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Caa 306: Auditing &Amp; Investigation Theory Question Paper
Caa 306: Auditing &Amp; Investigation Theory
Course:Bachelor Of Commerce
Institution: Kca University question papers
Exam Year:2009
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UNIVERSITY EXAMINATIONS: 2008/2009
THIRD YEAR STAGE II EXAMINATION FOR THE DEGREE OF
BACHELOR OF COMMERCE
CAA 306: AUDITING & INVESTIGATION THEORY
DATE: AUGUST 2009 TIME: 2 HOURS
INSTRUCTIONS: Answer All Questions
QUESTION ONE
You are the auditor of Tropical Garments Ltd., one of Kenya’s largest garment manufacturing
companies. Because of the size of the company’s operations, labour costs represent the major portion
of the company’s production costs for the year.
The managing director, Mr. Lawson, has consulted you concerning the company’s accounting systems
and systems of internal control. He is particularly concerned with the payroll system as the company’s
accountant, whose services were terminated last month, he had neglected his duties generally, and in
particular, had left the management of the payroll system totally to his junior staff.
The company employs approximately 300 workers in six (6) departments. Within the departments,
there are a number of supervisors each of whom is responsible for 10 to 20 workers. A portion
manager and his assistant are responsible for the overall operations of the factory.
The payroll cost is currently approximately Sh. 1,800,000 per week and Mr. Lawson suspects that
there may be a number of irregularities such as payments to none existent employees and/or the
payment of a full week’s wages to employees who took time off.
Initially, Mr. Lawson wanted you to criticize the company’s existing system, but he has now
requested you to design a new system from scratch. Owing to a shortage of resources, the company is
not able to:
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• Increase its administrative staff. At present there are four administrative staff, the accountant, an
accounts assistant and two clerks.
• Computerize the payroll system
• Outsource the preparation of the payroll (outsourcing is giving the work to an independent, third
party such as computer bureau)
• Establish a separate Human Resources function. At present the production manager and his
assistant perform this function. Mr. Lawson has already implemented the following controls.
o The production manager or his assistant approves the employment of new staff in writing.
A new employee form is used.
o The company obtains proof of identification such as a copy of each worker’s identity card.
o The employee’s normal hours of work are subject to an agreement between the company
and a trade union.
o Minimum rates of pay have been agreed with the trade union. The company generally pays
rates in excess of the required minimum rate of pay as agreed with union.
o Mr. Lawson approves all rates of pay increase in writing.
o The company issues workers with formal written contracts of employment, which are
signed by Mr. Lawson.
o The above documents are then sent to one of the clerks in wiring.
o Mr. Lawson has also mentioned that;
o Owing to pressure from the trade union, the company is forced to pay the weekly wages in
cash and cannot implement a system of payment by bank transfer.
o Employees are expected to work overtime from time to time.
o A merchandise time clock is located at each of the two entrances to the factory.
Required
Draft a letter to Tropical Garments Ltd in which you set out your recommendations for a suitable
system of internal control over the payments of weekly wages. (25 Marks)
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QUESTION TWO
You are the audit supervisor on the audit of RS Ltd., a company listed on the Nairobi Stock Exchange.
RS Ltd. sells building materials, plumbing supplies and ceramic tiles through its home improvements
retail outlets.
The results of operations and the financial position of RS Ltd. for the previous financial year as well
as the current financial year are summarized as follows:
Actual Year ended Budget Year ended
31 December 2003 31 December 2003
Sh. Million Sh. Million
Turnover 11,480 13,780
Profit before interest
and tax 1,270 1,500
Profit before tax 920 1,200
Profit after tax 630 800
Ordinary Shareholder’s
Funds 3,240 3,640
Total assets 5,500 6,000
You are currently planning the audit for the year end 31 December 2004. The following matters have
come to your attention during your review of last year’s working papers and the most recent
management accounts and during discussions with the financial director of RS Ltd.
1. MPH Ltd., the holding company of RS Ltd, is in financial difficult. MPH Ltd holds 50% of the
ordinary shares in issue.
2. RS Ltd. also has retail outlets in Tanzania, Uganda, Ethiopia and Sudan.
3. The managing director of RS Ltd., Mr. Peter Rush, has acquired an interest in a national car
hire business. It appears from discussions with the financial director of RS Ltd. are encouraged
to use this car hire company at all times. Car hire expenditure is a material component of the
operating costs of RS Ltd.
4. The RS Ltd.’s pension fund has a large surplus. During the current financial year, the company
has temporarily suspended its contributions to the pension fund.
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5. RS Ltd. made a loan to Mr. Peter Rush to purchase shares in the company. The financial
director intends to obtain repayment of the loan before the financial year end and to re-advance
the funds from the RS Ltd. share trust.
6. RS Ltd. is currently involved in a dispute. A customer is alleging that certain building supplies
purchased from the company were sub-standard and the customer is claiming damages of
Sh.50 million. RS Ltd. has rejected this claim. A preliminary trial date has been set for
February 2005.
During a discussion with Mr. Peter Rush, he offered to supply, free of charge, the bathroom tiles and
plumbing materials for the house you are in the process of building.
Required
a) Outline the potential audit risks apparent from the above matters and state briefly the audit
procedures necessary to address the risks you have identified. Detailed audit programme steps
are not required. You simply need to set out each of the issues that will need to be covered by
your audit procedures. (10 Marks)
b) Indicate what matters you need to consider, what steps you should take before responding to
the offer from Mr. Peter Rush. In addition state what you believe to be the appropriate
response to Mr. Peter Rush. (15 Marks)
QUESTION THREE
John Mwangi has recently asked your firm’s advice on whether to purchase Nathoo Merchants Ltd,
which is a small builders’ supply merchant. John Mwangi has previously been the proprietor of a
small do-it-yourself business (which is a similar trade to the builders’ supply merchant, but sells
mainly to individuals), and he has recently been left a substantial sum of money on the death of his
father.
Nathoo Merchants Ltd. sells:
1. Paint and decorating material
2. Hand tools and small electrical tools (for instance electric drills).
3. Electrical fittings, and
4. Building materials (bricks, wood, sand and cement).
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The current owner of Nathoo Merchants Ltd is retiring and is proposing to sell his business to John
Mwangi. Nathoo Merchants Ltd is financed by equity. Bank loans and overdrafts. There are no current
accounts or loan accounts between the directors and the company.
The audited accounts of Nathoo Merchants Ltd for the three years ended 30 April are available and
John Mwangi has asked you to carry out an investigation into whether the accounts are reliable. The
accounts of Nathoo Merchants Ltd have been prepared by the auditor. From your knowledge of the
auditor’s reputation and the weakness in the system of internal control in Nathoo Merchants Ltd, you
believe there may be material errors in the accounts.
In the year ended 30 April 2002, Nathoo Merchants Ltd had a turnover of 34 million. The company
operates from its own freehold premise and it sell mainly to small builders and some individuals. Most
of the sales are on credit but its sales to individuals are for cash. If he decides to purchase Nathoo
Merchants Ltd, John Mwangi plans to work full-time in the business.
You are required to:
a) List and briefly describe the investigations you would carry out in checking:
i) The profit and loss accounts for the three years ended 30 April 2002 (9 Marks)
ii) The balance sheet as at 30 April 2002 (9 Marks)
a) List and briefly describe the factors you would consider in advising John Mwangi whether
iii) To purchase all the shares in Nathoo Merchants Ltd or (4 Marks)
iv) To purchase the assets, goodwill and liabilities from the company. Your answer should
describe the factors, which you would consider in advising John Mwangi which assets
and liabilities of Nathoo Merchants Ltd he should purchase. (3 Marks)
QUESTION FOUR
On 1 July 2005, Jenga Properties Ltd, a small company involved in building construction and property
development, appointed your firm XYZ and Associates, Certified Public Accountants as auditors in
succession to another firm, Compromise and Associates, Certified Public Accounts.
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You have been assigned to the new client as audit manager and have had an initial interview with the
estate manager. At this interview held towards the end of July 2005, you obtained the following
information.
1. The financial year-end of the company is 31 December. The ongoing auditors did not attend
the year-end stocktaking for the last three years as they apparently considered that reliance on
the engineer’s or quantity surveyor’s reports was sufficient.
2. Audited accounts were issued with unqualified auditor’s report for all the previous years.
3. The ongoing auditors are likely to co-operate with your firm.
4. Receipts are issued to customers only if requests are made by the customer.
5. Materials delivered to site are not always supported by signed delivery notes.
6. Payments to suppliers are generally based on the balance shown by their monthly statements.
7. Lodgments are not always made intact and on daily basis as certain suppliers give substantial
discounts if paid in cash and Jenga Properties Ltd. generally avails of such discounts.
8. Some suppliers who are paid in cash in order to avail discounts do not issue receipts
automatically. However, where a receipt has not been issued, the cash payment is supported by
an internally generated cash payment voucher.
9. Certain prospective house purchasers have recently been denied mortgages due to “technical
problems over title”.
10. Correspondence received from the revenue authority indicates that the contract revenue for the
last audited financial statements for the year ended 31 December 2004 does not reconcile with
the Value added tax (VAT) returns.
The following details which were extracted from the audited accounts to 31 December 2004 were
available to you by the estate manager:
Income statement Balance sheet
Sh. ‘000; Sh. ‘000’
Contracts executed 125,000 Undeveloped land 32,500
Cost of contracts 115,000 Work in progress 14,000
Gross profit 10,000 Plant and machinery
(net book value) 2,250
Wages and other overheads 9,500 Material on site 1,400
Net Profit 500 Accounts receivable 8,250
58,400
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Share capital 5
Retained earnings 5,895
Accounts payable 50,000
Taxation 2,500
58,400
The partner in your firm, to whom you report, has explained to you that the client understands that
your firm will take a more strict line with them than the previous auditors did. The client is however
anxious to avoid any qualification of their accounts. Furthermore, they were concerned about the poor
quality of their internal accounting records and their lack of usefulness of management purposes.
Required:
With reference to the information given above:
a) Set out the matters which you consider might cause your firm to quantify the audit report on
the financial statements for the year ended 31 December 2005, and in relation to each matter
identified, indicate briefly the measures which the client should take in order to minimize the
possibility of your firm having to qualify the audit report. (13 Marks)
b) List briefly the measures you would recommend to be taken by the client to improve the
quality of the accounting record, indicating the objective of each suggested measure.
(12 Marks)
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