval the invoice number is recorded against the order and the
program credits the relevant creditors’ account with the total amount of the invoice. If the
status of the order is “pending”, the invoice is filed in a temporary file. These invoices are
compared to a list of completed orders on a daily basis.
6. A report of partially completed orders outstanding for longer than four weeks is produced
on a daily basis. This printout is sent to the purchasing manager who contacts the suppliers
regarding the outstanding quantities. Should a supplier not be able to complete the order,
the purchasing manager is able to change the status of the order to “complete”. A daily
report of orders whose status has been changed to “complete” is prepared for the attention
of the store’s manager.
7. At month end the system:
• Debits the stock control account in the ledger with the aggregate standard cost of
the month’s stock receipts

• Debits the VAT input control account with the applicable VAT

• Credits the creditors control account in the ledger with the aggregate amount of the
month’s stock purchases processed; and

• Calculates the price variance for each completed order and posts these amounts to
the price variance control account

REQUIRED:

Write a letter to management in which you set out weaknesses, the potential 20
consequences of the weakness as well as your recommendation with regard
to the system to control over the purchases of spare parts stock, as described
above.

(PAAB – adapted question)

SOLUTION TO INTERGRATED QUESTION

Auditor’s Letterhead
Private & Confidential
Date:
The Directors
Roska Mine (Pty) Ltd
P O Box 2

51
Pretoria
0001
Dear Sirs
Roska Mine (Pty) Ltd – Audit for the Financial Statements for the year ended …….
During our audit for the year ended ……. We have reviewed the accounting systems and internal
control procedures operated by your company. We set out in Appendix 1 to this report the
important points which arose as a result of our normal audit procedures together with our
recommendations.
We could point out that the matters dealt with in this report came to our notice during the conduct
of our normal audit procedures, which are designed primarily for expressing our opinion on the
financial statements of your company. In consequence our work did not encompass a detailed
review of all aspects of the system and cannot be relied upon necessarily to disclose defalcations
or other irregularities or to include all possible improvements in internal control, which a more
extensive special examination might reveal. The responsibility for the implementation and
continued operation of effective internal controls rests with the management of your company.
This report has been prepared for the private use of Roska Mine (Pty) Ltd. Its content should not
be disclosed to third parties.
Would you please acknowledge receipt of this letter in writing. We look forward to receiving your
comments on the points made. Should you require any further information or explanations please
do not hesitate to contact us.
We should like to take this opportunity of thanking all the staff for their co-operation and assistance
during the course of our audit.

Yours faithfully
A & B Auditors
APPENDIX 1

Internal control weakness Potential consequence Recommended improvements

Standard costs not Stock may be incorrectly A daily exception report of

updated valued and profit margins standard cost changes should be
eroded printed for further follow up by
stores manager

The orders generated by The system could All orders must be checked and
the system are not generate unauthorised authorised before mailing
checked and compared to orders resulting in
the printout for accuracy unauthorised purchases
and completeness

No separation of duties Irregularities will not be All deliveries should be handled

between receiving of detected timeously by a receiving department
independent of the stores function

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goods and recording of
stock received

VAT invoices not checked VAT input claims may be Invoices should be checked to
for validity incorrect ensure that only valid VAT
invoices are processed

Goods received not Unauthorised goods may A daily exception report on

matched to goods ordered be received and unmatched items should be
recorded. This could also printed and authorised by the
include obsolescent goods receiving manager and
goods forwarded to the store’s manager
for follow-up

Maximum 20 marks

SUMMARY
We think that you should by now realise that auditing the revenue and receipts business process
is very similar to the acquisitions and payments business process – it's only the documents and
accounts that differ. So substantive procedures are not so difficult after all. In this lesson we
identified the source documents, books of prime entry and accounts that are relevant to the
acquisition and payments business process. We also looked at the accounting flow of transactions
and balances for this business process. We identified the risks, linked them to their related
assertions.
Finally, we formulated the substantive procedures for acquisitions and payments transactions and
the trade payables (balances).

REFLECT
Reflect on the notes that you made during your activities and reflections and go back to the
learning outcomes as set out at the beginning of this lesson. Make sure that you are able to
achieve those outcomes before moving on to the next lesson.

SELF-ASSESSMENT

53
After having worked through the lesson and the references to the prescribed study material,
determine if you are able to answer the following question.

1. Formulate the substantive procedures for classes of transactions and account balances
(e.g. purchases, payments and trade payables) the acquisitions and payments
business process.

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Lesson 9.3 Inventory and production business process

Learning outcomes

After having worked through this lesson you must be able to

• Formulate the assertions and substantive procedures for the inventory business
process.

INTRODUCTION
Inventory may represent a significant balance in manufacturing, wholesale and retail companies.
In retail entities the audit of inventory is not complex, as products are bought directly from
suppliers and sold to the public. On the other hand, in a manufacturing company, the audit of
inventory is more complex as there are various processes involved in using raw material to arrive
at a final product.
Inventory forms the link between the revenue business process and the expenditure business
process and therefore the keeping of records about the purchases, sale and returns of
merchandise form part of the inventory process.
In the previous lessons you have learnt how to formulate substantive procedures in some of the
business processes. Substantive procedures should be formulated by referring to how, what and
why (refer to lessons 9.1 and 9.2 for guidance). The aim of this lesson is to explain how
substantive procedures are formulated in the inventory and production business process.
Note that substantive procedures for inventory transactions consist mainly of the audit of
movements on the inventory records through purchases, sales, returns and other adjustments,
while the substantive procedures for inventory balances and related disclosures refer to the
balance disclosures reflecting on the statement of financial position.

Revision
You cannot audit a business process if you do not understand how it works. Refresh your memory
by revising the process flow diagrams in Auditing Notes Chapter 12.
The inventory and production business process include the following classes of transactions and
account balances.

Statement of financial Statement of comprehensive income

Position

Inventory Cost of sales (note that substantive procedures relating to cost

of sales will be dealt with in the acquisition and payment
business process – refer to lesson 9.2)

55
 Study
Study Auditing Notes chapter 12 Auditing the cycle but excluding par 5.1 as it relates to tests of
controls, as well as ISA 501 (Audit evidence – Specific considerations for selected items),
paragraphs .04 to .08.
Note the following in the above study sources:

• Attendance of the inventory count by the auditor includes both substantive

procedures and tests of controls.
• Financial statement assertions in the inventory and production business process
(remember, the assertions are also described in ISA 315, par A190).
• Make sure that you know the difference between a test of control and a
substantive procedure. The definitions are described in ISA 330, paragraph 04.
Remember, this lesson deals with substantive procedures only. Tests of controls
were dealt with in TL 103.
• Substantive procedures are performed through inspecting, observing, external
confirmation, recalculating, re-performing, analytical procedures, inquiring or
by means of CAATs.

Formulating substantive procedures in the inventory and production business process can be
illustrated by means of activities 9.3.1 and 9.3.2.

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Self-reflection activities
After studying the theoretical concepts above, we want you to attempt activities 9.3.1
and 9.3.2 below under examination conditions. Mark the activities yourself by awarding
1 mark for each properly formulated procedure. (Don't look at the comments or solution
yet.) The self-refection is the essential part of the activity. We want you to think
about what went wrong and how you can remedy your mistakes – you must
come up with suggestions and answers. Your self-reflection may include questions
you ask yourself like: Did I understand the purpose of the question? Did I understand
the theoretical principles? Must I read up more (research) the topic? Must I practise
more, by repeating the question? What did I learn from doing the activity? What made
the question difficult? And so on. The self-reflection exercise is more important than
the marks. Self-reflection nurtures critical thinking and at the same time improves your
communication skills. These are the soft skills that the accounting and auditing
professions require and give recognition for.

ACTIVITY 9.3.1 – FORMULATION OF SUBSTANTIVE PROCEDURES, USING

CAATs
You are the audit senior in charge of the audit of CompTech Limited (CompTech). The
trainee accountants working on the audit of CompTech prepared the following working
paper.

Client: CompTech

Year end: 30 September 20xx Prepared by: EM

Date: 17 October 20xx Reviewed by: LB A1

Subject: Inventory

CompTech uses an automated (computerised) inventory system and performs

regular physical inventory test counts. All inventories are issued directly to
customers from the warehouse at the head office in Sandton.
Inventories are measured at the lower of cost or net realisable value. The cost
price is determined in terms of the first-in-first-out cost formula.
Pre-numbered goods received notes are used to record receipts of inventory,
while pre-numbered delivery notes are used to record the issue of goods to
customers.
Because of the effective working of the inventory system and internal controls in
the inventory business process, no other adjustments due to theft or damages
were made to the closing balance of inventory.

57
 The inventory balance will be audited using data CAATs.
The inventory master file contains the following fields:
 inventory item number
 inventory item description
 date of last purchase per item
 date of last sale per item
 quantity on hand at the beginning of the financial year
 year-to-date sales quantity
 year-to-date purchase quantity
 quantity on hand at the end of the financial year
 unit selling price at year end
 unit purchase price at year end
 value of the inventory at the end of the financial year

Required:
Refer to working paper A1 entitled “Inventory”. Describe the substantive procedures that
you will perform on the accuracy, valuation and allocation of inventory using data
CAATs. You are not required to deal with substantive procedures relating to
consignment inventory. Also, your answer should also not deal with substantive
procedures regarding the related disclosures of the inventory balance.

(13 marks)

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FEEDBACK ON ACTIVITY 9.3.1

Comments on activity 9.3.1

The working paper is provided below and analysed line by line in order to guide you in the
formulation of your answer. The value-adding comments are indicated in brackets.

Client: CompTech

Year end: 30 September 20xx Prepared by: EB A1

Date: 17 October 20xx Reviewed by: LB

Subject: Inventory

CompTech uses an automated (computerised) inventory system and performs

regular physical inventory test counts. All inventories are issued directly to
customers from the warehouse at the head office in Sandton. (Comment: This
indicates to you that the audit of the inventory business process can be performed
using CAATs. It also indicates that there are no consignment inventories to other
warehouses as all inventories are issued directly to customers.)
Inventories are measured at the lower of cost or net realisable value. The cost
price is determined in terms of the first- in-first-out cost formula. (Comment: This
points out what the accounting basis is in the financial statements and should be
taken into account when recalculating the value of inventory at year end.)
Pre-numbered goods received notes are used to record receipts of inventory, while
pre-numbered delivery notes are used to record the issue of goods to customers.
(Comment: Briefly indicates how inventory is receipted and issued.)
Because of the effective working of the inventory system and internal controls in the
inventory business process, no other adjustments due to theft or damages were
made to the closing balance of inventory. (Comment: This indicates that it won't
be necessary to describe audit procedures regarding write-off of inventory due to
theft or damages.)
The inventory balance will be audited using data CAATs. (Comment: You have to
make use of CAATs to audit the inventory balance.)
The inventory master file contains the following fields: (Comment: Make use of the
master file and its fields to formulate your audit procedures. Most of the fields will
be used in your answer and some of them might be used more than once.)

• Inventory item number (Comment: Inventory item number can be used to

identify duplicate inventory numbers (refer to procedure in 6.5). You can also

59
 use it to extract a sample of inventory to be physically verified, but then it
relates more to the existence assertion.)

• Inventory item description (Comment: The inventory description field can be

used when comparing the inventory items from the master file to the inventory
descriptions on the purchase or sales invoices [refer to procedures 3 and 7].)

• Date of last purchase per item (Comment: The date of last purchase per item field
and the date of last sale per item field can be used to identify slow moving or
obsolete stock or when scanning for error conditions [refer to procedures 4 and
6.2].)

• Date of last sale per item (Comment: The date of last purchase per item field and
the date of last sale per item field can be used to identify slow moving or
obsolete stock or when scanning for error conditions [refer to procedures 4 and
6.2].)

• Quantity on hand at the beginning of the financial year (Comment: The quantity
on hand at the beginning of the financial year field can be used to recalculate the
opening balance of inventory and this balance can then be compared with the
prior year's closing balance in the master file [refer to procedure 1].)

• Year-to-date sales quantity (Comment: The year-to-date sales quantity field

should be used together with the date of last sale per item field to describe a
procedure related to identification of slow moving or obsolete stock [refer to
procedure 4].)

• Quantity on hand at the end of the financial year (Comment: The quantity on hand
at the end of the financial year should be used together with the value of the
inventory at the end of the financial year field to identify cases where there are
zero quantities in this field but a balance in the value of the inventory at the end
of the financial year field [refer to procedure 6.3].)

• Unit selling price at year end (Comment: The unit selling price at year end field
should be used to identify cases where the purchase price exceeds the selling
price [refer to procedure 6.1] or when identifying negative values [refer to 6.4].
Also use this field to confirm that the sales prices are correct as described in
procedure 7. Lastly, use this field to calculate the impairment where the selling
price is below the cost price [refer to procedure 8 below].)

• Unit purchase price at year end (Comment: The unit purchase price at year end
should be used to confirm that the correct price is used in terms of IAS 2
[procedure 3] as per the purchase invoices. It should also be used to identify
cases where the purchase price exceeds the selling price [refer 6.1].)

• Value of the inventory at the end of the financial year (Comment: The value of the
inventory at the end of the financial year field should be used together with the
other applicable fields to recalculate the closing balance as described in
procedure 2 below. It is also used to compare the balance in this field with the
balances in the general ledger and trial balance. Also use this field when you
need to identify cases where there are amounts in this field but zero in the
quantity on hand at the end of the financial year field [refer 6.3 below]. If you

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should include analytical procedures in your answer also describe the procedure
as in point 9.1.)

General comments:
To answer this type of question, you should describe substantive procedures and not tests
of controls.
Remember to restrict your answer to the accuracy, valuation and allocation assertion;
otherwise you will waste valuable time.
This question specifically required you to use data CAATs to describe substantive
procedures. Therefore, do not include procedures where you need to perform the
procedure without the use of CAATs.
The question does not restrict you in terms of analytical procedures and therefore you
may include these as they also form part of substantive procedures.
When you formulate your substantive procedures describe your answer in terms of how,
what and why (refer to lessons 8.1 until 8.3 to refresh your memory).

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Solution: Substantive procedures for the valuation of inventory
Accuracy, valuation and allocation
1. Use CAATs to calculate the opening balance of this year by using the applicable fields
in this year's master file and comparing this balance with the closing balance of the
prior year either by recalculating the closing balance using the same fields in the prior
year's master file or with the closing balance in the financial statements. Follow up on
differences. (1 mark)
2. Use CAATs to recalculate the value of the inventory at year end (1 mark) and
compare this value with the value in the general ledger and trial balance (1 mark).
3. Use CAATs to extract a sample of inventory item numbers for further follow ups by
comparing the purchase price in the master file with purchase prices on the purchase
invoices, taking into account IAS 2 where all costs directly attributable to the acquisition
of inventory should be taken into account (purchase price, import duties, insurance on
imports, transport, handling costs, etc). (1 mark)
Slow moving or obsolete stock
4. Use CAATs to extract an exception report of inventory on hand at year end that reflects
zero year-to-date sales or no sales for more than six months to identity slow
moving or obsolete stock and follow up with management. (1 mark)
5. Use CAATs to perform an analytical procedure to identify slow moving or obsolete
stock by comparing this year's purchases with this year's sales and in the months
where the movement of purchases does not correlate to a similar movement in sales,
perform a detailed analysis thereof. (1 mark)
6. Use CAATs to scan the inventory master file for “error” conditions and follow up
exceptions with management. For example (1 mark each):
6.1 average unit purchase price exceeds the unit selling price
6.2 zero in the quantity field but the date of the last purchase is more recent
than the date of the last sale
6.3 amounts in the value field but zero in the quantity field
6.4 negative purchase price or selling price or quantity
6.5 duplicate inventory item numbers
Accuracy, valuation – impairment
7. Use CAATs to select a sample of inventory items from the master file for further follow
ups by tracing the selling price per item to the most recent sales invoices. (1 mark)
8. Use CAATs to extract items still in inventory at year end that are sold at selling prices
below cost prices and discuss the need for write down with management. (1 mark)
Analytical procedures
9.1 Compare the current year closing balance of inventory with the inventory balance of
the prior year and follow up on any significant fluctuations with management. (1 mark)
(14 x 1 = 14, maximum 13)

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ACTIVITY 9.3.2 – FORMULATION OF SUBSTANTIVE PROCEDURES, WITHOUT

THE USE OF CAATS
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.
Cost is determined on the FIFO basis. Direct costs of manufacturing and a proportion
of manufacturing overheads, based on normal operating capacity, are included in the
cost of manufactured goods
Inventories at cost on 28 February 20x21
20x20 20x21
R'000 R'000
Finished goods 4 280 3 845
Work-in-progress (70% complete) 1 190 1 084
Raw materials 995 799
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. (20 marks)

FEEDBACK ON ACTIVITY 9.3.2

Substantive procedures to audit the accuracy, valuation and allocation of finished goods
Inventory count sheets
1. Recalculate the value of individual items on the final inventory list by multiplying the
quantity with the unit price. (1)
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2. Cast the final inventory list. (1)
3. Agree the total of the final inventory list (audited) to the balance of the inventory control
account in the general ledger and the trial balance. (1)
4. Perform standard analytical tests, including comparisons with previous years' figures
and calculating the inventory turnover and gross profit percentages. Obtain acceptable
explanations for deviations identified. (1)
5. Perform an analytical procedure to identify slow moving stock by comparing this year's
monthly purchases with this year's monthly sales and in the months where the
movement of purchases does not correlate to a similar movement in sales, perform a
detailed analysis thereof. (1)
6. Compare the selling price on the approved price list with cost price on the inventory list
to identify instances where the cost price is higher than the selling price.
(1)
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 sales conditions/offers. (1)
8. Confirm the selling prices by inspecting a number of sales invoices before year end
with the selling prices on invoices after year end to determine that the selling prices did
not drop. (1)
9. Where selling prices are lower than cost prices, request management to make the
required adjustment to net realisable value (if material). (1)
10. Confirm through inspection of the previous year's financial statements that the
accounting policy with regard to inventory is applied consistently. (1)
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. (1)
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. (1)
13. Perform the following test on the formula costing records:
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. (1)
• 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. (1)
13.2 Labour component
• Confirm the allocated labour costs with the approved wages information received from
the wages department. (1)
• Agree the hourly rate in the formula costing records with the hourly wage rate in the
wage records and actually paid. (1)
13.3 Overheads
• Confirm the allocated manufacturing overheads with the approved allocation basis and
the use of accurate information pertaining to normal operating capacity
(1)
• Evaluate the manufacturing overheads allocation basis, including the periodic changes
to this basis, for reasonableness and discuss with the financial manager if required.
(1)
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. (1)

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15. Obtain a written representation with regard to the inventory value as at year end.
(1)

(20 x 1 = 20)

Comments on activity 9.3.2

– To answer this type of question, you should describe substantive
procedures and not tests of controls.
– Remember to restrict your answer to the accuracy, valuation and
allocation assertion; otherwise you will waste valuable time.
– This question specifically required you to describe substantive procedures
without the use of CAATs. Therefore, do not include procedures where you
need to perform the audit procedure with the use of CAATs.
– When you formulate your substantive procedures describe your answer in
terms of how, what and why (refer to lessons 9.1 and 9.2 to refresh your
memory

NOTE:
Although activity 9.3.1 required you to formulate substantive procedures with the
assistance of CAATs in contrast with activity 9.3.2, which required the formulation of
substantive procedures without using CAATs, we might combine these requirements
in an examination where you could be required to describe substantive procedures
which include CAATs (e.g. include substantive procedures by inspecting, observing,
external confirmation, recalculating, re-performing, analytical procedures, enquiring
or by means of using CAATs).
Also, activities 9.3.1 and 9.3.2 focused on the “accuracy, valuation and allocation”
assertion. Please note that you should be able to describe substantive procedures
on the other assertions which relate to the inventory account balance.

Recommended reading
These are interesting reads on fraud that occurs within the inventory business process and the
risks involved. This is for your enrichment. It is not compulsory to read these documents.
https://www2.deloitte.com/content/dam/Deloitte/in/Documents/risk/Corporate%20Governance/A
udit%20Committee/in-gc-fraud-schemes-questions-to-consider-noexp.pdf

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DIAGRAMMATIC SUMMARY OF THE INVENTORY AND PRODUCTION BUSINESS
PROCESS

Step 1
• Process Purchase Orders (PO)

Step 2
• Receive Stock

Step 3
• Store stock

Step 4
• Process raw materials (if manufacturing only)

Step 5
• Store finished goods (if manufacturing only)

Step 6
• Despatch ordered goods

Step 7
• Update accounting records

For every functional area in a business process, you are expected to understand the same points
listed in the diagram under possible risks in the revenue and receipts business process earlier.

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Schematic representation on the audit of inventory and under which business processes
this would fall

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INTERGRATED QUESTION
[This question integrates all the knowledge you have acquired thus far, and is at the level of
integration that you can expect for the exam]
Netcom Ltd is one of South Africa’s largest cellular service providers and has contracts which
are in excess of 80,000 subscribers. The company sells a large range of cellular phones
(handsets) which are imported from four foreign suppliers. Customers have the option of electing
to use one of the two local cellular networks and are required to sign a subscription contract with
Netcom Ltd upon purchase of handsets. Subscription contracts are for a minimum period of one
year. Netcom Ltd has “blanket” agreements with each network operator which entitles Netcom
Ltd, on behalf of its customers, access to and use of the cellular networks. The cellular network
operators are responsible for monitoring the frequency and duration of phone calls made by
customers of Netcom Ltd on a monthly basis. This information is regularly supplied to Netcom
and forms the basis for monthly invoicing of customers for phone calls. In addition, customers
are charged a monthly administration fee by Netcom Ltd.

Netcom Ltd receives a confidential rebate from cellular network operators for each new
subscriber introduced to their network. Netcom Ltd services its customers eight branches
situated in the major centres in South Africa. All branches and the head office in Johannesburg
have warehouse facilities and administration departments. Branches are responsible for
invoicing, collection of debtors and inventory control. All other accounting and administration
functions are performed at the company’s head office

You have been informed by your manager that you will be in charge of the audit of Netcom Ltd
for the year ending 31August 20x3. You have reviewed the previous year audit files and held
discussions with Mr. Bill Best, the logistics manager of Netcom Ltd, as part of your planning
procedures. Mr. Best has confirmed that there have been no significant changes to the inventory
receivables and handset sale systems during the current financial year. He also reported that
there have been no significant staff changes in the logistics department and approximately one
third of employees had been appointed during the current financial year.

You have also met with the managing director of Netcom Ltd, Ms. Lulu Belle, who indicated that
Netcom Ltd had incurred material inventory losses during the first six months of the current
financial year. She is also very concerned about the issue and suspects that fraud or theft may
be the reason for the losses incurred. Ms. Belle has asked you to pay particular attention to
inventory during your audit and to identify the reasons for the inventory losses that have arisen.

You have updated the inventory, receivables and handset sales systems descriptions in the
audit planning file and they now read as follows:

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Inventory, receivables and handset sales systems

All inventory is ordered by the logistics manager, Mr. Best, based on expected sales and existing
inventory levels. There are no guidelines regarding minimum and maximum order levels due to
the unpredictable nature of customer demand. Prices for handsets are negotiated once a year
with suppliers and fixed for the period. Inventory is valued at standard costs and these standard
costs are reviewed annually after price negotiations with suppliers. Netcom Ltd does not enter
into forward exchange contracts to cover foreign purchases.

All inventory is airfreighted to OR Tambo International Airport and then it is transferred to the
central warehouse of Netcom Ltd situated in Johannesburg. Quantities are checked against
supplier invoices and shipping documentation upon arrival at the central warehouse. Individual
serial numbers of handsets are recorded on pre-numbered goods received note (GRNs). No
quality checks are performed on handsets received as goods are delivered in sealed boxes.
GRNs are captured by employees in the central warehouse and used to update the inventory
records.

Transfers of inventory to branches are requested by means of an internal order and the same
procedures for the dispatch to branches and receipt by branches of handsets are followed as
for external sales and purchases. Access to warehouses is not restricted due to the volume of
transactions. Security cameras have been installed in warehouses to discourage theft. Video
tapes of activity in warehouses are made and these are reviewed weekly on a random basis.

Sales representatives obtain written orders from customers supported by the necessary trade
references and application forms. These documents are reviewed by the financial manager or
branch accountants who sign the orders as evidence of the approval of the granting of credit.
Pre-numbered “request for stock” forms are then completed based on the approved orders.
Handsets are collected from warehouses by sales representatives. Warehouse employees
check details of request for stock forms against handsets being removed from warehouses and
sign as evidence of these check procedures. Copies of request for stock forms are retained in
warehouses and are used to update inventory records. The originals of the request for stock
forms are sent to the administration department and this information is used to record quantities
on pre-numbered sales invoices. Sales prices are obtained from authorised price lists.

Full inventory counts are performed on a monthly basis by the logistics department. Differences
between physical count and inventory records are investigated and where necessary
adjustments are processed by the count teams. The general ledger stock control account is
adjusted each month to reflect the stock count value.

Sales representatives deliver handsets to customers who sign the delivery note copies of the
sales invoices as evidence of receipt of the handsets. The delivery note copies of the sales
invoices are returned to the administration departments where they are filled in sequence and
are used to update the debtors’ ledger.

Payments from customers are received through the mail by the debtors’ clerk who prepare the
deposit slips. The deposit slips are handed to the company’s driver who is responsible for
making deposits at the bank. Copies of the bank stamped deposit slips are returned to the
debtors’ clerks who allocate the payments to the debtor’s accounts in the debtor’s ledger.
Payments are allocated against the invoices which are shown on the customer’s remittance
advices. The debtors’ clerks are responsible for the follow up of overdue debtor accounts.

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The debtors’ ledger is reconciled to the general ledger control account on a monthly basis. This
reconciliation is reviewed by the financial manager who signs the reconciliation as evidence of
his review.

REQUIRED:

Part Question Marks

1 List the audit risks you would take into account when planning the audit of 10
Netcom Ltd.
2 Prepare a file note, for inclusion in the audit planning file, outlining the 10
weaknesses in the system of internal control in respect of the inventory,
receivables and handset sales systems.
3 State what substantive procedures should be performed to address the 10
completeness assertion regarding inventory, and
4 Indicate what procedures you plan to perform to identify the source and extent 10
of inventory losses incurred by Netcom Ltd during the 20x3 financial year.

SOLUTION TO INTERGRATED QUESTION

1. Audit Risk

• Poor internal control system

• Inventory:
o Handsets are susceptible to theft.
o The inventory losses incurred to date indicate problems with the inventory control
system.
o The risk is high of inventory technological obsolescence.
o Since the standard costs are not updated regularly the net realizable value (NRV)
may exceed cost.
o The fact that standard costs are not updated regularly also increases the risk that
inventory are not correctly valued at year-end.

• Imports:
o The risk of error is higher due to complexity of accounting entries.
o Uncovered foreign liabilities may result in material forex losses.
o Risk of incorrect cut-off due to inventory in transit at year end.

• Debtors:
o Risk of incorrect cut-off given sales personnel hold invoices.
o Fraud as a result of poor segregation of debtors duties.

• Rebates:
o Risk increases since it will be difficult to verify completeness of rebate.
o Handsets may also be sold at a loss due to the rebates.

• Branches:
o The risk increases due to the decentralization of the business and risk that branch
managers may override internal controls.
o Risk of incorrect cut-off due to goods in transit at year end.

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• Other:
o Increased risk due to high staff turnovers.
o Increase risk due to reliance on networks for billing information.
o Risk increases due to large volume of transactions (80,000 customers)
o Risk increases due to the fact that the company is growing rapidly.
Maximum 10 marks
2. Weaknesses

• Poor access controls:

o There is no restriction on access to warehouse.
o There are no gate checks.
o There is poor segregation of duties since warehouse staff record entries
themselves.

• On receipt of handsets:
o There are no quality checks.
o No comparison is done between what is received and the original order placed.
o The serial numbers of handsets are not agreed to delivery note.

• Purchase orders:
o There are no order limits.
o Management does not authorise purchase orders.

• Standard costs:
o Standard costs are not reviewed regularly.
o No review of variances is done.

• Stock counts:
o There is poor segregation of duties since count teams process adjustments
themselves.
o No review or authorization of differences is done by management.

• Invoicing:
o No matching between invoices and request for stock forms takes place.
o There are no sequence checks on invoices and request for stock forms.

• Credit risk:
o There is no proper verification of orders and references.
o Management does not review long outstanding amounts.

• Sales representatives carry stock and perform admin functions – poor segregation of
duties.
• Debtors clerk has too many duties – poor segregation of duties
• No security measure is in place regarding the banking function.
• Debtors payments are incorrectly allocated on age analysis.
• No proper mail register is maintained.

Maximum 10 marks

3. Completeness of Inventory

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 • Stock Count:
o Inspect the client’s stock count procedures and policies, in order to evaluate
whether they appropriately address completeness. E.g. The procedures have a
way of identifying stock that is on the floor that is not recorded.
o Perform a sample of test counts and follow up to client stock sheets to ensure
completeness of recording of the count sheets.
o On a sample basis trace quantities from stock count to stock records to ensure
that quantities have been completely recorded. Inspect evidence that management
has investigated differences between count and records to ensure variances have
been completely addressed.
o Review reconciliation of stock sheets to general ledger stock account to test
completeness.
o Re-perform casting and additions on stock sheets/records to test completeness.
o Walk through premises to inspect any stock not counted to test completeness.

• Cut-off:
o Perform cut-off testing on GRNs and supplier invoices by inspecting dates on the
source documents.
o Review creditors’ reconciliations for outstanding transactions related to the
financial year.

• Stock excluded from count

o Follow up on outstanding purchase orders in order to identify any stock that is
potentially unrecorded.
o Review shipping for goods in transit which may potentially be unrecorded.
o Obtain confirmations of any consignment stock which may potentially be
unrecorded.
o Obtain confirmations of any stock held by sales representatives and/or
demonstration stock which may be potentially unrecorded.

• Other
o Obtain a written representation in order to address the assertions being tested.
o Perform sequence checks on GRNs to address completeness of the GRN’s.
o Confirm that stock sheets are sequentially numbered to address the completeness
of the stock sheets.
o Perform analytical review procedures to test completeness.
Maximum 10 marks

4. Source and extent of losses

• Discuss stock losses with management.

• Hold discussions with staff to where stock losses might probably occur.
• Perform analytical procedures.
• Analyse stock count adjustments and correcting journal entries.
• Consider the impact of poor internal control.
• Employ security firm to view videos.
• Review staff employment procedures.
• Investigate which employees don’t take leave regularly.
• Visit a branch and:
o Observe activity in warehouse.
o Enquire about the standard of living of the staff working at the branch.
o Perform a few spot counts on stock and investigate differences.
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o Investigate unsigned delivery notes.
• The extent of the loss can be calculated by taking the number of handsets at the
beginning of the year, add the purchases per shipping documents and deduct all sales
for the year. The theoretical quantity can then be compared to the quantity on hand at
year end to determine the loss for the year.
Maximum 10 marks

SUMMARY
In this lesson we discussed and explained substantive procedures (without and with the use of
CAATs) for auditing inventory balances and related disclosures. The next lesson will describe
substantive procedures in the payroll and personnel business process.

SELF-ASSESSMENT
After having worked through the lesson and the references to the prescribed study material,
determine if you are able to answer the following question.

1. Formulate the assertions and substantive procedures for classes of transactions and
account balances in the inventory and production business process.

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Lesson 9.4 Payroll and personnel business process

Learning outcomes

After having worked through this lesson you must be able to

• Formulate the assertions and substantive procedures in the payroll and personnel
business process.

INTRODUCTION
In lesson 8 you have learnt how to formulate substantive procedures in some of the business
processes. Substantive procedures should be formulated by referring to how, what and why.
The aim of this lesson is to explain how substantive procedures are formulated in the payroll and
personnel business process.

Revision
You cannot audit a business process if you do not understand how it works. Refresh your memory
by revising the process flow diagrams in Auditing Notes Chapter 13.
The two main types of transactions are processed through the payroll and personnel business
process:

• payment to employees for services rendered (salaries and wages)

• accrual and payment of payroll-related liabilities (employee deductions such as taxes,

pension fund and medical aid)
The payroll and personnel business process include the following classes of transactions and
account balances.

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Statement of financial position Statement of comprehensive income

Bank and cash Wages and salaries (including deductions

such as PAYE, UIF, SDL, pension fund,
Accounts payable (accumulated leave, medical aid and other)
unclaimed wages, SARS, pension fund,
medical aid and other)

Study
Study the paragraphs in the section “Auditing the cycle”, except those sections dealing with tests
of controls, in Auditing Notes chapter 13.
Note the following in the above study source:
Financial statement assertions in the payroll and personnel business process (remember, the
assertions are also described in ISA 315, par A190). Make sure that you know the difference
between a test of control and a substantive procedure. The definitions are described in ISA
330, paragraph 04. Remember, this lesson deals with substantive procedures only. Tests of
controls were dealt with in TL103. Substantive procedures are performed through inspecting,
observing, external confirmation, recalculating, re-performing, analytical procedures,
enquiring or by means of CAATs.

Self-reflection activity
After studying the theoretical concepts above, we want you to attempt activity 9.4.1
below as if under examination conditions. Mark the activities yourself by awarding 1
mark for each properly formulated procedure. (Don't look at the comments or solution
yet.) The self-reflection is the essential part of the activity. We want you to think about
what went wrong and how you can remedy your mistakes – you must come up
with suggestions and answers. Your self-reflection may include questions you ask
yourself: Did I understand the purpose of the question? Did I understand the theoretical
principles? Must I read up more (research) the topic? Must I practise more, by repeating
the question? What did I learn from doing the activity? What made the question difficult?
And so on. The self-reflection exercise is more important than the marks. Self-reflection
nurtures critical thinking and at the same time improves your communication skills.
These are the soft skills that the accounting and auditing professions require and give
recognition for.

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 ACTIVITY 9.4.1
Clothing-4-U Limited (C4U) is a company that manufactures clothing for all Mr Price
outlets in South Africa. Over the past year the company has grown constantly and
currently has 600 permanent wage workers employed at its factory.
Your audit firm is appointed as the auditor of C4U, with you as audit senior in charge of
auditing the payroll and personnel business process. A major concern for you is that you
will fail to detect material overstatement of the salary and wage expenses, mainly owing
to the:

• 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

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 containing all the
necessary information about the employees is maintained in the human resources
department.
(3) Employees are paid a fixed hourly rate depending on their job grade.
The job grade is determined on appointment and reviewed once a year based on
experience 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:

Job grade Normal rate per hour Overtime rate per hour

Grade A R100 R150

Grade B R125 R175

Grade C R150 R200

(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.

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(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
– 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.

Required:
Formulate the substantive procedures that you will perform in the payroll and personnel
business process 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.
(20 marks)

Before you answer the question, think how you would approach the question. Refer to guidance
provided in the previous lessons, make your own notes and compare your notes with your
fellow students, for example share notes on what you have learnt when answering substantive
procedure questions, your approach, and so on.
Hints for approaching this question:

• This question requires you to limit your answers to specific assertions and therefore
you have to describe substantive procedures that deal with those assertions only.
• You have to make use of CAATs when formulating your procedures.
• You have to use the information provided in the question when formulating your
substantive procedures.
• When you formulate your substantive procedures describe your answer in terms of
how, what and why (refer to lesson 8.2 to refresh your memory).

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 FEEDBACK ON ACTIVITY 9.4.1
Substantive procedures in the payroll and personnel business process
1 mark for each substantive procedure which is described correctly

Occurrence

• Use CAATs to select a sample of employees from the employee master file of C4U
and follow up on differences with management (1 mark each):
– Verify all information against the personnel files kept in the human resources
department, for example inspect employee contracts, copies of identity
documents, banking details and taxation numbers.
– Perform physical positive identification of the employees on a surprise
basis by inspecting the information on the staff card.
– Inspect the returns made to outside entities, for example SARS, to ensure
that the employees in the sample are included on the SARS return.
– Enquire with managers to whom the employee reports whether the employee
has been employed throughout the year.
• 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 identify additions or
removals of employees and compare the information with supporting documents in
the personnel files (employee contract/resignation letter, etc), or
• 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).
• 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 (1 mark
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

(8 x 1 = 8)
Accuracy
• Use CAATs to recalculate net wages to confirm the accuracy of net wages.
• Use CAATs to compare total of the net wages in the master file with the balance in
the general ledger and trial balance.
• Use CAATs to extract a sample of employees indicating the normal or overtime hours
worked and compare with the hours logged by the biometric reader access
system.
• Use CAATs to scan the employee master file for any job grade or rate changes
during the year and follow up differences with management. (There should be no
changes because job grade and rate changes are only reviewed annually.)
• Use CAATs to compare the rate of job grades A, B and C with applicable rates for
normal hours and overtime hours in the master file of C4U and print an exception report

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whenever the wrong rate is used for a specified job grade. Follow up exceptions with
management.
• Use CAATs to extract a sample of employees reflecting the rate and job grades and
verify these details with details described in the personnel file in the 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 (e.g. medical aid billings, PAYE/SITE tables).
• Use CAATs to extract a sample of employees indicating their deductions and
recalculate the deductions (PAYE, medical aid) to confirm that calculations are
performed correctly. Follow up difference with management.
• 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 (1 mark
each):
– 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

(12 x 1 = 12)
Analytical procedures
• Perform analytical procedures by using CAATs to compare the following:
– The total wage expense for the current year with the total wage expense for
the prior year. Follow up on any differences above or below the 12% increase
with management (accuracy/occurrence).
– Current year wage expense compared with the budget. Follow up on any
differences with management (accuracy/occurrence).
– Compare the month-to-month wages and follow up on any material
differences (accuracy/occurrence).
• By using CAATs and the fields available in the master file of C4U perform analytical
procedures by comparing the total of the net wages value per month for
each employee with the total net wages year to date value for each
employee. Follow up differences with management (accuracy).
• Perform the following analytical procedures by using CAATs:
– Calculate the average wages per employee for each month by dividing the
total wages by the number of employees and follow up on any material
differences when comparing the average per month against the different
months (accuracy).
– Compare the number of employees of this year with the prior year
(accuracy/occurrence).
(6 x 1 = 6)

(Maximum for the question: 20 marks)

Comments

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(1) Make sure that the substantive procedures that you describe in your answer deal with
occurrence and accuracy. Chapter 13 in Auditing Notes has very good examples of such
substantive procedures. Just make sure that you describe the substantive procedures as
substantive procedures where you make use of CAATs. This is easy: just think about it and
convert the substantive procedure. This could be illustrated by the following example.
Substantive procedure:
Select a sample of employees from the salaries register and inspect the documentation in
the employee's personnel file and employee contract.
Substantive procedure using data CAATs:
Use CAATs to select a sample of employees from the employee master file and verify all
information in the master file against the personnel file and employee contract.
(2) Do not think that you will receive marks if you say you made use of CAATs. Your substantive
procedure must be logical and meaningful. This could be illustrated by the following
example:
Student's answer:
Use CAATs to inspect a sample of personnel files in the human resource department.
How can a computer inspect a personnel file? Think about it, it is not possible. The computer can
only extract samples and compare these with information stored in its memory. Further
corroboration is required by the auditor to the personnel files.
(3) As mentioned previously, you need to apply your knowledge to the information provided
in the question. Before formulating your solution, read through the information line by line
and identify what will be applicable to your solution. For example, in the question it is
mentioned that the job grade is determined on appointment and reviewed once a year. This
implies that there should be no changes to the job grade during the year and that it might be
possible for you to generate an exception report on this. Another example is that overtime
may not exceed 30 hours per month. Can you see that you have to use this information and
indicate that you will use CAATs to generate an exception report if overtime exceeds 30
hours?
(4) Students often ask me how they should use the fields in the master file. The fields indicate
the information available to you. For example, for the accuracy assertion, you will use CAATs
to recalculate the net wages. By providing you with the fields, you should be able to describe
exactly how you will use CAATs to recalculate net wages. When you work through the
solution you should be able to identify how most of the fields in the master file are used to
formulate the substantive procedures. You will also find that some of the fields are not used.
Examples of such fields include gender and race as well as address and contact information.
Now, try to think of an example of a substantive procedure where you use these fields. There
is no such example, because duplication of address and contact information, for example,
will have no influence on the financial statements. It is quite possible that employees might
have the same contact information, for example if a husband and his wife work for the same
company.
(5) Depending on the required assertion in the question, it is quite possible that you can have
the same substantive procedure for most of the business processes, for example use
CAATs and print exception reports on negative values, duplication of information and
missing information. Keep this in mind and if relevant write these down when you formulate
your substantive procedures for all the business processes.

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(6) Remember that substantive procedures include analytical procedures. You can therefore
include analytical procedures in your answer if you are required to formulate substantive
procedures.
In brief, according to ISA 520 which deals with analytical procedures, analytical procedures
can include
• comparisons of the entity's financial information, for example with
– prior periods
– anticipated results of the entity, such as budgets and forecasts or expectations of
the auditor
– similar industry information
• consideration of relationships, for example
– among the entity's financial information, such as the gross profit percentage
– between financial information and non-financial information, such as payroll costs
to the number of employees

Note: The question in activity 9.4.1 is one example of what could be required of you in the
examination in terms of substantive procedures in the payroll and personnel business
process. We can also require you to ...
• formulate substantive procedures without the assistance of CAATs
• formulate substantive procedures including CAATs (e.g. include substantive
procedures by inspecting, observing, external confirmation, recalculating, re-
performing, analytical procedures, enquiring or by means of using CAATs)
• formulate substantive procedures on classes of transactions and related
disclosures dealing with the other assertions as in activity 9.4.1
• formulate substantive procedures on account balances and related disclosures.

RISKS IN THE BUSINESS PROCESS

One of the significant in the payroll and personnel business process is the potential fraud as a
result of unauthorized payments to fictitious employees as well as payment of wages and
salaries whilst no work was performed by the employees.

What substantive procedures can you perform to identify these risks within your client?
Complete activity 9.4.2 to which relates to these?

ACTIVITY 9.4.2
Complete the substantive procedures you would perform for each risk identified:

Risk Substantive procedures

1. Non-existent employees

2. Terminated employees

3. Unclaimed wages

4. Fraudulent hours

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 FEEDBACK ON ACTIVITY 9.4.2

Types of fraud Substantive procedures

1. Non-existent employees • Select a sample of transactions from the payroll

masterfile and agree these to the employment
contracts to confirm that the individuals are
employees of the entity.
2. Terminated employees • Select a sample of terminated employees from the
employment listing and trace and agree to payouts
made in that month to confirm that they were paid
everything that was due to them.
• For the sample above, examine the subsequent
payroll payments (following month) to confirm that
these employees were not paid
3. Unclaimed wages • Attend a wages payout on a surprise basis and
observe the process. Take note that all employees
sign for the amounts they receive.
• Note the process that is followed for any unclaimed
wages
• Investigate reasons for unclaimed wages and
follow up till when the employee receives it.
4. Fraudulent hours • Perform a reconciliation on the total hours paid and
trace and agree this with payroll Masterfile. Follow
up on any variances
• Inspect payroll masterfile for appropriate approvals

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DIAGRAMMATIC SUMMARY OF PAYROLL & PERSONNEL BUSINESS PROCESS

For every functional area in a business process, you are expected to understand the same points
listed in the diagram under possible risks in the revenue and receipts business process earlier.
INTERGRATED QUESTION
[This question integrates all the knowledge you have acquired from previous tutorial letters thus
far, and is at the level of integration that you can expect for the exam]

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You are the auditor of Excellence Sourcing Ltd (ES) and are presently busy with the planning of
the audit for the year ended March 20x8.
ES is an Information Technology service provider specializing in the management of large
computer networks, integrated enterprise resource management systems and communication
networks.
Many of the company’s management contracts incorporate a cost-plus factor for determining
revenue and it is therefore very important for the company to maintain accurate records of the time
spent and costs incurred on each contract.
Having followed a systems based audit approach during the 20x7 audit, you would like to follow
the same approach in the current year audit due to the importance of relying on the system as a
basis for the allocation of costs to contracts.
The significant change to the accounting system in the current year has been the introduction,
effective 1 September 20x7, of a new payroll system. Details of these are below:
General

• Line managers are responsible for the employment ad termination of staff.

• Rates of pay are set in consultation with the human resource department and in
accordance with company policy.
• All changes are recorded on standard forms which are approved by the managers and
the human resource department.
• Employees record their time worked on time sheets which are summarized and approved
by the line managers.
• Employees are properly supervised by the line managers ad this supervision ensures
that the times recorded are genuine.
• These summaries are checked in detail and reviewed and signed by both the line
managers and the human resources department.

Until 31 August 20x7

• All payroll records were maintained on the computer system at head office and were
administered by a separate payroll department.
• The employee permanent records were updated from the forms referred to above
• Time sheet summaries were then captured in batch mode and the system generated the
payroll.
• The payroll was checked in detail by the payroll department.
• Employees were paid by EFT at the end of each month.
• The payroll system produced detailed costing printouts which were subsequently captured
into the general ledger system for costing purposes.

From 1 September 20x7

• Payroll processing is now performed by Salomina Payroll Solutions Ltd (SPS), a service
provider that specialises in the processing of payrolls.
• As a result, the employees in the payroll department have been reduced. All employees
who left the department were reallocated to other departments within the company.
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• A number of senior staff were re-allocated to Internal Audit
• All employees are required to have bank accounts to be paid.
• Employee permanent records are updated on-line, by the payroll department, from the
forms received from the human resource department.
• The SPS system produces comprehensive information with regards to changes to
employee permanent records. The information is downloaded, printed out and checked by
the payroll department.
• The time summaries are now captured on-line, directly onto the SPS system. Once the
information has been captured, the captured data is downloaded, printed out and checked
by the payroll department.
• The SPS system produces detailed exception reports. These are checked by the payroll
department and any errors are corrected.
• The SPS system then produces the final payroll.
• The final payroll is received electronically, checked by the payroll department and reviewed
and approved by the line managers.
• Each line manger then enters a pin code into the payroll system and the SPS system then
transfers to the payroll department, a file containing details of amounts to be paid to
employees.
• Once the payroll department has verified this file against the final payroll, the funds are
transferred directly into employees’ bank accounts.
• The payroll department monitors the review and distribution of reconciliations setting out
the difference in gross payroll costs from one pay period to the next. These reconciliations
are distributed to, and reviewed by, the line managers and any queries are referred to
Internal Audit
• The SPS system also produces a file containing costing information. This file is merged into
the company’s accounting system in order to update the costing records.
• The company’s Internal Audit function has been strengthened considerably. Internal Audit
now contains a section which devotes its full attention to the payroll function and regularly
tests the controls over the payrolls, including checking the existence of employees and the
accuracy of payrolls etc.

REQUIRED:

Part Question Marks

1 Identify the additional risks, affecting your audit for the current year, arising from 10
the changes to the payroll system
2 Discuss the impact of the changes to the payroll system on your audit approach 18
and further audit procedures to the payroll for the current year

SOLUTION TO INTEGRATED QUESTION

Once you have marked your answer, please logon on to myunisa and take part in the
“Discussion forum: Integrated question payroll and personnel” with the lecturers and
other students where all problems identified can be dealt with.

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 RISKS
1.1 The risk of uncontrolled access to the system creates the possibility of manipulation of:
• Employee permanent data (standing data).
• Time records.

Manipulation may involve unauthorized alteration, fictitious records or corruption.

1.2 There is a possibility of systems access by third parties, exposing the company to the
risk of manipulation of data by hackers, corruption of data by hackers, and the corruption
of data by viruses.
1.3 Data could be corrupted, manipulated or duplicated on transfer to SPS’s file servers.
1.4 The data transferred to SPS may be incomplete.
1.5 Due to the on-line input of time records, the company is more dependent on
programmed controls for the validation of payroll input.
1.6 There is a risk of malfunction in the initial period after the introduction of the new system.
1.7 There is a risk of error as a result of staff not being fully trained on the new system and
limited experience.
1.8 The company is more dependent on programmed controls for the processing of payroll
and the related funds transfers.
1.9 The information for the costing records is systems generated and therefore dependent
on the accuracy of payroll records and the programmed controls over processing payroll.
1.10 The new system is more complex and therefore could result in more errors.
1.11 The new system is dependent on the competence of SPS and the controls managed by
SPS.
1.12 The company faces a risk of financial loss due to payroll payments being system
generated and effected by the system.
Maximum 10 marks
AUDIT APPROACH
1.1 Follow the same approach used in prior year up to 31 August 20x7 as system was
unchanged.
1.2 Obtain an understanding of the new system to assess the system’s adequacy as a basis
for the preparation of accounting information and to conduct a preliminary assessment of
control risk.
1.3 Obtain knowledge and understanding of the controls in the new system. Document these
controls and perform a detailed evaluation.
1.4 Obtain a detailed understanding of the work performed by internal audit and assess the
competence of the internal audit function.
1.5 Review the controls over the development and implementation of the new system.
1.6 Audit the transfer of balances from the old system to the new system:
1.6.1 Evaluate ES’s procedures for transferring the opening balances.
1.6.2 Perform limited substantive tests of opening balances on the new system which
incorporate tests of details and analytical reviews.
1.7 The audit approach from 1 August will still be a combined systems-based approach due to
the following:
1.7.1 It may be necessary to follow a systems-based approach owing to the extent to
which the accuracy of the costing records depends on the accuracy of payroll
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processing.
1.7.2 It may be necessary to evaluate the controls performed by SPS due to systems
dependence on these controls.
1.7.3 A systems-based approach is possible as SPS is likely to have sound controls and
the controls performed by SPS ae monitored by Internal Audit
1.7.4 A systems-based approach will be cost effective allowing a reduction in substantive
work.
1.7.5 A systems-based approach will also enable a better understanding of the system
and provide the opportunity for value added comments to management.
1.8 A combined systems-based approach is likely to incorporate the evaluation of:
1.8.1 Controls over access to the system.
1.8.2 Validation controls over the transfer of data between SPS and ES.
1.8.3 Programmed application controls managed by SPS.
1.8.4 The general control environment at SPS.
1.8.5 The user controls performed by the payroll department (manual controls over
computer information).
1.8.6 Independent manual controls, e.g. supervision of staff by line managers and the
checking of time sheets.
1.8.7 The evaluation of tests of controls performed by internal audit.
1.9 Testing of controls is likely to involve:
1.9.1 A review of the general control environment, including access controls
1.9.2 Testing of controls at SPS, either:
1.9.2.1 By an audit visit to SPS with client’s permission.
1.9.2.2 An independent control review performed by SPS’s auditors. In this
case we will need to consider:
1.9.2.3 The relevance, to the ES audit, of the controls evaluated by SPS’s
auditors.
1.9.2.4 The competence and expertise of SPS’s auditors.
1.9.3 Review of the work of internal audit
1.9.4 Tests of controls performed by us:
1.9.4.1 On a limited scale in areas already tested by internal audit.
1.9.4.2 In areas identified above but not tested by internal audit
1.10 With regards to substantive procedures:.
1.10.1 Substantive procedures will be reduced substantially due to reliance on
controls.
1.10.2 More use of analytical reviews as opposed to tests of detail.
1.10.3 Year-end substantive work will be focused on payroll related liabilities,
such as payroll deductions and leave pay provisions.
1.11 Consideration will be given to the need for a computer audit specialist to assist in the
evaluation of programmed controls .
1.12 Consideration will also be given to the timing of audit visits and the allocation of suitably
qualified audit staff.
Maximum 18 marks

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 SUMMARY
This lesson explained how substantive procedures are formulated in the payroll and personnel
business process. The next lesson will explain how substantive procedures are performed in the
finance and investment business process.

SELF-ASSESSMENT
After having worked through this lesson and the references to the prescribed study material,
decide whether you feel comfortable about doing the following:

1. Formulate the assertions and substantive procedures for classes of transactions and
account balances in the payroll and personnel business process.

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Lesson 9.5 Finance and investment business process

Learning outcomes

After having worked through this lesson you must be able to

• Formulate the assertions and substantive procedures for share capital and
reserves; long-term loans and finance leases; property, property plant and
equipment’ and investments.

INTRODUCTION
In your personal capacity you have to, or will have to soon, raise capital (loan) to buy your own
car or home (a non-current asset). Just persevere with your studies until you complete your
CA(SA) qualification so that you can earn a decent salary. You may even consider starting your
own business and create employment. Soon you will be generating surplus funds and start saving
(for retirement) (e.g. buy shares, property). Just imagine you inherit a couple of “Apple” or
“Google” shares from an unknown family member who resided in the USA! The point we want to
raise is that you are or will also soon be exposed to the finance and investment business process
– therefore, again, the concept is not something abstract. In this lesson you are going to learn
how to formulate the substantive procedures for the finance and investment business process for
a business (audit). This lesson covers our final business process and I think if you reflect back on
lesson 9 and all the business processes that you have mastered so far, things are beginning to
make sense to you. Maybe you have even gained confidence and can tell a friend that formulating
substantive procedures is really easy!
This is a long lesson, but the principles are the same for all accounts in the finance and investment
business process. You just need to take care that you know the source documents and accounting
treatment of each account.

THE ACCOUNTING SYSTEM

In your financial accounting modules, you have learnt how to account for the raising of capital
(share issue or non-current loans), revaluation surpluses and investing capital (e.g. the acquisition
of property plant and equipment – and journal entries for depreciation), IAS requirements for
finance and operating leases and, very importantly, the underlying principles of the fair value
concept. All this knowledge is very important for this lesson because you are then able to visualise
the accounting process of transactions, balances and related disclosures for the finance and
investment business process.
Remember what we have drilled into you so far: before you can audit a business process, you
must first be able to name the source documents and visualise the business environment and the
transaction flow from initiation of the transaction through to recording it in the accounting books
of prime entry and general ledger and its presentation and disclosure in the AFS. Let's begin with
a revision activity to get you oriented.

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 SELF-ASSESSMENT ACTIVITY
Compile a table and list the source documents, accounting records and risks for the purchase
of property plant and equipment, investments, share issues, obtaining long-term loans and
finance lease liabilities. This is necessary if you have to test the occurrence of the transaction.
To answer this question, refer to Chapter 14 in Auditing Notes. You may also need to refer to your
accounting books.

FUNCTIONING OF THE FINANCE AND INVESTMENT BUSINESS PROCESS

The finance and investment business process is different from the other business processes,
because finance and investment transactions usually occur less frequently and the amounts are
substantial. Therefore, the focus of the auditor shifts to the authorisation and approval of the
transactions (budgets, powers in terms of the MOI, minutes of meetings, etc).
The finance business process relates to funding (inflow) while the investment business process
relates to investment or capital expansion (outflow). In this business process, remember to
incorporate your Companies Act knowledge and accounting disclosure and presentation
requirements.

Study
Refer to Auditing Notes chapter 14 THE ACCOUNTING SYSTEM AND CONTROL ACTIVITIES
and also THE FINANCE AND INVESTMENT CYCLE AT PRORIDE (PTY) LTD.
Identify the possible risks relating to this business process (this affects your focus of testing –
relevance).
For those who do not have practical experience, are you able to visualise ProRide (Pty) Ltd's
authorisation procedures and controls over their finance and investment business process?
Now that you can visualise the business process, you can audit it.

AUDITING THE FINANCE AND INVESTMENT BUSINESS PROCESS

Remember, we have said that the audit procedures must be spot on the target (bull's eye) and
anything that misses the target will waste time and cost money. To be relevant you must identify
the risks and the assertions for transactions and balances.

Reflect and discuss

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You own a business (75% of the share capital) that through hard work has grown into a large
business and you issued additional shares (25%) to help finance its growth. You are no longer
involved in the day-to-day running of the business but have appointed competent people to run
the business on behalf of you and the other shareholders. You also wish to expand your business
into the rest of Africa and invest surplus funds in medium-sized companies that show growth
potential.
Reflect and discuss how you would like the finance and investment business process to be
managed so that your business does not lose profits due to fraud or bad business decisions.
Example
Good planning through budgets, best financing decision methods, and so on.
Designing your substantive procedures to target risks and collecting sufficient appropriate audit
evidence to support the assertions makes good sense – but the auditor will not always know
where all the risks are hidden until some testing has been performed. The auditor has to consider
risks at financial statement level, at account balance level and at transaction level and then design
the audit procedures to target those risks, to be in a position to express an opinion of the AFS in
spite of the risks. Because the finance and investment business process involve huge amounts,
approval of such transactions by authorised persons is crucial.

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Assertions for the finance and investment business process

Study
Refer Auditing Notes chapter 14 under the heading THE AUDIT OF THE CYCLE (Responding to
risk at assertion level). It is very important that you notice there are assertions for transactions
(vouching) and related disclosures, as well as for balances (verifying) and related disclosures.
Transactions begin with approval, matching and inspecting source documents (details) and
vouching these source documents to the recorded amounts in supporting registers (e.g. fixed
asset registers and the general ledger). Usually the general ledger account for the finance and
investment business process has an opening balance (previous acquisitions); the transactions for
the year are added or deducted to arrive at the closing balance and this balance is reflected in
the statement of financial position.
In lesson 8.6 we dealt with the auditing of accounting estimates as part of collecting audit
evidence. One of the study references was Auditing Notes chapter 14 under the heading
AUDITING FAIR VALUE, for auditing fair value. Now you can see where it fits into the business
processes and why it is so important.

ACTIVITY 9.5.1
Describe the assertions for …

• share capital
• long-term loans
• finance lease liabilities
• property, plant and equipment
• investment in shares

FORMULATE SUBSTANTIVE PROCEDURES

Now that you have learnt the assertions for this business process, we are ready to formulate the
substantive procedures for transactions, balances and related disclosures. Remember
transactions are vouched (throughout the year) but a balance (at year end) is verified.
Transactions are like a video, while balances are like a snapshot. With the finance and investment
business process the transactions are so few; therefore, the transaction and balance components
are usually combined. You start with the opening balance, vouch the transactions and verify the
final balance.
Share capital

Study
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Refer to Auditing Notes chapter 14 under the heading AUDIT PROCEDURES – THE FINANCE
CYCLE, SHARE CAPITAL, to do the following activity.

ACTIVITY 9.5.2
You are the audit manager of ProRide (Pty) Ltd. You are provided with the trial balance
at year end, indicating that share capital amounts to R1,5 million (Cr).
Required:
Formulate the audit procedures to verify the share capital account at year end.

Long-term loans and finance lease liabilities

Note that both the long-term loan and finance lease liabilities have important accounting features
that you must apply from your accounting studies.

Study
Refer to Auditing Notes chapter 14 under the heading AUDIT PROCEDURES – THE FINANCE
CYCLE, LONG-TERM LOANS, FINANCE LEASE LIABILITIES.

ACTIVITY 9.5.3
You are the audit manager of ProRide (Pty) Ltd. You are provided with the trial balance
at year end, indicating that the long-term loans balance amounts to R550 000 (Cr)
(previous year R0).
Required:
Formulate the audit procedures to verify long-term loans at year end.
The above study reference will enable you to formulate the answer to the activity.

Property, plant and equipment

Study
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Refer to Auditing Notes chapter 14 under the heading AUDIT PROCEDURES – THE
INVESTMENT CYCLE, PROPERTY, PLANT AND EQUIPMENT.

ACTIVITY 9.5.4
You are the audit manager of ProRide (Pty) Ltd. You are provided with the trial balance
at year end, indicating that the property plant and equipment (PPE) balance amounts to
R1 550 000 (Dr) (previous year R550 000).
Required:
Formulate the audit procedures to verify PPE at year end.
The above study reference will enable you to formulate the answer to the activity.

Investment in shares

Study
Refer to Auditing Notes chapter 14 under the heading AUDIT PROCEDURES – THE
INVESTMENT CYCLE, INVESTMENTS IN SHARES.

ACTIVITY 9.5.5
You are the audit manager of ProRide (Pty) Ltd. You are provided with the trial balance
at year end, indicating that investments in shares at year end amount to R450 000 (Dr)
(previous year R150 000).
Required:
Formulate the audit procedures to verify investment in shares at year end.
The above study references will enable you to formulate the answer to all the activities.

Discuss your answer in the group discussion forum with your e-tutor and fellow students.

NOTE: In all the activities you had to formulate all the procedures but in the examination one or
two assertions may be examined (e.g. accuracy, valuation and allocation or presentation).
Therefore, read the question carefully.

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SUMMARY
In this lesson we identified the authorisation processes, source documents, supporting registers
and accounts that are relevant to the finance and investment business process. We also looked
at why this business process is different from the revenue and purchases (acquisition) business
processes. We identified the assertions but noted the difference between transactions and
balances (opening balance plus/minus additions/disposals [transactions] = closing balance).
Finally, we formulated the substantive procedures for share capital, long-term loans, finance
leases, property, plant and equipment and investments.

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 REFLECT
Reflect on the notes that you made and go back to the assessment criteria at the beginning of
this lesson. Make sure that you are able to achieve those outcomes before moving on to the next
lesson.

SELF-ASSESSMENT
After having worked through the lesson and the references to the prescribed study material,
determine if you are able to answer the following questions:

1. Formulate the assertions and substantive procedures for share capital and reserves;
long-term loans and finance leases; property, property plant and equipment’ and
investments.

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LESSON 10: OTHER CONSIDERATIONS
OVERVIEW

An audit opinion must be substantiated by sufficient appropriate audit evidence. In this lesson we
are going to look at the different forms of audit evidence that can be obtained based on additional
such as evidence produced by experts, evidence required for accounting estimates and related
parties.

Lesson Title
Relying on information produced by the work of a management's expert
10.1
(ISA 500)
10.2 Using the work of an auditor's expert (ISA 620)
10.3 Accounting estimates and related disclosure (ISA 540 (Revised))
10.4 External confirmations (ISA 505)
10.5 Written representations (ISA 580)
10.6 Related parties (ISA 550)

LEARNING OUTCOMES

At the end of the lesson, you should be able to

• Understand the role of management’s expert (ISA 500) and the auditor’s expert
(ISA 620) as part of the collecting audit evidence.

• Understand accounting estimates (ISA 540 (Revised)), external confirmations (ISA

505), and written representations (ISA 580) as part of the collecting of audit
evidence.

• Understand related parties (ISA 550) as part of the collecting of audit evidence.

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Lesson 10.1 Relying on information produced by a management’s expert (ISA
500)

Learning outcomes

After having worked through this lesson you must be able to

• Describe the considerations affecting the nature, timing and extent of the
auditor’s procedures when relying on the work of the management expert.

• Describe the auditor’s procedures in order to rely on the work of the

management expert.

INTRODUCTION
In this lesson we are going to look at a section of ISA 500 dedicated to the problem of how and
when to rely on information (audit evidence) produced by a management's expert. In a scenario-
based question, you must be able to identify or recognise when management has
employed/appointed an expert and what the auditor (you) must first do before you can rely on
such work. That is why it is so important to read between the lines of a scenario given in the
examinations. Therefore, you should read your scenarios very critically because valuable clues
(alert signals) are provided in the text.
A management's expert simply refers to someone employed or appointed by the client (and not
by the auditor) who possesses certain expertise/skills in a field other than accounting and auditing,
and whose work in that field is used by the client in the preparation of the financial statements. In
the next lesson we will learn about the requirements when the auditor uses his or her own expert.
Note the difference between a “management's expert” and an “auditor's expert”.

RELIABILITY OF INFORMATION PRODUCED BY A MANAGEMENT'S EXPERT

Clients pay for the services rendered by their experts and often they are on their payroll.
Sometimes their services are required on a contractual basis. You, the auditor, may want to use
or rely on the work performed by a management's expert to serve as part of your collection of
audit evidence. Although these individuals or firms may be regarded as experts in their fields, the
auditor cannot simply accept the expert's work at face value. You, the auditor, must still answer
the basic question: Can I rely on the evidence produced by this expert of the client? Before placing
reliance on the work of a management's expert (to use the information as part of your audit
evidence) you have certain responsibilities to perform in terms of ISA 500. In this lesson we are
going to learn about these responsibilities and considerations. Read ISA 500, paragraph 8, to
orientate yourself for the next activity.

ACTIVITY 10.1.1

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Let's assume your client manufactures anti-retroviral drugs (medication used for the
treatment of infection by retroviruses primarily HIV; see
https://www.sciencedaily.com/terms/antiretroviral_drug.htm) to sell to the local
pharmacies. Manufacturing anti-retroviral tablets is a complex process, and
consequently the company's inventory is in various stages– some is in raw material
form, some is in work in progress form (mixed raw materials, at varying stages of
completion) and some is in finished goods form (tablets). To assist in the valuation of
this inventory, a pharmaceutical valuation specialist, would be needed. The client
employs such a valuation specialist.

Study
1. May you use the work produced by the valuation specialist as evidence? Study ISA
500, par. 8, to answer the question.
2. Compile a list of things that you must first consider before you can rely on the
information generated by the valuation specialist. Structure your answer as follows:
– Competence and objectivity of management’s expert
– Understanding of the work of management’s expert
– Appropriateness of the work produced by management’s expert
Study ISA 500, pars. A48 to A59, to answer the question.
3. Assume that you intend to rely on the work performed by the valuation specialist
employed by your client. Describe the considerations affecting the nature, timing
and extent of your procedures when relying on the work of the valuation specialist
(management’s expert).
Study ISA 500, par. A47, to answer the question.
Would you be able to answer all the above questions if we were to ask them in the examination?
Reflect on these questions and answers. Do you understand the logic and see the bigger picture
why the auditor must consider all these things before relying on the work of a management’s
expert, before using it as part of your audit evidence?

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 SUMMARY
In this lesson the concept of a management’s expert was explained, and you were made aware
of the things that you as the auditor must consider in terms of ISA 500 before reliance can be
placed on the work of a management’s (the client’s) expert.

REFLECT
Reflect on all the notes that you made and refer to the learning outcomes as listed at the beginning
of this lesson and make sure that you can achieve these before moving on to the next lesson.

SELF-ASSESSMENT
After having worked through the lesson and the references to the prescribed study material,
determine if you are able to answer the following questions:

1. Describe the considerations affecting the nature, timing and extent of the auditor’s
procedures when relying on the work of the management expert.
2. Describe the auditor’s procedures in order to rely on the work of the management
expert.

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Lesson 10.2 Using the work of an auditor’s expert (ISA 620)

Learning outcomes

After having worked through this lesson you must be able to

• Describe the factors and implications justifying the need for using experts and
the extent of relying on the work of the different types of experts.
• Evaluate the adequacy of the work performed by the auditor’s expert.

INTRODUCTION
In lesson 10.1 we learnt about the requirements in terms of ISA 500 when the auditor intends to
rely on the work of a management’s expert. In this lesson we will examine the requirements that
ISA 620, on using the work of an auditor’s expert, specifies if and when you as the auditor,
wish to make use of an expert that you appoint. The auditor is not expected to be an expert in
other professions and sometimes the nature of a client’s business requires the opinion of an
expert. However, auditors cannot just appoint experts left, right and centre because they don’t
feel like applying their minds! That practice will simply raise the audit fee (someone must pay for
the expert) and unnecessary costs will make your audit firm uncompetitive, meaning no business.
Therefore, such an appointment must be justified. Also remember that the auditor is ultimately
responsible for the audit opinion and therefore the auditor is still responsible for the work
performed by the expert. So, you cannot just “pass the buck” and think you are done!
After studying this lesson, you (the auditor) must be able to determine whether or not it is
necessary to make use of an expert (auditor’s expert) and be able to determine whether or not
the work performed by the expert is adequate for your purposes (i.e. to obtain sufficient, relevant
and reliable audit evidence).
RELYING ON THE WORK OF AN AUDITOR’S EXPERT (ISA 620)
It is important that you recognise the difference between a management’s expert, which we dealt
with in lesson 10.1 and an auditor’s expert, which we will learn about now.

ACTIVITY 10.2.1
Define the term auditor's expert.

Study
ISA 620, par 6(a), to determine the definition.

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 ACTIVITY 10.2.2
Let's assume that you are the audit manager at an audit firm. Your client has been
sued by one of its major customers for a substantial amount for damages caused by
one of your client's products. Your client brushes it off as nothing serious, but your
professional judgement makes you think otherwise. You are therefore convinced that
you need the input of a senior advocate or senior council (SC) to help you to put a value
on a possible adjusting event.
Required:
1. Describe the factors that should be considered to determine whether or not to use
an expert. (Do you think you should make use of an expert in this case?)

Study
ISA 620, par 7 and pars A4 to A9, to answer the question.

2. Describe all the factors that you will consider to determine to what extent reliance
can be placed on an expert's work. (ISA 620, par A14, explains the concepts of
competence, capability and objectivity.)

Study
ISA 620, pars A15 to A20 to answer the question. As part of a question in the examination, you
may be asked to consider this, so always be aware of how to apply and integrate your knowledge.

3. ISA 620, paragraph 10, states: “The auditor shall obtain a sufficient understanding
of the field of expertise of the auditor's expert …”
This may be done through discussions with the expert. Formulate questions that you would ask
the expert to enhance your understanding of the expert's field of expertise.

Study
Study ISA 620, pars A7 & A22, to answer the question.

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If the question was changed to “Formulate substantive procedures”, how would you convert
your answer to be a substantive procedure?

4. ISA 620, paragraph 11, requires the auditor to agree on the terms and conditions
relating to the work of the auditor's expert. List the matters that may be agreed upon.

Study
Study ISA 620, par 11 and, pars A23 to A31, and the appendix to answer the question.

5. In the end you have to evaluate the adequacy of the expert's work. Describe how
you will assess the appropriateness of the expert's work.

Study
ISA 620, pars 12 – 13 and A32 to A40.
6. Are you required in terms of the ISA to make reference to the auditor's expert in the
audit report? Substantiate your answer.

Study
ISA 620, pars 14 – 15 and A41 & A42.

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 SUMMARY

Sometimes the auditor may need to appoint an expert to assist him or her with auditing a specific
transaction or balance or disclosure thereof. The auditor is still ultimately responsible for the audit
and, therefore, for determining whether or not the work of the expert is reliable and makes sense.
In this lesson you learnt about what to consider and how to evaluate the work of the expert in
terms of ISA 620.

REFLECT
Reflect on all the notes that you made and refer to the learning outcomes at the beginning of this
lesson and make sure that you can achieve them before moving on to the next lesson.

SELF-ASSESSMENT
After having worked through the lesson and the references to the prescribed study material,
determine if you are able to answer the following questions:

1. Describe the factors and implications justifying the need for using experts and the
extent of relying on the work of the different types of experts.
2. Evaluate the adequacy of the work performed by the auditor’s expert.

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Lesson 10.3 Auditing accounting estimates and related disclosures (ISA 540
(Revised))

Learning outcomes

After having worked through this Lesson you must be able to

• Define and analyse the concept of accounting estimates.

• Describe the formulation of the audit procedures for accounting estimates.

INTRODUCTION
In business, the accountant often has to make a prediction and pass an entry in the accounting
records, presenting and disclosing what cannot be measured/determined accurately (estimate).
These entries and disclosures are nevertheless essential to provide the reader of the annual
financial statements with a fair or reasonable representation of the financial results and financial
position. In our daily lives we estimate many things (e.g. when you plan a weekend away to the
coast you will estimate how much it will cost and then decide if you can afford to go or whether
you should postpone it until you have saved sufficient funds).
In this lesson we are going to learn how the auditor collects sufficient appropriate evidence
regarding accounting estimates made by management and the disclosure thereof. These
requirements are set out in ISA 540 (Revised) on auditing accounting estimates.
DESCRIBE THE NATURE OF ACCOUNTING ESTIMATES AND DEFINE TERMS
Before you can audit something, you need to understand what it entails. Let's start off by
examining the nature of accounting estimates.

Study
Study ISA 540 (Revised), paragraphs 2 to 9.

ACTIVITY 10.3.1
Explain the nature of accounting estimates and the effect they may have on the audit
process.

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 Reflect
Do you see that the applicable financial reporting framework plays a very important role in
accounting estimates (substantiate)? Therefore, you must know the disclosure requirements in
terms of International Accounting Standard (IAS 37). In addition, you must enquire from
management what their accounting policies are in terms of the relevant accounting framework.

Study
Study ISA 540 (Revised), paragraphs A1 to A7.

ACTIVITY 8.7.2
List 13 examples of accounting estimates. This exercise is important because from the
information given you must be able to identify a scenario that involves an accounting
estimate. When we call out “allowance for doubtful debts” while you are in a deep sleep
you must instinctively respond “ISA 540 (Revised)”!
We want you to study a couple of definitions. You will never be examined on definitions,
but they are nevertheless very important to enable you to understand the ISA – see
them as the terms of reference.

Study
Study ISA 540 (Revised), paragraph 12, highlight/underline the definitions and reflect on their
meanings.
RISKS THAT ACCOUNTING ESTIMATES HOLD FOR THE AUDITOR
Auditors like accounts that balance and that can be verified against a reliable source/s of
evidence. Accounting estimates have all the attributes of a potential surprise: they involve
conditions of uncertainty; they require judgement, and management bias plays a big role.
Therefore, the nature of accounting estimates immediately takes the auditor out of his or her
comfort zone. However, these fears can be overcome (managed) through collecting sufficient
appropriate evidence that will test that the accounting estimates are correctly recognised and
disclosed in the AFS at the correct amounts.
How does the auditor manage this risk? The first step in auditing accounting estimates is to
assess the risks involved in the particular estimate that has to be audited. Let's zoom into the risk
assessment procedures to help ease the auditor's nerves.

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Study
Study ISA 540 (Revised), paragraphs 13 to 15 and A19 to A63. The crux of these paragraphs is
that the auditor must identify the applicable accounting framework, understand how management
identifies accounting estimate transactions and how management calculates the estimate. In the
end, if everything makes sense to the auditor, he or she will be at ease. Study ISA 540 (Revised)
paragraphs 18 to 32, on how the auditor is expected to respond to assessed risks.
I also want you to refer to your financial accounting study material and revise IAS 37. You must
be able to integrate the accounting and disclosure requirements into this lesson. Do you see the
integrated bigger picture?

ACTIVITY 10.3.3
The following activity will take some time to do, but it is very important that you do it
right. Study ISA 540 (Revised), paragraphs A19 to A63, and formulate the steps and
procedures to be performed by the auditor to assess the risk of accounting estimates.
I will start with a couple, but you must complete the activity.
(1) Obtain an understanding of the requirements of the applicable accounting
framework.
(2) Hold discussions with management about how management has applied these
requirements relevant to the accounting estimate.
(3) Obtain an understanding of regulatory factors
(4) Obtain an understanding of the entity’s internal control relevant to accounting
estimates

THE AUDITOR'S RESPONSE TO THE RISK ASSESSMENT

ISA 330 requires the auditor to design and perform audit procedures with the nature, timing and
extent responsive to the assessed risks of material misstatement in relation to accounting
estimates at both the financial statement and assertion levels. That is why the previous activity is
so important. Our next step is to formulate the audit procedures to audit accounting estimates.
Auditing accounting estimates focuses on the correct accounting (fair value) as well as
presentation and disclosure.

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 Study
Study ISA 540 (Revised), paragraphs 33 to 36 and A137 to A144.

ACTIVITY 10.3.4
Let's assume your audit client accounts for a warranty provision on the products that it
manufactures and sells. The client provides you with the policies and calculations.
Required:
(1) Formulate the audit procedures to audit the value of the provision.
(2) Formulate the audit procedures pertaining to the presentation of the warranty
obligation.

Feedback on activity 10.3.4

1. Refer to Auditing Notes chapter 14 under the heading PROVISIONS, CONTINGENT

LIABILITIES AND CONTINGENT ASSETS, under the “Valuation” heading.
2. Refer to Auditing Notes chapter 14 under the heading PROVISIONS, CONTINGENT
LIABILITIES AND CONTINGENT ASSETS, under the “Presentation” heading.

SUMMARY
In this lesson we learnt about the nature of accounting estimates and how these can be
interwoven with IAS 37. We formulated risk assessment procedures and substantive audit
procedures to audit accounting estimates.

REFLECT
Reflect on all the notes that you made and refer to the learning outcomes at the beginning of this
lesson and make sure that you can achieve these before moving on to the next lesson.

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SELF-ASSESSMENT
After having worked through the lesson and the references to the prescribed study material,
determine if you are able to answer the following questions:

1. Define and analyse the concept of accounting estimates.

2. Describe the formulation of the audit procedures for accounting estimates.

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Lesson 10.4 External confirmations (ISA 505)

Learning outcomes

After having worked through this lesson you must be able to

• Define and analyse the concept external confirmations.

• Describe the formulation of the audit procedures for external confirmations.

• Describe the actions to be taken by the auditor when the client refuses the auditor to
send out a confirmation request; or no response to an external confirmation is
obtained.

INTRODUCTION
In lesson 5.1 (The theory of audit evidence), we looked at the various methods to obtain audit
evidence (e.g. inspection, observation). One of those methods was obtaining external
confirmations of information as a written response to the auditor from a third party. We also
learnt that external confirmations are more reliable than evidence obtained directly from the client
or oral confirmations. Because external confirmations sometimes render a more effective source
of evidence, we are going to learn how and when to use these.

EXAMPLES OF EXTERNAL CONFIRMATIONS

To use external confirmations effectively, we must first have some idea of when external
confirmations are most likely to be used. Now remember that you cannot request external
confirmations for everything (remember relevance!) – our aim is to use external confirmations
effectively during the audit. For example, you will not use an external confirmation to examine the
occurrence of the loan when you have the loan agreement, which is a more reliable source of
evidence.
When I use the term “effectively”, I mean that the auditor must use external confirmations that will
provide relevant and reliable audit evidence.

Reflect and discuss

Refer to any set of annual financial statements (AFS). You can google a company like Shoprite,
Pick n Pay or Woolworths if you like(. Now, from the AFS, identify the accounts that you think it
would be effective to audit by using external confirmations and then list examples of balances or
transactions that would be suitable for external confirmation.

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I hope you applied your mind and came up with examples – please add to the examples given
below.
Some examples would be bank balances, accounts receivables balances, loan balances,
inventory held by third parties, and related party transactions. Did you notice from your reflection
that external confirmations are mainly used to verify account balances? Study ISA 505, par A1.
They can also be used to confirm terms of agreements, contracts or transactions.

EVALUATING MANAGEMENT'S RESPONSE WHEN REQUESTING AN EXTERNAL

CONFIRMATION AND EVALUATING RESPONSES TO CONFIRMATIONS

Study
Study ISA 505, paragraph 6. Notice the type of categories of external confirmations. This
background knowledge is important to know because when I ask you, for example, to verify
accounts receivable, the terms positive and negative confirmations must immediately come to
mind. We will look at this in more detail in this lesson.
Study ISA 505, paragraph 7. This paragraph tells us how the auditor should go about using
external confirmations. This is important, and we are going to study it in more detail in a moment.
Study this section in the meantime so that you understand the overall process.
Study ISA 505, paragraphs 8 and A8 to A10. What on earth will you, the auditor, do when the
client refuses to allow you to send out a confirmation request? Tough one – you must know what
to do when this happens. Don't jump to conclusions and just say “qualify the audit report”. We
want to avoid a qualification.
Study ISA 505, paragraphs 10 to 16 and A11 to A25. Remember the auditor (you) cannot accept
audit responses at face value – you must still apply professional judgement to evaluate their
reliability.
When evaluating responses which just don't seem right to you, you must think further – think of
risks and possible fraud. The term professional judgement is often used in auditing literature and
is a complex phenomenon to study if you are a researcher. But in a nutshell, it means wisdom –
what humankind seems to lack. Think of grandparents – they have wisdom that they gained
through years of living experience. The auditor as a professional is expected by the public to apply
wisdom too. Professional judgement is gained through technical knowledge (all your studies) and
groomed during workplace experience. Therefore, while learning auditing, your aim must be to
accumulate wisdom and not merely pass an examination by “spotting” questions. Without good
foundations you will fall short in the workplace – and forfeit any potential career progress or
promotions.
What do you do if the response to the external confirmation raises doubt about its reliability? What
do you do when you receive no response to your request? What happens when the response to
the external confirmation provides you with an exception? This is very important.
You must be able to answer all these questions. You will find the answers in the above study
references.

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THE EXTERNAL CONFIRMATION PROCESS
In practice you will be required to plan the external confirmation process and you must be able to
explain this process, say to a trainee accountant at your auditing firm.

Study
Study ISA 505, paragraphs A1 to A7, and jot down or highlight the main steps to consider when
planning to use external confirmations.

ACTIVITY 10.4.1
Formulate the steps to be followed by the auditor when planning to use external
confirmations (when to use confirmations, selecting the appropriate confirming party,
designing the requests and follow up).

You will find the solution to the above activity in the above study reference. One thing that I want
to highlight is about considering the assertion being tested. Which assertions do you think an
external confirmation can test? To answer this question, you must think of what you are asking to
be confirmed!

APPLYING THE PRINCIPLES TO THE BUSINESS PROCESSES

You have learnt the theoretical underpinnings for using external confirmations. Let's now examine
how this knowledge is translated into the audit procedures.

Study
Refer to Auditing Notes chapter 10 under the heading SUBSTANTIVE PROCEDURES FOR THE
AUDIT OF TRADE RECEIVABLES with specific rerference to the sub-heading relating to the
Debtors Circularisation.
Refer to Auditing Notes chapter 10 under the heading SUBSTANTIVE PROCEDURES FOR THE
AUDIT OF BANK AND CASH with specific reference to the sub-heading Procedures (bank
accounts)

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Refer to Auditing Notes chapter 11 under the heading SUBSTANTIVE PROCEDURES ON THE
TRADE AND OTHER PAYABLES BALANCE with reference to the sub-headings of Assertion:
Accuracy, valuation and allocation and also under the Assertion: completeness (specifically the
bullet point relating to “If necessary obtain confirmations of balances directly from a sample of
creditors…”):
Notice how the external confirmation is used selectively when auditing trade payables – it is
different to trade receivables because you have trade payable statements, which are externally
generated.
Refer to Auditing Notes chapter 14 under the heading LONG-TERM LOANS with reference to the
sub-heading of Audit Procedures.

SUMMARY
In this lesson we learnt what ISA 505 has to say about when to use and how to plan when you
intend to use external confirmations. In addition, we learnt what to do if management does not
give you permission to request an external confirmation and what to do if there is an exception or
difference on the external confirmations. Finally, we looked at how external confirmations are
used when formulating substantive audit procedures. Reflect on the notes that you made.

REFLECT
Go back to the learning outcomes formulated at the beginning of this lesson and make sure that
you are able to meet those outcomes before moving on to the next lesson.

SELF-ASSESSMENT
After having worked through the lesson and the references to the prescribed study material,
determine if you are able to answer the following questions:

1. Define and analyse the concept external confirmations.

2. Describe the formulation of the audit procedures for external confirmations.
3. Describe the actions to be taken by the auditor when the client refuses the auditor to
send out a confirmation request; or no response to an external confirmation is obtained.

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Lesson 10.5 Written representations (ISA 580)

Learning outcomes

After having worked through this lesson you must be able to

• Define and analyse the concept written representations.

• Describe the formulation of the audit procedures for written representation.
• Describe the actions to be taken by the auditor when management refuses to provide
a written representation.

INTRODUCTION
Management is responsible for the fair presentation of financial statements. Written
representations remind management of this responsibility and also serve as useful audit evidence
to complement other evidence gathered during the course of the audit.

Study
Study ISA 580 and the relevant sections dealing with written representations in Auditing Notes
chapter 8.
Note the following:

• The objectives of the auditor with regard to written representations (ISA 580, par
.06).

• The definition of “Written representation” (ISA 580, par .07).

• The written representations to be obtained from management regarding their

responsibilities (ISA 580, pars .10–.12).

• The date and form of written representations (ISA 580, pars .14–.15).

• The auditor's response regarding doubt as to the reliability of written

representations and requested written representations not provided (ISA 580,
pars .16–.20).

• Including the obtaining of a written representation from management as part of your

substantive procedures in an examination often earns a mark. The following serves as
an example of an audit procedure dealing with a written presentation relating to the
valuation of the inventory balance which will earn marks in an examination: “Obtain a
written representation with regard to the inventory value as at year end”.

• We will never ask you to draft a written representation in the examination, but please
read Appendix 2 of ISA 580 so that you can see what it looks like in practice.
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SELF-ASSESSMENT ACTIVITY
Your client provides you with a written representation referring to trade receivables
(debtors) and informs you that there is no need for you to confirm the debtors balances
via external confirmation.
Required:
Comment on whether you would accept your client's request.

FEEDBACK ON SELF-ASSESSMENT ACTIVITY

A written representation is a written statement from a non-independent source and therefore
cannot be regarded as reliable evidence. Representations by management cannot serve as a
substitute for other audit evidence that the auditor could reasonably expect to be available;
therefore, I could not accept my client's request. With management’s permission, I would obtain
external confirmation of debtors balances.

SELF-ASSESSMENT ACTIVITY
A written representation referring to revenue is given to you, as the auditor of the
enterprise. However, you are unable to obtain sufficient appropriate audit evidence to
vouch the revenue figure, which is material in relation to the financial statements.
Required:
(1) Identify the matter that should be considered by the auditor based on the above-
mentioned situation.
(2) What would the auditor's action be if management refuses to provide a written
representation that is necessary in order to obtain sufficient, appropriate audit
evidence?

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 FEEDBACK ON SELF-ASSESSMENT ACTIVITY
(1) If the auditor is unable to obtain sufficient appropriate audit evidence regarding a matter
that has or may have a material effect on the financial statements and such evidence
is expected to be available, this will constitute a limitation on the scope of the audit,
even if a written representation from management has been received on the matter.
(2) If management refuses to provide the written representations needed, this constitutes
a scope limitation and the auditor should express a qualified opinion or a disclaimer of
opinion. ISA 700, 705 and 706 deal with audit reports and we will study these in lesson
11.

SELF-ASSESSMENT
After having worked through the lesson and the references to the prescribed study material,
determine if you are able to answer the following questions:

1. Define and analyse the concept written representations.

2. Describe the formulation of the audit procedures for written representation.
3. Describe the actions to be taken by the auditor when management refuses to provide
a written representation.

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Lesson 10.6 Related parties (ISA 550)

Learning outcomes

At the end of this lesson, you must be able to

• formulate the audit procedures to identify related party relationships and transactions

• discuss the possible effect of issues relating to related parties on the audit report

Introduction
What is a related party? Is it a big party where you and your cousins, brothers and sisters get
together and enjoy yourselves with plenty of food and drink, like in the Mafia movies? Obviously
not, but in a sense, it is a little like that – there is a form of family relationships involved. The
related party concept you will learn about refers to a business relationship. Related business
relationships are often formed in business because this makes good business sense: Think for
example of a holding company (the mother or father) and subsidiary (brother or sister)
relationship. But why, then, can a related party relationship be a problem for the auditor? The
holding company has more “say” or “influence” with regard to the subsidiary and might then
possibly influence transactions between the parties. Where this influence or control is abused and
manipulated for the purpose of carrying out illegal or unethical transactions, it becomes the
auditor’s problem, and the auditor must be on the lookout (be on the alert) for such transactions.
Just read the newspapers and notice how power and influence are often abused and most of the
time linked to greed (financial gain). Therefore, related party transactions can pose a high inherent
risk in the eyes of auditors leading to the identification of fraud risk indicators.
We represent this diagrammatically below. Do you notice that transactions can occur between
the holding company, its subsidiaries, and directors as well as between the subsidiaries
themselves?

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 SUBSIDIARY
1

DIRECTORS HOLDING SUBSIDIARY

2
COMPANY

SUBSIDIARY
3

You should remember that related parties are not limited to a holding company and
subsidiary relationships; it can expand to other relationships as well. We will elaborate on
this below and again in the lesson that discusses the Companies Act.

Related parties and need for the auditor

Related party relationships suggest control or influence exerted over the reporting entity.
However, keep in mind that being related in business does not necessarily imply that this
is wrong. The problem comes in when control and influence are exerted to benefit the
controller, and when it is no longer an “arm’s length transaction”. This happens when
there is some sort of illegal scheme behind the transaction. In other words, I am referring
to those transactions (illegal schemes) that you do not want the press to publish, because
you know they are wrong. For example, how can you sell the newly purchased luxury
company vehicle to the director’s spouse at cost less 80% and justify your action?

Study

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Read ISA 550, paragraph 2. Are you able to describe the nature of a related party
relationship and transaction to a friend? If you still do not understand, do your own
research by googling “related party transactions”.
The auditor must always be on the lookout (alert) for transactions that have a high risk
attached to them; they are often embedded in complex related party transactions. The
South African Revenue Service (SARS) also views related party transactions (e.g.
transfer pricing) as something to flag. When you complete the tax return for companies,
you will notice the questions SARS asks you in this regard. As you climb the career ladder,
do not get involved in or bullied into transactions that are not ethically sound; it is not
worth it – say “no way”.
Auditing does not happen in a vacuum – you must consider legal issues, risk, tax,
accounting and many other points that all play a role in producing the final product, namely
the annual financial statements. Always remember while studying your other subjects to
think laterally. Ask yourself: How can I integrate this knowledge into auditing? For this
lesson, you must be able to integrate IAS 24 (related party disclosures) into ISA 550.
Certain legislation such as King IV and the Companies Act requirements should also be
considered when studying this lesson.

Study

• Read IAS 24 and make sure that you know the fair presentation frameworks. Why
is this important? Because the auditor must form an opinion of the fairness of the
presentations and disclosures.

• Study the definitions in ISA 550.10 and ISA 550.A4 and A5 with a view to
understanding the concepts.

• Study the objectives of the auditor – ISA 550, paragraph 9. This is what your
responsibility as an auditor culminates in when you audit related party transactions.
Study them with the objective of making a short “I am responsible for” list in mind.

Reflect and discuss

Why do you think the auditor should be responsible for looking at related party
relationships and transactions during an audit?

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Now compare your reflection with ISA 550 (pars 3-7).

The auditor’s responsibility in related party relationships and transactions

Knowing why the auditor should be on the lookout for related party transactions, the first
question that comes to mind is: When will the auditor become aware of related party
relationships at a client? The answer: During the risk assessment procedures, where
the auditor obtains an understanding of the client’s business environment in order to
assess the risk of material misstatement (ISA 315 [revised]) and considers the possibility
of fraud (ISA 240). Therefore, there must be discussions among members of the
engagement team, enquiries directed to management, reviewing of policies and control
documents such as directors’ interest in contracts, pending litigation, and so on. In
addition, members of the engagement team should be directed to the importance of
maintaining professional scepticism throughout the audit regarding the potential for
material misstatement associated with related parties.

Activity 10.6.1

• Describe the steps that the auditor can perform to understand an entity’s related
party relationships and transactions as part of the risk assessment
procedures. Include the people that you would question (e.g. the internal auditors).
Reference to develop the solution: ISA 550, paragraphs 13 to 14 and A9 to A21.
• List all the possible documents or records such as entity income tax returns,
shareholder registers and significant contracts that the auditor can inspect that
may provide information about related party transactions and why you think those
documents may be useful. (CIPC searches are also useful.)
Reference to develop the solution: ISA 550, A22 and A23.
• List the examples of transactions that may be regarded as transactions outside
the entity’s normal course of business. These should be treated as a
significant risk. Keep in mind that you need to consider relevant terms,
conditions, and business rationale of the transaction and whether any of these
significant transactions outside the normal course of business have been
authorised and approved by management or those charged with governance.
Reference to develop the solution: ISA 550, paragraph A25.
• Describe the risk factors that could lead to the material misstatements associated
with related party relationships and transactions.
Reference to develop the solution: ISA 550, paragraphs A29 and A30.

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Equipped with the knowledge that you have gained from the above exercises, you are
now able to identify a related party transaction from a scenario and know where to look
for the evidence. You also know when to be alert and where to focus. This entails the
exercise of professional scepticism and you should understand the importance of
maintaining professional scepticism when planning and performing audit work on related
parties. Therefore, you are now able to formulate good audit procedures (i.e. specific
instructions to the trainee accountant). Remember to include ISA 550, paragraph 26.

Reflect and discuss

Let us assume that you formulated these good audit procedures to identify related party
transactions at a client and you identified that a material related party transaction does
indeed exist. What do you think the auditor must do next?

Study

Study ISA 550, A31 to A50. This is a lot of reading, but it is very important. Make a mind
map or decision tree to assist you with this section. Once you have completed it, compare
it with the above reflection and discussion.

Disclosure of related party relationships and transactions

Would you be able to answer all the above questions if we were to ask them in the
examination? Reflect on these questions and answers. Do you understand the logic and
see the bigger picture of why the auditor must consider all these things before relying on
the work of a management expert and using it as part of the audit evidence?
At the beginning of this lesson, I referred you to ISA 315 (revised) and IAS 24. This is why
your accounting knowledge is important.

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Reflect and discuss online with your e-tutor and fellow students

How would you feel about the following situation? Let us assume that there is a material
related party transaction at a client, but that it has been adequately disclosed in the AFS.
Will this related party transaction still bother you? Substantiate your answer.

Study

Study ISA 550, paragraphs A46 to A48 and A50.

Summary

In this lesson, we looked at the concept of related party relationships and transactions
and why these transactions are often loaded with risk. We also examined where and how
to look for these transactions. You learnt how to deal with such transactions and why
proper disclosure is so important (and the effect of non-disclosure).

Reflect
Reflect on all the notes that you made and refer to the learning outcomes listed at the
beginning of this lesson. Make sure that you have achieved these before moving on to
the next lesson.

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Self-assessment

After working through the lesson and the references to the prescribed study material,
answer the questions that follow.

1. Formulate the audit procedures to identify related party relationships and

transactions.
2. Discuss the possible effect of issues relating to related parties on the audit
report.

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4 SELF-ASSESSMENT QUESTIONS

4.1 Introduction
This section contains questions on the lessons included in this tutorial letter. The
suggested solutions to these questions are available the next section of this tutorial letter.
Please note that these questions only cover certain aspects of the study material and
prescribed textbook. This does not mean that the areas that are not covered are less
important. All the study material in the various lessons is of equal importance.
Please take note that most of these questions are included to give you practice on
answering questions on important principles that we have covered in lessons 8 to 10.
Certain questions are integrated with the information that you have already studied in
TL103 and TL104. These questions will assist you in practising questions of an integrated
nature. Integrated questions will be placed on myunisa throughout the year.

4.2 Important principles to remember when answering a question

The following table contains important principles to remember when answering a
question:

Principles of importance
when answering a Detail guidelines
question
Question • Read the “required” section thoroughly.
• Make sure that you understand what is required from
you.
• Identify the theory applicable to the question.
• Read the text-section (case study/scenario) of the
question carefully.
• Make notes, write down thoughts and underline
important words, keeping the theory in mind.
• Understand the given situation in the question.
• Search for relevant information/answers in the
question, in other words, don’t do a “memory dump”.
Apply your knowledge and theoretical principles to
the information provided in the question.
• Use the mark allocation as a guideline to determine
how many points should be written down.
Layout • Make sure that you answer a question in the
requested format, for example a letter,
memorandum, table, etc. Marks will be allocated for
using the required format.

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Principles of importance
when answering a Detail guidelines
question
• If no specific layout of the question is prescribed,
your answer should be presented as follows: use
- bullets; or
- numbers; or
- appropriate headings/sections.
• If possible, leave lines open between the different
headings and sentences.

Language • A high standard of language usage should be

maintained, for example, instead of “look” use
ABCD “inspect” or instead of “hear”, use “enquire”.
• Do not use “SMS” language.
• Do not use abbreviations that are not generally
accepted.
Handwriting • Take note that your handwriting should be neat and
clear.

Time • Answer all the questions.

• In order to apply time management, you should keep
in mind that the available time in the examination is
limited to three hours for 100 marks. Therefore, 1.8
minutes are available to earn 1 mark, for example a
question of 20 marks should be answered in a
maximum of 36 minutes. Thus, it is easy to calculate
how much time you should spend on each question.
• With reference to the question section above and the
answer section below it means that you will have to
write down 14 valid points in 36 minutes to earn the
20 marks (this time-allocation only applies to
“describe” questions).
• Keep to the time calculated for each question.

Answer • Answer only what is required.

• Use and make the information provided in the
question applicable to the answer.

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 Principles of importance
when answering a Detail guidelines
question
• Provide clear and specific answers based on the
given facts and requirements of the question.
• Remember that marks will be allocated for logical
arguments, proper presentation of the facts, good
auditing language and clear facts.
• The number of points required per answer is
indicated by the marks allocated to the question. You
will earn 1 mark for each valid point which is properly
described.

COMMON MISTAKES
Let's look at some of the common mistakes that students make in the examination so that
we can train ourselves to avoid them. It boils down to not formulating the procedures
properly and not being relevant:

• Students often formulate generic audit procedures and do not make them
applicable to the scenario (memory dump).

• Students do not make the procedures applicable to the scenario – no marks can be
awarded for these types of procedures.

• Students often elaborate too much on one issue and forget to cover all the relevant
issues.

• Students often don't manage their time properly and are therefore unable to cover
all the relevant issues.

• Students' knowledge of the business processes is often not up to standard and they
then find it difficult to identify and deal with all the issues.

• Students often battle to link the audit procedures to the relevant assertions.

• Students often find it difficult or are scared to answer integrated questions and
therefore struggle to incorporate their knowledge of the other subjects into their
solutions.

• Students often find it difficult to determine whether they need to discuss the class of
transaction and related disclosures or account balances and related disclosures
assertions or both.

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Suggestions about answering substantive testing questions

(1) Substantive testing questions could require candidates to describe audit
procedures to audit all or specified assertions related to

• a class of transactions and events, and related disclosures

• account balances and their related disclosures

(2) Make use of assertions to serve as subheadings, for the following reasons:

• It is a framework from which you can develop a mind map. It helps you
to structure your answer.
• It enhances the presentation of the suggested solution and therefore
earns presentation marks.
• It ensures that your thoughts remain focused.
• It ensures that all appropriate assertions are dealt with.

(3) You will often be required to describe substantive procedures to test a specific
assertion only, in which case you should take care to relate your answer to the
required assertion only. When a question is silent on this, your answer should
deal with all the relevant assertions.
(4) When detailed procedures are required it is not sufficient to state “Perform cut-
off tests” as a procedure. You have to describe in detail the cut-off procedures
which you will perform. Look at the detail that will be required.

For purchases For sales

Note number of last goods received Note the last delivery note number for
voucher (GRV) for year during your the year during your attendance at the
attendance at the inventory count. inventory count.

Confirm by means of inspection that the Confirm by means of inspection that the
10 GRVs before the last number for the 10 delivery notes before the last number
year are included in the current year's for the year are included in the current
creditors journal. year's sales journal.

Confirm by means of inspection that the Confirm by means of inspection that the
10 GRVs after the last number for the 10 delivery notes after the last number
year are not included in the current for the year are not included in the
year's creditors journal. current year's debtors journal.

(5) If a question specifically requires you to deal with related disclosure

requirements, you should provide all the details as per the IAS statements.
When not specifically required, a general statement such as “inspect the
financial statements and accounting policies and confirm that these are in
agreement with IFRS” will be sufficient.

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(6) Analytical review procedures form part of substantive procedures, so do not
forget about them (ISA 520, pars 5 and A4 to A5). Also state that unexpected
fluctuations/ratios should be followed up. Name at least two examples of specific
relevant ratios that the auditor should calculate in the circumstances.
(7) Although this rule applies more to postgraduate auditing (you will earn bonus
marks in this module), it is important that you develop the ability to apply lateral
thinking while studying Financial Accounting, Management Accounting,
Taxation and the Companies Act. Therefore, when studying those subjects,

• visualise and note the accounting entries relevant to the

transactions/constituting the balance(s) given in the question
• note how the amounts of the accounting entries are calculated
• identify sources of evidence underlying the given
transactions/balances
• develop appropriate audit procedures by taking into account the
accounting entries and the appropriate sources of audit evidence

(8) Refrain from using statements such as “ensure”, “check”, “verify”, “see” “look”,
“confirm”, “consider”, “determine” and “assess” in your answers because they
usually don't lead to a description of audit procedures, but rather result in the
description of an assertion to be tested.
(9) If you are required to describe audit procedures you should describe them as
you would to a first-year trainee accountant. For example, if you tell him to
“check the ownership of vehicles” he won't know what procedures to perform.
You have to explain in detail: “inspect the registration documents and licences
and confirm that the vehicle is registered in the client's name.”
(10) Always identify source documents: “Reconcile creditor's balance with creditor's
monthly statement and goods received notes.”
(11) Where relevant, remember these general audit procedures that students tend
to forget:

• Recalculate castings and calculations of general ledger accounts,

annual financial statements, documentary evidence, reconciliations,
etc. Agree opening balances with closing balances on previous year's
working papers and audited financial statements.
• Follow applicable procedures when using the work of an expert.
• Test postings from the subsidiary ledgers to the general ledger.
• Agree the totals of lists (e.g. debtors age analysis or list of creditors)
with the general ledger account.
• Agree the balance of the general ledger account with the trial balance
and annual financial statements.
• Inspect minutes of meetings (management, board of directors, and
shareholders) for decisions taken, authorisation, etc.

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• Perform analytical procedures: give examples of ratios to be used.

• Refer to IAS statements regarding the accounting treatment, where
possible.
• Obtain/request from management:
• a signed written representation on the matter being audited
• attorney's letter
• bank confirmation letter
• For a first audit request access to the predecessor auditor's working
papers (with the client's permission) in respect of opening balances.
• Do overall review for abnormal items/exceptions in general ledger
accounts, subsidiary ledgers, etc
• Presentation and disclosure – inspect for compliance with the
following:
• IASs, IFRSs and accounting policies

(12) There's usually uncertainty about in how much detail an audit procedure
should be discussed. Use the following as guidelines:

• Examine the question properly, especially the “required” part, and

determine whether specific instructions are given.
• When instructions are not given – note the mark allocation of the
question to determine the extent of the answer required.
• Always start with general procedures.
• Determine whether the extent of your planned answer is comparable
with the marks allocated to the question.
• When your planned answer seems limited – expand it by including
more detailed procedures.
• When instructions are given – follow them.

(13) Make use of the information contained in the question (scenario). For
example:

• People mentioned, for example the “production manager”, should

agree quantities produced to budgeted production quantities. Do not
refer to the financial manager only.
• Documents mentioned should be included in your answer.
• Amounts provided should be used.
• Do not make unfounded assumptions.
• If assumptions are made, substantiate them on the grounds of
information which is given in the question and describe the relevant
assumption in the suggested solution.
• Give journal entries where applicable (e.g. as part of an audit
procedure to test the allocation of a transaction).

(14) Double-check your reasoning.

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 • Identify the general ledger accounts affected by a transaction in the
given scenario.
• Write out the journal entries – to ensure that you understand the
accounting treatment.
• Audit those entries from where they originated (measurement and
recognition) up to the point where they are presented in the financial
statements.

(15) Audit work already performed – outstanding procedures.

When a question requires you to describe further procedures, you should
base your answer on procedures that should normally be performed during the
particular stage of the audit, on the specified item, taking into account the
appropriate audit approach and the procedures already performed according
to the question.
(16) Describe additional procedures.
When a question requires you to describe additional procedures, your answer
should be responsive to significant risks described in the question: describe
procedures that should be performed in addition to the normal audit
procedures. Your answer should thus not merely include general audit
procedures.
Your answer may include normal audit procedures which should be extended,
and which should focus on specific shortcomings.

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4.3 Questions to be attempted as part of your preparation for the

examination
4.3.1 Non-integrated questions
QUESTION 1 10 marks
Your firm has been newly appointed as the auditors of Chemico Ltd, a wholesaler of
medically used chemicals. The period under review, for which you are responsible as
senior trainee on the audit, covers the year ended 31 August 20x9. The company has
one central warehouse and sells its products to distributors and large pharmaceutical
companies throughout the country. Inventory is a material figure on the trial balance.
Since this is the first time that your firm is performing the audit, permission was obtained
from the client to contact the predecessor auditors to obtain more information regarding
the opening balances. The previously appointed auditor simply informed you that he was
pressed for time and had to rush the 20x8 audit. He is therefore reluctant to allow you to
review the 20x8 audit working papers. This has immediately made you wonder how
reliable the opening balances are and why the auditor has issued an unmodified audit
report.

Inventory
While visiting the central warehouse of Chemico Ltd you established that perpetual
inventory records are maintained. Goods received notes and invoices are used to capture
inventory movements. While discussing the date and time to perform the physical annual
inventory count, the store manager informed you that the predecessor auditor has never
attended the inventory count.
REQUIRED
1.1 Discuss your concerns associated with the work performed by the
predecessor auditor on the current audit. You are also required to discuss
the potential effects on the current audit. 10

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QUESTION 2 12 marks
You are the newly appointed audit senior of Ice Is Nice Ltd (IIN), an existing audit client
of ABC Auditors. The financial year under review ended on 30 April 20x9. IIN is a large
ice cream manufacturer and sells ice cream to 70 grocery stores throughout South Africa.
IIN operates from one central factory and warehouse situated in Johannesburg.
RELYING ON INFORMATION PRODUCED BY A MANAGEMENT’S EXPERT
IIN manufactures various flavours of ice cream whereby raw materials are converted into
a finished product with fixed and variable overheads. It is not a complex process to
manufacture ice cream; and the process can be easily understood by observing the
production process. IIN employs a registered production engineer, Mr Mechanic, on a
contractual basis. Mr Mechanic has been a contract worker for five years and is
responsible for certifying and calculating cost pricing of the work in progress. The auditors
have set the risk of material misstatement of inventory at an acceptable level.
USING THE WORK OF INTERNAL AUDITORS
IIN has an internal audit department. In an attempt to keep the audit fee for upcoming
audits at an acceptable level, the partner who is responsible for the audit of IIN and the
audit committee of IIN has suggested that the auditors place more reliance on the internal
auditors.

REQUIRED Marks

2.1 With reference to the information included under the heading RELYING ON
INFORMATION PRODUCED BY A MANAGEMENT’S EXPERT:
Describe the aspects you will consider in determining the nature, timing
and extent of the audit procedures when relying on the work of the engineer, 6
Mr Mechanic.

2.2 With reference to the information included under the heading USING THE
WORK OF INTERNAL AUDITORS:
Describe six aspects you need to consider when determining the nature
and extent of work of the internal auditors that can be used. 6

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LESSON 9 – SUBSTANTIVE PROCEDURES: THE CONCEPTS

QUESTION 3 5 marks
Librarians Ltd’s (Librarians) main business involves the sale of books to various book
stores all over South Africa. You are the audit senior in charge of the audit of Librarians
for the year ended 31 December 20x8.
Sales
Librarians use an automated sales system. Based on your identification and assessment
of risk in the planning stage of the audit of Librarians, you decided to use a combination
of tests of details and substantive analytical procedures to obtain audit evidence of
Librarians’ sales total during the current financial year.
The financial manager of Librarians, Mr Jenkins, provided you with the following
information:

• Librarians’ financial statements and trial balance for the current and prior financial
year-end;

• Librarians’ budget for the current financial year-end; and

• Financial statements of other enterprises in the same operating sector with a

similar clientele.
REQUIRED
Refer to the information under the heading “Sales” and describe the analytical
procedures that you will perform during the audit of the sales of Librarians Ltd.
(Source: Unisa exam 2016)

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QUESTION 4 8 marks

You have been assigned to the audit of salaries on the audit of Libvest Ltd, a large listed
investment company. The company has approximately 15 000 employees, located in 78
offices around the country. As a result of information gathered when conducting
“identifying and assessing the risk of material misstatement” procedures, it has been
decided that a physical verification of employees country wide, should take place. You
have been requested to select a sample of employees for verification. All salaried
employees are listed in the salaried employees database. The masterfile contains the
following fields:
1. Surname and initials
2. Bank account number (salaries are paid by EFT)
3. Taxation Reference number
4. Identity number
5. Grade, e.g. grade 1 – company director, grade 12 – junior clerk
6. Permanent or temporary
7. Date of employment
8. Date of Resignation, Dismissal, Retirement
9. Home address
10. Work location – e.g. Cape Town office
11. Gross Remuneration
12. UIF
Your senior has instructed you not to simply extract a single statistically based sample
from the total population on the database. He requires that you use your audit software
to:
i) extract lists of employees (if any) whose records on the masterfile reveal
information which may raise uncertainty about their existence and
ii) to extract any other samples you might consider necessary to carry out a
successful physical verification.
REQUIRED
Identify the lists of employees and samples which you would extract to comply with the
instructions from your senior. Explain briefly why each list or sample would be selected.
(Source: Graded Questions on Auditing 2013)

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LESSON 10 – FORMULATING SUBSTANTIVE PROCEDURES FOR THE BUSINESS

PROCESSES

QUESTION 5 30 marks

You are the audit manager for the 20x1 audit of Thandi’s Garden Tools (Pty) Limited, a
manufacturer of standard garden tools. Their financial year end is 28 February 20x1 and
they have been your client for four years. The manufacturing process of garden tools is
not a complex process and can be easily understood by observing the production
process. The audit plan indicated no unusual risk of misstating inventory at the assertion
level.

You attended the client’s annual inventory count and are satisfied with the counting
procedures. You have a copy of the final stock count sheets and you are satisfied that the
descriptions and quantities provide a true reflection of the inventory count at year end.
The stock count sheets are computerised and reflect the following information: product
code with a description, quantity, cost price and selling price. The cost accountant
provided you with the costing records. Every garden tool has a blueprint with the exact
specifications (diagrams), product codes of raw materials used in the manufacturing
process and costing. From this blueprint the cost price of a trailer is determined and used
on the inventory sheets.

Thandi’s Garden Tools (Pty) Limited employs a registered production engineer, Mr

Mbeki, on a contractual basis. Evans has been a contract worker for five years and is
responsible for ensuring the accuracy of the blueprints and he also certifies the stage
of the work in progress. The cost accountant is responsible for costing the items.
Cost is determined on the first-in-first out (FIFO) basis. Direct costs of manufacturing and
a proportion of manufacturing overheads, based on normal operating capacity, are
included in the cost of manufactured goods

Inventories at cost on 28 February 20x1

20x1 20x0
R’000 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 Marks

Part 1
Describe the aspects that you will consider before relying on the work of the engineer.
(10)
Part 2
Describe the substantive procedures that you will perform to ensure that finished
goods are correctly valued at year end. (18)
Communication skills -presentation and layout. (2)

(Source: Unisa exam 2013)

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QUESTION 6 35 marks

Your audit firm is currently engaged in the 31 March 20x1 year-end audit of Environomics
Limited, a large manufacturing company listed on the JSE (Johannesburg Stock
Exchange). The company manufactures outdoor furniture from recycled plastics using a
“cold” process. Management is strongly committed to running the business efficiently and
simultaneously reducing greenhouse gas emissions by 40% over the next three years.
Management reported on these plans in the Corporate Responsibility Report that forms
part of the Annual Report. As a senior member of the audit team, you will be responsible
for overseeing the audit of current and non-current liabilities and to review the Annual
Report.
Your next task is to oversee the audit of non-current liabilities and to search for
unrecorded current liabilities.
In respect of non-current liabilities, you have been presented with the following
schedule:
Opening balance 1 April 20x1 R780 000
Add: New loan obtained from J S Wheeler (private investor) R250 000
Less: Current portion of non-current loans transferred to current liabilities R120 000
Closing balance 31 March 20x2 R910 000
Note: You may assume that Environomics Limited non-current loans consist only of
interest-bearing loans i.e. no capitalised finance leases, debentures etc are included.
The only procedures carried out so far on the audit that relate to the search for unrecorded
current liabilities are the following:
 The trade receivables’ listing has been cast and the total agreed to the general
ledger and trial balance.
 The trade receivables’ statements have been checked to the trade receivables’
listing to determine whether they have been included at the correct (not understated)
amount.
 The current year's trade receivables’ listing has been compared to the listing for the
previous year – no major variations were identified.
 A list of current provisions and allowances has been drawn up and tested for
completeness.

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REQUIRED Marks
6.1 Describe the procedures you would perform to satisfy yourself as
to fair presentation of non-current liabilities in the financial
statements of Environomics Limited at 31 March 20x2. (17)

6.2. Describe any further substantive procedures which should be

conducted to identify unrecorded current liabilities at 31 March
20x2. (16)

Communication marks (2)

(Source: Unisa exam 2010)

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QUESTION 7 12 marks

You are in the final year of your training contract at a large auditing firm. To allow you
to obtain the necessary practical training in terms of the SAICA training contract, the
engagement partner has allocated you to Signs4Africa (Pty) Ltd.
Signs4Africa (Pty) Ltd has been an existing client of the particular engagement partner
of your firm for a couple of years. The company is medium sized and mainly
manufactures signposts and banners. A major portion of the company’s income is
generated from the sale of traffic and road signs. Road signs are regulated in terms of
the Road Transportation Act 74 of 1977 that specifies inter alia, the size and colour of
road signs. The largest portion of trade receivables of Signs4Africa (Pty) Ltd therefore
consists of provincial and national road authorities.
The company’s financial year ended on 30 June 20x1. You started with the planning of
the audit on 15 May 20x1. You requested the most recent trial balance from the client,
and they e-mailed you the trial balance dated 30 April 20x1. From the trial balance, you
noticed that trade receivables and inventory are material amounts and that the bank
balance is in credit.
You phoned the credit manager of Signs4Africa (Pty) Ltd, and he told you that material
amounts are owed to the client by certain provincial authorities, some of which have
been outstanding for more than four months. On further discussions with him, you
established that a dispute has arisen between Signs4Africa (Pty) Ltd and one of the
provincial authorities. Signs4Africa Pty (Ltd) manufactured and invoiced road signs
which the provincial authority is refusing to accept and pay because these road signs
bear the names of towns and streets that have changed subsequent to the date of the
original order. The particular provincial authority is arguing that the name changes were
published in the Government Gazette and is therefore deemed public knowledge. During
April 20x1, Signs4Africa (Pty) Ltd has taken the provincial authority to court, but the
matter is still sub judice. Discussions with Signs4Africa (Pty) Ltd’s legal advisor revealed
that the case might be lost on technical grounds. You are not satisfied with this response
and feel that you do not understand the legal jargon.
In the meantime, the issue of the non-paying customer is creating major cash flow
problems for Signs4Africa (Pty) Ltd. The company holds its inventory securely at the
factory and comprises of work in progress, finished goods and raw material. The
computerised costing system used last year is still operative and is reliable.
Your task is mainly to devote attention to the more important areas of the audit. You will
also design substantive procedures for specific business processes, finalise the audit
and formulate the audit report. In assessing risks of material misstatements, your firm
uses a scale of low, medium and high.
REQUIRED 12 marks
Formulate substantive procedures to audit the allowance for credit losses (provision
for bad debts) at year end on an individual basis.

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QUESTION 8 24 marks

ABC Auditors has been newly appointed as the external auditor of Dentists-on-Call
Limited (Dentists-on-Call), a group of dentists who provide professional dental care to
patients. The company’s year-end is 30 June. You are a senior member of the audit team
performing the audit for the 20x1 year-end.

TRADE RECEIVABLES

Dentists-on-Call uses an online booking system to allow prospective/existing patients to

make dentist appointments online only.

Patients and/or parents/guardians of prospective patients of younger than 18 years who

wish to make appointments on Dentists-on-Call’s website are first required to register
online.

Dentistry services are provided only to patients who are registered with a medical aid and
to private patients (i.e. patients without a medical aid) who must pay a deposit upon
registration on the company’s website. The credit limit for each online registration is
automatically set at R10 000.

Patients who are registered with a medical aid are required to settle only the amount (if
any) that will not be covered by the medical aid, within 30 days after the dentist
appointment. Mrs Ouch, the accountant, sends the bills to the medical aid and claims the
outstanding amount directly from the patient’s medical aid. For private patients, the
deposit is set off against the total amount invoiced, and the balance is payable within 30
days after the dentist visit.

The accounts receivable balance in the financial statements of Dentists-on-Call is

approximately R850 000. The following information is available regarding Dentists-on-
Call's revenue and accounts receivable system:

1. Performance materiality for the accounts receivable balance is calculated as R400

000.

2. Dentists-on-Call's revenue and accounts receivable system is fully automated. The

audit team has decided to use computer-assisted audit techniques (CAATs) to
perform the necessary substantive procedures.

3. The accounts receivable master file contains the following fields for each debtor
(patient and/or person liable to settle the patient’s account):

- Account number.
- Name.
- Address and contact details.
- Total amount owed at the beginning of the financial year.

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- Total amount owed at the end of the financial year.

- Total amount aged: current, 30 days, 60 days, 90 days, 120 days and over.
- Credit limit.
- Credit terms.

4. The accounts receivable balance at year-end was reduced by the allowance for
credit losses (doubtful/bad debt). The allowance for credit losses is based on a
percentage of the total amount owed by debtors. The same percentages are used
each year.

5. A positive debtors circularisation letter was sent to each debtor (patient and/or
person liable to settle patient’s account) and ABC Auditors received responses from
all debtors.

REQUIRED

Formulate the substantive procedures that you will perform with the assistance of
only computer-assisted audit techniques (CAATs) for the year ended 30 June 20x1
in order to obtain sufficient, appropriate audit evidence for the existence and
accuracy, valuation, and allocation of Dentists-on-Call 's trade receivables and the
allowance for credit losses (doubtful/bad debt) balances at year-end.

Examination tip: Start your sentence with “Use CAATs to ...”.

Exclude any procedures related to presentation and disclosures, as well as the debtor’s
circulation letters. (22)
Communication skills – clarity of expression in formulating substantive procedures. (2)

(Source Unisa exam 2017)

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QUESTION 9 17 marks
You are the audit manager at an audit firm in Polokwane. The client for whom you have
to conduct an audit is Green Growth (Pty) Ltd (GG), a medium-sized company showing
growth potential. You are responsible for the audit for the financial year ending 31
December 20x8.
GG manufactures and sells liquid fertilisers to wholesalers on credit. Although the
manufacturing process is complex, the product is claimed to be environmentally friendly
and GG has the potential of becoming an international supplier.
All sales are on credit to approved customers, and transactions are initiated once a
customer order has been received. When an order is the received, an invoice is prepared
in triplicate consisting of white, yellow and blue copies. Before picking the goods from the
store, the warehouse clerk is presented with a picking slip (which is the yellow copy of the
invoice). The customer signs the delivery note on receipt of the goods (the blue copy of
the invoice). Sales are accounted for in the sales journal on the invoice date.
REQUIRED Marks
Formulate the substantive audit procedures you will perform to audit credit sales for the
year ending 31 December 20x8. (17)
(Source: Unisa exam 2015)

4.3.2 Integrated questions

NOTE: These questions demonstrate how questions are integrated with the topics
covered in TL102 and TL103.

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QUESTION 10 68 marks
BACKGROUND INFORMATION

Memories R Us (MRU) is an international photography company that specializes in

providing wedding photography services to world famous celebrities and business
individuals who have a high net worth.

The company has seven offices situated in Johannesburg, New York, Paris, Lagos, Hong
Kong, Melbourne and Rio De Janeiro. MRU employs 20 full time employees across its
international offices who are mostly responsible for carrying out administration and
marketing functions on behalf of the company. Most of the employees have been with
MRU since its inception and are considered to be the brains and magic behind the
company’s success.

Humble Beginnings
MRU was formed is 20x5 when photos that were taken at a celebrity wedding by MRU
chief executive officer (CEO), Ryan Smith, went viral on social media. As a result, more
celebrities started booking MRU because of the company’s high quality services. To cope
with the demand and to ensure that MRU could provide services to more celebrity
weddings, MRU started subcontracting its wedding contracts to other high profile
photographers. This model proved to be highly successful and within five years MRU saw
offices being opened across the globe.

Management
MRU is managed and 100% owned by Ryan Smith. Ryan holds a bachelor’s degree in
art and history as well a certificate in business administration. Ryan attributes his success
to his late father of whom he says “My father taught me everything I know about business.
He taught me never to fear failure and that the world rewards risk taking”.
Financial Performance
On average MRU has enjoyed a 30% year-on-year growth in net profit after tax. Net profit
before tax for the most recent financial year which ended 30 June 20x20, amounted to
R45 million. Cash and cash equivalents grew by 48% to R15 million for the same period,
mainly due to strong currency fluctuations. The company’s reporting currency is the South
African Rand.

REVENUE
MRU derives 80% of its revenue from wedding photography service contracts. The
remaining balance is made up of photographic products that are manufactured by MRU
and sold to clients as part of the said contracts (see working paper X5). All MRU contracts
are dollar denominated.

Salient contract features

MRU does not provide any wedding photography services and related products unless it
has concluded a final and binding contract with its client. For a contract to be final and
binding the following features need to be present:

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Contract field name Contract field description

Client_name The name and surname of the person responsible for payment

A unique identifier made up of the first three letters of the client

Contract_number
surname and the month and year of the wedding date.

Wedding_Date The date the wedding will be taking place.

Wedding_Venue Physical address of where the wedding will be taking place..

Number of photography service hours. Maximum allowable hours

Wedding_Duration
is 10 hours per day.

The amount chargeable per hour for photography services for

Wedding_rate one photographer. This rate is set yearly at the company’s annual
general meeting.

Relates to travel, accommodation and subsistence of the

Travel_fee wedding photographer for wedding venues falling outside a 50km
radius of the company’s offices for that location.

Relates to amounts charges in respect of products that form part

Product_Fee
of the contract.

Total amount to be paid by client. Includes the wedding rate,

Total_fee
travel fee, and product fee.

Deposit_payable 80% (minimum) standard deposit of the total fee.

Balance_payable Total fee less deposit paid.

The discount terms are as follows:

Discount_terms - 10% trade discount if the balance is paid seven days or

more prior to the wedding date
- 5% settlement discount if the balance is paid seven days
or less prior to wedding date
Interest of 10% per annum is chargeable from the first day after
Interest_terms
the wedding date on outstanding balances.

Relates to the type of services to be provided on the wedding

Services
date.

Relates to products that will be delivered to the client on the

Final_product
delivery date.

Delivery_date The final date by which final products must be delivered to client

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Once a contract has been signed by both parties the above information is recorded on
MRU’s client management and revenue system called Memoir. All fields that relate to
amounts are automatically calculated by the system. In addition, the system also records
the following information for reporting purposes:

Transaction_date The date on which a transaction takes place.

The following codes are used to identify the

nature of the transaction:

01 = Deposit payment
Transaction_type_code
02 = Balance payment

03 = Discount

04 = Interest

The distance between the wedding venue

Travel_kilometers
and MRU’s offices

MRU provided you with an electronic copy of the wedding contract revenue schedule
which consist of a listing of each contracts’ revenue. The audit team was also provided
with read-only access to Memoir to use to perform their audit procedures on.

In terms of the MRU’s memorandum of incorporation, any changes to the above terms
must be done in terms of a board meeting with a full quorum.

The Mill-Belinda Contract

Mill and Belinda Dates are the world’s richest couple with a net worth of over $150 billion.
After coming across MRU’s profile on social media, Mill and Belinda were so impressed
that they booked MRU to capture their lavish out-of-this world wedding for a total contract
fee of $800 000.

The terms of the contract were as follows:

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 Client name Mill Dates

Contract number DAT0620x20

Wedding Date 26 June – 2 July 20x20 (7 days)

Wedding Venue The La Roche (Dubai)

Wedding Duration 70 hours (10 hours per day)

Wedding rate $ 2 114.28

Travel fee $ 50 000.00

Product fee $ 10 000.00 (optional)

Total fee $ 800 000.00

Deposit payable 80% upon signing of contract

Balance payable 20% payable within 7 days of wedding

Discount terms 15% trade discount if balance is paid 7 days or more prior
to the wedding date

Interest terms Interest of 10% per annum is chargeable from the first day
after the wedding date on outstanding balances.

Services Wedding photography by 5 photographers

Final product All the images from the wedding in digital format.

Mill and Belinda have the option of requesting MRU to

produce 200 glossy photo magazines with pictures from
their wedding for their guests at price of $10 000. The couple
can also add any other pictures that are sentimental to their
relationship. If the couple does not use MRU, they can easily
obtain the magazines from another company since they
already have the pictures in digital format.

Delivery date 31 August 20x20

The contract was signed by both parties on 1 February 20x20. On this same day the full
contract fee amount was paid by the couple into MRU’s bank account. MRU recognised
the full amount as revenue (services rendered).

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WORKING PAPERS

CLIENT NAME MRU YEAR END 30 June

20x20 X5
AUDIT SECTION Impairment testing – Inventory
Impairment of inventory seeks to ensure that an entity's assets are not carried at more than
their recoverable amount. Entities are required to conduct impairment tests where there is
an indication of impairment of an asset.

Write-down to net realisable value (NRV)

NRV is the estimated selling price in the ordinary course of business, less the estimated
cost of completion and the estimated costs necessary to make the sale.

Impairment

Impairment tests over all inventory balances revealed an indication of impairment over the
finished goods inventory balance only. Events or conditions that may indicate impairment
comprise, inter alia, damaged goods and slow moving goods.

Extract from the notes to the financial statements

Inventory

Description Notes 20x20 20x19

R’000 R’000

Raw materials 1 500 360

Work in progress 2 120 150

Finished goods 3 50 80

670 590

Notes
1
Raw material relates to materials used to manufacture photographic paper, photo magazines and
photobooks.
2
Work in progress (WIP) relates to uncompleted photographic paper, photo magazines, photobooks at
year end. WIP is determined using the stage of completion method at year end.
3
Finished goods include direct costs, labour costs and appropriate allocation of overheads. NRV for
finished goods is determined by a packaging manufacturing expert.

Audit Work performed

1. Obtained the NRV calculation from the managements’ expert. No further work has
been conducted.

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CLIENT NAME MRU YEAR END 30 June
20x20 C63
PREPARER Trainee DATE 5 July 20x20

REVIEWER Partner DATE 25 July 20x20

AUDIT SECTION Test of controls – subcontractors (payroll)

Description of the process

The following is an extract from the system description for the payroll of subcontractors.

Subcontractors are professional photographers hired by MRU to carry out its contractual
obligations with its clients.

Subcontractors are paid an hourly wage capped at 10 hours per wedding in line with the
company’s policy. The hourly wage rate differs from subcontractor to subcontractor
depending on the level of experience and international recognition and is approved by
MRU’s board at the beginning of each financial year. All travel related payments are paid
by MRU on behalf of the subcontractor. Subcontractors are paid monthly on the last day of
the month.

Payroll preparation for subcontractors is done through the use of a system called PayMe.
To obtain access to the software, each user has to enter their unique username and
password. Controls in respect of passwords include that all passwords should consist of
eight characters, comprising a combination of symbols, numeric digits and alphanumeric
characters. Passwords must be changed on a monthly basis and the system must log off
after three unsuccessful access attempts. Activity reports of access gained, unchanged
passwords and unsuccessful access attempts are generated on a daily basis and printed
to a printer that can only be accessed by the manager of the information technology
department.

Timekeeping and payroll preparation

In order to record hours, subcontractors are required to upload all the wedding photos taken
at the wedding onto the system. The system automatically detects the time stamps (time
the photo was taken) of the first and last photo to calculate the amount of hours to record.
The system automatically detects if the minimum number of photos are present. Each
subcontractor is required to upload a minimum of 2000 photos. The chief editor
automatically receives an e-mail after every upload. In response she performs a quality
check on the photos uploaded to ensure they meet MRU’s expectations. Once the quality
check is completed the chief editor authorises the upload by selecting the “authorise hours”
function. A monthly sequenced log is kept of all authorised hours and the log is reviewed
by Ryan Smith at month end. Ryan Smith signs the authorised hours log as proof that he
has reviewed it.

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The PayMe system automatically calculates the net wages (gross wages net of deductions)
and prepares the payroll. The chief financial officer (CFO) signs off the payroll after she has
compared the total hours on the payroll with the hours on a summary report produced after
every upload.

E-MAIL FROM THE CFO

To: Engagement Partner

From: CFO of MRU
Date: 3 July 20x20
Subject: Miscellaneous queries

Dear Audit partner

It has come to my attention that one of your audit trainees needs authorisation from
myself in order to send out a bank confirmation to verify our cash balances at year end.
As you know such information is very sensitive and I wouldn’t want to expose our bank
accounts just to anyone.
Question 1:
Can I obtain this information on your behalf and give it to you verbally?
Question 2:
If we are already providing you with written representation concerning our bank account
is it necessary to send out these confirmations?
Regards,
CFO

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 REQUIRED MARKS
SUB- TOTAL
TOTAL

1 With reference to the section dealing with Revenue:

a) Describe the risks of material misstatement at
assertion level relating to revenue for the year ended
30 June 20x20. 4 38

b) Suggest automated controls that MRU should have in

place to ensure that information captured on the 8
Memoir software is valid, accurate and complete.

Your answer should address ONLY the following fields:

• Wedding_date
• Contract_number
• Wedding_duration
• Travel_fee

Present your answer in the following format:

Communication - presentation
2
c) Describe the computer assisted auditing techniques
(CAATs) substantive audit procedures to obtain
sufficient appropriate audit evidence on CONTRACT 12
REVENUE for the year ended 30 June 20x20.

d) Describe the substantive audit procedures that you

will perform to obtain sufficient appropriate audit
evidence over Mill-Belinda contract revenue for the 12
year ended 30 June 20x20.
Limit your substantive procedures to the following
assertions:

• Occurrence
• Accuracy

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2 With reference to working paper X5:

a) Describe the shortcomings of the working paper in
terms of the requirements of audit documentation.
4 16
b) Draft a list of questions you will pose to management
in order to obtain sufficient and appropriate evidence
regarding the competence and objectivity of the 4
management’s expert.

c) Describe the additional substantive procedures you

would perform to obtain sufficient and appropriate
evidence over the accuracy of the impairment 18
expense for the year ended 30 June 20x20.

Ignore procedures that relate to the expert’s competence

and objectivity.

3 With reference to working paper C63:

Describe the substantive procedures you would perform to
ensure payments made to subcontractors are accurately
recorded for the year ended 30 June 20x20. Ignore procedures 8 9
that relate to CAATs.
Communication skills – clarity of expression
1

4 With reference to E-mail from the CFO, draft a memorandum in

which you respond to:
2 5
a) Question 1

b) Question 2
2
1
Communication skills – logical argument

TOTAL 68

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5 SELF-ASSESSMENT SOLUTIONS
5.1 Introduction
This section contains the solutions to the self-assessment questions which was provided in the
previous section of this tutorial letter. This does not mean that the lessons that are not covered
are less important.

5.2 Important principles to remember before you work through the

solutions
You must take note of the following important principles before you work through the answers of
the various questions:

• You must write out the answer within the required time.

• Mark your answer against the suggested solution.

• Take note of the mistakes/omissions made and correct your answer.

• When working through the solutions you must not study the solutions off
by heart. Rather try and understand how we got to that solution, then you
will be able to apply the principles to other questions as well.

• Make notes in the study material at the end of each study lesson of the
mistakes made and aspects to concentrate on to obtain marks.

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5.3 Suggested solutions to the self-assessment questions

5.3.1 Non-integrated solutions
QUESTION 1.1 10 marks

Concerns:

1. The predecessor auditor did not perform his work with due care. His actions could bring
the profession in disrepute. (1)
2. He was negligent and knowingly issued a false report. (1)
3. He did not adhere to the SAICA Code of professional conduct. (1)
4. I would have reported his conduct to SAICA and IRBA. (1)
5. Previous auditor is reluctant to allow you to access his previous working papers. (1)
6. Previous auditor did not attend physical stock counts. (1)
7. Pressed for time - work not performed properly (integrity). (1)
8. The predecessor auditor has issued an unmodified report while the financial
statements might be wrong. (1)

QUESTION 1.2 10 marks

1. Obtain the previous year’s financial statements (20x8) and agree the inventory figures on
the statement of financial position with the inventory opening balance (20x8) in the general
ledger. (1)
2. Agree the inventory opening balance (20x9) in the general ledger with the value of the
inventory indicated on the perpetual inventory list of 31 August 20x8. (1)
3. Perform valuation procedures on the perpetual inventory list 31 August 20x8:
• Trace suppliers’ invoices to cost price on perpetual inventory lists and applied in
terms of cost formula. (1)
• Test arithmetical accuracy on lists (quantity x cost price). (1)
• Test selling prices against price lists of 31 August 20x8 or sales invoices. (1)
• Agree the selling prices to the cost prices used in the valuation of inventory to
ascertain that inventory was accounted for at lower of cost or net realisable value.
(1)
4. Review the reasons for credit notes issued during the first few months after 31 August
20x8 and any customer complaints received may also be inspected to determine any
obsolete or unusable inventory. (1)
5. Inspect the minutes of meetings for any large write down of inventory during the first few
months of the financial year. (1)
6. Inspect journal entries for any large write down of inventory during the first few months
of the financial year. (1)
7. Compare the gross profit percentages/inventory days per year for 20x8 with prior years’
and determine a trend. (1)
8. Perform cut off procedures: (1)
• Goods received notes: Test 10 entries before and after 31 August 20x8 that they
are appropriately included and excluded from the inventory records. (1)
• Sales invoices: Test 10 entries before and after 31 August 20x8 that they are
appropriately included and excluded from the inventory records. (1)
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9. Reconcile the units of the opening inventory of 20x8 to the current inventory count
of 20x9 by using the following formula: opening units (20x8) plus units purchased minus
units sold equals the units as per the 20x9 inventory count. (1)
10. As Chemico did perform an inventory count (‘the store manager informed you that the
predecessor auditor never attended the inventory count’); additional procedures could be:
• For a large sample of items on the inventory listing of 31 August 20x8, agree the
number of items on the listing to the physical count sheets of the inventory count
performed by Chemico. (1)
• Inspect the documented inventory count procedures (internal controls) to evaluate
to what extend reliance can be placed on the inventory count performed by Chemico.
(1)
• Compare these documented procedures to the actual procedures performed during
the 31 August 20x9 inventory count to determine if reliance can be placed on the
controls. (Compliance of procedures). (1)
11. Obtain a written representation that opening balances for inventory are correctly
reflected. (1)

Maximum 10 marks

QUESTION 2.1 6 marks

1. The risks of material misstatement of inventory are at an acceptable level. (1)

2. Alternative sources of audit evidence can be used like last years’ working papers and
analytical review procedures. (1)
3. The nature, scope and objectives of Mr Mechanic’s work should be relatively easy to
understand and can be verified through observing the production process. (1)
4. Hold discussions with Mr. Mechanic to familiarise yourself with the nature, scope and
extent of his work. (1)
5. Consider situations or events that may threaten Mr. Mechanic’s objectivity e.g. familiarity
with management; intimidation threats etc. (1)
6. Mr. Mechanic is employed by the entity on a contractual basis allowing scope for
independence compared to a permanent employee. (1)
7. On the other hand, management can exercise control or influence over the work of Mr.
Mechanic, so this could be a threat that should be kept in mind. (1)
8. Mr. Mechanic is a qualified engineer and possibly belongs to a professional society that
has ethical standards and therefore a certain amount of professionalism can be expected
from his work. (1)
9. The auditor has previous experience with this client and therefore with the expert and
would know if there are any risks. (1)
Available 9 marks
Limited to a maximum of 6 marks

QUESTION 2.2 6 marks

1. Consider the nature and scope of work to be performed by the internal auditors. (1
2. Consider if the work to be performed by the internal auditors is relevant to the external
auditor’s overall strategy and audit plan. (1)
3. Consider which areas of the audit involved significant judgements. (1)
4. Consider the degree of judgement needed to be exercised in planning and
performing audit procedures and evaluating audit evidence. (1)
5. Consider the assessed risks of material misstatement at the assertion level for

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particular classes of transactions, account balances, and disclosures. (1)

6. Consider if the internal auditors’ organisational status and relevant policies and procedures
adequately support its objectivity. (1)
7. Consider the level of competence of the internal auditors. (1)
8. Consider whether using the work of the internal auditors to the extent planned will still
result in the external auditor being sufficiently involved in the audit. (1)
Available 8 marks
Limited to a maximum of 6 marks

LESSON 8 – SUBSTANTIVE PROCEDURES: THE CONCEPTS

QUESTION 3 5 marks

Analytical procedures on the sales value of Librarians:

• Inspect the financial statements and trial balance and compare the sales total of this year
with the sales total of the prior year. (1)
• Inspect the current financial year end’s financial statements and trial balance and
compare the sales total with the budgeted sales total. (1)
• Inspect the sales total in the financial statements of the current year and compare to the
sales total in financial statements of other enterprises in the same operating
sector/similar clientele. (1)
• Calculate the gross profit margin of the current financial year and compare it to the
gross profit margin of the prior financial year. (1)
• Calculate the gross profit margin of the current financial year and compare it to the
budgeted gross profit margin. (1)
• Compare the increase or decrease in sales with the increase or decrease in debtors.
(1) If debtors increase and sales decrease follow up with management.
• If you are provided with the general ledger indicating the monthly sales, you may also
perform the following analytical procedure: Compare the sales on a monthly basis to the
monthly budgeted prediction of sales. (1)
• Follow up unusual fluctuations with management. (1)
Available 8 marks
Limited to a maximum of 5 marks

QUESTION 4 9 marks

1 mark for sample and 1 mark for explanation

As physical verification is part of testing for occurrence of salaries (i.e. fictitious employees), I
would select the following:

1. All employees who have the same bank account number as another employee. This is
abnormal so I would want to physically verify such employees (note: there may be valid
account sharing e.g. husband and wife).
2. All employees for whom there is
2.1 No tax reference number
2.2 No identity number

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 All employees should have a tax and identity number and it is possible that employees with
missing tax and identity numbers are fictitious.
3. A sample of temporary staff still on the database. It is easier to include “fictitious”
employees by “engaging” and “dismissing” temporary workers.
4. Any employees whose names and identity numbers or taxation numbers are identical.
It may have been deliberately listed twice.
5. A sample of employees from all locations in order to physically verify employees at each
location.
6. A sample of employees appointed during the year and who are still employed. There is a
higher risk that these employees were appointed fictitiously.
7. A random sample (or possibly a random sample after stratification by grade) of the entire
population. We need a representative sample but there are likely to be many more
employees in the grades say 8 to 12.
Available and maximum: 8 marks

QUESTION 5 10 marks

Part 1 – Relying on the work of an expert

1. Inventory composition is not too complex and by observing the production process with
the blueprints should not be a complex exercise. (1)

2. The audit plan indicated no unusual risk of misstating inventory at assertion level is
expected. (1)

3. However as per the auditing reporting schedule there is an uncertainty regarding the
company’s ability to continue as a going concern. (1) This would result in an increased
risk for the overstatement of inventory (assets) effecting the existence and valuation and
allocation assertions. (1)

4. Alternative sources of audit evidence can be used like last years’ working papers and
Analytical review procedures to substantiate the engineer’s finding. (1)

5. The nature, scope and objectives of Mbeki’s work is relatively easy to understand and can
be verified through observing the production process. (1)

6. Hold discussions with Mbeki to familiarise yourself with the nature, scope and extent of
his work. (1)

7. Consider situations or events that may threaten Mbeki’ objectivity e.g. familiarity with
management; intimidation threats etc. (1)

8. Mbeki is employed by the entity on a contractual basis allowing scope for independence
compared to a permanent employee. (1)

9. On the other hand, management can exercise control or influence over the work of Mbeki
so, this could be a threat that should be kept in mind. (1)

10. Mbeki is a qualified engineer and possibly belongs to a professional society that has ethical
standards and therefore a certain amount of professionalism can be expected from his work.
(1)

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11. As a registered production engineer Mbeki is likely to have the skills and competence to
carry out the task. (1)

12. The cost accountant performs the costing and discussions can be held with him to determine
if anything on the blueprint bothers him. (1)

13. The auditor has previous experience with this client and therefore with the expert and
would know if there are any risks. (1)

(Available14 x 1 = 14)
Maximum 10

Part 2 - Costing

1. Discuss the blueprints with Mbeki to obtain a general understanding of the diagram and
the costing. (1)

2. Observe the manufacturing process and establish the reasonableness of the components,
measurements and quantities as reflected the blueprints. (1)

3. Compare the blueprints (components, quantities & measurements) with previous years’
working papers to establish consistency in the costing and obtain explanations for any
variances. (1)

4. On a sample basis agree the number of the units on the final stock count sheets to the
number of units on the stock count sheets obtained during the inventory count at year end.
(1)

5. Scrutinise the final stock count sheets for any unusual items not reflected on the count
sheets obtained during the inventory count. (1)

6. On the blueprints perform the following tests to cost the trailers:

6.1 Raw material component:
• Agree the component codes and unit cost price used in the blueprints with those
reflected in the stock count sheets for the respective raw materials. (1)
• Trace the unit prices of components to the relevant supplier’s invoices (1) to
establish whether the correct prices have been used in terms of the FIFO cost
formula. (1)

6.2 Labour component

• Examine the labour hours used to manufacture a trailer model and compare the
number of hours with the previous years’ costing. (1)
• Agree the hourly rate used in the blue print with the hourly wage rate in the wage
records. (1)

6.3 Overheads
• Enquire from the cost accountant and Mbeki regarding the basis of allocation of
overheads and the reasonableness thereof. (1)
• Recalculate the allocated manufacturing overheads with reference to the approved
allocation basis and the use of accurate information pertaining to normal operating
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 capacity. (1)

7. Cast the costing in the blueprints(1) and agree the total of the unit price of a garden tool
model with unit price reflected in the stock count sheets(1).

8. Cast (adding) and cross cast the stock count sheets for finished goods (Quantity x unit
price). (1)

9. Trace the value of finished goods per the stock count sheets and agree it to the inventory
control account in the general ledger balance and trial balance. (1)

10. Agree the amount in the trail balance to the amount of finished goods disclosed in the notes
to the financial statements. (1)

11. Perform analytical tests (inventory turnover; gross profit percentages etc) and trend
analysis of component costing. Compare with corresponding figures of prior years. Obtain
acceptable explanations for deviations identified. (1)

12. Compare the selling price on the approved price list/invoices around year end with cost
price on the inventory list to ensure that it is higher than the cost price. (1)

13. 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 sales conditions/offers. (1)

14. Where selling prices are lower than cost prices, request management to make the
required adjustment to net realisable value. (1)

15. Inspect the stock count sheets for finished goods identified during the count as damaged
and/or obsolete(1). Discuss with management and write off where appropriate and trace
the journal entries to the general ledger(1).

16. Inspect the financial statements for the accounting policy with regard to inventory and ensure
that it is appropriate and applied consistently. (1)

17. Inspect financial statement presentation and disclosure that it is consistent with the
evidence collected and that the information is appropriately disclosed. (1)

18. Obtain a written representation with regards to the inventory value as at year end.
(1)

(26 x 1 =26 + 2 for communication and clear language use = 28)

Maximum 20 marks

QUESTION 6 35 marks

6.1Long-term liabilities

1 Obligation/existence

1.1 Obtain the loan agreement for the new loan obtained from JS Wheeler, and inspect for the
following:

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authorising signatures (both parties) (1)

authenticity (valid legal document) (1)

1.2 By inspection of the agreement and enquiry of the financial manager, confirm that the loan is
not contrary to any requirements of the company's articles of association, for example, loan
covenants, and that special authority required has been obtained, such as general resolution
from shareholders. (1)

1.3 Inspect the directors' minutes for the authority to enter into such loan contract. (1)

1.4 Confirm, in writing, the balance, terms and conditions directly with both JS Wheeler and the
other long-term creditors making up the balance of R910 000 plus the R120 000 of the current
portion. (1)

2 Valuation and allocation

2.1 Confirm the opening balance of R780 000 by inspecting the previous year's audited financial
statements and the general ledger/auditor work papers. (1)

2.2 Cast the schedule and the general ledger account. (1)

2.3 Agree the closing balance of R910 000 with the draft financial statements and general ledger
(may be reflected as [R910 000 + R120 000] in the general ledger). (1)

2.4 Confirm that the amount of the new loan is R250 000 by inspection of the loan agreement
and confirmation obtained from Wheeler. (1)

2.5 Trace receipt of R250 000 to the cash receipts journal. (1)

2.6 Obtain a breakdown of the current portion transferred to current liabilities. (1)

2.6.1 Confirm repayment terms by inspecting the loan agreements and confirmations to which
they apply. (1)
2.6.2 Recompute amounts to be transferred. (1)
2.6.3 Inspect loan agreements for any loans in respect of which a current portion has not been
transferred to confirm that this is the correct treatment. (1)

2.7 Confirm by inspection of the loan agreement that there are no terms which result in the
effective rate of the loan being different from the interest rate specified in the agreement, for
example, the loan being repaid at a premium (amortisation purposes). (1)

2.8 Inspection of dates on the documentation/agreement confirms that the loan was raised during
the financial year under audit. (1)

3 Completeness

3.1 Reconcile interest paid for the year on long-term loans to the loans reflected in the general
ledger. (If the interest appears overstated, it may be that long-term loans have been omitted.)
(1)

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3.2 Include representation concerning the completeness of long-term loans in the representation
letter. (1)

3.3 Obtain bank confirmation letters and compare the information with that which is recorded in
the accounting records. (1)

4 Assertions pertaining to presentation and disclosure

4.1 Inspection of the draft annual financial statements confirms that disclosures are accurate and
complete in terms of the Fourth Schedule and financial reporting standards. (1)

For example: R910 000 is reflected under long-term liabilities.

R120 000 is reflected under current liabilities.
The following details are correctly disclosed as per the relevant loan
agreements/confirmations:
Rates of interest, dates of repayment and amounts of repayment instalments (if applicable)
are disclosed.
Securities granted in respect of the loans are disclosed. (1)

4.2 Read the financials and confirm that the disclosures, for example, accounting policy note is
understandable. (1)

(Marks available 22x 1 = 22 marks)

Maximum 17 marks

6.2 Perform the following (additional) procedures

1 Completeness

1.1 Obtain the number of the last goods received note (GRN) made out for the year ended 31
March 20x2. Working backwards from that number, determine whether a corresponding
creditor had been raised on 31 March 20x2 for all goods received prior to that date. (Check
dates on the GRNs to confirm goods were received prior to 31 March 20x2). (1)

1.2 Inspect the date of delivery on the matching delivery note for a sample of GRNs dated after
31 March 20x2 for evidence that delivery actually took place after year-end and not before it.
(1)

1.3 Follow up, by enquiry and inspection, on any unmatched (to GRNs) invoices at 31 March
20x2 to determine whether goods or services had been received, for which a creditor should
be raised. (1)
1.4 Confirm with management that suppliers of services (as opposed to goods for which GRNs
should be made out) have been raised as creditors where services were supplied prior to 31
March 20x2 but no invoice was received, for example, lawyers. (Note: It may be the case that
GRNs have not been made out for services received.) (1)

2 Analytical procedures

2.1 Extract and analyse pertinent ratios for comparison with prior periods, for example, days of
outstanding creditors. (1)

2.2 Scan the creditors control account and follow up any unusual/ unauthorised debit entries.
(1)

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3 Post balance sheet procedures

3.1 Select a sample of large payments from the cashbook for (say) two months after year-end.

* For each payment, trace to the supporting documentation, in particular the goods received
notes and supplier delivery notes. (1)
* If the goods received note/supplier delivery note is dated prior to year-end, confirm by
inspection that the amount was included on the creditors list at year-end. (1)

3.2 Scrutinise the audit work papers for inventory and follow up on any items for which inventory
on hand materially exceeded inventory recorded. (The cause may have been the failure to
record the receipt of the inventory and hence the corresponding liability.) (1)

3.3 Refer to the work paper on long-term liabilities to confirm that the correct current portions of
all long-term loans have been included (see 2.6.3). (1)

3.4 Inspect the account headings under current liabilities for the inclusion of taxation payable and
provisions. (1)

4 Accruals

4.1 Obtain a schedule of accruals at 31 March 20x2 and compare to prior year schedule in audit
work papers for inclusion of all account headings such as rent, electricity, and wages. Follow
up on omissions. (1)

4.2 Inspect general ledger accounts for regular, that is, monthly or quarterly, expenses to
determine whether the expected number of debits has been made, for example, 12 rent
payments. (1)

4.3 Inspect the wage records/audit work papers to determine whether the accruals for wages
and/or leave pay have been included. (1)

5 Overall

5.1 Discuss all problem creditors (disputed), identified by enquiry and inspection of the creditors
correspondence file with management, paying particular attention to any creditors whose
balances have been omitted. (1)

5.2 Compare all the account headings appearing under current liabilities in the balance sheet at
31 March 20x2 to those of prior years and follow up on any omission. (1)

5.3 Consider circularising any creditors in respect of which you require further evidence regarding
completeness. (Note: This is not possible for creditors who have been completely omitted.)
(1)

5.4 Include reference to completeness of current liabilities in written representation from

management. (1)

( Available marks (18 x 1) = 18 marks)

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 Maximum 16 marks+2 Communication marks

QUESTION 7 12 marks

1. Enquire from management the policies and procedures followed to identify and write off
irrecoverable debtors. (1)

2. Obtain the list of individual bad debts identified by the client and cast the list. (1)

3. Identify additional bad debts from the trade receivables age analysis and perform the
following procedures:

3.1 Review correspondence with the debtor to identify valid disputes. (1)

3.2 Review attorney’s file for evidence as to the recoverability prospects of debtors handed
over. (1)

3.3 Review debtor confirmations received back for indications of disputes. (1)

4. Agree the individual balances on the list of bad debts to the relevant balances on the
trade receivables age analysis. (1)

5. Any long outstanding balance on the age analysis not provided for needs to be
investigated. (1)

6. Query balances provided as bad debts which are current (30-60 days). (1)

7. Discuss the recoverability of bad debts with the credit controller and with management.
(1)

8. Select a sample of trade receivables and test the correctness of the ageing of the
balances as reflected on the aged list of trade receivables by vouching to the sales
invoices and receipts to determine whether they have been allocated to the correct period.
(1)

9. Inspect receipts from trade receivables subsequent to the financial year end. Inspect
that these amounts are excluded from the list of bad debts. (1)

10. Add additional bad debts identified to the list after performing the above procedures.
(1)

11. Agree the final allowance to the journal entry and general ledger balance. (1)

12. Discuss the collectability with management. (1)

13. Obtain a written representation confirming the estimation of bad debts. (1)

14. Inspect the financial statements to confirm that the trade debtors balance appear as a
separate line item under current assets on the face of the statement of financial position,
net of impairments and that all required disclosures have been included. (1)

(Available 16x 1 = 16 marks)

Maximum 12 marks
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QUESTION 8 24 marks
Reference: Lesson 8.2 & 10.1

TRADE RECEIVABLES
Existence
1. Use CAATs to extract a sample of closing balances of debtors from the trade receivables
masterfile at year end and: (1)
• Compare these balances with the balances on the circularisation responses received
from these debtors. (1)
• Inspect bank statements electronically to confirm that payments are received after year
end for these debtors (e.g. download into excel and use “find” function). (1)
• Use CAATs to extract a list of the last sales invoices prior to year end including material
sales entered in June 20x1 and trace to the sales invoices and the online dentist
appointment system to confirm that the dentist appointment took place before year end
in order to confirm that the debtor balance exists at year end. (1)

2. Use CAATs to compare the masterfile of the current year end to the previous year’s
masterfile to identify new accounts (1). Trace these debtors accounts to their initial online
registration on Dentists-on-Call’s website to substantiate their existence. (1)

Accuracy, valuation & allocation

Gross amount
3. Use CAATs to recalculate/cast the total trade receivables closing balance in the trade
receivables masterfile. (1)

4. Use CAATs to compare the total trade receivables balance in the masterfile with the balance
in the debtors control account, general ledger and trial balance. (1)

5. Use CAATs to scan the masterfile for credit closing balances (negative values) (1) and
follow up to establish a reason. Inspect the journals in which these debtors have been
reversed and reclassified as liabilities in the financial statements. (1)

Existence/accuracy, valuation and allocation

6. Use CAATs to scan the master file and print an exception report for “error” conditions
such as … (1)
• duplicate account numbers (existence) (1)
• blank (missing) fields (e.g. no name, account number or address where there is an
amount in the total amount owed column (existence/valuation). (1)

7. Use CAATs to perform the following analytical procedures on the trade receivables
balance (1):

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 • Use CAATs to compare the closing balances of debtors in the current year with closing
balances of debtors in the previous year. (1)
• Use CAATs to calculate the average number of days outstanding of debtors and compare
with the previous years. (1)

ALLOWANCE FOR CREDIT LOSSES (also known as “allowance for doubtful/bad debts”)
8. Use CAATs to select a sample of debtors from the masterfile and test the ageing of
debtors by tracing the amounts owed to the source documents/evidence (online dentist
appointment system, invoices, receipts) to determine whether they had been allocated to
the correct period. (1)

9. Use CAATs to cast/ recalculate the allowance for credit losses (1) and
compare this value with the value in the general ledger and trial balance (1).

10. Use CAATs to compare the actual bad debts written off during this financial year with
the previous year’s allowance for credit losses to confirm that the allowance percentage
is reasonable. (1)

11. Use CAATs to extract long outstanding and material debtors who had exceeded their credit
terms (1).
{In the case of Dentists-on-Call all debtors should pay their accounts within 30 days.
Thus, all debtors should be extracted that have amounts in the 60 day and/or 90 day and
over field}

12. Use CAATs to extract a list of debtors who had total amounts owing which exceed their
credit limit (which in this case is R10 000) (1).

13. Use CAATs to extract a list of debtors who have a hold on their account (1).

14. Perform the following analytical procedures on the allowance for credit losses and follow
up with management (1):
• Use CAATs to calculate the allowance for credit losses as a percentage of sales of
the current year and the previous year and compare with each other. (1)
• Use CAATs to calculate the allowance for credit losses as a percentage of debtors
of the current year and the previous year and compare with each other. (1)
• Use CAATs to scan the age analysis of the current year and the previous year to
identify whether outstanding debtor balances are getting older. For example: Identify
whether there are more debtors with balances of 120 days and older in the current year
than in the previous year. (1)
• Use CAATs to compare the allowance of the current year to the previous year.
(1)
• Use CAATs to calculate debtors days outstanding and compare to the prior year.
(1)

(28x 1 = 28 + 2 for clarity of expression in formulating substantive procedures = 30)

Maximum 24 marks

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QUESTION 9 17 marks

Substantive procedures to audit credit sales

Reference: Lesson 9.1

1. Select a sample of transaction entries recorded in the sales journal and trace the
transaction to (occurrence): (1)
• A customer order (½)
• A picking slip and delivery note (½)
• An invoice, and (½)
• The invoice details were of goods sold by the client. (½)
2. Select a sample of invoices and for each invoice and confirm (Accuracy): (1)
• The mathematical accuracy of the invoice by recalculating extensions, casts,
discounts and VAT calculations. (1)
• The prices and discounts to official price lists and other relevant agreement
documentation. (1)
• That the invoice conforms to valid VAT invoice requirements. (1)
• Agree the quantity and description of the invoiced goods to the picking note (1)
3. Obtain the last document numbers of sales invoices and delivery notes used at year
end to (cut-off procedures): (1)
• Agree the cut-off numbers with the last entry in the sales journal. (1)
• Sequence test the last two weeks before year end for any missing invoice numbers
(none should be found). (1)
• Scrutinise the sales journal after year end for any invoices lower than the cut-off
invoice (none should be found). (1)
• Confirm by means of inspection that the 20 delivery notes before the last number
for the year are included in the current year’s sales journal. (1)
• Confirm by means of inspection that the 20 delivery notes after the last number for
the year are excluded from the current year’s debtor’s journal. (1)
• Select material entries in the sales journal after year end and trace them to the
supporting delivery notes to ascertain that they were not delivered before year end.
(1)
4. For classification tests:
• Agree the transfer amounts from the monthly sales journals to the sales and VAT
control accounts in the general ledger. (1)
• Scrutinise the sales account for the inclusion of amounts recorded as revenue but
do not constitute sales e.g. interest (1)
5. Perform analytical review procedures for trends and fluctuations (completeness) (1)
• Gross profit analysis (½)
• Sales prior periods (½)
• Sales trends prior periods etc. (max 1 mark for examples) (½)
6. Inspect the annual financial statements that the revenue accounting policy is clearly
expressed and understandable, and inspect that sales is correctly aggregated in the
statement of comprehensive income (one line) and correctly disaggregated in notes to
the financial statements (1)

165
 Available (1x 17 = 17 + ½ x 7 = 4½) = 21½
Maximum marks 17

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5.3.2 Integrated solutions

QUESTION 10 68 marks

REQUIRED 1

1. With reference to section 2 Revenue:

a) Describe the risk of material misstatement at assertion level relating to revenue for
the year ended 30 June 20x20.

Reference: Lesson 3

1 There is a risk of misstatement of revenue due to contracts being dollar (1)

denominated. This may result in incorrect translation to the rand.
2 As deposits are received in advance there is a risk that revenue includes income (1)
received in advanced for weddings taking place post year end.
3 There is a risk that revenue includes interest income on late payments. This (1)
should be included as other income.
4 There is risk that revenue is not reduced by the trade discount as all revenue (1)
amounts are recorded in full.
5 There is risk that revenue includes amounts in relation to travel. This should be (1)
recorded as other income.
6 There is a risk that revenue is not correctly classified and/or presented in the AFS (1)
between:
• Services rendered (1)
• Other income
Available 7
Max 4

b)Suggest automated controls that MRU should have in place to ensure that information
captured on the Memoir software is valid, accurate and complete.
Reference: Lesson 4

Field Name of control Automated control

1 Wedding_date Minimum keying ½ The software should ensure (1)
in of information.the date is entered using a
drop down menu calendar.
Missing data ½ The software should prevent (1)
field processing until this field has
check/mandatory been entered.
field

2.1 Contract_number Mandatory fields ½ The software should prevent (1)

processing until this field has
been entered.
167
2.2 Field size check ½ The software should ensure (1)
that field size consists three
alphabets followed by six
numerical digits.
Shading of fields ½ The software should (1)
automatically generate this
field by taking the first three
letters of the client surname
and the month and year of the
wedding date. This field should
be shaded with user unable to
change this field.
3.1 Wedding_duration Limit check ½ The software should (1)
automatically check that this
field does not exceed the
allowable 10 hours per day.
3.2 Alpha-numeric ½ The software should (1)
checks automatically check that only
numerals have been entered
i.e. no alphabets
3.4 Missing data ½ The field should prevent (1)
field processing until this field has
check/mandatory been entered.
field

Valid character ½ The software should prevent (1)

and sign check negative quantities from being
entered.
4 Travel_fee Dependency ½ The software should only (1)
checks accept input only if the travel
kilometers exceed 50km.
Reasonableness ½ The software should assess (1)
checks this field is reasonable when
compared to weddings at the
same venue.
Alpha-numeric ½ The software should prevent (1)
checks alphabets from being entered.

Valid character ½ The software should prevent (1)

and sign check negative quantities from being
entered.
Available 19½
Communication skills – layout 2
Max 8

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c) Describe the computer assisted auditing techniques (CAATs) you would perform in
order to obtain sufficient appropriate audit evidence over wedding contract revenue.

Reference: Lessons 8 and 9

1. Use CAATS to select a sample of contract revenue 1

2. Using CAATs cast and cross cast the wedding contract revenue schedule to ensure 1
its accuracy
3. Using CAATs examine the records for inconsistencies such as:
3.1Missing fields 1
3.2Fields with negative amounts 1
3.3Duplicate transactions 1
4. Using CAATs, search the Wedding_Date field for dates that fall post year end to 1
determine if these should not be excluded
5. Using CAATs, search the Wedding_Rate field for amount below or above the rate 1
approved the company’s AGM
6. Using CAATs, search the Wedding_Duration field for transactions which exceed the 1
maximum allowable hours per day (more than 10 hours). This could be an indication of
fictitious services.
7. Using CAATs extract the travel kilometers field which exceeds 50 and confirm that 1
those transactions include travel fees
8.Using CAATs extract exception report for transactions that have travel kilometers 1
less than 50 but travel fees have been included
9.Using CAATs, sort and stratify the records by:
9.1Location (wedding venue) to determine revenue by location as % of total revenue. 1
This will assist in selecting samples to be tested.
10.Use CAATs to sort revenue amounts from highest to lowest revenue amount per 1
contract to identify high risk value transactions.
11.Using CAATs recalculate:
11.1Total fee for all transactions 1
11.2Discount granted for transactions which were settled in full prior to wedding date 1
11.3Interest income for transactions which had outstanding balances after wedding 1
date
12.Using CAATs select transactions with code 02 to verify that:
12.1Balance payments for transactions which were granted discount took place before 1
wedding date
12.2Balance payments for transactions which incurred interest took place after 1
wedding date)
13.Using CAATS to determine sales only made to approved client. 1
Available 18
Max 12
Note: Marks are not awarded for analytical procedures as there was not sufficient
information given in the scenario and analytical procedures are not complete without
following up the deviations with management.

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d) With reference to the Mill-Belinda wedding contract revenue:

Describe the substantive audit procedures that you will perform to obtain sufficient
appropriate audit evidence over contract revenue for the year ended 30 June 20x20
Reference: Lessons 8 and 9

Occurrence and accuracy

1 Obtain written representation regarding the accuracy and occurrence of Mill- 1
Belinda contract revenue
Occurrence [IFRS 15:9]
2.1 Inspect that contract is signed by both parties on 1 February 20x20. 1
2.2 Inspect the contract for each party’s rights - Mill Belinda have right to receive 1
photography services, digital photos and 200 photo magazines
2.3 Inspect the contract for payment terms – 80% deposit upon signing of the 1
contract and 20% balance payable within 7 days of wedding date
2.4 Inspect the contract has commercial substance i.e. it is not a barter transaction 1
2.5 Inspect the MRU’s bank account for flow cashflows on 1 February 20x20. 1
Accuracy
3.1 Inspect the contract that total contract fee is $800 000 1
3.2 Inspect the contract for discount terms of 15% if payment is received 7 prior to 1
wedding date
3.3 Recalculate the transaction price - $800 000 less 15% trade discount = $680 1
000
3.4 Recalculate the stand alone selling price of the wedding magazine and 1
photography services as follows:
The stand-alone selling prices are as follows: 1
Wedding magazine= $10 000
Photography services and travel fees= $50 000 + (2114.28*70*5)
= $789 998
Total of the stand-alone selling prices $799 998
Wedding magazine
$680 000*10000/799 998 1
=$8500
Photography services and travelling
$680 000*789998/799 998 1
=$671 500
The number of days will be used to allocate the revenue.
On the 30th of June MRU is entitled to 5 days out of the 7 days.
$671 500*5/7
=$479 643
3.5 Obtain $/ZAR exchange rate on 30 June 20x20 from a reputable financial 1
institution
3.6 Recalculate the photography service and travelling revenue to be recognised for 1
the year ended 30 June 20x20
3.7 Request management to adjust the revenue in respect of Mill-Bellinda contract
as follows:
Dr Revenue $680 000 1
Cr Revenue received in advance $680 000

Dr Revenue received in advance $479 643 1

Cr Revenue – photography services $479 643

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3.8 Inspect the general ledger/trial balance/annual financial statements that the Mill- 1
Bellinda is included at the correct amount
Available 18
Max 12
Note:
• Where student indicates re-calculate the travel fees, no marks awarded any marks as
there is no information available to perform this.
Travel fees are not contract revenue, the question asked for the contract revenue on this
transaction. Travel fees are billed separately, and go to a separate account. This is a
classification issue, not required to be addressed in the scenario.
• Request Mill Belinda to confirm either in writing or email their balance of their contract -
this is done at year end for balances i.e. debtors’ confirmation.

REQUIRED 2

With reference to working paper X5:

a) Describe the shortcomings of the working paper in terms of the requirements of

audit documentation.

Reference: Lesson 3

1 The working paper does not indicate the name of the preparer. 1
2 The working paper does not indicate the date at which it was 1
prepared/completed.
3 The working paper does not indicate by whom it was reviewed. 1
4 The working paper does not indicate the date at which it was reviewed. 1
5 The working paper does not contain a detailed explanation of the audit 1
procedures performed.
6 The working paper does not contain the results of the audit procedures 1
performed (conclusion).
Available 6
Max 4

b) Draft a list of questions you will pose to management in order to obtain sufficient
and appropriate evidence regarding the competence and objectivity of the
management’s expert.

Reference: Lesson 10

1 What qualifications/memberships to a professional body does the expert hold? 1

2 What experience does the expert have in respect of similar work e.g. NRV 1
calculation of WIP for manufacturing companies
3 Does the expert have any financial interests in MRU e.g. shareholding, loans, 1
excessive fees etc.

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4 Does the expert have any past/present relationships with owners, management 1
or employees of MRU?
5 Does the expert have unrestricted access to information needed to carry out 1
their duties?
6 Are there any time pressures/unrealistic deadlines imposed on the expert in 1
carrying out their duties?
Available 6
Max 4

c) Describe the additional substantive procedures you would perform to obtain

sufficient and appropriate evidence over the accuracy of the impairment expense
for the year ended 30 June 20x20.

Reference: Lesson 8 and 9

1 Obtain written representation regarding the accuracy of impairment expense 1

2 Obtain impairment expense schedule from management:
2.1 Cast and cross cast for mathematical accuracy 1
2.2 Agree the total to the general ledger/trial balance/financial statements 1
3 Inspect the management expert calculation (NRV) and perform the following:
3.1 Enquire from the expert regarding reasonableness of assumptions used 1
3.2 Test the accuracy of source data used by referring to the source documentation 1
3.3 Re-perform the calculation using the same underlying assumptions and source 1
data
3.4 If material differences exist between the expert and auditor calculation, consider 1
the use of auditor expert
3.5 Agree costs to sell to supporting documentation e.g. invoices, quotations 1
3.6 Inspect the most recent selling prices for finished goods to assess 1
reasonableness of NRV calculation
4 Impairment calculation
4.1 Compare finished goods cost at year end to NRV calculated above and if cost is 1
greater than NRV
4.2 Recalculate impairment loss for the year = Inventory cost less NRV 1
4.3 Inspect impairment expense journal entry has been processed for the same 1
amount.
Available 12
Max 8

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REQUIRED 3

With reference to working paper C63:

Describe the substantive procedures you would perform to ensure payments made to
subcontractors are accurately recorded.

Reference: Lessons 8 and 9

1 Obtain a written representation regarding the accuracy of payments to 1

subcontractors
2 Obtain subcontractors payment schedule
2.1 Cast and cross cast for mathematical accuracy 1
2.2 Agree total per schedule to general ledger/trial balance/annual financial 1
statements
2.3 Agree payments per the schedule to bank statements 1
3 For a sample of payments perform the following: 1
3.1 Obtain authorised hours per PayMe system and agree them to payroll 1
3.2 Obtain wage rate as approved per minutes of directors’ meetings and agree to 1
payroll
3.3 Obtain most recent deductions tables (from SARS) and agree them to payroll. 1
3.4 Recalculate gross wages (authorised hours x approved wage rate) 1
3.5 Recalculate net wages (gross wages less deductions) 1
3.6 For each wedding inspect authorised hours that they do not exceed 10 hours 1
3.7 Inspect that payments/payroll does not include any travel related amounts 1
Available 12
Max 8
Communication mark 1

Note that the assertion for the payment of wages is accuracy.

Note: No marks awarded for the following
• Where students confirm any of the approval processes as this is not linked to accuracy
(except if linked to pint 3.2 on mark plan)
• We must only award marks for substantive audit procedures dealing with accuracy and
also, we stated that CAATS were not to be included.
• Test of controls/CAATS for which no marks awarded.

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 REQUIRED 4

With reference to Email from MRU Financial Director, respond to:

a) Questions 1
b) Questions 2

Reference: Lesson 5.1

Question 1:
1 The answer is no because: 1
2 Audit evidence is more reliable when it is obtained from independent sources 1
outside the entity. In this case the bank would need to provide the confirmation.
3 Audit evidence obtained directly by the auditor is more reliable than audit 1
evidence obtained indirectly or by inference. In this case we (the auditors) would
need to obtain it directly from the bank.
4 Audit evidence is more reliable when it exists in documentary form, whether 1
paper, electronic or other medium. In this case we cannot accept any verbal
confirmation, it needs to be in document format.
Question 2
5 The answer is yes because: 1
6 Although written representations provide necessary audit evidence, they do not 1
provide sufficient appropriate audit evidence on their own about any of the
matters with which they deal.
7 Furthermore, the fact that management has provided reliable written 1
representations does not affect the nature or extent of other audit evidence that
the auditor obtains about the fulfillment of management’s responsibilities, or
about relevant assertions.
Available 7
Communication skills – logical argument 1
Max 5

We wish you all the best with the rest as you write Test 3 and carry on with tutorial letter 105.
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UNISA 2024

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