Topic 4 - Audit of Internal Controls

TOPIC 4: INTERNAL CONTROL
4.1 Components, Importance and Limitations of Internal Control
Key:
1. The first bar in the chart represents all the business and fraud risk factors that could result in the
financial statements being materially misstated (before any consideration of internal control).
2. The second bar reflects the control procedures designed and implemented by management to mitigate
the identified risks.
3. The extent to which the second bar does not completely mitigate the identified risks is often called
management’s residual risk.
4.1.1 Definition of Internal Control
ISA 315 (Identifying and assessing the Risks of Material Misstatements through understanding the Entity and Its
Environment ) defines internal control as a process (e.g accounting books, records and systems and other
controls) designed, implemented and maintained by Those Charged With Governance (TCWG) and management
of other personnel to provide reasonable assurance about the achievement of an entity’s objectives (i.e to
address identified business and fraud risks that threaten the achievement of stated objectives) such as:
 Effectiveness and efficiency of operations.

 Reliability of financial reporting.
 Compliance with applicable laws and regulations.
Note:
1. A control is always designed to respond to (mitigate) a possible risk. A control that does not address a
risk is obviously redundant.
2. The first step therefore in evaluating control design is to identify the risks that require mitigation
by control.
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3. The second step is then to identify what controls are in place to address those risks.
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Bcom Auditing Notes 2021

4.1.2 Internal Control Objectives and Relevance to the audit
Internal control is management’s response intended to mitigate an identified risk factor or achieve a control
objective. There is a direct relationship between an entity’s objectives and the internal control it implements to
ensure their achievement.
Internal control objectives can be broadly grouped into four categories:

• Strategic, high-level goals that support the mission of the entity;
• Financial reporting (internal control over financial reporting);
• Operations (operational controls); and
• Compliance with laws and regulations.
Internal control relevant to an audit primarily pertains to financial reporting. This addresses the entity’s
objective of preparing financial statements for external purposes.
Operational controls, such as production and staff scheduling, quality control, and employee compliance
with health and safety requirements, would not normally be relevant to the audit, except where they assist the
auditor in assessing the risks of misstatements in financial statements [For example, if production statistics were
used as a basis for an analytical procedure, the controls to ensure the accuracy of such data would be relevant.
If non-compliance with certain laws and regulations has a direct and material effect on the financial statements,
the controls for detecting and reporting on such non-compliance would be relevant]
4.1.3 Understanding the client’s internal control
ISA 315 requires the auditor to obtain an understanding of the entity’s internal control. This is usually done
together with understanding the entity and its environment, when performing risk assessment.
The following risk assessment procedures (among others), are used to obtain an understanding:
 Observing the application of specific controls e.g. attending a wages payout.

 Inspecting documents (e.g. system manuals, invoices) and reports e.g. investigation of variances
between budgeted and actual amounts.
 Walk-through tests – Tracing transactions from initiation to recording and custody.
 The client’s system records in their previous audit files- but there is need to update this major changes
may have occurred.
 Re-performance
 Interviews with client key staff
 Examining client’s own documentation of the ICS – in policies and Procedures Manual
4.1.4 Components of internal control
i) Control environment
The control environment includes the governance and management functions and the attitudes, awareness and
actions of those charged with governance and management concerning the entity’s internal control and its
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importance in the entity. A strong Internal Control environment provides a good foundation for the other
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components of the internal control. For example, if management has a negative attitude toward control in general,
this will undermine the effectiveness of other controls (such as sales, etc.) no matter how well they were designed.
Control Environment has the following elements:

 Communication and enforcement of integrity and ethical values – Integrity and ethical values
are essential (foundational) elements, which influence the effectiveness of the design, administration,
and monitoring of other of other controls. The will require for example having a written code of
conduct and whether management actions support the code.
 Commitment to competence – includes consideration of the competence of staff recruited by
management to do the work.
 Participation by those charged with governance – this includes attributes such as:
 Their independence from management
 Their experience and knowledge of the entity’s operations
 The extent of their involvement in management of the entity , the information they receive from
the entity and how they scrutinize the entity’s activities
 The appropriateness of their actions, including how difficult questions are raised and pursued
with management, and their interaction with internal and external auditors
 Management’s philosophy and operating style e.g.
 Approach to taking and managing business risks
 Attitudes and actions towards financial reporting
 Attitudes towards information processing and accounting functions and personnel
 Organizational structure – whether it is appropriate to achieving the entity’s objectives
 Assignment of authority and responsibility for operating activities and how reporting
relationships and authorization levels are established.
 Human resources policies and practices e.g. for recruitment, orientation, training, evaluation,
counseling, promotion, compensation and remedial actions
ii) The entity’s risk assessment process
This is an entity’s process for:
 Identifying business risks relevant to financial reporting objectives
 Estimating the significance of the risks
 Assessing the likelihood of their occurrence
 Deciding about actions to address those risks
The Auditor should understand the entity’s risk assessment process and if the entity lacks such a process, the
auditor should discuss with management whether business risks relevant to financial reporting objectives have
been identified and how they have been addressed.
iii) Information system relevant to financial reporting
An information system relevant to financial reporting objectives includes the entity’s business processes and
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accounting system.

Business Processes (Sales, Purchases, Payroll, Business processes are structured sets of activities
etc.) designed to produce a specified output. They result in
transactions being recorded, processed, and reported
by the information system.
Accounting System This includes accounting software, electronic
spreadsheets, and the policies and procedures used
to prepare periodic financial reports and the period-
end financial statements and disclosures.
An information system has procedures, policies, and records (manual and automated) designed to address the
matters set out below
iv) Control activities

Control activities are the policies and procedures that help ensure that management directives are carried out.
Business process controls can generally be classified as
Control activities relevant to an audit include the following (SOAPSPAMI):
 Segregation of duties (i.e. SODA - Segregation Of Duties and Authority)– this is assigning different
people the responsibilities of Initiation of transaction; Authorization of transactions, Execution of
transaction; Recording transactions and maintaining Custody of assets arising from the transactions.
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[For example, the board of directors authorizes the purchase of goods, the purchasing department carries
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out the purchase of the assets, the goods are received and kept by the store and the purchase invoices

are recorded by the finance department] Segregation of duties reduces risks of any person to both
perpetrate and conceal errors or fraud in the normal course of the person’s duties. Ensures Internal
Check.
 Organizational controls – Having a clear organization structure that segregates duties
 Accounting Information processing - in a computerized system, these controls are divided into two
groups:
 Application controls which apply to the processing of the specific individual transactions e.g.
arithmetical controls like checking the arithmetical accuracy of invoices.
 General IT controls which are policies and procedures that relate to many applications and
support the continued proper operation of IT environment e.g. password controls.
 Physical controls – these restrict access to assets and records to reduce the risk of theft or loss. They
include the use of safes and the periodic counting and comparison with recorded amounts, for example,
comparing inventory counts with inventory counts with inventory records.
 Supervisory controls - A clear system of supervising staff when undertaking assignments.
 Performance reviews – these include the comparison of actual performance against budgets, current
period and prior period performance, internal and external data (e.g. receivables balances with debtors)
and investing the differences and actions taken.
 Authorization – all entity transactions should be authorized by appropriate officials to ensure that they
are carried out in accordance with the established procedures. For example, the purchase of non- current
assets should be authorized by the board of directors.
 Management Controls – Including Human Resources Controls
 Internal Audit and Internal Check – Internal audit is an independent appraisal function within an
organization established to check on compliance to policies and procedures. Internal check, goes hand
in hand with segregation of duties such that the work of one individual is automatically checked by that
of another.
v) Monitoring of Controls
This is a process to assess the effectiveness of internal controls performance over time and taking the necessary
remedial actions. The monitoring may be done through ongoing activities e.g. continuous monitoring of customer
complaints and separate evaluation by internal auditors, external regulators and external auditors. In smaller
entities, the monitoring of controls of controls is often done by management’s or the owner – manager’s close
involvement I operations.
4.1.5 Internal control in small entities
The way in which internal control is designed, implemented and maintained varies with an entity’s size and
complexity. Below are some key aspects of internal control in small entities.
Internal control element Nature of element in small entities
Control environment  Audit evidence for element of the control environment may not be
available in documentary form as the communication between
management and other personnel may be informal and yet effective.
For example, small entities might not have a written code of conduct
but, instead, develop a culture that emphasizes the importance of
integrity and ethical behavior through oral communication and by
management example.
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 Consequently the attitudes, awareness and actions of management
______owner – manager are of particular importance to the auditors
understanding of a smaller entity’s control environment.
Risk assessment  There is unlikely to be an established risk assessment process in a
small entity as it is likely that management will identify risk through
direct personal involvement in the business.
Information System  Information systems may be less sophisticated with no detailed
accounting procedures and accounting records.
 Small entities with active management involvement may not need
extensive descriptions of accounting procedures, sophisticated
accounting records, or written policies.
Control activities  Smaller entities often have fewer employees which may limit the
 Segregation of extent to which segregation of duties is practicable. However, the
duties active involvement of the owner – manager may mitigate certain
 information risks arising from lack of segregation of duties. The owner –
processing manager may be able to exercise more effective oversight than in
 authorization a larger entity. This may compensate for the generally more limited
 physical controls segregation of duties.
 performance reviews  However, the owner – manager may be more able to override
controls because the system of internal control is less structured
and may easily perpetrate fraud.
 Detailed control activities may not be relevant because of controls
applied by the management. For example, only management
authorizes credit to customers and approves purchases.
 Control activities relevant to the audit of a smaller entity are likely
to relate to the main transaction cycles such as revenues,
purchase and employment expenses.
Monitoring of controls  Management’s monitoring of control is often done by the

management’s or the owner – manager’s close involvement in
operations. Internal audit may not be necessary.
N.B
In the case of very small entities, there may not be many control activities that could be identified by the auditor,
or the extent to which their existence or operation have been documented by the entity may be limited. In such
cases, it may be more efficient for the auditor to perform further audit procedures that are primarily substantive
procedures.
In some rare cases, however, the absence of control activities or of other components of control may make it
impossible to obtain sufficient appropriate audit evidence.
4.1.6 Prerequisites for an effective internal control

These include the following:
i. The quality of Management.
ii. The quality of the staff
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iii. The resources available.

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iv. The quality of internal audit.

4.1.7 Limitations of Internal control
Internal control (regardless of how well it is designed and implemented) can only provide reasonable assurance
about achieving financial reporting objectives.
The major limitations include:
 Controls whose costs exceed benefits may not be put in place.
 Most controls are directed at transactions of a usual nature
 The potential of human error – Human judgments required in any system and simple human failures
such as errors or mistakes. A breakdown in internal control can occur because of misunderstandings of
instructions, mistakes of judgment, fatigue, etc. for example, information produced for the purposes of
internal control may not effectively be used because the individual responsible for reviewing the
information does not understand its purpose or may fail to take appropriate action
 Collusion between two or more persons – circumvention of internal controls by the collusion of two or
more people. Controls that depend on the segregation of duties may be circumvented by collusion of two
or more people. For example, a personnel officer may collude with the chief finance officer to add ghost
workers on the district payroll
 Controls may not keep pace with changes in conditions.
 Management itself may manipulate transactions or estimates – Inappropriate management override of
internal control, such as revising the terms of a sales contract or overriding a customer’s credit limit.
 Changes in the environment making controls inadequate.
 Human cleverness – however secure the computer code designed to prevent access, there is always
some hacker who gets in.
Internal control, no matter how well designed and operated can only reduce but not eliminate the risks of material
misstatement in the financial statements, because of the inherent limitations of internal control. Therefore, tests
of controls alone cannot be used by an auditor to collect audit evidence.
4.1.7 Importance of internal control to auditors
ISA 315 requires an understanding of the entity’s internal control relevant to the audit. Understanding of the
client’s internal control assists the auditor in:
 Identifying types of potential misstatements
 Identifying factors that affect the risks of material misstatement
 Design the nature, timing and extent of further audit procedures
 Report whether proper books of account have been kept (as required by the Uganda Companies Act).
4.2 Documenting the Accounting and Internal Control System
As part of the documentation of the audit, the auditor is required to document a client’s accounting and Internal
Control System in relation to the following transaction cycles, inter alia : Revenue (sales) cycle, Purchases cycle,
Inventory management , Payroll management, Cash and Bank management , and revenue and capital
expenditure.
4.2.1 Methods of documenting the accounting and ICS
Auditors use one or a combination of narrative notes, flow charts, questionnaires and checklists to document the
system. The record of the accounting system is kept in the permanent file and update each year.
a) Narrative notes
These are a written description of the client’s system. The notes show what occurs and any controls which
operate at every stage of each transaction cycle.
Advantages include:
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 They are simple to record after a discussion with the client staff.
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 They can facilitate understanding of all members of the audit team, especially more junior
members might find the other methods more complex.
Disadvantages include:
 They may be bulky and time consuming for large or complex entities – that is why they are suitable
for small entities
 The method makes it more difficult to identify missing internal controls as the notes record the
detail but do not identify control deficiencies clearly.
b) Flow charts
This is a pictorial representation of the physical flow of information through the accounting system. Flow lines
represent the sequences of processes and other symbols used (identified in a key) show the inputs and outputs
to the process. Below is an example of a revenue/ sales flow chart.
Receive purchase order
Yes No
Does order
need
approval?
Acknowledge
Prepare a
acceptance of
Approval by sales order
order to customer
credit
controller
Prepare a goods
dispatch note and
delivery of goods
Prepare a sales
invoice and post it to Send the invoice to
the general ledger the customer
tthe
Flow charts are usually accompanied by notes explaining key functions. Flow charts may also be used together
with the other methods. Different flow charts are drawn for the various transaction cycles.
Advantages include:
 They precisely show the whole system at a glance and are easy to follow and are therefore suitable for
large entities.
 They clearly show the strengths and deficiencies in the accounting system
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 Making major alterations may require re-drawing the flow chart completely
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 they do not show functions properly and have to be accompanied by notes

c) Internal Control Questionnaires (ICQS)
An internal control questionnaire is a list of questions used to assess whether the appropriate controls exist in
each major transaction cycle. Questions in the ICQ are phrased in such a way that they require ‘Yes’/’No’
answers. A ‘Yes’ answer means that the control exists and a ‘No’ answer indicates a deficiency in the system.
Each operational and accounting area / cycle will have a detailed ICQs based on the specific internal controls
that ought to be in that specific area/cycle.
Below is an example of questions in the Cash and Bank ICQ:
I.C.Question Answer Comment
Are the duties of the person making up the cashbook separated from those of the people YES/NO
responsible for making payments and handling receipts?
Are procedures in place to ensure that under no circumstances should pre-signed cheques be
held?
Are bank reconciliations prepared regularly (between the cash book and the bank statements)?
Advantages include:
 They are easy to prepare and are a timely method for recording the system.
 They ensure that all controls present in the system are considered and recorded and therefore clearly
highlight missing controls or deficiencies.
 It can be easy for the client’s staff to overstate the level of the controls present as they are asked a
series of questions relating to potential controls
 A standard list of questions may miss out unusual controls
d. Internal Control Evaluation questionnaires (ICEQs)

Many audit firms use ICEQs to evaluate whether there are controls which prevent or detect specific errors or
mission, rather than establishing whether particular controls exist in the system, as in the case of the ICQ. The
ICEQ has key or control question that indicate significant risks if the controls in these areas are weak or non –
existent.
A key question in the ICEQ for the purchases cycle is: is there reasonable assurance that all liabilities recorded
are only for goods received? The answer to this question may be got from the following subsidiary questions:
 Is there satisfactory segregation of duties in the purchase cycle?
 Are all goods received checked as to quantity and quality?
 Are goods received checked notes issued for all goods received?
 Are all recorded purchase invoices supported by goods received notes?
 Are all purchase invoices approved by the user for the goods?
 Are all goods received notes cancelled to prevent their use for another invoice?
Getting answers to the key questions involve much judgment and require experience.
Advantages include
 As they are drafted in terms of specific objectives, they may be applied to several systems compared to
ICQs.
 They help the auditor to identify key controls that may be tested when testing controls and highlight
areas of weaknesses where substantive tests are required.
Disadvantages include
 They may be drafted vaguely and therefore misunderstood.
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e. Checklists
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These have statements like ‘goods are inspected as to quantity on arrival’ instead of questions. Ticks in tick boxes
indicate the statements which are true. These have advantages and disadvantages similar to those of ICQs and
ICEQs and are not commonly used.
4.3 Evaluation of Internal Control
ISA 315 requires auditor to evaluate the design of internal control and whether the controls have been
implemented i.e. whether the controls exist and are being used in practice. Auditors consider whether the control,
individually or in combination with other controls, is capable of effectively preventing, or detecting and correcting
material misstatement.
4.3.1 Procedures used in the evaluation
 Inquiring of entity personnel
 Observing the application of specific controls e.g. attending a wages payout.
 Inspecting documents and reports.
 Walk – through tests.
 The ICEQs – also used in recording the system.
4.3.2 The audit approach
Results from the evaluation of controls in the accounting system determine the auditor’s general approach to the
audit. There are two approaches to audit:
 A combined approach – this where the auditor uses both Tests of Controls (Systems Based Auditing)
and Substantive Procedures to collect audit evidence.
 A substantive approach – this where the auditor uses substantive procedures to collect audit
evidence.
If the auditor expects that lower risk of material misstatements because an entity has effective controls, the auditor
must use Tests of Controls to test the operating effectives of the controls. Where the controls are found effective,
then substantive tests must be performed to detect misstatements. A combined approach, where appropriate, is
a more effective and effective audit approach.
On the other hand, the higher the risk assessed by the auditor, then all the evidence needed to reduce audit risk
to an acceptable level in expressing an opinion on financial statements must be derived from a predominantly
substantive approach.
Evaluation of internal control
Auditor expects effective controls Auditor expects ineffective

controls
Adopt a combined approach
Perform tests of controls (TOCs)

TOCs show TOCs show Adopt a substantive approach
that controls that controls Perform extensive substantive
are effective are ineffective procedures to obtain evidence
Perform reduced substantive

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procedures to obtain evidence

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Issue an audit report & Communicate deficiencies

in internal control in a management letter
4.4 Tests of controls
4.4.1 Need for tests of controls

Tests of controls are audit procedures designed to evaluate the operating effectiveness of controls in preventing
or detecting and correcting, material misstatements at the assertion level.
ISA 315 requires auditors to perform tests of controls if the:
 Evaluation of internal control shows that the system is designed effectively and control risk is assessed
as low. The lower the planned assessed level of control risk, the greater the amount of testing that is
required.
 Auditor intends to rely on the operating effectiveness of controls in determining the nature, timing and
extent of substantive procedures.
Tests of controls are performed only on controls the auditor has found suitably designed to prevent, or detect and
correct, a material misstatement in an assertion. The greater the reliance the auditor places on the effectiveness
of a control, the more the tests of controls that should be performed. There is no need to test controls that are
poorly designed or those not implemented as the auditors are not going to rely on them.
It may not be appropriate for the auditor to carry out tests of controls in detail when:
 The controls are very weak or non-existent as in the case of many small firms.
 A business has a few, but large transactions as all transactions may be material and should be tested.
 When the directors or senior management are suspected of overriding the controls and committing
fraud.
4.4.2 Types of tests of controls
The nature of the control influences the type of procedure required to obtain audit evidence about whether the
control was operating effectively. Tests of controls include the following: (similar to the risk assessment
procedures covered earlier):
 Inspection of documents for evidence of proper operation of the control, where an audit trail exists
e.g evidence of authorisation like signatures and stamps. An audit exists if individual transactions can
be traced through the various accounting processes of recording and preparation of financial
statements and simalarly, figures can be traced from financial statements back to source documents.
 Observation of controls, e.g. observe how goods are dispatched or received.
 Re-performances of control procedures like checking prices, calculations and additions of invoices,
checking whether docments (e.g delivery notes and sales invoices) were atched. if the control is
programmed, such as checking authorisation passwords, the auditor runs unauthorised transactions
through the program and checks whether such transactions are correctly identified and excluded.
 Inquiries about internal controls which leave no audit trail- however, inquiry alone may provide
sufficient evidence on operating effectiveness of controls and should be combined with other
procedures.
4.4.3 Performing tests of controls
When collecting audit evidence about the operating effectiveness of the controls, the auditor checks, among
others:
 The Existence of the controls during the period under audit i.e. whether the prescribed controls actually
exist, and by whom or by what means (e.g. electronically) they were applied.
 The effectiveness of the controls i.e. whether the controls prevent or detect the misstatements they aee
designed to prevent or detect.
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 The consistency with which they were applied i.e. whether they applied throughout the period. If the
control was operating for any part of the year, then no reliance can be placed on the control when it was
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not operating.

Generally, auditors test controls:
 For the particular time, e.g. during inventory counting at the end of the period.
 Throught the period for transactions occurring throughtout the accounting period like sales
The auditor may design a test of controls to be performed concurrently with a test of details on the same
transaction, also known as a dual-purpose test. For example, the auditor may examine an invoice to determine
whether it has benn approved (test of control) and at the same time check whether the invoice calculations and
total are accurate (substantive procedure for test of details)
If audit evidence about the operating effectiveness of controls is obtained during interim audit, the auditor
should:
 Obtain audit evidence about significant changes to those controls during the subsequent period
 Determine the additional audit evidence to be obtained for the remaining period, for example, by
extending tests of controls or testing the entity’s monitoring of controls
When collecting additional audit evidence during the period remaining, factors considered by auditors include:
 the significance of the assessed risks of material misstatements at the assertion level
 The specific controls that were tested during the interim period, and significant changes to them since
they were tested, including changes in the information system, processes and personnel
 the degree to which audit evidence about the operating effectiveness of those controls was obtained
 The length of the remaining period
 The extent to which the auditor intends to further substantive procedures based on the reliance of
controls
 The control environment
If tests of controls are performed during the interim audit and there are significant changes before the end of the
accounting period, the auditor should perform further tests of controls during final audit.
4.4.4 Revision of risk assessment, audit strategy and the audit plan
When evalating the operating effectiveness of controls, a material misstatement detected by the auditor’s
procedures is a strong indicator of the existance of a significant deficiency in internal control.
If deviations from controls are detected, the auditor should try to analyse the deviations to establish whether:
 The tests of controls performed provide an appropriate basis for reliance on the controls,
 Additional tests of contros(e.g. by increasing sample sizes) should be done . or
 The identified risk of misstatement is higher than that initially assessed, in which case, the auditor:
 Revises the assessed risk
 Amend the audit strategy and audit plan
 Increases the extent of substantive procedures ( to detect misstatements) during final audit.
The results the tests of controls are used to determine the nature, timing and extent of substantive procedures.
Where tests of controls confirm that the controls are operating effectively, the auditor continues with the combined
audit approach (also called the Reliance approach) and performs the normal level of substantive testing at the
period end. This reduces audit costs as substantive tests take more time and therefore, are more expensive
especially in a manual audit.
4.6 Audit of the sales system

4.6. 1 Key functions in a typical credit sales system
The sales or revenue system invloves transactions and events in the sale of goods or services. The sales system
is audited together with the recieveables and cash systems. Although the sales system varies from entity to entity,
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the functions below are carried out irrespective of whether the system is manual or computerised. The manual
system processes are covered below as they clearly show the segregation of duties and assists in understanding
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how the computerised system works.

Key functions Processes
 The sales persons in the sales department or in the field receive
Selling purchase orders from customers or prepare sales orders. The orders
 Receive customer orders are received orally, by written purchase orders, by telephone or by
 Check availability of goods email on the internet. Even if a sales order is not prepared, the
information is recorded.
 Check customer credit
worthiness approve credit  The sales persons or computers check the availability of goods and
the customers are informed of the expected delivery date.
 Someone independent of sales e.g. the credit manager, finance
manger, chief executive officer etc, should approve the credit . Credit
limits should be set for each customer so that approval can be done
automatically by the computer
 Credit approval involves checking new customers’ performance
(KYC) from audited financial statements and getting credit information
from credit agencies. for old customers, one checks their repayment
history. Appropriate credit limits are set and revised regularly
 The approved order is sent to delivery/ shipping section
Delivery / shipping of  The delivery section uses the approved sales orders to look for the
goods goods in the warehouse / store / shop
 The delivery section staff counts the goods and prepare Goods
Dispatch Notes (GDNs) / Delivery Notes as per customer’s
orders
 Senior personnel reconcile the goods with the GDNs and
customers’ orders to ensure that correct products and quantities
are sent to customers then authorise despatch
 The warehouse/ store personnel updates the inventory records
 Goods are delivered to customers who acknowledges recipts of
goods by signing the GDNs/ delivery notes
 The GDNs and the sales orders are sent to the invoicing section in
Finance Department
Invoice customers  Invoices (and most accounting source documents) must have
the following key features [ pre-printed, Serial numbering, multi-
copies, authorisation ]
 Staff in the invoicing section check the matching of the GDNs and
the sales orders and then prepare sales invoices
Accounting for sales  The sales invoices are recorded in the sales journal and the
 Sales journal Original Copies sent to customers
 Recievables ledger  Sales invoices are posted to the recievebales ledger by the
 General ledger receivable ledger accountant
 Sending monthly  Periodically, the recieveables ledger accountant summarises all
statements to transactions into a Journal Voucher and sends it to the General
Ledger section where it is posted by the general ledger senior
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customers
 Age analysis of accountant in the receivables ledger control account
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receivables

 In a computerised system , the indidual sales invoices are
automatically posted to the recieveables ledger and the
recievievables ledger control account
 The recieveables ledger and the recievebales ledger control
account are reconciled monthly by personnel independent of
sales, the recievebles ledger and cash office
 Monthly statements are then sent to customers –they check
overstatements and mispostings, such as sales or cash recipts
posted to incorrect accounts or cash reciepts not credited to the
accounts
 Aga analysis of receivables in line with agreed to terms should be
periodically done
Receive goods returned  The goods receiving section personnel receive, count, inspect
by customers goods for damage and send the returned products to the
 Prepare goods returned warehouse / store
notes  The receiving warehouse/ store personnel update the inventory
 Prepare & approve records and prepare good returned notes, which are forwarded to
credit notes finance department.
 Update the inventory  Upon reciept of the goods returned notes, an accountant prepares
records, recievables a credit note that is approved by the finance manager.
ledger accont and  The recievables ledger accountant credits the customers’
general ledger accounts.
 periodically, journal vouchers are prepared and sent to the general
ledger for posting to the recievables ledger control account.
Receive cash from  Cash received is receipted and recorded by the cashier in the cash
cutomers book, the recievables ledger and general ledger updated
 Segregation of duties : sales staff and cashiers
4.6.2 Control activities and Common controls in sales

Control activities Common controls
Segregation of duties  Credit is separate from sales as the sales staff may sell on credit risk
customers in order to increase sales performance.
 Asset custody form asset recording e.g. warehouse keeps inventory but the
inventory control account is maintained in the genral ledger by the
accounting department. A person combining both responsibilities could steal
or lose inventory and adjust the inventory records to conceal the envent.
Cash is received by the cashier but recorded in the recievables ledger by the
recievbles ledger accountant to minimise teaming and lading fraud that may
involve steeling cash received from debtors and delaying or not recorded it in
the receivables ledger accounts.
 Separating record keeping functions e.g. sales from cash, the recievables
ledger from the payables ledger and receivables ledger from the general
ledger.This requires collusion of two or more individuals to commit fraud which
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increases the risk detection and therefore is less likely to occur.

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 The separation of custody of assests (e.g. inventory and cash) and
the recording of transactions allows the reconciliation of assests with
the accounting records.
 The auhtorisation of adjustments to records such as the issuing of
credit notes or the writing of bad debts should also be kept separate
from the handling of assests and the recording function. This
ensures that the accounting records are not adjusted for items that
are misappropriated or lost and also to assist the reconciliation
proces.
Transaction  Credit check

authorisation  Delivery of goods
 Goods return policy
Information  Sales orders, goods dispatch notes, sales invoices, sales journal, accounts
processing recievables (receivables ledger), recievables control (general ledger),
 Accounting inventory ledger, inventory control, sales, general ledger, goods returned
records & notes, credit notes
documents  pre – numbered sales orders, delivery notes, sales invoices – this helps in
 Data access tracing documents and identifying transactions
controls
Physical controls  Physical access to inventory e.g. fences, guards
 Access to accounting records above e.g. An individual with access to both
cash and the general ledger cash account could remove cash from the firm
and adjust the cash account to cover the act.
Supervion  Supervison compensates for the indequate segregation of duties or improves

Indpendent the effectiveness of controls.
verification  Independent verfifcation in the:
Performance reviews  Delivery / shipping section e.g. verifies that the goods sent from the
warehouse are correct in type and quantity
 Invoicing section e.g. reconciles the original sales order with the
shipping notice to ensure that customers are billed for only the
quantities shipped.
 General ledger section e.g. reconciling the recievables total with the
receivables ledger control account balance would detect a sales
transaction entered in the sales journal but not posted to the
customer’ account in the recievables ledger.
4.6.3 Assertion / control objectives, key controls and tests of controls

The auditor identifies and focuses on the key controls for the appropriate audit assertions for each class of
transactions. These controls could be manual or automated. Tests of controls are then devised for each key
control that is to be tested.
15
When describing audit procedures, one should show how the audit procedures are performed, the
accounting records involved and the audit assertion being tested.
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For example : ‘Check that all sales invoices are recorded’ is a wrong description of an audit procedure in the
audit program. This audit procedures may be stated as follows: ‘Trace a sample of sales invoices to the sales
journal to check the completeness of recorded sales transactions’.
Assertion & control objectives Key controls Key tests of controls
Occurrence  Segregation of authosisation of credit  Observe and evaluate whether
To ensure that all: sales, delivery of goods, invoicing, there is proper segregation of
 Sales recorded are bona receivable ledger, general ledger duties.
fide transactions for &receiving cash
goods actually delivered /  Sales are recorded only if there are  Select a sample of sales invoices
shipped or services goods dispatch notes(GDNs)/delivery (e.g. from the sales journal) and
provided to customers notes/ shipping documents and inspect the related GDNs /
 Orders are only accepted approved sales orders. delivery notes / shipping
if goods are available to documents and the authorised
be delivered to customers sales oreders.
 Goods and services are  Examine application controls for
provided at authorised authorisation.
prices and on authorised  Quantities delivered are reconciled to  Inspect reconcilation of GDNs to
terms quantities invoiced independently of sales invoices.
delivery and invoicing
 Monthly statements are sent to  Review the entity’s procedures
customers and customer complaints for sending monthly customer
are handled independently of statements and dealing with
transaction processing customer complaints. Examine
the customer correspondence file
and review the nature of
customer complaints and
determine if there is a pattern.
 Deliver notes are signed by customers  Inspect a sample of delivery
as acknowledgement for receiving notes for signatures of
goods customers.
 Credit terms for cutomers are  Review the enitity’s procedures
authorised by senior staff. for granting credit to customers.
 Credit checks or references are  Review all sales orders for new
obtained for all new customers customer to ensure satisfactory
 Appropriatee credit limits are set for credit refrence were obtained
customers and are reviewed regularly  Examine applicaion controls for
 New orders are not accepted before credit limits
checking the credit limits.  Examine a sample of sales
 Changes in standing data for orders for evidence of proper
customers are authorised by senior credit approval by appropriate
staff only senior staff member.
 Authorised price lists and terms of  Compare prices and terms on a
trade are in place sample of sales invoices to the
authorised price list and terms of
trade.
 Examine application auhtorised
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prices and sales terms.

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Completeness  All GDNs and sales invoices used are  Review the entity’s procedures
To ensure that: pre- numbered all documents are for accounting for numerical
 Goods are despatched accounted for. sequences of a sample of GDNs
for all approved orders and sales invoices and carry out
on a timely basis a sequence check on the sample
 All income for goods of GDNs and sales invoices and
despatched is recorded carry out a sequence check on
in accounting records i.e. the samples, inspect cancelled
all goods despatched are documents and inquire into
invoiced/receipted missing ones.
 GDNs are reconciled with sales  Select a sample of GDNs and
invoices and quantities delivered are inspect that they were matched
periodically reconcilled to those to the respective sales invoices
invoiced that were later recorded in the
 Goods delivered are checked against sales journal / ledgers. Inspect
GDNs. for evidence of supervision.
 Sales invoices are reconciled to the  Observe the checking of goods
daily sales report delivered or inspect a sample
 Inventry is reconciled with sales at goods being delivered.
the end of the day.  Review the sample of
 A report/ an open – order file for reconciliations per formed.
unfulfilled orders is  Inspect the open – order file for
prepared/maintained and reviewed unfilled orders.
regularly
Accuracy  Inspection of quantity, quality and  Observe the checing of goods to
To ensure that all: condition of goods against sales GDNs
 Orders are recorded orders / customers’ orders/ GDNs.  Select a sample of sales invoices
completely and  Sales invoices and credit notes are (e.g. from the sales journal) and
accurately approved by an independent person inspect it for evidence of
 Goods are despatched and recorded after checking prices, accuracy checks and re-perform
correctly to customers calculations, additions, trade terms the checks.
and are of acceptable and details compared to supporting  Inspect eveidence for the
quality. GDNs, customers’ orders goods supervison of casting the sales
 Goods despatched are returned notes journal and posting invoices to
invoiced correctly  Supervisory review and approval of the sales ledger and the total to
 Sales invoices are posting sales the general ledger
recorded correctly  Regular reconciliation of the  Inspect a sample of
 Sales discounts are only recievables control account and the reconciliations of the recievables
provided to valid recievables ledger by an independent ledger and the recievables control
customers person account in general ledger.
 Monthly statements are sent to  Review procedures for sending
customers statements
 Periodic ageing of recievables an  Review customers
having debt collection procedures correspondences
(e.g. Contacting customers on phone,  Inspect the periodic ageing of
by email or letter and later engaging recievables and review
debt collectors) and approval of write procedures for follow up of over –
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–offs of uncollectable debts by the due receivables and

board of directors. authorisation of writing offf of bad
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debts by the board of directors.

Cut – off : Cut-off is a special
aspect of completeness. Cut-off  All GDNs are sent to the invoicing  Compare daes on the last sales
refers to accounting transactions section daily invoices and credit notes before
(e.g revenues, expenses) in the  Invoices for all goods dispatched or the period end and the first sales
proper period – i.e neither services provided are raised daily. invoices and credit notes after
postponing some recordings to the start of the period with dates
next-period nor accelerating next- of the corresponding GDNs and
period transactions into current goods returned notes.
year account );  Compare dates on sales invoices
for proper classification in the
To ensure that all sales invoices general ledger.
and credit notes are recorded in
the correct period
Classification  A chart of accounts is maintained and  Examine a sample of sales
To ensure that all sales updated regularly. invoices for proper classification
transactions are properly classfied  The coding of invoices is in the general ledger.
in the accounts in accordance with independently checked  Test application controls for
written policies proper codes
The initial audit program (column 1 & 2) is organized by audit assertion to ensure that controls are assessed (and
possibly tested) for each assertion. it is then organized into a performance format to maximise effeciency e.g. all
tests for the delivery of goods are grouped together. Similar tests are not repeated when verifying different
assertions.
4.6.4 - Implications if the controls are not operating effectively
Deficiencies in internal control over sales may lead to material misstatements mainly arising from clerical
mistakes, employee fraud (e.g. despatching goods to non-existent customers) and misapplication of revenue
recognition accounting policies. Therefore, the auditor should modify the substantive tests as follows:
 Recorded sales may never have ocurred – extend substantive procedures in the audit receivables and
cash
 Sales may be recorded in the wrong accounting period – extend cut-off tests at the year end
 Sales may be recorded wrongly leading to understatement or overstatement of receivables in the new
period.
 Sales may be classified wrongly – increase substantive procedures on sales and receivables to check
that the transactions are for bona fide sales
Linking Risk Assessments, Internal Controls and Tests of Control - Sales Cycle
Risk of Material Misstatement Control Activity Test of Control Activity
Sales Revenue is recorded when the All invoices are matched to delivery For a sample of sales revenue entries in general
goods had not been delivered to documents before recording in the ledger, vouch to proper delivery document
customers General ledger
Goods will be sent to a new customer Credit department performs a detailed For a sample of new customers, examine
that is unable to pay for the goods check (KYC) for all new customers documentation that indicates a proper credit
check was performed
Goods will be sent to a customer, and All delivery documents are matched to For a sample of delivery documents, trace
revenue is not recorded sales invoices that have been amount shipped to a sales invoice recorded in
recorded the general ledger
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REVISION QUESTION - SALES
Pearl of Africa Ltd (PAL) manufacturers building materials and sells them to retailers, corporate and individual
customers directly through their field sales staff. You are an auditor supervisor in Manpower & Co, responsible for
the audit of PAL for the period ended 31 December 2012. You are currently reviewing documentation of PAL’s
internal control in preparation for the interim audit.
Customers order goods through the field sales staff and directly at the factory. When the sales staff receive orders,
they do not check the availability of goods at the factory ware house. Full payment is made in advance by individual
customers before the dispatch of goods.
Goods are despatched via company transporters. However, they do not always record customer signatures as proof
that the customer has received the goods. Over the past 12 months there have been customer complaints about the
delay between sales orders and receipt of goods. PAL has investigated these and found that, in each case, the sales
order had been entered into the sales system correctly but was not forwaded to the despatch department for fulfilling.
PAL’s corporate customers undergo credit checks prior to being accepted and credit limits are set accordingly by
sales ledger clerks. These customers place their orders through onee of the sales team, who decides on sales
discount levels.
Required:
In respect of the internal control of PAL:
i) Identify and explain FIVE deficiencies
ii) Recommend a control to address each of these deficiencies
iii) Describe a test of control Manpower & Co. would perform to assess if each of these controls is
operating effectively.
4.7 Audit of the prchases system
The purchases system involves the purchase of goods and services. Purchases can be made for cash or on credit.
The audit of the purchase system includes the payables and payments systems, although the audit of payments is
covered under the cash system. Although the purchases system varies from entity to entity, the functions and
processes are carried out irrespective of whether the system is manual or computerized.
4.7.1 Key functions in a typical credit purchases system
Key Function Processes
Buying goods/ services  When inventories drop to a predetermined reorder point, purchase
 Monitor inventory levels and requistions (PRs) are raised by the store/department, approved by
preparation of purchase requistions the respective head and store sent to the procurement department
 Preparations of purchase orders to intiate a purchase process.
 Purchase orders (POs) are raised by the procurement department
after evaluation of bids and selection of the best suppliers by the
Board of directors /contracts board, originals are sent to the
suppliers and copies are sent to the goods receiving section until,
pending the arrival of goods. A copy is kept by procurement
Receive goods/services  Goods are received by the goods receiving section/ store. The
goods are counted, inspected and checked against copies of Pos
(Inspection Report is issued)
 When accpeted, Goods Received Notes (GRNs) are raised stating
the quantity and condition of the goods.
 The inventory records (Bin Cards and Stores Ledger) are
updated, the procurement department is notified and the original
GRNs are sent together with copies of the POs to the payables
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ledger section in the accounting department, pending the arrival of

the purchase invoices from suppliers.
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Accounting for purchases  When the purchase invoices are received by the accounts
 purchase journal payable section, they are matched with the GRNs and copies of
 Purchases ledger POs.
 General ledger  Sometimes, the invoices are first sent to the beneficiary
departments for approval, acknowledging recipt of the goods
or services.
 The payables ledger section checks prices, calculations and totals
of the purchase invoices for accuracy.
 When the reconciliation is complete, the transaction is recorded in
the purchases journal (Purchases section) and purchases account
and payables ledger control account (General Ledger section)
 After recording the liability, the payables accountant forwards
the purchase invoices, POs, GRNs to the finance manager.
Return of rejected goods to suppliers  Preparation of goods reurned notes by the store/warehouse staff
and debit notes by the accounting department.
 Authorisation of debit notes by the finance manager and posting
them in the payables ledger and general ledger.
Payement of suppliers  The purchase invoices are approved for payment by the finance
manager and paymentnmade to suppliers on the due dates. (more
is covered under the cash system)
 The payment is debited to suppliers’ account in the payables ledger
by the payable ledger account and credited the bank account in the
general ledger by the senior accountant
4.7.2 Control activities and common controls

Control activities Common controls
Segregation of duties  Segregation of inventory control account in the general ledger from yhe
warehouse/store enables the auditor to reconcile inventory records to the
physical inventory.
 Segregation of the general ledger and payables ledger from cash payements.
Aperson writing cheques, posting to the cash account and maintaining the
payables ledger could perpetrate fraud withdrawing cash and then adjust the
cash account accordingly to hide the transaction. Also he or she could establish
fraudulent payables accounts and then write cheques to pay non- existennt
obligations.
Transaction authorisation  Authorisation of purchase requistions promotes efficient inventory management
and ensures the purchases transactions are legtimate. If minimisez excessive
inventories typing up the entity’s cash reserves and stock – outs leading to lost
sales and manufacturing delays.
 Authorisation of purchase invoices for payments
Information processing:  PRs,POs,GRNs, payales ledger, general ledger
 Accounting records
& documents
 Data access control
Physical controls  Security of physcal assets
 Insurance of the assets
20
 Limit access to the accounting records above.

Supervision  Close supervion of goods receiving reduces the risk of raising the GRNs without
Page
properly inspecting the goods and the theft of goods during transit.

Independent Verification  The payables ledger section reconciles the purchase invoices, GRNs and POs
before liability is recorded
 Reconciliation of the payables ledger control account in the general ledger with
the payables ledger accounts.
Performance reviews
4.7.3 Assertions, objectives, controls and tests of controls

Assertion & objectives Common controls Key tests of controls
Occurrence  Segregation of authorisation of  Inspet the procurement manual
pruchases, receiving goods, payables and inquire about procurement
All recorded purchases are only ledger, general ledger, authorisation of procedures
for goods or services received. payments and cashier functions  Observe and evaluate the
 Procurement authorisation procedures segregation of duties.
All purchase orders are and policies for goods and services are  Inspect a sample of purchase
properly authorisd and are the place: invoices and chec that for each:
best suppliers  PRs are used to intiate all purchases there is a GRN. There is a
 Purchasing department is rsponsible properly authorised PO which
for all purchases comply with the procurement
 Authorisation of purchases by the procedures:
board of directors or contracts  Read minutes of the
board(in Government) board of directors /
 Use appropriate method of purchase contracts board
e.g. open bidding, restricted bidding,  Review the tender
direct purchase, quotations etc eveluation
 Tenderr evaluation to identify the best  For a sample of GRNs, check
supplier in terms of: that each has an authorised PO
 Price and quality (e.g. has signatures and
 Delivery time stamps)
 Payment terms & discounts Pos  Observe the receiving of goods
are used for all purchases and to confirm that checking is done
are authorised by appropriate and DNs are signed.
senior staff. Procurement
department follows up al pending
orders to minise late deliveries by
suppliers.
 GRNs are prepared for all good
accepted.
Completeness  Pos and GRNs are matched with  Review procedures for
All purchases for the period are purchase invoices accounting for the numerical
recorded  Pos and GRNs are counted for sequence documents.
periodically  Review records for evidence of
 The recording of upplier invoices in the checking.
purchase journal and payables ledger is  Select a sample of Pos and
checked by an independent person check that they were matched to
GRNs and purchase invoices.
Obtain explanantions for
unmatched Pos and GRNs.
21
 Select a sample of GRNs and

check the corresponding
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invoices that were later
recorded.
 Inspect applicatio controls.
Accuracy  Purchase invoices are matched with  Select a sample of purchase
Purchases are recorded GRNs and Pos and debit notes are invoices and returns and
correctly in the accounting matched with goods returned to examine the supporting GRNs
records suppliers that are later recorded and Pos and documents
correctly in the purchase journal, returning goods to suppliers.
payables ledger and general ledger.  Review a sample of supplier
 The arithmetic accuracy of purchase invoices and the purchase
and the purchase journal invoices is journal for evidence of
checked. arithemetic checks and re-
 The payables ledger balances are perform the checks.
reconciled with supplier statements  Inspect a sample of
regularly by someone independent of rconciliations.
the payables ledger.
 The payables ledger is reconciled with
the payables ledger control account
monthly.
Cut – off  All GRNs are sent to accounts payable  Compare dtaes on the last
Purchases are recorded in the section daily GRNs before the period end and
correct accounting period the first GRNs after the start of
the period with dates of the
corresponding supplier
invoices.
 Compare dates on purchase
invoices with dates recorded in
the purchase journal and ledger.
Classification  A chart of accounts is mantained  Examine a sample of purchase
All transactions are properly  The coding of invoices is independently invoices for proper coding.
classfied in accounts checked  Review the purchase journal
and general ledger for
reasonaleness by comparing
expenses to the bdget and the
prvious period.
Revision Question
Steel industries Ltd (SIL) manufactures building items in Namanve Industrial Area and sells them in Uganda and the
neighbouring countries. The company’s year – end was 31 December 2012. Below is a despcription of the company’s
purchasing and payments system.
Purchasing System
Whenever production material are required, the relevant department sends a requisition form to the ordering
department. An order clerk raises a purchase order and contacts a number of suppliers to see which can dispatch
the goods first. The supplier is then chosen. The order clerk sends out the purchase order. This is not sequentially
numbered and only only orders above 10 million require authorisation.
Purhase invoices are input daily by the purchase ledger clerk, who has done that work for many years and, as an
22
experienced team member, he does not apply any application controls over the input process. Every week the
purchase day book automatically updates the purchase ledger, the purchase ledger is then posted manually to the
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general ledger by the purchase ledger clerk.

Payments system
SIL maintains a current account and a number of foreign currency accounts. The current account is reconciled weekly
but the foreign currency accounts are reconciled after every two months.
In order to maintain a good liquidity position, SIL has a policy of delaying payements to all suppliers for as long as
possible. Supplier are paid by electronic bank transfer. The finance director is given the total amount of the payments
list, which he authorise and then processes the bank payemnets.
Required:
As the external auditors of SIL, write a management letter with a covering letter on the purchasing and payments
system of the company decribed above that:
i) Identify and explain FOUR deficiencies in the system.
ii) Explains the possible implications of each deficiency and
iii) Shows a recommendation to address each deficiency.
4.8 Audit of the Inventory Internal Control System
Key functions
The inventory system is connected to the sales and purchases system and many of the inventory controls have
been covered in the two systems. Additional tests are done on recording the movement (receiving and issuing ),
storage and accounting for inventory.
4.8. 1 Assertion, control objectives, key controls and key tests of controls
Assertions/control objectives Key controls Key tests of controls
Occurrence &  Appropriate levels are set for:  Check that the levels are
Existence  Maximum inventory reviewed and are
levels appropriate
 Minimum inventory  Review documents in use
levels and select a sample of
All inventory movements are  Re- order quantities GRNs & GDNs and check
authorised and recorded  Lead times that they were authorised
And reviewed regularly and reconciled with
for adequacy inventor records
 All goods received are recorded  Carry out a sequence
using pre – numbered GRNs and check of GRNs & GDNs
checked against an approved  Check a asample of
Pos. reconciliations done and
 All goods issued are recorded dget evidence for review b
using GDNs/DNs onlynon reciept an independent person.
of authorised sales orders/loading
orders/store requistions (for
internal use)/relocation forms.
 Reconcilaition of inventory
ledgers with the store ledger
control account and variances
investigated.
 Physical safeguards of inventory  Review the physical

against theft e.g. restricting security of inventory and
access to stores/warehouses, discuss the policies and
high value items kept in locked procedures with relevant
23
sections, CCTV. staff.

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 Segregation of receiving,  Observe security
recording and dispatch of goods in arrangements for
the store. inventory
All inventory included in the SOFP  Inventory is counted regularly  Observe and evaluate the
exists.  Insurance of inventory segreagation of duties
 Inventory with traveling sales men  Review adequacy of
(Physical security and Insurance) inventory counting
procedures and attend the
count to ensure they are
carried out.
Completeness  Procedures in place to include  Review procedures for
All inventory purchase and sales are inventroy held by third partie and goods held by third parties
recorded exclude that held for third parties and consignment
 Reconcilaitionof accoting records inventory
with physical inventory  Review the reconcliaitions
performed and check
whether they were
reviewed by an
independent person
Accuracy  Periodic comparison of physical  Review procedurs for
All inventory is accurately recoded inventory with inventory records. counting inventory and
and valued at the lower of cost and  Review of standard costs identification of items to be
net realizable value  Continious review of the condition written down.
of inventory to identify slow  Review procedures for
moving and excessive items developing standard costs
 Inspect costing records
and variance reports
 Review valuation of stock
for compliance with ISA 2.
Cut - off  All GRNs and GDNs are  Inspect documents for
All purchases and sales are recorded daily in inventory evidence of daily
recoreded on the correct accounting ledgers. recording of GRNs and
period  Reconcilaition of inventory GDNs
records with general ledger.  Review and test the
 Reconcilaition of count figures entities procedures for
and inventory records and counting inventory
investigation of variances  Inspect reconciliaiton of
inventory counts to
inventory records
Classification  Having inventory codes Check the review of account coding
Inventory is properly classfied in on purchase documents and
financial statements appropriate authorisation
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4.9 Audit of the Cash and Bank Internal Control System
4.9.1 Key functions in a typical cash reciepts system
Cash includes cheques and the cash system includes cash reciepts and cash payments. The Key functions in
cash reciept include the following:
 Issue of reciepts by the cashier and record the cash in the cash account/cash book/cahs reciept
journal.
 Preparation of bank deposit slips and banking the cash.
 If cash is paid by debtors, record the payments in the receivable ledger acccounts and the receivables
ledger control account in the general ledger.
 Regular bank reconcliation, preferably by a person independent of the cash procedures above.
4.9.2 Assertions, control objectives, key controls and key tests of controls for cash reciepts
Assertions/ control Key controls Key tests of controls
objectives
Occurrence & Existence  Segregation of duties of cashier , receivables  Observe and evaluate the
Only cash receipts for the ledger, payables ledger and general ledger segregation of duties.
entity’s sales are received functions.  Observe mail opening
and banked  Restrictions on people receiving cash e.g. procedures.
cashiers, ushers in church, salesmen.  Observe cash sales,
 At least two people should be present when collection and receipting and
opening mail or counting cash collected-one storage procedures.
has custody of cash and the other the record.  Inspect application controls
 Use of electronic banking. for electronic banking.
 Recording cash received immediately and  Review documents for
banked intact e.g. evidence of independent
-Receipting cash received, keeping check.
receipts safely and monitoring receipt  Review the bank
books being used. reconciliations and check they
-Listing all cash / pledges received e.g. at are done and reviewed
fund raising functions or listing cheques on regularly and discrepancies
opening letters. followed up
-Using cash registers or point of sale  Review insurance policies.
devices.
-Recording receipts in the cash book daily.
 A second person checking and signing receipts
before original copies are removed from receipt
books.
 Keeping cash safely e.g by restricting access to
cash offices, keeping cash in safes or strong
rooms with security locks or swipee card
access, using armed guards for cash offices or
while taking cash to the bank, using bullion
vans for large sums of cash and varying
banking time and banking routes, CCTV
cameras.
 Preparation of daily cash summary that is
reconciled with the receipts /t ill roll by an
25
independent person.
 An independent reconciliation of cash from field
Page
sales staff with inventory taken and returned.

 Daily banking of all cash/ cheques received and
an independent reconciliation of the amount
banked, the bank deposit slips and the daily
cash summary.
 Regular bank reconciliation (atleast monthly) is
done and is independently reviewed.
 Insurance policies for cash and cashiers.
 Unused cheques should never be signed in
blank or pre-signed.
 Cash received by traveling salesmen should be
accounted for properly and adequate security
should be provided for such employees. This
should include arranging for appropriate
insurance covers.
Completeness  Segregation of duties.  Observe and evaluate the
All cash receipts are  Use of electronic banking. segregation of duties.
recorded.  Regular bank reconciliation is done and  Inspect application controls
independently reviewed. for electronic banking.
 Daily cash receipts are reconciled with posting  Review the bank
to customer accounts to prevent teeming and reconciliations and check
lading fraud. they are done and reviewed
 Statement of accounts are prepared and sent regularly.
to customers regularly.  Review the reconciliation.
 Restriction on opening new bank accounts  Review a sample of
customers and check the
statements are sent monthly.
Accuracy  Daily reconciliation of remittance advices,  Review the reconciliations.
All cash receipts are receipt , cash book, customer accounts and  Review procedures for
recorded at correct the general ledger. sending the statements to
amounts.  Customer statements are sent monthly to customers and examine
customers. customer correspondence
 The receivables ledger is reconciled with the and complaints and
receivables ledger control account. investigate non-cash credits
 Reglar bank reconciliation is done and to accounts receivable.
independently reviewed.  Review the bank
 Cheques should be written in full names of the reconciliations and check
company and not abbreviated acronyms. Eg they are done and reviewed
Not “MUBS”, KCC, NMS etc but “Makerere regularly.
University Business School”, Kampala city
council, National Medical stores.
Cut-off  Regular bank reconciliation is done at the  Review the bank
All cash receipts are period end. reconciliations.
recorded in the correct
accounting period.
Classification  A chart of accounts is maintained.  Review the reconciliations.
All cash receipts are  Transactions are coded properly and the  Examine a sample of posting
recorded in the correct codes are checked independently. for proper coding.
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accounts.  Test application controls for

proper codes.
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4.9.3 Assetions, control objectives, key controls and key tests of controls for cash payments
Assertions / control objectives Key controls Key tests of controls
Occurrence  Segregation of payables  Observe and evaluate the
Payments are only made for goods or ledger, general ledger , segregation of duties.
services authorised and received cashier, cheque signing/  Select a sample of
electronic funds transfer payments and check that:
(EFT) functions. - It is supported by
 Cheque or electronic approved invoices,
payments are made only if: GRNs and Pos that
-There are supporting documents were cancelled.
like purchase invoices, GRNS and - The cheques were
POs that are signed are signed/ EFT was made
independently approved. by authorised people.
-The supporting documents are
stamped “paid” and the cheque
number written on by the cashier, so
that they cannot be used for another  Review the reconciliation
payment. and check if it is carried out
 Cheque signatories/ those regularly and independently
making electronic payments reviewed.
should:
- Not also authorise
supporting documents
for payment.
- Agree cheques / bank
transfers to supporting
documents before
signing or effecting the
transfer.
- Be authorised and have
authorisation limits.
- Be two people from
independent
departments.
- Not sign blank cheques
and cheques in favour
of themselves.
 Regular bank reconciliation
is done and independently
reviewed.
 Supplier statements are
independently reviewed and
reconciled to payables
records
All payments are recorded  Daily cash payments are segregation of duties.
27
reconciled to posting to  Review the reconciliation

payables accounts. and check if it is carried out
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 supplier statements are regularly and independently
independently reviewed and reviewed.
records.
 Regular bank reconciliation
is done and independently
reviewed.
Accuracy.  Cash payments are  Review the reconciliation and
reconciled to posting to check if it is carried out
Payments are recorded correctly payables accounts regularly. regularly and independently
 Supplier statements are reviewed and errors followed
independently reviewed and up.
records.
 The payables ledger is
reconciled with the payables
ledger control account
monthly.
Cut-off  Daily reconciliation of  Review the reconciliations.
cheque/EFT payments,
Payments are recorded in the correct cashbook, customer
accounting period accounts and the general
ledger.
Classification  A chart of accounts is  Examine a sample of
maintained. posting for proper coding.
All payments are recorded in the  Transactions are coded  Test application controls for
correct leder accounts. properly and the codes are proper codes.
checked independently.
4.9.4 Petty Cash ICS

i. Petty cash should be operated on an Imprest System and amount of float should be reasonable.
ii. Petty cashier should be different from the main cashier.
iii. There should be a limit on the payments from petty cash
iv. Serially numbered Petty cash vouchers should be prepared and duly signed by the person who receives
money. Cash taken must be properly accounted for.
v. Petty cash vouchers should be checked and approved by a senior official.
vi. Petty cash float should only be replenished after full accountability of all petty cash expenses.
vii. There must be planned and surprise count of petty cash floats, by management or the internal auditor.
Imbalances should be thoroughly investigated. Particular attention should be paid to any IOUs included
amongst the petty cash vouchers since they may actually be unauthorized loans to employees or the person
holding the float.
viii. All expenses recorded in the petty cash book should be analysed and posted to the respective expenditure
accounts in the general ledger
Example
Safi Cleaners (SC) is a cleaning company. Customers’ offices are cleaned daily and are involved monthly.
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Customers pay by cheque or cash, which is received in the cash office. The following procedures are applied in
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the cash received cycle:

A cashier receipts all the cheques or cash received and then posts all the receipts in the cash book and then
places all the money into a locked small cash box.
The contents of the cash box are counted each day and every few days these sums are banked by whichever
staff is available.
The cashier also updates the sales ledger.
Usually on a monthly basis the cashier performs a bank reconciiation , which he then files, if he misses a month,
then he catches this up in the following month’s reconciliation.
Required:
For the cash cycle of SC:
i) Identify and explain THREE deficiencies in the system.
ii) Suggest controls to addres each of these deficiencies.
iii) List tests of controls the auditor of SC would perform to assess if the controls are operating
efectively.
4.10 Audit of the Payroll ICS .

The payroll system includes the following segregation of duties:
 Authorisation of recruitment, termination/ dismissal and payrates and keeping staff
information and (Board of directors / Human Resource Department (HRM).
 Recording and approval of workdone in the case of wages (Production
Department/supervisors)
 Payroll preparation_calculation of wages & salaries (Payroll section)
 Payment of wages, salaries and deductions (Payment section/cashier)
 Recording wages and salaries (General ledger section).
4. 10.1 Assertion, objectives, controls and tests of controls
Assertions Common controls Key tests of controls
Objectives
Occurrence  Segregation of HRM, recording workdone,  Observe and evaluate the
Payment of wages and payroll preparation, payment & general segregation of duties
salaries is made only to ledger.  Inspect and test authorisation
genuine entity employees  Written authorisation of staff recruitment, procedures.
for work done promotion , termination, dismissal of staff,  Inspect a sample of starters and
salary & wage rates, benefits ( by the leavers during the period to
board of directors), time worked/ overtime check whether proper records
(supervisors). are kept.
 HRM keeps records for each employee  Observe the clocking in and
showing details of recruitment, salary clocking out/signing attendance
scales/ rates of pay, allowances, registers to see whether they are
promotion, retirement, dismissal or properly supervised.
resignation & specimen signature.  Test a sample of time sheets,
 Clockcards/ attendance registers are used clock cards and overtime forms
to record time worked and work done is for approval by supervisors.
inspected for quality and appproved.  Test authority for payment of
 The cards and timing devices and the casual labour, particularly if in
clocking in and clocking out or the signing cash.
of the attendance registers by employees  Attend a wages payout to
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and properly supervised. Overtime is observe that the laid procedures

authorized in advance by the supervisor are followed
Page
and monitored.

 If payment is made in cash, the following  Before the payout, compare the
procedures should be in place: net pay and the physical cash.
- The cashiers should be  Match entries in the unclaimed
independent of payroll wages book with the entries on
preparation. the payroll.
- Employees are identified before  Check that unclaimed wages are
signing for the money. banked regularly by reviewing
- No employee should be allowed the cash book and bank
to take the wages of another statements.
employee.  Review reasons for non-payment
- A surprise attendance at the pay- in the unclaimed wages book
out is made periodically by an and the pattern of unclaimed
independent official. wages
- Unclaimed wages are recorded in
a register and held until claimed
or until a predefined period after
which the money should be re-
banked.
All payroll expenses are  Pre-numbered clock cards are used. segregation of duties.
recorded for work done  HRM sends all changes to the payroll  Review the numerical sequence
by employees. section that are made immediately. of clock cards.
 Maintenance of control accounts for  Review the procedures for
payroll expenses and their regular sending the payroll changes.
regulation.  Review a sample of
 Comparison of names on the payroll with reconciliations.
those on the bank transfers.  Review evidence of comparison.
Accuracy  HRM sends all changes to payroll section  Review the procedures for
The payroll costs are and changes are made immediately. sending the payroll changes and
computed and recorded  The payroll calculations are checked perform a starters’ and leavers’
correctly before the authorisation of the payroll. test.
 Monthly payroll reconciliations are done.  Recalculate a sample of payroll
 The payroll information is periodically calculations.
reconciled with staff lists.  Review the payroll
 The payroll costs are compared to the reconciliations
budget by management for  Review the comparisons.
reasonableness  Review the reconciliations of the
 Reconciliation of the payroll netpay with payroll masterfile and the payroll
the cheques/bank transfers, deductions control accounts.
with LST/PAYE/NSSF returns
 The payroll masterfile and the general
ledger payroll control accounts are
reconciled regularly
Cut-off  HRM sends all changes to payroll section  Review the procedures for
Payroll transactions are and changes are made immediately. sending the payroll changes and
recorded in the correct perform starters’ and leavers’
accounting period. test.
30
Classification  A chart off accounts is maintained.  Review the reconciliations.

 Transactions are coded properly and the  Examine a sample of posting for
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codes are checked independently. proper coding.

Payroll costs are  Test application controls for
recorded in proper proper codes.
accounts
4.11 Audit of capital and revenue expenditure.

It is important to distinguish capital and revenue expenditure to avoid understating or overstating profit. Key
contols over capital and revenue expenditure are similar to those already covered in the purchase system.
However, as non-current assets are usually material items, their controls and tests of controls are usually handled
when performing their substantive tests.
4.11. 1 Assertions, objectives, controls and tests of controls

Assertions Common controls Key tests of controls
Objectives
Occurrence  Authorisation of all acquisitions and  Inspect asset purchases for
disposals by the board of directors. All appropriate authorization in board
 Acquisitions and disposals acquisitions are included in the capital minutes and approved capital
of non-current assets are budget approved by the board. budget.
properly authorised.  Assets are properly maintained and  Inspeect board minutes for
adequately insured. authorization for disposals of assets
 Non-current assets are  Precautions against theft/ damage e.g..  Agree the authorized purchase and
securely kept and properly - Labelling/engraving assets disposal prices to invoices and the
maintained - Restriction of access cash book.
- Use of asset transfer forms  Review asset maintenance policies
- Insurance
Completeness  Capital expenditure is recorded in the  Confirm existence of non-current
asset register. asset register which adequately
All non-current assets are  The non-current asset register is identifies assets and comments on
recorded reconciled regularly with the general their current condition.
ledger and any discrepancies  Test evidence of reconciliation of the
investigated and resolved. register with the general ledger.
Classification  Similar to purchase controls  Similar to purchase tests of controls
 Distinction between capital and  Check repairs and maintenance for
Expenditure is properly revenue expenditure by proper capital expenduture.
classified coding of invoices.
Example
Introductions
Motor Cycle Co Ltd (UMCCL) owns a motor cycle assembly factory in Kampala Industrial Area. It imports the
motor cycle parts from china. The workers at the factory have an eight hour working day and sometimes there is
need to work overtime in – order to meet production targets.
The wages system
Production workers arrive for work at about 8:00am and clock in using electronic clock cards. The card is scanned
by the time recording system and each worker’s identification number is read from their card by the scanner. The
logging in is not monitored as it is assumed that the workers are responsible and would not commence without
logging in. The workers’ pay is based on hours recorded.
The workers work in groups of about ten, under the supervision of a foreman. Each day, each group is allocated
31
the number of motor cycles to assemble. At least 5 motor cycles have to be assembled by each group and if
necessary, they are allowed to work overtime inorder to complete the day’s production quota. The foreman is
Page

not required to supervise the overtime but should ensure that the workers are not spending extra time during
the lunch break as this would increase the overtime worked. The workers log off Daily.
Payment of wages
Details of time worked each week are sent electronically to the payroll system, where the hours worked are
allocated to the computerised payroll system to each employee’s wages records. Staff in the payroll section
compare hours worked from the time recording system to the computerised system and enters a code word to
confirm the accuracy of transfer. The code word also acts as authorisation to calculate net wages. The code
word is the name of the dog belonging to the section head and is generally known in the section.
Each week the computerised system calculates:
 Gross wages, using the standard rate and overtime rates per hour for each employee.
 Statutory deductions from wages, and
 Net pay
The list of net pay for each employee is sent over the UMCCL internal network to the accounts department. In
the accounts department, an accounts clerk ensures that the employee bank details are on file. The clerk then
authorises and makes payment of those employees using UMCCL online banking systems. Every few weeks,
the financial accountant reviews the total amont of wages made to ensure the management accounts are
accurate.
Termination of employees
When employees hae UMCCL, the human resource departmeng sends emails to the payroll section detailing
the employee’s termination date and any accumulated leave pay. The receipt of email by the payroll section is
not monitored by the human resource department.
Salaries system for managers
All UMCCL arre paid any monthly salaries and are not entitled to overtime payments. Salaries were increased
in July by 6%.
Required:
As the external auditors of UMCCL, write a management letter to the directors of UMCCL in respect of FOUR
weakness in the wages system.
4.12 Controls in a Compterised Accounting System / Auditing a Computerised Environment and the
Problem of LOVE (Loss Of Visible Evidence)
4.12.1 Introduction
Controls in a computerised accounting system differs from a manual one (where transactions are recorded on a
step by step basis), as the transaction is captured once in the system. For example, when a sales invoice is
raised, it is immediately posted to the recieveables ledger and the general ledger
Internal controls in a computerised system are divided into General Controls and Application controls.
4.12. 2 General Controls
General controls are policies and procedures that relate many applications, support the effective functioning of
application controls and ensure the continued proper operation of computer systems and the secuity of data.
They apply to computers and the end – User enviroment. They include control over the following:
General controls Examples
Development of computer applications  Standards over system design, programming and documentation
 System testing using test data
 Approval by computer users and management
32
 Segregation of system design and operation

 Installation procedures to ensure data is not lost or corrupted
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 Proper training of staff

Prevention or detection of unauthorised  Segregation of duties
program changes  Password protection of programs
 Full record of program changes
 Maintenance of program logs
 Use of Anti – virus software
 Use of read only memory over utility programs
Access Security  Restrciying access to computers using door locks, key pads
 Password controls like :
 Passwords not being related to items that are easy to
guess
 Keeping passwords secretely
 Changing passwords regularly
Continuity of operations  Keeeping copies of program and data files off – site
 Protection of hardware against fire and other harzards
 Power back – up sources
 Disaster recovery procedures e.g. back-up computers
 Maintenance service agreements and insurance
4.12.3 Application Controls

Applicatins controls are those controls (manual and computerised ) that relate to the transactions and standing
data pertaining to a computer based accounting system. They are specific to a given application and their
objectives are to ensure the completeness and accuracy of the accounting records and the validity of
entries made in those records.
An effective computer-based system will ensure that there are adequate controls exist at :
1. The point of Input of the computer processing cycle (Input Controls)
2. Processing stage of the computer processing cycle (Processing Controls)
3. Output stages of the computer processing cycle (Output Controls), and
4. Over standing data contained in master files (Master file Controls).
Application controls need to be ascertained, recorded and evaluated by the auditor as part of the process of
determining the risk of material misstatement in the audit client’s financial statements.
1. Input Controls
These are control activities designed to ensure that input is authorized, complete, accurate and timely.
Factors to be considered in determining extent of input controls include cost considerations, and confidentiality
requirements with regard to the data input.
Input controls common to most effective application programs include on-screen prompt facilities (for example, a
request for an authorised user to ‘log-in’) and a facility to produce an audit trail allowing a user to trace transaction
from its origin to disposition in the system.
Input contols / Validation checks examples
Formant checks These ensure that information E.g The requirement that the date of a sales invoice be
is input in the correct form input in numeric format only – not numeric and
alphanumeric
Range checks These ensure that information E.g , where an entity rarely, if ever, makes bulk-buy
input is reasonable in line with purchases with a value in excess of say 10,000,000/= a
33
expectations purchase invoice with an input value in excess of

10,000,000/= is rejected for review and follow-up.
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Setting a maximum weekly employee wage to say
200,000/=. Any amount entered above 200k is rejected
for review and follow-up
Compatibility checks These ensure that data input For example, a sales invoice value should be compatible
from two or more fields is with the amount of VAT charged on the invoice.
compatible.
Validity checks These ensure that the data For example, where an entity operates a sales system
input is valid with a maximum credit limit set (e.g post paid mobile
phone bills – sales input once the maximum is reached
should be rejected as invalid (in fact phone line is cut-off)
Exception checks These ensure that an For example, the carry forward of a negative value for
exception report is produced inventory held.
highlighting unusual
situations that have arisen
following the input of a specific
item.
Sequence Checks These facilitate completeness For example, where pre-numbered goods received notes
of processing by ensuring that are issued to acknowledge the receipt of goods into
documents processed out of physical inventory, any input of notes out of sequence
sequence are rejected. should be rejected.
Control totals These also facilitate For example, non-matching totals of a ‘batch’ of purchase
completeness of processing invoices should result inan on-screen user prompt, or the
by ensure that pre-input, production of an exception report for follow-up.
manually prepared control
totals are compared to control
totals input
Check digit verification This process uses algorithms For example, internally generated valid supplier numerical
to ensure that data input is reference codes, should be formatted in such a way that
accurate any purchase invoices input with an incorrectcode will be
automatically rejected. E.g An extra character added to
the account reference field on a purchase invoice to
detect mistakes such as transposition errors during input.
2. Processing Controls
Processing controls exist to ensure that all data input is processed correctly and that data files are appropriately updated
accurately in a timely manner. The processing controls for a specified application program should be designed and then
tested prior to ‘live’ running with real data.
Processing control examples
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Page

The use of Run-to-Run Run-to-run controls ensure the For instance, the beginning balances on the receivables
controls integrity of cumulative totals ledger plus the sales
contained in the accounting invoices (processing run 1) less the cheques received
records is maintained from from customers listed in the receivables ledger
one (processing run 2) should equal the closing balances on
data processing run to the the receivable ledger
next.
i.e. The totals from one
processing run, plus the input
totals from the second
processing, should equal the
result from the second
processing run.
Other processing controls should include the subsequent processing of data rejected at the point of input, for
example:
i. A computer produced print-out of rejected items.
ii. Formal written instructions notifying data processing personnel of the procedures to follow with regard to
rejected items.
iii. Appropriate investigation/follow up with regard to rejected items.
iv. Evidence that rejected errors have been corrected and re-input.
3. Output Controls
Output controls exist to ensure that all data is processed and that output is distributed only to prescribed authorised
users.
Oupt control exsmples
While the degree of output controls will vary from one organisation to another (dependent on the
confidentiality of the information and size of the organisation), common controls comprise:
i. Use of batch control totals, as described above (see ‘input controls’).
ii. Appropriate review and follow up of exception report information to ensure that there are no permanently
outstanding exception items.
iii. Careful scheduling of the processing of data to help facilitate the distribution of information to end users on a
timely basis.
iv. Formal written instructions notifying data processing personnel of prescribed distribution procedures.
v. Ongoing monitoring by a responsible official, of the distribution of output, to ensure it is distributed in
accordance with authorised policy.
4. Master file controls

The purpose of master file controls is to ensure the ongoing integrity of the standing data contained in the master files.
It is vitally important that stringent ‘security’ controls should be exercised over all master files
Master file controls include :
i. appropriate use of passwords, to restrict access to master file data
ii. the establishment of adequate procedures over the amendment of data, comprising appropriate
segregation of duties, and authority to amend being restricted to appropriate responsible individuals
iii. regular checking of master file data to authorised data, by an independent responsible official
iv. processing controls over the updating of master files, including the use of record counts and control
totals.
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4.13 Computer Assited Audit Techniques (CAATs)

The nature of computer-based accounting systems is such that auditors may use the audit client company’s
Page
computer, or their own, as an audit tool, to assist them in their audit procedures. The extent to which an auditor

may choose between using CAATs and manual techniques on a specific audit engagement depends on the
following factors:
• The practicality of carrying out manual testing
• The cost effectiveness of using CAATs
• The availability of audit time
• The availability of the audit client’s computer facility
• The level of audit experience and expertise in using a specified CAAT
• The level of CAATs carried out by the audit client’s internal audit function and the extent to which the
external auditor can rely on this work
CAATs are commonly classified into two:

1. Audit software
2. Test data
1. Audit software
Audit software is a generic term used to describe computer programs designed to carry out tests of control and/or
substantive procedures. These are computer programs used the auditor to interrogate a client’s computer files.
Such audit software programs may be classified as:
a) Packaged programs
These consist of pre-prepared generalised programs used by auditors and are not ‘client specific’. They may be
used to carry out numerous audit tasks, for example, to select a sample, either statistically or judgementally,
during arithmetic calculations and checking for gaps in the processing of sequences.
b) Purpose written programs

These programs are usually ‘client specific’ and may be used to carry out tests of control or substantive
procedures. Audit software may be bought or developed, but in any event the audit firm’s audit plan should ensure
that provision is made to ensure that specified programs are appropriate for a client’s system and the needs of
the audit. Typically, they may be used to re-perform computerised control procedures (for example, cost of
sales calculations) or perhaps to carry out an aged analysis of trade receivable (debtor) balances.
c) Enquiry programs
Those that are part of the client’s system, often used to sort and print data, and which can be adapted for audit
purposes, eg accounting software may have search facilities on some modules, that could be used for audit
purposes to search for all customers with credit balances (on the customers’ module) or all inventory items
exceeding a specified value (on
the inventory module).
2. Test data (Auditing around the computer)

Audit test data is used to test the existence and effectiveness of controls built into an application program used
by an audit client. As such, dummy transactions are processed through the client’s computerised system. The
results of processing are then compared to the auditor’s expected results to determine whether controls
are operating efficiently and systems’ objectiveness are being achieved.
For example, two dummy bank payment transactions (one inside and one outside authorised parameters) may
be processed with the expectation that only the transaction processed within the parameters is ‘accepted’ by the
system. Clearly, if dummy transactions processed do not produce the expected results in output, the auditor will
36
need
to consider the need for increased substantive procedures in the area being reviewed.
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4.14 Communication of deficiencies in Internal Control – The Management Letter
ISA 265 Communicating deficienceies in internal control to those charged with governance and management
gives the following definitions:
4.14.1 : A deficiency in internal control exists when:
 A control is designed, implemented or operated in such a way that it is unable to prevent, or detect and
correct, misstatements in the financial statements on a timely basis; or
 A control necessary to prevent, or detect and correct, misstatements in the financial statements on a
timely basis is missing.
A siginificant deficiency is a deficiency or combination of deficiencies in internal control that, in the auditor’s
judgement, is of sufficient importance to merit the attention of those charged with governance.
Examples of matters that may constitute a siginificant deficiency include:
 The likelihood of the deficiencies leading to material misstatements in the financial statements in the
future
 The susceptibility to loss or fraud of the related assest or liability.
 the subjectivity and complexity of determing estimated amountts, such as fair value accounting
estimates.
 The financial statement amounts exposed to the deficiencies.
 The volume of activity that has occurred or could occur in the account balance or class of transactions
exposed to the deficiency or deficiencies.
 The importance of the controls to the financial reporting process like those over significant transactions
with related parties.
 The cause and frequency of the exceptions detected as a result of the deficiencies in the controls
 The interaction of the deficiency with other deficiencies in internal control
 Absence/ineffective internal control elements
4.14.2 The management letter

ISA 265 requires the auditor to communicate:
 In writing significant deficiencies in internal control identified during the audit to those charged with
governance on a timely basis.
 To management at an appropriatte level of responsibility on a timely basis:
 In writing , significant deficiencies in internal control that auditor has communicated or intends to
communicate to those charged with governance and
 Other defeciencies in internal control identified during the audit that have not been
communicated to mangement by other parties and that, in the auditor’s proffessional judgement,
are of sufficient importance to merit management’s attention.
The written communication is called a mangement letter.
a) Purpose of the Management letter
(i) To enable the auditor to give his comments on the accounting records, systems and controls, and to
enable management take corrective action.
(ii) To enable the auditor to bring to the attention of management areas of weakness that might lead to
material errors.
(iii) In some audit engagements there is a requirement to make this report. These include local
authorities, stock exchange firms – brokers and listed companies, banks and insurance companies.
37
(iv) To enable the auditor communicate matters that may have an impact on future audits.
(v) To enable the management put right matters that may otherwise have led to audit report qualification.
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(vi) Can also be used to advertise the other services available from the audit firm.

b) Timing of the management letter
o Interim and final MLs.
(i) Procedures
- Discussion of weakness before letter is issued,
- It should be acknowledged
- All issues have to be responded to.
(ii) Addresses: The ML is addressed to the Board or the audit committee who then will decide on the
appropriate line managers to answer the audit issues raised there in.
c) Contents The auditor should include in the management letter:

 A decription of the defiecincies with sufficient information to enable those charged with
governance nad management to understand them.
 An explanantion of the potential effects of the deficiencies like reduced profitability,
asssests being stole, increased expenditure, errors in financial statements, and the
auditor need not quantify those effects
 The auditor may suggest recommendations specific to the deficiencies raised – their
implementation should be cost effective and the auditor should suggest who should
implement the procedures and when and management’s actual or proposed response,
and , wether or not the aditor has undertaken any steps to verify whether mangement’s
responses have been implemented.
In particular, the auditor should explain that the:
 purpose of the audit was for the auditor to express an opinion on the financial statements
 Audit included consideration of internal control relevant to the preparation of the
financial statements in order to design audit procedures that are appropriate in the
circumstances, but not for the purpose of expressing an opinion on the effectiveness of
internal control.
 Matters being reported are limited to those deficiences that the auditor has identified
during the audit and that the auditor has concluded are of sufficient importance to merit
being reported to those charged with governance.
 Purpose of the audit is not to express an opinion on the effectiveness of internal control
and that the deficiencies reported are limited to those identified during the audit.
 Information is provided for the puropse of those charged with governance and it may not
be suitable for other purposes.
The auditor may discuss the relevant facts and circumstances of the auditor’s findings with the appropriate level
of management if the findings (like management fraud) do not appear to call management’s integrity or
competence into question.
Management letter has two parts:
 Covering lette
 A appendix: shows the deficiencies, the effects and the recommendations – this may be in paragraph
or tabular format and space left for the client’s response.
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An example of management letter
Covering letter
ALEX & Co
Certified Public Accountants
P.O Box 1000
KAMPALA
April 15th 20X4
Private and Confidential
The Board of Directors
BCOM Ltd
P.O.Box 898, Kampala.
Audit of financial statements for the year ended 31 December 20x3
In accordance with our normal practice , we are writing to you with regard to matters arising out of our audit for
the year ended 31 December 20x3 which consider should be brought to your attention.
Our responsibilities as auditors are governed by the Company’s Act and principally require us to report on the
accounts laid before the company in the general meeting. The matters deailed in this report reflect matters coming
to our attention during the course of our audit. They are not intended to be a comprehensive statement of all
weaknesses that may exist or all improvements that could be made.
This report has been prepared for the sole use of the directors of BCOM Ltd. None of its contents may be
disclosed to third parties without our written consent. Alex & Co assumes no liability to any other persons. We
We would be pleased to discuss these points with you at your convenience. In the meantime we request that you
acknowledge receipt of the letter and also give us your responses to all the issues raised as per attached table.
Yours faithfully,
Alex & Co
Appendix
Purchases system
Deficiencies Consequences Recommendations Responses
No Goods Received Notes There is a possibility A copy of the purchase order should be
are raised in the stores that liabilities could be kept by the stores department and
when goods are received. set up for goods that checked to the goods to ensure the
Goods are only matched to have not been correct amounts and description match
the suppliers delivery note authorized. with goods received. A goods received
which is then forwarded to
note should then be prepared in
the accounts department
with invoice for settlement. triplicate; copy is given to the supplier,
They are not matched with copy retained in the stores and a copy
the copy of the purchase sent to the accounts department for
order. (give specific matching to the suppliers invoice.
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cases of delivery of such

goods dates, amounts
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etc)

REVISION QUESTION
Family Bread Limited (FBL) is a manufacturer of the bread brand - “family Loaf”. The company sells its products throughout
Uganda except in the war-disturbed areas of the north. Family loaf is the brand leader for bread products in Uganda. FBL
is managed as a family business with very close association of the owners in the day to-day operations of the company. It
sells its products both on credit terms, cash terms at the factory premises (located in industrial area of Kampala) and also
delivers on cash basis door to door within Kampala and all other major cities in the country. It operates a fleet of delivery
vans.
For both cash and credit sales customers just walk-in at the factory premises where a sales clerk by the names of Valeria
(she is a relative of the wife of the owner of the business) in the sales office receives the sales order and records them on
an order sheet (OS). The order sheet is then sent to the finished goods stores to check the availability of the specific type
of bread required. If the bread is out of stock the order form is sent back to the sales office who then instructs the production
department to initiate production of the specific bread required.
When goods are sent to customers, the order form acts a dispatch note and the dispatch clerk signs it. The signed order
form is then sent to the invoicing department to raise sales invoice in triplicate. One copy of the invoice is retained by the
accounts department, one is sent to the sales office and the original is sent to the credit customer when the monthly
statements are being sent out. The invoice booklets were designed by a son of the owners of the business and have no
identification numbers. Big credit clients like the hotels have insisted on signing for bread received, and a “black book” has
been procured for the purpose.
Cash customers pay cash to Valeria who records it on a “cash received sheet of paper” and delivers the bread to the
customer from the stores. Valeria is also responsible for banking the cash as and when she can find time to rush to the
bank. She also posts the cashbook and at the end of each month prepares a bank reconciliation statement for filing until
the external auditors ask for it. Valeria also receives the cash from the delivery van sales men, who of late have suffered a
number of ambushes from thieves and actually cash and products stolen from them.
The company is determined to increase its market share and its pricing procedures and selection of customer procedures
are very flexible, and Valeria can agree prices and credit terms for new and existing customers.
Required:
Identify the major weaknesses in the internal controls in the sales and debtors system described above. You should also
make recommendations for improving the system as appropriate.
N.B You should set out your answer in the form of a table where by for each weakness identified a corresponding
recommendation for improving the weakness is also given.
Weakness Recommendations
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MAKERERE UNIVERSITY
MAKERERE UNIVERSITY BUSINESS SCHOOL
FINAL EXAMINATION FOR THE DEGREE OF

BACHELOR OF COMMERCE
OF MAKERERE UNIVERSITY ACADEMIC YEAR 2019/2020
COURSE UNIT: Auditing COURSE CODE: COM3117

YEAR OF STUDY: Three SEMESTER: One
DATE: 3rd December, 2019 TIME: 9am – 12 Noon
INSTRUCTIONS:
1) This paper consists of THREE sections. Section A is compulsory
and carries 30 marks. Section A is comprised of one question
with two independent parts. Answer all parts of question one.
2) Section B is comprised of THREE questions and each question

carries 25 marks. Answer any TWO questions from Section B.
Section C is comprised of TWO questions and each question
carries 20 marks. Answer ONE question from section C.
3) Write the CAPITAL LETTER for the right answer to each

multiple choice question in your answer book.
4) Do not write anything on the question paper
5) Follow other university examination regulations and instructions

on the answer book.
41
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SECTION A – Answer all parts of the question in this section
Question 1
PART A
Kalibatanya Co. is a clothing retailer business which operates several stores in Uganda. The
company’s yearend is 31 October 2019. The company has an Internal Audit department
which has undertaken a number of internal control reviews. Most of the control reviews have
been performed on cash controls at the stores during the year. Unfortunately, the reviews
are only done at large stores and small ones are not visited by internal audit. You are an
audit supervisor of Walugyo, Nnambalirwa & Co. Certified Public Accountants and are
reviewing the internal controls documentation of Kalibatanya cash receipt system.
Each of Kalibatanya Co.’s stores has on average three or four cash tills to take customer
payments. All employees based at the store are able to use each till and individuals do not
have their own log-on codes, although employees tend to use the same till each day.
Customers can pay using either cash or a credit card and for any transaction, either the credit
card payment slips or cash are placed in the till by the cashier. Where employees’ friends or
family members purchase clothes from the same company, the employee is able to serve
them at the till point.
At the end of each day, the tills are closed down with daily readings of sales taken from each
till; these are reconciled to the total of the cash in the tills and the credit card payment slips
and any discrepancies are noted. To save time, this reconciliation is done by the stores
Assistant Manager in aggregate for all of the store tills together. Once this reconciliation has
taken place, the cash is stored in the shop’s small safe overnight and in the morning it is
transferred to the bank via collection by a security company.
The daily sales readings from the tills along with the cash data and credit card payment data
are transferred daily to head office through an interface with the sales and cash receipts
records. A clerk oversees that this transfer has occurred for all stores. On a daily basis, he
also agrees the cash transferred by the security company has been banked in full by agreeing
the cash deposit slips to the bank statements, and that the credit card receipts have been
received from the credit card company. On a monthly basis, the same clerk reconciles the
bank statements to the cash book. The reconciliations are reviewed by the financial controller
if there are any unreconciled amounts.
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Required:
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a) State key functions in a typical cash receipt system. (2 marks)

b) Identify and explain any FOUR key controls which the auditor may seek to place
reliance on in Kalibatanya Co.’s cash receipts system; and describe a test of control
the auditor should perform to assess if each of these key controls is operating
effectively. (4, 4 marks)
c) Identify and explain FIVE deficiencies in Kalibatanya Co.’s cash receipts system and
provide a recommendation to address each of the deficiencies. (5, 5 marks)
PART B.
1. The appointment of the external auditor for Ministry of Finance, Planning and Economic
Development in Uganda is done by
A) Shareholders
B) Taxpayers through their members of parliament
C) President
D) Speaker of Parliament
2. The following are examples of adjusting events as per IAS 10 Events after the reporting
date except,
A) Settlement of a court case which by the yearend, there were conditions existing
regarding the case settled
B) Closing inventory sold at less than cost that require write off
C) Discovery of material errors or fraud in the financial statements during audit
D) Material losses of non-current assets or inventory as a result of fire or floods in the
new year
3. ISA 560 Subsequent events requires the auditor to:

A) Obtain sufficient appropriate audit evidence about whether subsequent events
require adjustment of or disclosure is appropriately reflected in those financial
statements in accordance with the ISAs.
B) Respond appropriately to facts that become known to the auditor after the date of the
auditor’s report, that, had they been known to the auditor at that date, may have
caused the auditor to amend the financial statements.
C) Obtain sufficient appropriate audit evidence about whether subsequent events
statements in accordance with the IFRSs.
D) Obtain sufficient appropriate audit evidence about whether subsequent events
statements in accordance with the directives of the shareholders who appointed the
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auditors
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4. ISA 570 Going concern requires the auditor to do the following except;
A) Obtain sufficient appropriate audit evidence about the appropriateness of
management’s use of the going concern basis of accounting in the preparation of the
financial statements.
B) Conclude whether a material uncertainty exists that may cast significant doubt on the
entity’s ability to continue as a going concern.
C) Report findings on going concern assumption in line with the requirements of ISA 570
Going concern.
D) Obtain sufficient appropriate evidence about the material uncertainty and ensure that
any material uncertainty that may cast significant doubt on going concern is reported
to those in charge and the necessary provisions are made in the financial statements.
5. The following are requirements of ISA 450 Evaluation of misstatements identified during
the audit except;
A) Identify any previously unrecognized risks of material misstatement
B) Evaluate the effect of the uncorrected misstatements on the financial statements
C) Communicate all identified misstatements to management and request management
to correct them.
D) Request a written representation from management or those charged with
governance, whether they believe that the effects of the uncorrected misstatements
are immaterial, individually or in aggregate to the financial statements as a whole.
6. Substantive procedures are performed using the following audit procedures except;
A) Inquiry of management on whether there are any misstatements due to fraud they
may be aware of.
B) Inspection of documents supporting transactions such as invoices for accuracy and
proper cutoff
C) Inspection of the physical existence of recorded assets like tangible assets and
inventory
D) Confirmation from external parties of the existence of balances like receivables and
payables.
7. Which of the following is a key substantive procedure for period end bank and cash
balances?
A) Obtain or prepare bank reconciliation statements for the last month and check their
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arithmetical accuracy
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B) Obtain or prepare bank reconciliations for the various bank accounts at the reporting
date to verify existence, occurrence, accuracy, cut-off, rights and obligations.
C) Agree the balances per cash book/bank accounts on each bank reconciliation
statement to the year-end cash book, general ledger to verify accuracy of the
amounts.
D) Check that all cheques that bounced are cleared when re-banked or appropriate
steps are taken to effect recovery of the amount.
8. Which of the following is not a factor to be considered in determining sample size while
conducting an audit of financial statements
A) The confidence level C) Control risk
B) The tolerable rate of deviation D) Error term
9. Which of the following audit tests may be applied by the auditor to verify that transactions
affecting all purchases and sale of inventory are recorded in the correct period?
A) Check that goods received and not yet invoiced before the period end are accrued
by debiting purchases and crediting trade payables
B) Confirm that any inventory held by third parties is included in the year-end
inventory list and figure.
C) Request confirmation from third parties about the quantities and condition of
inventory held on behalf of the entity.
D) Observe the physical inventory count
10. ISA 580: Written representations requires the auditor to:

i) To obtain written representations from management that they have fulfilled their
responsibility for ensuring that internal controls are in place and effective
ii) To obtain written representations that support other audit evidence relevant to
the financial statements as determined by the auditor or as required by other
International Standards on Auditing
iii) To obtain written representations from management that they have fulfilled their
responsibility for the preparation of financial statements and for the existence
of the information provided to the auditor
iv) To respond appropriately to written representations or if management does not
provide the written representations requested by the auditor
v) To obtain written representations from management that they have fulfilled their
responsibility for the preparation of financial statements and for the
completeness of the information provided to the auditor
A) i, ii and v B) ii, iv and v C) ii, iii and iv D) iii, iv and v
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(1 mark for each multiple choice question up to 10 marks)

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(Total: 30 marks)
SECTION B – Answer any two questions from this section
Question 2
As preparations for final examinations were in high gear at Nakawa, some students such as
Ms. Kirabo Josephine disagreed with the interpretations of some terms used in preparing an
audit report by her fellow classmates. The ASAMU president also advised on the type of
opinions. However, some BCOM class students led by Mr. Makumbi Nasasira have
approached you and need detailed guidance on the following;
a) Circumstances that may lead to a modified opinion (4 marks)
b) Types and sample wordings of modified opinions (6, 6 marks)
c) Difference between emphasis of matter paragraph and Key Audit Matters (4 marks)
d) Auditor’s responsibilities for the audit of financial statements as per ISA 700 (Revised)
Forming an Opinion and reporting on financial statements. (5 marks)
(Total: 25 marks)
Question 3
a) Ms. Irankunda is a recent graduate of an unknown University and has been appointed as
an auditor with KPMN which is a renowned audit firm around town. She has been given
the following information for Company X but is stuck with it on how to go forward.
The company had opening balances on 1st July, 2018 for land and buildings as Ugx.
750,000,000; motor vehicles, Ugx. 100,000,000 while fixtures and fittings were Ugx.
20,000,000. The accumulated depreciation so far is Ugx.50, 000,000 for buildings, Ugx.
20,000,000 for motor vehicles and Ugx. 5,000,000 for fixtures and fittings. During the
year, part of the fixtures and fittings was disposed of. Fixtures and fittings which had cost
Ugx 10,000,000 with accumulated depreciation of Ugx. 3,000,000 were disposed of at the
yearend. The company depreciates its non-current assets at 20% on reducing balance.
Last year’s financial statements for the company were not audited. This year’s statement
of financial position reveals that, the carrying amounts for land and buildings is Ugx.
500,000,000, motor vehicles is Ugx. 50,000,000 and fixtures and fittings Ugx. 1,000,000.
The audit manager CPA Matayo Bakiddawo has set materiality at Ugx 500,000.
Required:
a) Guide Irankunda to ascertain the correct closing balances (as at 30 June 2019) of
the non-current assets following the requirements of IAS 16. (5 marks)
46
b) Which other key substantive procedures should Ms. Irankunda apply to verify that
the statement of financial position includes all tangible non-current assets
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(3 marks)

c) Which key substantive procedures can Ms. Irankunda apply to verify that all tangible
non-current assets included in the statement of financial position physically exists?
(3 marks)
d) Express an opinion on the financial statements of company X (based on the
scenario) above and clearly show the basis of opinion. (2, 5 marks)
e) Ms. Irankunda also wants to know if she can obtain external parties confirmations.
Other than confirmation of receivables, bank and payables, state other external
confirmations she can obtain (3 marks)
f) State the contents of a bank confirmation letter. (4 marks)
(Total: 25 marks)
Question 4
Okwakol Supermarkets Ltd (OSL) with its headquarters in Soroti operates supermarkets
(branches) in Lira municipality, Mbale city and Katakwi Town Council. The company’s
yearend is 31 October 2019. John Mary is the audit manager for Commerce & Co. Certified
Public Accountants (Commerce) and recently attended a planning meeting with the finance
director and have provided you with the planning notes below.
As an audit senior, you have learnt from your boss that OSL during the year spent Shs 800
million in rehabilitation of its supermarkets. As part of this rehabilitation programme their
Soroti warehouse has been extended and a smaller warehouse, which was only occasionally
used, has been disposed of at a profit. In order to finance this rehabilitation exercise, a sum
of Shs 400 million was borrowed from the bank. This is due to be repaid over five years.The
company will be performing a year-end inventory count at the Soroti warehouse as well as
at all the other supermarkets on 31 October 2019. Inventory is valued at selling price less an
average profit margin as the finance director believes that this is a close approximation to
cost.
Prior to 2018, each of the supermarkets maintained their own financial records and submitted
returns monthly to head office. During 2019 all accounting records have been centralised
within head office. Therefore at the beginning of the year, each supermarket’s opening
balances were transferred into head office’s accounting records. The increased workload at
head office has led to some changes in the finance department and in September, 2019 the
financial controller resigned. The search process of the financial controller is about to start.
During the year ended 31 October 2019, Okwakol supermarket had more suppliers and
because it had gained a large customer base, the suppliers gained more confidence and this
gave OSL chance to acquire more goods on credit from the suppliers. As a result, there were
several issues with payables which required the attention of the auditor. Further, the payroll
47
for OSL also had inconsistencies.

Page
Required:

a) Identify and describe FIVE audit risks and explain the auditor’s response to each risk
in planning the audit of OSL. (5,5 marks)
b) What are the key substantive procedures for completeness of payables? (5 marks)
c) Explain why the balances on the suppliers’ statements may be different from those of
the payables ledger accounts. (3 marks)
d) What are the substantive procedures for payroll expenses? (7 marks)
(Total: 25 marks)
SECTION C – Answer any one question from this section
Question 5
Shaliwa Namale is a graduate of Bachelor of Education (Economics) and a full member of
the Institute of Certified Public Accountants of Uganda (ICPAU). In her journey to become a
full member of ICPAU, she met CPA Rashidah Birungi whom they teamed up to form an
audit firm named Shaliwa, Rashidah & Co. Certified Public Accountants. This audit firm is
located on Qualicel building in the Kampala city center. They got their first client, Kanakulya
Enterprises Limited whose managing director is Mr. Nyindo.
The managing director, Mr. Nyindo has requested Rashidah to buy shares in his business so
that it is able to expand. He has promised that once she buys shares, all audits of the firm
will be undertaken by Shaliwa and Rashidah & Co. The managing partner (Rashidah) is now
thinking of what to do next. In Kanakulya Enterprises, it has also been established that
Shaliwa’s former boyfriend is the Finance Director. The finance director has suggested that
the auditors complete their audit within the next 2 weeks instead of one month.
Kanakulya Enterprises is planning an outing of its staff and the guest of honour will be either
of the auditors from Shaliwa, Rashidah & Co. CPA. Uganda Revenue Authority (URA)
recently assessed Kanakulya enterprises but the tax assessed was so high. On the outing
agenda, the managing director expects to discuss those taxation issues with the auditors.
The finance director has suggested to the managing director that, the audit fees be charged
based on the taxes saved for the company. The finance director has assured the managing
director that he can convince the auditors in case URA decides to penalize them for non-
payment of taxes to represent Kanakulya enterprises in court. As we speak now, the auditors
are about to accept all the engagements since the engagements will contribute a substantial
income to the audit firm.
Given that this is the first audit Shaliwa and Rashidah Enterprises are going to handle, they
are confused on most things. For the past one week, they have been revising the ICPAU’s
48
code of ethics for professional accountants but lament it is too long and are in need of
Page
someone to interpret for them certain sections.

Required:
a) Explain to the auditors, the general principles of an audit (4 marks)
b) The preconditions of an audit (4 marks)
c) Identify and explain any FIVE ethical threats to Shaliwa, Rashidah & Co. Certified
Public Accountants and possible safeguards that can be employed by Shaliwa,
Rashidah & Co. Certified Public Accountants. (12 marks)
(Total: 20 marks)
Question 6
a) There are several types of audits such as external and internal audits. These audits are
both in the public and private sectors.
Required:
i) What is the difference between internal and external audits? (4 marks)
ii) Where does the demand for auditing arise from? (6 marks)
b) The external audit of government is carried out by the Auditor General who is independent
from anyone. However, he can also appoint private audit firms to audit government
institutions on his behalf.
Required:
i) Other than the appointment of private audit firms to audit Government on his
behalf, explain the powers of the Auditor General as per section 24 of Uganda’s
National Audit Act of 2008 (5 marks)
ii) Explain the functions of the Auditor General as per section 13 of the Uganda’s
National Audit Act of 2008 (5 marks)
(Total: 20 marks)
……………………………………End of question paper…………………………………….
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Auditing Marking Guide for Bachelor of Commerce Year 3, AY 2019/20 Semester 1
SECTION A
Question 1 Part A
a) Key functions in a typical cash receipts system

 Issue of receipts by the cashier and record the cash in the cash account/cash book•
 Preparation of bank deposit slips and banking the cash.
 If cash is paid by debtors, record the payments in the receivable ledger accounts and the
receivables ledger control account in the general ledger.
 Regular bank reconciliation, preferably by a person independent of the cash procedures
above.
(1 mark each up to 2 marks)
b) Kalibantanya Co. cash receipts system strength and tests of controls
Key controls Test of control

Kalibantanya Co. has an internal audit Discuss with internal audit the programme of their
department which has undertaken a visits to stores and the areas addresses on these
number of internal control reviews, visits. This will assess the strength of this monitoring
which specifically focused on cash control. In particular, inquire of internal audit whether
controls at stores during the year. This over a rolling period all stores were visited.
is a strong monitoring control as stores Review the internal audit department files for the
will aim to ensure that company results of the store visits, to confirm that the all the
procedures are maintained as they stores programmed to be visited did all actually take
would not wish Internal Audit to report place and for exceptions noted and actions taken.
any exceptions at their store.
At the end of each day, the tills are For a sample of stores visited, the auditor should
closed down with daily readings of sales review the file of daily reconciliations to ascertain if
taken; these are reconciled to the total end of day till reconciliations have taken place on a
of the cash in the tills and the credit card daily basis.
payment slips and any discrepancies For reconciliations with discrepancies, discuss with
are noted. the store manager what actions were taken and how
Daily cashing up procedures should these differences were resolved.
ensure that the cash is controlled and
reduces the risk of fraud as employees
are aware that the assistant manager
will be looking for cash discrepancies.
Cash received from customers is taken During the store visits, enquire of staff how the cash
to the bank daily via collection by a is transferred to the bank. A sample of invoices from
security company. This ensures that the collection company should be reviewed and
cash is safeguarded and that the risk of confirmed. In addition, during these visits observe
theft when transferring to the bank is the cash collection process carried out by the
minimized. security company.
The daily sales readings from the tills During the interim audit at head office, compare the
along with the cash and credit card data daily sales readings from individual stores, including
50
are transferred to the head office some visited by the audit team, to the sales and cash
through a daily interface into the sales receipt records within the general ledger. Review the
Page
and cash receipts records. This should date on which the sales and cash receipt records

ensure that sales and cash records are were updated to ensure this occurred promptly. Any
updated on a prompt basis and are discrepancies should be discussed with the clerk
complete and accurate. responsible for overseeing this process.
On a daily basis the clerk agrees that Discuss with the clerk responsible for reconciling the
the cash banked and the credit card cash and credit card receipts the process he
receipts from the credit card company undertakes. Review the daily reconciliations he has
have been credited to the bank completed to confirm the process has been
statements in full. This should ensure undertaken as described.
the completeness of cash receipts, as
they are transferred in from two
sources, being the security company
and the credit card operator.
Bank reconciliations are undertaken on Review the file of bank reconciliations to ascertain if
a monthly basis. This should ensure there is one for each month and that they are either
that any discrepancies between the fully reconciled, or the financial controller has
cashbook ad the bank statements are evidenced their review of any unreconciled amounts.
identified promptly.
(1 mark for each key control and 1 mark for each test of controls, total: 8 marks)
b) Deficiencies and recommendations in Kalibatanya co.
Control deficiency Control recommendation

The internal audit department only undertakes The internal audit department should
cash control visits to the large stores and small have a rolling programme of visits to all
ones are not visited. This increases the likelihood the stores regardless of the size. This
of control errors, as the small stores may not programme can have a bias to large and
comply with company procedures and with it being high risk stores, but it should ensure that
a cash business heightens the chance of frauds all the stores are visited on a cyclical
occurring. basis.
All store employees are able to use each till and Only employees for whom criminal record
none have an individual log on code when using / credit checks have been undertaken
the tills. Allowing all employees access to the till should be able to use the tills to take
points increases the risk of fraud and error arising. customer payments. Each employee
Also, in the event of cash discrepancies arising in should have a designated till and a log on
the tills, it would be difficult to ascertain which code, which is required for each payment
employees may be responsible as there is no way transaction.
of tracking who used which till.
Where employees’ friends or family members Kalibatanya Co. should instigate a policy
purchase clothes in store, the employee is able to whereby employees are unable to serve
serve them at the till point. There is a significant friends / family members at the till points.
fraud risk as employees could fail to put the goods They should be required to request that a
through the till, but retain the cash paid by the manager or supervisor put these goods
friend / family members. Additionally, they could through the till. In addition, the CCTV
give the goods away for free or undercharge for cameras could be placed in the shops
goods sold, thereby granting unauthorized near the till points to record the daily till
discounts. transactions. The company should also
carry out regular inventory counts to
51
identify if any goods have gone missing

from stores.
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The daily reading of sales and reconciliations to the The reconciliations should be undertaken
tills is performed in aggregate rather than for each on an individual till by till basis rather than
till. This means if exceptions arise, it will be difficult in aggregate.
to identify which till caused the difference and
therefore which employees may require further till
training or have undertaken fraudulent
transactions.
The cashing up of tills along with the recording of The cashing up process should be
any cash discrepancies is undertaken by one undertaken by at least two individuals,
person – the assistant store manager. There is a ideally the assistant and the store
fraud risk as the store manager could remove some manager. One should count the cash and
of the cash and then simply record that there was the other record. Any exceptions to the till
an exception on this till. reading should be double checked to
confirm that they are not simply as
addition errors.
The cash is kept at the store overnight in a small The cash should continue to be collected
safe. Although in a safe, this is not secure as it is daily by the security company, rather than
likely that the cash sales for one day would be a in the morning.
significant sum if it is stolen overnight.
One clerk is responsible for several elements of the These key roles should be split between
cash receipts system. He oversees the daily a few individuals, with ideally bank
interface from stores, agrees that cash has cleared reconciliations being undertaken by
into the bank statements and undertakes the bank another member of the finance team.
reconciliations. There is lack of segregation of
duties and errors will not be identified on a timely
basis as well as increasing the risk of fraud.
The bank reconciliations are only reviewed by the The bank reconciliations should be
financial controller if there are an unreconciled reviewed by the financial controller on a
amounts. The bank reconciliation could reconcile monthly basis, even if there are no
but still contain significant errors which cancel each exceptions, and he should evidence his
other out. In addition, for a cash based business, review by way of signature on the bank
the bank reconciliation is a key control which reconciliation.
reduces the risk of fraud. If it is not reviewed, then
this reduces its effectiveness.
(1 mark for each deficiency and 1 mark for each recommendation, total: 10 marks)
Part B
No Answer Explanation
1. C Ministry of Finance, Planning and Economic Development is a
government entity and as such, its external auditor is the Auditor
General. In accordance with article 163(1) of the Constitution, the
Auditor General shall be appointed by the President with the approval
of Parliament.
2. D Material losses of mom-current assets or inventory as a result of fire or
floods in the new year could be classified as an accident and therefore
a non-adjusting event.
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3. C ISA 560: Subsequent events requires the auditor to: Obtain sufficient
appropriate audit evidence about whether subsequent events require
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adjustment of or disclosure is appropriately reflected in those financial

statements in accordance with the IFRSs and; Respond appropriately
to facts that become known to the auditor after the date of the auditor’s
report, that, had they been known to the auditor at that date, may have
caused the auditor to amend the auditor’s report.
4. D It is not the responsibility of the auditor to ensure any changes in the
accounts are effected. The auditor only obtains reasonable assurance.
5. A By Identifying any prevuiosly unrecognized risks of material
misstatement, the auditor is only carrying out final analytical procedures
to arrive at an overall conclusion on whether financial statements are
free from material misstatements.
6. A Inquiries are largely performed when testing controls.
7. B Obtaining or preparing bank reconciliation statements for the last month
and check their arithmetical accuracy; Agreeing the balances per cash
book/bank accounts on each bank reconciliation statement to the year-
end cash book, general ledger to verify accuracy of the amounts and,
Checking that all cheques that bounced are cleared when re-banked or
appropriate steps are taken to effect recovery of the amount, the auditor
is obtaining evidence for bank reconciliation statements.
8. D The answer is error term. An error term is a residual variable produced
by a statistical or mathematical model, which is created when the model
does not fully represent the actual relationship between the independent
variables and the dependent variables. This is less related to sampling
in auditing unless if it is used in academic research.
9. A Checking that goods received and not yet invoiced before the period
end are accrued by debiting purchases and crediting trade payables is
one of the audit tests to confirm cut off.
10. B ISA 580 Written representations requires the auditor to: Obtain written
representations from management that they have fulfilled their
responsibility for the preparation of financial statements and for the
completeness of the information provided to the auditor; support other
audit evidence relevant to the financial statements as determined by the
auditor or required by other ISAs; and, respond appropriately to written
representations or if management does not provide the written
representations requested by the auditor.
(1 mark each multiple choice question up to 10 marks)
SECTION B
Question 2
a) Circumstances that may lead to a qualified opinion

ISA 705 Modifications to the opinion in the independent auditor’s report requires an auditor to express
a modified opinion when:
 The financial statements as a whole are not free from material misstatement. A material
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misstatement may arise when: The selected accounting policies have not been consistent with
the financial reporting framework; the selected accounting policies have been applied
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inappropriately; all the required disclosures are not included; the disclosures are not presented in

accordance with the applicable financial reporting framework and; the disclosures do not achieve
fair presentation. (2 marks)
 The auditor is unable to obtain sufficient appropriate audit evidence to conclude that the
financial statements as a whole are free from material misstatement. Inability to obtain sufficient
appropriate audit (also called a limitation on the scope of the audit) may arise from: Circumstances
beyond the control of the entity e.g. when: The entity’s accounting records have been destroyed;
the accounting records of a significant component have been seized indefinitely by governmental
authorities. Circumstances relating to the nature or timing of the auditor’s work e.g. when: The
auditor is appointed late and is unable to observe the counting of the physical inventories.
Performing substantive procedures alone is not sufficient and yet the entity’s controls are not
effective. Limitations imposed by management e.g. when management prevents the auditor from:
Observing the counting of the physical inventory; requesting external confirmation of specific
account balances. (2 marks)
b) Types and sample wordings of modified opinions
A qualified opinion is issued when:
 The auditor, having obtained sufficient appropriate audit evidence, concludes that misstatements,
individually or in the aggregate, are material, but not pervasive, to the financial statements, or
 The auditor is unable to obtain sufficient appropriate audit evidence on which to base the opinion,
but the auditor concludes that the possible effects on the financial statements of undetected
misstatements, if any, could be material but not pervasive. (2 marks)
Sample wording:
In our opinion, except for the effects of the matter described in the Basis for qualified opinion
section, the financial statements give a true and fair view of the financial position of ABC Ltd as
at 31 December, 2018, and of its financial performance and its cash flows for the year then ended
and comply with the International Financial Reporting Standards and the Companies Act of
Uganda 2012.
OR:
In our opinion, except for the possible effects of the matter described in the basis for qualified
opinion section, the financial statements give a true and fair view of the financial position of ABC
Ltd as at 31 December, 2018, and of its financial performance and its cash flows for the year then
ended and comply with the International Financial Reporting Standards and the Companies Act
of Uganda 2012. (2 marks)
An adverse opinion is issued when the auditor, having obtained sufficient appropriate audit
evidence, concludes that misstatements, individually or in the aggregate, are both material and
pervasive to the financial statements. (2 marks)
Sample wording:
In our opinion, because of the omission of the matter discussed in the Basis for adverse opinion
section, above, the financial statements do not give a true and fair view of the financial position
of ABC Ltd as at 31 December, 2018, and of their financial performance and their cash flows for
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the year then ended and comply with the International Financial Reporting Standards and the
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Companies Act of Uganda 2012. (2 marks)

A disclaimer of opinion is issued when the auditor is unable to obtain sufficient appropriate audit
evidence on which to base the opinion, and concludes that the possible effects on the financial
statements of undetected misstatements, if any, could be both material and pervasive. This is the
case where most of the accounting records have been destroyed or are hidden by management.
(2 marks)
Sample wording:
Because of the significance of the matter described in the Basis for disclaimer of opinion section,
we have not been able to obtain sufficient appropriate audit evidence to provide a basis for an
audit opinion. Accordingly, we do not express an opinion on the financial statements. The reasons
for the auditor’s inability to obtain sufficient appropriate audit evidence are provided in the Basis
for disclaimer of opinion. (2 marks)
c) Difference between emphasis of matter paragraph and Key Audit Matters

An Emphasis of matter paragraph refers to a matter appropriately disclosed in the financial
statements that is of such importance that it is fundamental to users’ understanding of the financial
statements. Examples of circumstances that may lead the auditor to use an Emphasis of matter
paragraph include: Going concern as covered in ISA 570 (Revised), An uncertainty relating to the
future outcome of exceptional court case or regulatory action, A significant subsequent event that
occurs before the date of the auditor’s report, Early application (where permitted) of a new IFRS
that has a material effect on the financial statements and, A major catastrophe like a fire that has
significant effect on the entity’s financial position. (2 marks)
Key audit matters are matters that, in the auditor’s professional judgment, were of most
significance in the audit of financial statements of the current period. Key audit matters are
selected from matters communicated with those charged with governance. They include: Areas
of higher assessed risk of material misstatement, Areas involving significant management
judgment, including accounting estimates and, the effect on the audit of significant events or
transactions that occurred in period. Key audit matters are not a substitute for expressing a
modified opinion. (2 marks)
d) Auditor’s responsibilities for the audit of financial statements as per ISA 700 (Revised)
To form an opinion on the financial statements based on audit evidence obtained.
To express clearly that opinion through a written report. The opinion states whether the auditor has
obtained reasonable assurance that the financial statements as a whole are free from material
misstatement, whether due to fraud or error. In making this opinion, the auditor considers the
following:
 Whether sufficient appropriate audit evidence has been obtained.

 Whether uncorrected misstatements are material.
 Whether the financial statements are prepared, in all material respects, in accordance with the
requirements of the applicable financial reporting framework, i.e.
- The financial statements adequately disclose the significant accounting policies selected
and applied.
- The accounting policies applied are consistent with the applicable financial reporting
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framework and are appropriate.

- The accounting estimates made by management are reasonable.
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- The information presented in the financial statements is relevant, reliable, comparable, and
understandable.
- The financial statements provide adequate disclosures to enable the intended users to
understand the effect of material transactions and events on the entity’s financial position,
financial performance and cash flows.
- The terminology used in the financial statements, including the title of each financial
statement, is appropriate.
 Whether the financial statements achieve fair presentation, i.e.
- The overall presentation, structure and content of the financial statements.
- The financial statements, including the related notes, represent the underlying transactions
and events so as to achieve fair presentation.
- Whether the financial statements adequately refer to or describe the applicable financial
reporting framework (e.g. IFRSs. IFRS small and medium-sized entities and IPSASs).
(5 marks)
Question 3
a) Property, Plant and equipment schedule for Company X

Details Land and buildings Motor vehicles Furniture Total
1.7.2018 750,000,000 100,000,000 20,000,000 870,000,000
Disposals (10,000,000) (10,000,000)
30.6.2019 750,000,000 100,000,000 10,000,000 860,000,000
Depreciation:
1.7.2018 (50,000,000) (20,000,000) (5,000,000) (75,000,000)
Depreciation charge (140,000,000) (16,000,000) (1,000,000) (157,000,000)
Elimination on 3,000,000 3,000,000
disposal
30.6.2019 560,000,000 64,000,000 7,000,000 631,000,000
(½ mark each up to 5 marks)
b) Substantive procedures for completeness of PPE.
 Obtain or prepare a lead schedule of tangible non-current assets showing the gross amount,
accumulated depreciation and net book value and reconcile with the opening and closing
SOFPs.
 Reconcile the schedule of tangible non-current assets with the general ledger and the asset
register, obtain explanations for the differences
 Physically inspect a sample of the entity’s assets and check that they are included in the asset
register.
 Where an asset register is not kept, prepare a schedule of major assets showing the original
costs and the carrying amounts.
 Review the repairs and maintenance accounts in the general ledger for large items that may
be capital in nature and ensure that they are treated as capital expenditure.
c) Substantive procedures for existence of PPE
 Check that the entity inspects all assets in the asset register annually.
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 Select all high value assets and a sample of other assets from the asset register and physically
inspect them, check that they are they are in use, in good condition and are numbered.
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 Reconcile opening and closing numbers and amount for assets like motor vehicles.

 Inspect records (e.g. agreements) of income generating assets.
 Review insurance policies.
d) Express an Opinion
Adverse Opinion
We have audited the Property, Plant and Equipment items section of the statement of financial
position of Company X, as at 30 June 2019.
In our opinion, because of the matters discussed in the Basis for adverse opinion section,
below, the financial statements do not give a true and fair view of the financial position of
Company X as at 30 June 2019 and, do not comply with International Financial Reporting
Standards and the companies Act of Uganda 2012. (2 marks)
Basis of opinion
Land and buildings carrying amounts are overstated by Ugx. 60,000,000 while motor vehicles are
understated by Ugx.14, 000,000. Furniture is also understated by Ugx. 6,000,000. Given that all
the items of the PPE are misstated and the amount by which they are misstated is material, it
may also be likely that the PPE items form a substantial portion of the elements of the financial
statements and this means that the misstatement is not only material but also pervasive.
(3 marks)
Other matter paragraph
We bring attention of the users of the financial statements for Company X to the fact that, the
previous year’s financial statements were not audited and this implies that the opening balances
of the current year under audit may not be a true representation of the closing balances of the
previous year. (2 marks)
e) External confirmations other than receivables, bank and payables

 Inventory held for third parties
 Insurance claims from insurance firms
 Land ownership from land registry
 Pending litigation from entity lawyers and court registrars / clerks.
f) Contents of a bank confirmation letter
 Account and balance details:

- All account titles, numbers and balances and currency type.
- Details of accounts closed twelve months before the confirmation date and date of
closure.
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- Nature and extent of restrictions over any accounts held.


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Loan facilities:
- Loan amounts, repayment periods and interest rates.

- Overdraft facilities, limits and period.
- Securities given.
 Contingent liabilities like guarantees, comfort letters, foreign exchange currency contracts.
 Client securities held for safe custody.
 Details of banks and branches having a relationship with the client.
Question 4
a) Identity audit risk and response
Audit risk Auditor response

Okwakol Supermarkets Ltd (OSL) has spent Review a breakdown of the costs and agree to
Shs 800M on refurbishing its supermarkets. invoices to assess the nature of the expenditure
This expenditure needs to be reviewed to and, if capital, agree to assets recorded in the
assess whether it is of a capital nature and asset register and, if repairs, agree to the
should be included within non-current statement of profit or loss.
assets or expensed as repairs.
During the year a small warehouse has been Review the non-current asset register to ensure
disposed of at a profit. The asset needs to that the asset has been removed. Also confirm
have been correctly removed from property the disposal proceeds as well as recalculating
plant and equipment to ensure the non- the profit on disposal. Consideration should be
current asset register is not overstated and given as to whether the profit on disposal is
the profit on disposal should be included significant enough to warrant separate
within the statement of profit or loss. disclosure within the statement of profit or loss.
OSL has borrowed a five year loan of Shs During the audit, the team would need to confirm
400M from the bank. This loan needs to be that the Shs 400M loan finance was received. In
correctly split between current and non- addition, the split between current and non-
current liabilities. current liabilities and the disclosures for this loan
should be reviewed in detail to ensure
In addition, OSL may have provided its compliance with relevant accounting standards.
assets as security for the loan. There is a The loan agreement should be reviewed to
risk that the disclosure of any security given ascertain whether any security has been given
is not complete. and the bank loan should be confirmed as part
of the bank confirmation process.
OSL will be undertaking a number of The team should select a sample of sites to visit.
simultaneous inventory counts on 31 It is likely that the Soroti warehouse contains
October, 2019 at the Soroti warehouse and most goods and therefore should be selected. In
all the other supermarkets. It is not practical relation to the other supermarkets, the team
for the auditor to attend all of these counts; should visit those with material inventory
hence it may not be possible to gain balances and/or those with a history of inventory
sufficient appropriate audit evidence over count issues.
inventory counts.
OSL’s inventory valuation policy is selling Testing should be undertaken to confirm cost
price less average profit margin. Inventory and NRV of inventory and that on a line-by-line
should be valued at the lower of cost and net basis the goods are valued correctly.
realisable value (NRV) and if this is not the
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case, then inventory could be under or In addition, valuation testing should focus on
overvalued. IAS 2 Inventories allows this as comparing the cost of inventory to the selling
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an inventory valuation method as long as it

is a close approximation to cost. If this is not price less margin to confirm whether this method
the case, then inventory could be under or is actually a close approximation to cost.
overvalued.
The opening balances for each supermarket Discuss with management the process
have been transferred to the head office’s undertaken to transfer the data and the testing
accounting records at the beginning of the performed to confirm the transfer was complete
year. There is a risk that if this transfer has and accurate.
not been performed completely and Computer-assisted audit techniques could be
accurately, the opening balances may not utilised by the team to sample test the transfer
be correct. of data from each supermarket to head office to
identify any errors.
There has been an increased workload for The team should remain alert throughout the
the finance department, the financial audit for additional errors within the finance
controller has left and his replacement is just department.
about to start. This increases the inherent
risk within OSL as errors may have been In addition, discuss with the finance director
made within the accounting records by the whether he will be able to provide the team with
overworked finance team members. The assistance for any audit issues the new financial
new financial controller may not be controller is unable to resolve.
sufficiently experienced to produce the
financial statements and resolve any audit
issues.
(1 mark for each audit risk, 1 mark for each auditor’s response, Total: 10 marks)
b) Substantive procedures for completeness of payables
 Obtain a list of payables from the payables ledger, cast the list and agree it to the payables
ledger control account and the SOFP. Agree a sample of individual balances to the
payables/general ledger accounts.
 Inspect invoices/bills received and payments made after the year end for services received
before the year end and check that they were accrued or should be accrued.
 Calculate the payable days and compare to prior years and industry average, investigate any
significant differences, considering changes in the business.
 Compare individual accruals with the amounts in the prior year to identify any omissions from
the list in the current or previous periods.
 Read the directors’ minutes, contracts, loan agreements, leases and correspondence from
government agencies.
 Carry out confirmation of a sample of major suppliers irrespective of the closing balance.
c) Why balances on the supplier statement may differ from the Payables ledger account
 Timing differences e.g. Goods in transit: Check whether the goods were received before the
year-end by inspecting GRNs and are included in closing inventory and purchase accruals; If
not, it would be a cut-off error that should be investigated; If the goods were received after the
year-end, the difference with the statement would be correct.
Cash-in-transit – check the dates of the cheques and when they were credited in the cashbook
and debited on the bank statements after the year-end.
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 Errors by the client that should be adjusted, or if they are by the suppliers, they are reconciling
items till they are corrected by the suppliers.
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 Disputes between the client and the suppliers e.g. check that they are resolved as quickly as
possible.
 Window dressing e.g. where the: Cheques were prepared simply to reduce payables at the
end of the period and were kept in the safe and should therefore be reversed or, Invoices
were not posted deliberately in order to reduce the level of payables.
d) The substantive procedures for payroll expenses
 Reconcile the gross pay on the payrolls to the salary and wages expense in the financial
statements and general ledger and investigate any differences to verify accuracy and
completeness.
 For a sample of pay periods, agree information on the payrolls to appointment letters in
human resource department records, clock cards, attendance registers, time reports
approved by supervisors for time rates and production records in case of piece rates to verify
occurrence.
 Verify the existence of employees on the payroll by inspecting human resource records, tax
and NSSF returns, staff lists from various branch managers, attending the wages payout or
performing a head count.
 Trace a sample of time sheets/clock cards/production records to the payrolls to verify
completeness.
 For a sample of employees, recalculate gross pay, statutory deductions and net pay to verify
the accuracy of the payrolls. Verify the basis of other deductions to supporting documentation.
 Cast a sample of payrolls and payroll records to verify the accuracy.
 Agree total net pay per payrolls to EFT schedules, bank transfer summary, payroll cheques
issued, cashbook/bank accounts and total cash withdrawn for wage payments to confirm
completeness and accuracy.
 Reconcile the payroll totals to the payroll control accounts for salary, PAYE, NSSF, loan
deductions etc to verity completeness and accuracy.
 Perform analytical procedures to verify existence, occurrence, completeness and accuracy:
- Review monthly payroll expenses, investigate fluctuations in monthly expenses, compare this
to the previous year and budgets and discuss with management any significant variances.
- Compare the total payroll expense to sales and production levels and investigate any
significant differences.
- Perform a proof in total of total wages and salaries, incorporating joiners and leavers and pay
increase.
 Agree the year-end liabilities in the SOFP to the payrolls and subsequent payment after the
year-end in the cash book to confirm occurrence, completeness, accuracy and cut-off. Confirm
that deductions were remitted on time by reviewing correspondence for any disputes.
SECTION C
Question 5
a) The general principles of an audit

Planning ensures the audit is performed in accordance with following general principles of an
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audit in ISA 200:

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 Compliance with code of ethics for accountants. This requires an auditor to comply with the
fundamental principles, namely, integrity, objectivity, professional competence and due care,
confidentiality and professional behavior.
 Perform an audit in accordance with the ISAs – an auditor should comply with all ISAs relevant
to the audit. An auditor is required to state whether the audit complies with ISAs which means
compliance with only relevant ISAs and not all of them. However, an audit that is conducted
in accordance with ISAs may fail to detect a material misstatement due to inherent limitations
of an audit.
 Professional scepticism – an auditor should perform the audit with an attitude of professional
scepticism that the financial statements may contain material misstatements. Professional
scepticism means the auditor:
- Recognising that management can always commit fraud despite their honesty and integrity in
the past as they can override any good internal control.
- Having a questioning mind – this means making critical assessment of the audit evidence obtained.
- Being careful to avoid overlooking unusual circumstances that may indicate possible error or
fraud.
 Professional judgment – an auditor should exercise professional judgment throughout the
audit. Professional judgement is the application of relevant training, knowledge and
experience. It is used, for example, in:
- Assessing materiality and risk.
- Deciding the nature, timing and extent of audit procedures.
- Evaluating whether sufficient appropriate audit evidence has been obtained.
- Evaluating management’s judgments in applying financial reporting standards, laws and
regulations.
- Forming an audit opinion.
 Sufficient appropriate audit evidence – the auditor should obtain sufficient appropriate audit
evidence in order to obtain reasonable assurance that the financial statements are free from
material misstatements.
b) The preconditions of an audit
 Determine whether the financial reporting framework is acceptable – one should consider factors
like the nature of the entity, the purpose of the financial statements and the applicable laws. (2
marks)
 Obtain management’s agreement that it acknowledges and understands its responsibility:
- For the preparation of the financial statements that comply with the applicable financial
reporting framework and show a true and fair their fair view.
- For internal control that will enable them to prepare financial statements that are free from
material misstatement whether due to fraud or error.
- To provide the auditor with:
o Access to all information relevant to the preparation of the financial statements.
o Additional information necessary for the audit.
o Unrestricted access to the entity staff that is necessary for the auditor to obtain audit
evidence. (2 marks)
c) Ethical threats and possible safeguards
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Ethical threat Possible safeguard

The managing director, Mr. Nyindo has Rashidah being a managing partner
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requested Rashidah to buy shares in his should not buy shares in the company.

business so that it is able to expand. This may
lead to a self-interest threat
The managing director has promised that once The audit firm may undertake an
the managing partner buys shares, all audits of independent audit at least for a period
the firm will be undertaken by Shaliwa and of 3 years. The client (Kanakulya) can
Rashidah & Co. This may lead to self-interest or search for other auditors at least after 3
familiarity threat. Once all audits are undertaken years.
by Rashidah, it is possible that objectivity is lost
In Kanakulya Enterprises, it has also been Given that Shaliwa former boyfriend is
established that Shaliwa’s former boyfriend is the one of the directors, Shaliwa should not
Finance Director. This poses familiarity threats. be included on the team. In case she is
included, then an independent quality
control reviewer should appointed to
review Shaliwa’s work.
The finance director has suggested that the Audit work should be performed based
auditors complete their audit within the next 2 on the audit plan. In case, the
weeks instead of one month. This is unrealistic. management insists on completing the
Work may not be completed fully based on the audit in 2 weeks, the auditors may
audit plan. This may lead to intimidation threat discuss the matter with management
and incase it us not resolved, consider
resigning.
Uganda Revenue Authority (URA) recently The auditors should decline the offer to
assessed Kanakulya enterprises but the tax provide taxation services. Alternatively,
assessed was so high. On the outing agenda, the the auditors may advise another audit
managing director expects to discuss those firm to handle taxation issues. Given
taxation issues with the auditors. This may lead that Shaliwa, Rashidah and Co. CPA is
to self-review or self-interest threat a new audit firm, it may not handle the
two assignments.
The finance director has assured the managing The auditor should not accept to
director that he can convince the auditors in case represent Kanankulya in court.
URA decides to penalize them for non-payment
of taxes to represent Kanakulya enterprises in
court. This may lead to advocacy threat.
The finance director has suggested to the The auditors need to insist on the code
managing director that, the audit fees be charged of ethics. Audit fees should be charged
based on the taxes saved for the company. This based on time and experience required
may led to self-interest or self-review threat. to complete the audit.
(1 mark each threat, 1 mark each response; total: 12 marks)
Question 6
a) Difference between internal and external audits
External audit Internal audit

Objective To express an opinion on the To improve the entity’s operations by
truth and fairness of the reviewing the efficiency and effectiveness of
entity’s financial statements. its internal control.
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Reporting External auditors report to Internal auditors normally report to

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shareholders in case of the management or those charged with

company. External audit governance. Internal audit reports are private
reports are contained in and confidential and are only intended for the
financial reports and are addressee of the report, normally the board
publicly available to other of directors and the audit committee.
interested stakeholders.
Scope of The external auditor’s work is The internal auditor can have a wide scope of
work limited to verifying the truth work and it is determined by the requirements
and fairness of the financial of management or those charged with
statements, although the governance. Commonly internal audit focus
internal control system is on the entity’s internal control, but any other
tested to provide evidence on area of operations can be reviewed including
the completeness and value for money audit.
accuracy of the financial
statements.
Relationship The external auditor is Internal auditors are appointed by
with the appointed by shareholders management. As internal auditors are
entity which enhances normally employees of the entity they lack
independence from independence. However, the internal audit
management. department can be outsourced and this can
increase their independence.
Regulation External audit is regulated by Internal audit is not normally required by law
law like the Companies Act. except in listed companies, financial
institutions and public sector bodies.
External auditors are An internal auditor may be any person
members of professional although many also belong to professional
accountancy bodies (like the bodies like the Institute of Internal Auditors.
ICPAU in Uganda) and are
licensed annually.
(1 mark each difference up to 4 marks)
The demand for auditing arises from better stewardship, accountability and agency where
ownership is separate from management.
Stewardship is the management of another person’s property, finance etc, Directors and
management are stewards and are supposed to manage the company in order to maximize the
shareholders’ wealth. An audit checks whether the directors and management have been good
stewards of the company. (2 marks)
Accountability means that people in positions of power should be accountable for their actions
and decisions. For example, directors are accountable to shareholders of a company. Therefore,
directors are required by the Companies’ Act to prepare periodic financial statements showing
the company’s financial position and performance as their accountability to shareholders.
However, there is need to have an independent audit of financial statement to check this
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accountability. (2 marks)
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An agency relationship exists between the principal (the shareholders) and the agents (the
directors) who manage a company on their behalf. Although directors are expected to maximize
the wealth of shareholders, they may serve their personal interests and falsify the financial
statement to defraud shareholders. This may lead to financial loss, bankruptcy and even business
collapse. (2 marks)
Therefore, there is need for shareholders to appoint independent auditors annually to audit the
financial statements to check whether the directors have been good or bad agents. This enables
shareholders to reward directors for better performance or punish them the mismanagement of
the companies. Consequently, this leads to good corporate governance (i.e. the way a company
is run and managed). (2 marks)
(Up to 6 marks)
b) Powers of the Auditor General

 Have access to all books and accounts, money, stores, vouchers, stamps and securities
subject to its audit and to any place where any such books and accounts, money or stores
are kept;
 Require any person to supply any information or answer any question relating to books and
accounts, money or stores subject to audit
 At any convenient time, cause a search to be made of, and extracts taken from any books or
accounts relating to money or stores subject to its audit, without paying any fee.
 Have access to electronic information relating to the audit as he or she has to other documents
 Have access to any government property
 Station his or her staff at the premises of the organization being audited, and that organization
shall provide those staff with adequate office space and facilities during the period under audit
 Request for the opinion of the Attorney General in writing s to any question regarding the
interpretation of any Act, regulations or agreements concerning the powers of the Auditor
General, or the discharge of his or her duties, and the Attorney General shall give his or her
opinion within a reasonable time.
Functions of the Auditor General
The Auditor General shall—

 Audit and report on the public accounts of Uganda and of all public offices including the courts,
the central and local government administrations, universities and public institutions of a
similar nature, and any public corporation or other bodies or organisations established by an
Act of Parliament;
 Conduct financial, value for money audits and other audits such as gender and environment
audits in respect of any project or activity involving public funds;
 Audit classified expenditure; “classified expenditure” means the expenses and commitments
incurred by an authorised agency for the collection and dissemination of information related
to national security interests and includes the cost of procurement and maintenance of the
related assets;
 Audit all Government investments; The Auditor General audits all government investments of
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whatever amount especially where Government has controlling interest but of course as
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Government, the auditor general can audit any government investment even when it does not
have controlling interest for example Munyonyo Commonwealth Resort Hotel.
 Carry out procurement audits; a procurement audit is a project management process that
reviews different contracts and contracting processes to determine the completeness, efficacy
as well as the accuracy of the procurement process.
 Audit treasury memoranda. A Treasury Memorandum is the document that is issued by the
Finance Minister in response to a report by the Public Accounts Committee when they have
finished reviewing an Auditor General Report and it details how the breaches outlined will be
corrected.
(1 mark each function up to 5 marks)
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MAKERERE UNIVERSITY
MAKERERE UNIVERSITY BUSINESS SCHOOL
FINAL EXAMINATION FOR THE DEGREE OF

BACHELOR OF BUSINESS ADMINISTRATION
OF MAKERERE UNIVERSITY ACADEMIC YEAR 2018/2019
COURSE UNIT: Auditing COURSE CODE: ACC3209

YEAR OF STUDY: Three SEMESTER: Two
DATE: 15th May, 2019 TIME: 9am – 12 Noon
INSTRUCTIONS:
6) This paper consists of THREE sections. Section A is compulsory
and carries 30 marks. Section A is comprised of one question
with two independent parts. Answer all parts of question one.
7) Section B is comprised of THREE questions and each question

carries 25 marks. Answer any TWO questions from Section B.
Section C is comprised of TWO questions and each question
carries 20 marks. Answer ONE question from section C.
8) Write the CAPITAL LETTER for the right answer to each

multiple choice question in your answer book.
9) Do not write anything on the question paper
10) Follow other university examination regulations and

instructions on the answer book.
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SECTION A – Answer all parts of the question in this section

Question 1
PART A
You are the audit senior of Bashir and Roxy Certified Public Accountants and your team has
just completed the interim audit of Sempa Industries Limited whose year end is 31 st
December 2018. You are in the process of reviewing the systems testing completed on the
payroll cycle, as well as preparing the audit programmes for the final audit. Sempa Industries
Limited manufactures lights and the manufacturing process is predominantly automated;
however there is a workforce of 85 employees, who monitor the machines, as well as
approximately 50 employees who work in sales and administration. The company
manufactures 24 hours a day, seven days a week. The payroll system operates as follows;
The company operates three shifts every day with employees working eight hours each. They
are required to clock in and out using an employee swipe card, which identifies the employee
number and links into the hours worked report produced by the computerised payroll system.
Employees are paid on an hourly basis for each hour worked. There is no
monitoring/supervision of the clocking in/out process.
On a weekly basis, the payroll department calculates the cash wages to be paid to the
workforce. This is calculated based on the hours worked report multiplied by the hourly wage
rate, with appropriate tax deductions. These calculations are not checked by anyone as they
are generated by the payroll system. During the year, the hourly wage was increased by the
Human Resource Department and this was notified to the payroll department verbally.
Each Friday, the payroll department prepares the pay envelopes and physically hands these
out to the workforce, who operate the morning and afternoon shifts, upon production of
identification. The pay envelopes for night shift workers are given to the factory supervisor to
distribute. If any night shift employees are absent on pay day, then the factory supervisor
keeps these wages and returns them to the payroll department on Monday.
The sales and administration staff are paid monthly by bank transfer. Employee numbers do
fluctuate and during the month of July, two administration staff joined; however, due to staff
holidays in the Human Resource Department, they delayed informing the payroll department,
resulting in incorrect salaries being paid out.
Required:
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a) Identify and explain FIVE deficiencies of Sempa Industries Limited’s payroll system
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and provide a recommendation to address each of these deficiencies. (10 marks)

b) Which substantive procedures would you carry out to authenticate payroll expenses?
(5 marks)
c) Last week, Sempa Industries Limited received officials from Uganda Revenue
Authority who reviewed the wages calculations and discovered that incorrect levels of
tax had been deducted by the payroll systems. This was because of the old tax rates
that were applied while determining net pay. The Chief Accountant has queried the
audit team why they did not identify this noncompliance with the tax laws.
Required:
Explain the responsibilities of management and auditors of Sempa Enterprises Limited
in relation to compliance with laws and regulations under ISA 250: Consideration of
Laws and Regulations in an audit of financial statements.
(3 marks)
d) Explain the meaning of the following terms as used in auditing
i) Dual- purpose tests (1 mark)
ii) Substantive procedures (1 mark)
PART B.
1. State whether the following statement about performance materiality is true or not?
“The performance materiality level is affected by the auditor's understanding of the entity
and the nature and extent of misstatements identified in prior audits”.
A) True B) False
2. Before accepting an appointment as auditor, the nominated auditor is expected to

communicate with the existing auditor to ensure that there is no professional reason why
he should not accept the appointment:
A) In all cases.
B) Only in respect of audits under the Companies Act.
C) Only in respect of audits of large companies.
D) Only where he has reasonable cause to believe that there is some such reason.
3. Which of the following audit procedure can be used by the auditor to verify that the entity
owns or has ownership rights to all investments
A) Vouching the acquisition price in the accounting records
B) Confirmation requests to custodians of title documents
C) Cutoff tests
D) computation of amortised costs
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4. ISA 580: Written representations requires the auditor to:

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vi) To obtain written representations from management that they have fulfilled their
responsibility for ensuring that internal controls are in place and effective
vii) To obtain written representations that support other audit evidence relevant to the
financial statements as determined by the auditor or as required by other
International Standards on Auditing
viii) To obtain written representations from management that they have fulfilled their
responsibility for the preparation of financial statements and for the existence of
the information provided to the auditor
ix) To respond appropriately to written representations or if management does not
provide the written representations requested by the auditor
x) To obtain written representations from management that they have fulfilled their
responsibility for the preparation of financial statements and for the completeness
of the information provided to the auditor
B) i, ii and v B) ii, iv and v C) ii, iii and iv D) iii, iv and v
5. Which of the following is prima facie the most reliable audit evidence?
A) Evidence as to the existence of the company's work in progress inventory derived
from physical inspection by the auditor.
B) Evidence as to the collectability of certain receivables derived from discussions with
the credit control manager.
C) Evidence as to the validity of a trade receivable derived from a telephone confirmation
of the balance with the customer.
D) Evidence as to the accuracy of finished goods inventory derived from full monthly
stock takings performed by responsible company officials.
6. Which of the following audit tests may be applied by the auditor to verify that transactions
affecting all purchases and sale of inventory are recorded in the correct period?
E) Check that goods received and not yet invoiced before the period end are accrued by
debiting purchases and crediting trade payables
F) Confirm that any inventory held by third parties is included in the year-end inventory
list and figure.
G) Request confirmation from third parties about the quantities and condition of inventory
held on behalf of the entity.
H) Observe the physical inventory count
7. Which of the following inherent risks should be considered in planning the audit of not for
profit organisations
A) The amount of time allocated to the Not for profit organization activities by trustees
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may be little
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B) There may not be division of duties between the management of the Not for Profit
organisations and the trustees of the same organization
C) Many Not for Profit organisations may not have internal audit department and the
control system may not be monitored effectively
D) In most Not for profit organisations, there is a problem of completeness of income for
example invoices are not raised to obtain donations.
8. While reviewing Grace’s purchases cycle, you identified that goods received notes for
raw material purchases are not sequentially numbered.
Which of the following areas would you consider to be most at risk of material
misstatement, as a result of this internal control deficiency?
A) Rights and obligations of inventory
B) Existence of inventory
C) Valuation of payables
D) Completeness of payables
9. Which of the following substantive procedures can be used by the auditor to verify that all
tangible non-current assets included in the statement of financial position physically
exists?
A) Reconcile opening and closing numbers and amount for assets like motor vehicles
B) Reconcile the schedule of tangible non-current assets with the general ledger and
the asset register, obtain explanations for the differences
C) Review lease agreements for correct treatment of finance and operating leases
D) Physically inspect a sample of the entity’s assets and check that they are included in
the asset register.
10. Which of the following substantive procedures can be used by the auditor to verify that
the statement of financial position includes all tangible non-current assets?
A) Review repairs and maintenance accounts in the general ledger for large items that
may be capital in nature and ensure that they are treated as capital expenditure
B) Check that the entity inspects all assets in the asset register annually
C) Review insurance policies
D) Perform a proof in total calculation for the depreciation, considering the timing of
additions and disposals and compare this to expected amount to the actual charge
and investigate any significant differences.
(1 mark for each multiple choice question up to 10 marks)
(Total: 30 marks)
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SECTION B – Answer any two questions from this section
Question 2
Uthman was recently appointed as an Audit Manager of Sejjaaka, Kaawaase & Co. and
immediately was assigned the audit of Kyenda Industries Limited. Uthman is currently
planning the final audit of Kyenda Industries Limited, which is a listed company, for the year
ended 31 December, 2018. The company purchases consumer packaged goods and sells
these through its website and to wholesalers. Kyenda Industries Limited is a new client to
your firm and the Audit Director has already had a planning meeting with the finance director
and has provided to Uthman the following notes along with the financial statements extracts.
Rather than undertaking a full year end inventory count, the company undertakes monthly
perpetual inventory counts. As part of the interim audit which was completed earlier in the
year, an audit assistant attended a perpetual inventory count in September and noted that
there were a large number of exceptions where the inventory records were consistently
higher than the physical inventory in the ware house. When discussing these exceptions with
the finance director, the assistant was informed that this had been a recurring issue all the
year. In addition, the audit assistant noted that there were some inventory which according
to the records, were at least 90 years old and hence becoming obsolete.
Kyenda Industries Limited has a head office where the audit team will be based to conduct
the final audit fieldwork. However, there are four additional sites where some accounting
records are maintained and these sites were not visited during the interim audit. The records
for these sites are incorporated monthly through an interface to the general ledger. A fifth site
was closed down in 2017; however, the building was only sold in 2018 at a loss of
Ugx.825,000,000.
One of the Kyenda Industries Limited’s wholesale customers is alleging that the company
has consistently failed to deliver goods in a saleable condition and on time, hence it has
commenced legal action against Kyenda Industries Limited for a loss of profits claim.
The directors have disclosed their remuneration details in the financial statements in line with
the International Financial Reporting Standards (IFRS), which does not require a separate
list of director’s names and payments. However, in the country in which Kyenda Industries
Limited is based, local legislation requires disclosure of the names of the directors and the
amount of remuneration payable to each director.
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Kyenda Industries Limited Financial Statements Extracts For the Year Ended 31
December (Amounts in Ushs
Draft Final
2018 2017
Revenue 25,230,000 21,180,000
Cost of sales (15,840,000) (14,015,000)
Gross profit 9,390,000 7,165,000
Operating expenses (4,903,000) (3,245,000)
Profit before tax 4,487,000 3,920,000
Inventory 2,360,000 1,800,000
Trade and other receivables 1,590,000 1,250,000
Cash 0 480,000
Trade and other payables 3,500,000 2,800,000
Overdraft 580,000 0
Required:
a) Calculate SIX ratios, for both years which would assist Uthman in planning the audit
of Kyenda Industries Limited. (6 marks)
b) From a review of the above information and the ratios calculated, describe FIVE audit
risks and explain the auditor’s response to each risk in planning the audit of Kyenda
Industries Limited. (10 marks)
c) Uthman intends to ask management of Kyenda Industries Limited to assess the going
concern of the company, explain auditor’s responsibilities as espoused in ISA 570:
Going concern. (4 marks)
d) Summarise any FIVE audit procedures in performing going concern reviews of any
company. (5 marks)
(Total: 25 marks)
Question 3
a) Recently, there was a heated debate among students of one of the BBA discussion
group regarding subsequent events and these have come to you as an expert in
auditing to help them to respond to the following questions;
i) Define subsequent events as per ISA 560: subsequent events. (2 marks)
ii) Explain the key dates during the completion of the external audit.
(5 marks)
iii) The subsequent event period is divided into three phases and particular
procedures are done in each phase. Which audit procedures are relevant in the
first phase? (3 marks)
b) At the end of the audit, ISA 700: Forming an opinion and reporting on financial
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statements stipulates that the auditor shall form an opinion in writing based on the
evidence gathered
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Required:
i) Explain the types of modified opinions and in each case, state how the opinion
can be written. (3, 3 marks)
ii) Explain the difference between emphasis of matter paragraph and other matter
paragraph. (4 marks)
c) ISA 505: External confirmations, requires the auditor to obtain confirmations from third
parties on a number of issues among which include bank balance.
Required:
Explain the bank balance confirmation procedures. (5 marks)
(Total: 25 marks)
Question 4
You were recently appointed the audit manager of Akot, Lakot and Co. Certified Public
Accountants and you are in charge of two audits which are soon commencing. These
companies are; Lira Charity Uganda and Picafari Industries Limited. Lira Charity Uganda
promotes women empowerment while Picafari Industries manufactures stationary products
and its draft total liabilities are 16.2 million. You noted that both clients’ financial year ended
on 31 October 2018. The following matters have been brought to your attention for each
company.
Lira Charity Uganda

Completeness of income
Lira Charity Uganda is a not for profit organization which generates income in a number of
ways. It receives monthly donations from its many subscribers and these are paid by bank
transfer to the charity. In addition, a large number of donations are sent through the post to
the charity. Lira Charity Uganda also sells tickets for its charity events held every quarter.
Lira Charity Uganda adopted International Financial Reporting Standards. During the audit
planning, completeness of income was identified as a key risk.
Picafari Industries Limited

i) Trade payables
The finance director of Picafari Industries Limited has informed you that at the year end, the
purchase ledger was kept open for one week longer than normal as a large bank transfer
and cheque payment run was made on 3 November 2018. Some purchase invoices were
received in the same week and were recorded in the 2018 purchase ledger as well as the
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payment run.
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ii) Trade receivables

Picafari Industries Limited has a large number of small customers; the normal credit terms
offered to them is 30days. However, the finance director has informed you that the average
trade receivables days have increased quite significantly this year from 34 days to 55 days.
This is partly due to difficult trading conditions and also because for six months of the year,
the role of the credit controller was vacant. The company has historically maintained on
average an allowance for trade receivables of 1.5% of gross trade receivables.
Required:
a) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate audit evidence in relation to the above matters. (13 marks)
b) In carrying out your audit, you note that the balances on the supplier statements are
different from those on the payables ledger accounts. What could have caused it?
(4 marks)
c) ISA 530: Audit sampling gives guidance on sampling. Explain factors considered in
determining sample size. (8 marks)
(Total: 25 marks)
SECTION C – Answer any one question from this section

Question 5
a) In 1992, the Accountants Act created the Institute of Certified Public Accountants of
Uganda. The Act was revised and currently, we have the Accountants Act, 2013. The
accountants Act 2013 categorized members of ICPAU. The ICPAU has a code of
ethics as well.
Required:
i) Explain the membership to ICPAU. (6 marks)
ii) Explain the fundamental principles of the code of ethics. (8 marks)
b) ISA 610: Using the work of internal auditors gives guidance on internal audit.
Explain the factors considered by the external auditor in assessing whether to rely on
the work of internal auditors or not. (6 marks)
(Total: 20 marks)
Question 6
The National Audit Act, 2008 is an Act to give effect to article 154 (3) and 163 of the
constitution of the republic of Uganda, 1995 (as amended) by providing for the office of the
Auditor General.
Required:
a) Explain the independence of Auditor General as enshrined in the National Audit
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Act 2008 and bring out clearly those indicators of independence of the Auditor
General (2, 6 marks)
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b) Explain the tenure of service and remuneration of Auditor General as enshrined in
the National Audit Act, 2008. (4 marks)
c) Explain the powers of Auditor General as stipulated in the National Audit Act, 2008.
(8 marks)
(Total: 20 marks)
……………………………………End of question paper……………
MARKING GUIDE
SECTION A
Question One PART A
a) Identify and explain FIVE deficiencies and provide a recommendation for each case
Deficiency (ies) Recommendation
There are no monitoring / supervision Clocking in and out should be monitored by a
procedures relating to the clocking in supervisor of an appropriate level, or by CCTV
and clocking out of employees. This cameras installed to deter employees from clocking
means that staff may ask colleagues to in for one another.
clock them in when they are not actually
present resulting in a payroll cost in Furthermore, employees should be automatically
excess of that expected for the actual clocked out at the end of their shift, and should be
hours worked. required to clock back in if they are completing pre-
agreed overtime.
Payroll calculations are not reviewed A payroll supervisor should periodically recalculate
and 100% reliance is placed on the the net pay based on the gross pay and expected
accuracy of the payroll system. This deductions, then compare the result with the
means that any errors made, for example computer generated figures for a sample of
as a result of standing or underlying data employees. The payroll supervisor should always
being incorrect or errors occurring review the payroll before wages are paid. The review
during payroll processing, then they should be evidenced by a signature and wages should
would not be discovered. This may lead not be paid until this signed review is completed.
to overpayments or underpayments (and
incorrect payroll costs) and may result
and lead to losses or disgruntled
employees.
The Human resource department has HR should be required to gain written board
used verbal authorization to inform the authorization for any proposed wage increase before
payroll department of any pay increases. passing this to Payroll. Similarly, the payroll should
This indicates a lack of authorization at be informed only to action a wage increase or other
board level and could lead to invalid change on receipt of written authorization approved
increases in employee wages (e.g. for by the board.
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HR personnel’s friends or relatives)

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The factory supervisor is trusted with Payroll officials should be available for certain hours
substantial cash sums in advance for during the night shift to distribute wages. The night
distribution of wages to the night shift. shift workers should also be required to produce
This cash is susceptible to theft and loss identification before they are given their pay packets.
while not with employees or securely Alternatively, the night shift workers may be paid
stored. through bank transfer.
The factory supervisor keeps absent Any amounts not paid out on Fridays should be kept
employee's wages over the weekend by payroll in a safe or other secure means until
before handing back to payroll and this Monday when the employee can collect from Payroll.
further increases the risk of loss or theft
of cash wages.
Staff holidays in the Human Resource HR staff duties and responsibilities should be
department have meant that payroll reallocated when staff are ill or on holiday,
information relating to new joiners was including the responsibility of immediate
not communicated on a timely basis, communication of new joiners/leavers to payroll.
which in turn meant that joiners were
not paid on time leading to disgruntled
In addition new joiner forms showing start date
employees and inaccurate payroll should be completed and authorized and passed to
records. payroll so that they are aware of the need to update
the payroll records.
2 marks for each deficiency and 2 marks for each recommendation, Up to 10 marks
b) Substantive procedures to authenticate payroll expenses

 Compare the total payroll expense to the previous year and investigate any significant variances.
This will help to establish whether there are any anomalies in the payroll especially when there
were no promotions, demotions, recruitments or salary increment.
 Reconcile the gross pay on the payrolls to the salary and wages expense in the financial statements
and general ledger and investigate any differences to verify accuracy and completeness.
 For a sample of pay periods, agree information on the payrolls to appointment letters in human
resource department records, clock cards, attendance registers, time reports approved by
supervisors for time rates and production records in case of piece rates to verify occurrence.
 Verify the existence of employees on the payroll by inspecting human resource records, tax and
NSSF returns, staff lists from various branch managers, attending the wages payout or performing
a head count.
 Trace a sample of time sheets/clock cards/production records to the payrolls to verify
completeness.
 For a sample of employees, recalculate gross pay, statutory deductions and net pay to verify the
accuracy of the payrolls. Verify the basis of other deductions to supporting documentation.
 Cast a sample of payrolls and payroll records to verify the accuracy.
 Agree total net pay per payrolls to EFT schedules, bank transfer summary, payroll cheques issued,
cashbook/bank accounts and total cash withdrawn for wage payments to confirm completeness
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and accuracy.
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 Reconcile the payroll totals to the payroll control accounts for salary, PAYE, NSSF, loan
deductions etc to verity completeness and accuracy.
 Perform analytical procedures to verify existence, occurrence, completeness and accuracy:
- Review monthly payroll expenses, investigate fluctuations in monthly expenses, compare this
to the previous year and budgets and discuss with management any significant variances.
- Compare the total payroll expense to sales and production levels and investigate any significant
differences.
- Perform a proof in total of total wages and salaries, incorporating joiners and leavers and pay
increase.
 Agree the year-end liabilities in the SOFP to the payrolls and subsequent payment after the year-
end in the cash book to confirm occurrence, completeness, accuracy and cut-off. Confirm that
deductions were remitted on time by reviewing correspondence for any disputes.
(1 mark each substantive procedure up to 5 marks)
c) Responsibilities – Laws and regulations

It is Sempa Industries’ management that have a responsibility to ensure that the entity complies with
the relevant laws and regulations. It is not the auditor's responsibility to prevent or detect non-
compliance with laws and regulations. (2 marks)
The auditor's responsibility is to obtain reasonable assurance that the financial statements are free from
material misstatement, and in this respect, the auditor must take into account the legal and regulatory
framework within which the entity operates. ISA 250 Consideration of laws and regulations in an
audit of financial statements distinguishes the auditor's responsibilities in relation to compliance with
two different categories of laws and regulations:
 Those that have a direct effect on the determination of material amounts and disclosures in
then financial statements
 Those that do not have a direct effect on the determination of material amounts and disclosures
in the financial statements but where compliance may be fundamental to the operating aspects,
ability to continue in business, or to avoid material penalties.
For the first category, the auditor's responsibility is to obtain sufficient appropriate audit evidence
about compliance with those laws and regulations. For the second category, the auditor's responsibility
is to undertake specified audit procedures to help identify non-compliance with laws and regulations
that may have a material effect on the financial statements. (2 marks)
The auditors must also maintain professional skepticism and be alert to the possibility that other audit
procedures may bring instances of identified or suspected non-compliance with laws and regulations.
(1 marks)
(Available marks = 5 marks, Allocated marks = 3 marks)
d) Meaning of;
i) Dual- purpose tests - This is where a test of controls is performed concurrently with a test
of details on the same transaction. For example, a sample of invoices may be inspected to
check whether was approved (which is a test of control) and whether the transaction was
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recorded accuracy in accounting records (which is substantive test of details). (1 mark)

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ii) Substantive procedures – These are audit procedures designed to detect material
misstatements at the assertion level. Most substantive procedures are performed on the
financial statements during final audit. (1 mark)
PART B
No. Answer Explanation
1. A The performance materiality level is affected by the auditor's understanding of
the entity and the nature and extent of misstatements identified in prior audits.
Performance materiality refers to the amounts set by the auditor at higher than
the materiality level for particular classes of transactions, account balances or
disclosures where the materiality level might otherwise mean that such items are
not tested.
2. A Such a communication is necessary for all audit appointments. The purpose of
finding out the background to the proposed change is to enable the nominee
auditor to determine whether it would be proper for him to accept nomination. In
particular, the nominee auditor will wish to know if the change in appointment
arises from an attempt by management to conceal unsatisfactory practices or
improprieties from shareholders or others.
3. B Confirmation requests to custodians of title documents. This is done while
confirming rights and obligations. The entity investment title documents need to
bear the name of the entity.
4. B ISA 580 Written representations requires the auditor to: Obtain written
representations from management that they have fulfilled their responsibility for
the preparation of financial statements and for the completeness of the
information provided to the auditor; support other audit evidence relevant to the
financial statements as determined by the auditor or required by other ISAs; and,
respond appropriately to written representations or if management does not
provide the written representations requested by the auditor.
5. A Evidence originated by the auditor and as such, is prima facie more reliable than
the other options which are all examples of evidence obtained from other sources.
6. A Checking that goods received and not yet invoiced before the period end are
accrued by debiting purchases and crediting trade payables is one of the audit
tests to confirm cut off.
7. D Inherent risk is the susceptibility of an assertion to a misstatement that could be
material individually or when aggregated with other misstatements, before
consideration of any related controls. Inherent risk arises from the nature of the
entity and its environment. So, not for profit entities have a problem whereby
they are not able to predict their incomes and this in turn leads to a problem of
completeness of income for example invoices are not raised for donations.
8. D The fact that GRNs are not sequentially numbered means that GRNs may be
omitted from accounting records and it would be difficult to trace the unrecorded
GRNs. As a result, the risk is that payables (and inventory) is understated.
9. A Reconciling opening and closing numbers and amount for assets like motor
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vehicles is one of the ways for confirming existence of tangible non- current
assets
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10. A Review the repairs and maintenance accounts in the general ledger for large items
that may be capital in nature and ensure that they are treated as capital
expenditure, otherwise, such capital expenditure items may be treated as revenue
expenditure.
(1 mark each multiple choice question up to 10 marks)
SECTION B
Question Two (Mr.Frank Kabuye)
a) Computation of ratios for 2018 and 2017

Ratio 2018 2017
Gross margin 9,390,000/25,230,000 = 37.2% 7,165,000/21,180,000 = 33.8%
Operating margin 4,487,000/25,230,000 = 17.8% 3,920,000/21,180,000 = 18.5%
Inventory days 2,360,000/15,840,000 X 365 1,800,000/14,015,000 X 365
=54 days = 47days
Inventory turnover 15,840,000/2,360,000 = 6.7 14,015,000/1,800,000 = 7.8
Receivables days 1,590,000/25,230,000 X 365 1,250,000/21,180,000 X 365
= 23days = 22 days
Payables days 3,500,000/15,840,000 X 365 2,800,000/14,015,000 X 365
=81 days =73 days
Current ratio 3,950,000/4,080,000 = 0.97 3,530,000/2,800,000 = 1.26
Quick ratio (3,950,000 – (3,530,000 –
2,360,000)/4,080,000 = 0.39 1,800,000)/2,800,000 = 0.62
½ mark for each ratio computed for 2018up to 3 marks and ½ mark for each ratio computed for
2017, up to 3 marks; Total = 6 marks
b) Audit risks and auditor’s response

Audit risk Auditor’s response
Kyenda is a new client for Sejjaaka, Kaawaase Sejjaaka, Kaawaase & Co. should ensure it
& Co. As the team is not familiar with the has a suitably experienced team. Also,
accounting policies, transactions and balances of adequate time should be allocated for team
the company, there will be detection risk on the members to obtain an understanding of the
audit. company and the risks of material
misstatement, including attendance at an
audit team briefing.
The company utilizes a perpetual inventory The completeness of the perpetual inventory
system at its warehouse rather than a full year counts should be reviewed and the controls
end count. Under such a system, all inventory over the counts and adjustments to records
must be counted at least once a year, with should be tested.
adjustments made to the inventory records on a
timely basis. Inventory could be under or In addition, the level of adjustments made to
overstated if the perpetual inventory counts are inventory should be considered to assess
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not complete. their significance. This should be discussed

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with management as soon as possible as it

During the interim audit, it was noted that there may not be possible to place reliance on the
were significant exceptions with the inventory inventory records at the year end, which
records being higher than the inventory in the could result in the requirement for a full year
warehouse. As the year end quantities will be end inventory count
based on the records, this is likely to result in
overstated inventory.
During the interim audit, it was noted that there The aged inventory report should be
were some inventory which according to the reviewed and discussed with management to
records were at least 90 days old. In addition, assess if certain inventory is slow moving.
inventory days have increased from 47 days to
54 days. It would appear that there may be an Detailed cost and net realizable value testing
increase in slow-moving inventory. to be performed to assess whether an
allowance or write down of inventory is
The valuation of inventory as per IAS 2 required.
Inventories should be at the lower of cost and net
realizable value. Hence there is a risk that
obsolete inventory has not been appropriately
written down and inventory is overvalued.
Kyenda Industries maintains accounting records Discuss with management the significance
at four additional sites which were not visited and materiality of the records maintained at
during the interim audit, and the records from the four sites. The team may then need to
these sites are incorporated monthly into the visit some of these sites during the final audit
general ledger. There is a detection risk if the to undertake testing of the records held there.
audit team team does not visit or undertake
testing of the records at these sites. Further, if the Sejjaaka, Kaawaase & Co. needs to ensure
interface does not occur appropriately, there is a that it has obtained sufficient appropriate
risk that accounting records are incomplete. audit evidence over all the accounting
records of the company, not just for those at
the head office.
In addition, computer assisted audit

techniques could be utilized by the team to
sample test the monthly interface of data
from each site to head office to identify any
errors.
In 2018, a building was disposed of with a loss Agree that the asset has been removed from
of Ugx.825,000,000. There is a risk that the the non-current assets register, recalculate
disposal has not been removed appropriately the loss on disposal calculation and agree all
from the accounting records or that the loss on items to supporting documentation.
disposal calculation is incorrect.
Discuss the depreciation policy for land and
In addition, significant profits or losses on buildings with the finance director to assess
disposal are an indication that the depreciation its reasonableness. Review the level of losses
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policy for land and buildings may not be on disposal generated from other asset sales
appropriate. Therefore depreciation may be to ascertain if this is a more widespread issue.
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understated and consequently assets overstated.

A customer of Kyenda Industries has Sejjaaka, Kaawaase & Co. should write to
commenced legal action against Kyenda for a the company lawyers to enquire of the
loss of profits claim. If it is probable that the existence and likelihood of success of any
company will make payment to the customer, a claim from the wholesale customer. The
legal provision is required. If the payment is results of this should be used to assess the
possible rather than probable, a contingent level of provision or disclosure included in
liability disclosure would be necessary. If the financial statements.
Kyenda has not done this, there is a risk over the
completeness of any provisions and the
necessary disclosure of contingent liabilities.
The directors have not disclosed the individual Discuss this matter with management and
names and payments for each of the directors’ review the requirements of the local
remuneration. This is in line with IFRS but legislation to determine if the disclosure in
disclosure of this is required by local legislation. the financial statements is appropriate.
In cases where the local legislation is more
comprehensive than IFRS, it is likely the
company will comply with the local legislation.
The directors’ remuneration disclosure will not

be complete and accurate if the names and
individual payments are not disclosed in
accordance with the relevant local legislation
and hence the financial statements will be
misstated as a result of the non-compliance.
Revenue has grown by 19% in the year; During the audit, a detailed breakdown of
however, cost of sales has only increased by sales will be obtained, discussed with
13%. This is a significant increase in revenue management and tested in order to
and along with the increase in gross margin may understand the sales increase. Increased cut-
be due to an overstatement of revenue. off testing should also be undertaken to
verify that revenue is recorded in the right
period and is not overstated.
Gross margin has increased from 33.8% to The classification of costs between cost of
37.2%. Operating margin has decreased from sales and operating expenses will be
18.5% to 17.8%. This movement in gross margin compared with the prior year to ensure
is significant and there is a risk that costs may consistency. Also, increased cut-off testing
have been omitted or included in operating should be performed at the year end to ensure
expenses rather than cost of sales. that costs are complete.
The overall liquidity of the company is in Detailed going concern testing to be
decline, with the current and quick ratios performed during the audit as there may be a
decreasing from 1.26 to 0.97 and 0.62 to 0.39 doubt over going concern and the basis of
respectively. In addition, the cash balances have accounting should be discussed with
decreased significantly over the year, and the management to ensure that the going concern
company now has an overdraft of Ugx.580,000 basis is reasonable.
81
at the end of the year.

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Further, the trade payable days have increased
from 73 to 81 days, implying the company is
struggling to meet its liabilities as they fall due.
All of these changes in key ratios could signal
going concern difficulties.
(1 mark for each audit risk, 1 mark for each response up to 10 marks)
c) Auditor’s responsibility in respect to going concern

ISA 570 Going concern (Revised) gives guidance to auditors in this area. The standard requires the
auditor to:
i) Obtain sufficient appropriate audit evidence about the appropriateness of management’s use
of the going concern basis of accounting in the preparation of the financial statements.
ii) Conclude whether a material uncertainty exists that may cast significant doubt on the entity’s
ability to continue as a going concern.
iii) Report in accordance with the standard.
(2 marks each responsibility up to 4 marks)
d) Summary of audit procedures for going concern reviews

i) Analyse and discuss the entity’s cash flow, profit and other relevant forecasts with
management.
ii) Analyse and discuss the entity’s latest interim financial statements/management accounts.
iii) Review any loan agreements to determine whether the terms have been breached.
iv) Read minutes of meetings of shareholders, board directors and other committees for additional
information.
v) Inquire of the entity’s lawyer regarding court cases and claims.
vi) Confirm the adequacy of sources of finance e.g. loans, disposal of assets and related parties.
vii) Review subsequent events and their effect on going concern.
viii) Consider the position regarding unfulfilled customer orders.
ix) Review reports of regulatory authorities.
(1 mark each procedure up to 5 marks)
Question Three
a) Define subsequent events and explain the key dates of external audit completion
i) ISA 560 Subsequent events defines subsequent events: As events occurring between the
date of the financial statements and the date of the auditor’s report, and, Facts that become
known to the auditor after the date of the auditor’s report. (2 marks)
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ii) Key dates during the completion of the external audit

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Reporting date - This is the date when financial statements of the entity are prepared. In other
words, when the financial year of the firm comes to an end. The reporting date is also known
as the financial statements date.
Date when financial statements are signed by the directors - Normally, when financial
statements are complete that is to say, when all the adjustments are incorporated, the directors
will sign such financial statements. This means that all the assertions are now confirmed.
Date when the auditor’s report is signed – This is the date when the auditor has satisfied
him or herself that he or she has obtained sufficient appropriate evidence and will append his
or her signature on the report and put the date when he or she has signed that report.
Date when financial statements are issued – This is the date when financial statements are
issued to the directors of the company being audited. At this point, financial statements may
be given to third parties like banks especially when the company wants to acquire a loan.
Date when financial statements are approved at the Annual General Meeting – This is the
date when the annual report is approved at the AGM. The auditor reads the auditor’s reports to
the shareholders.
iii) Audit procedures relevant between the reporting date and the date of the auditor’s report
The auditor has a duty to perform to the following audit procedures to identify all subsequent
events:
 Inquire from management whether there have any: New commitments, borrowings or
guarantees; Sales or destruction of assets; Issue of new shares or debentures or change in
the financing structure; Unusual accounting adjustments; Major events affecting the
entity’s going concern assumption; and, Developments regarding provisions and
contingencies e.g. court cases.
 Review procedures management has established to identify subsequent events.
 Read minutes of meetings of the entity’s board held after year end for unusual items.
 Review the latest interim financial statements, budgets, cash flow forecasts and
management reports.
 Inquire from the entity’s lawyers about court cases and claims.
 Obtain written representations that all subsequent events that require adjustment or
disclosure have been adjusted or disclosed.
 Discuss the matters with management and request management to adjust the financial
statements or disclose the material subsequent events. If they agree, issue an unmodified report
and if they refuse, issue a modified report.
b) Types of modified opinion and writing of such opinions
i) Type of modified opinion Mode of writing
83
Qualified opinion (Except for): This is issued  In our opinion, except for the effects of the
when:
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matter described in the Basis for qualified

opinion paragraph, the financial statements

 The auditor, having obtained sufficient give a true and fair view of the financial
appropriate audit evidence, concludes that position of ABC Ltd as at 31 December,
misstatements, individually or in the 2016, and of its financial performance and
aggregate, are material, but not pervasive, its cash flows for the year then ended and
to the financial statements, or comply with the International Financial
Reporting Standards and the Companies
Act of Uganda 2012, or
In our opinion, except for the possible effects
of the matter described in the basis for
 The auditor is unable to obtain sufficient qualified opinion paragraph, the financial
appropriate audit evidence on which to statements give a true and fair view of the
base the opinion, but the auditor concludes financial position of ABC Ltd as at 31
that the possible effects on the financial December, 2016, and of its financial
statements of undetected misstatements, if performance and its cash flows for the year
any, could be material but not pervasive. then ended and comply with the International
Financial Reporting Standards and the
Companies Act of Uganda 2012.
Adverse opinion: This is issued when the In our Opinion, because of the possible effects
auditor, having obtained sufficient appropriate of the matters described in the basis of opinion
audit evidence, concludes that misstatements, paragraph, financial statements do not show a
individually or in the aggregate, are both true and fair view of the financial position of
material and pervasive to the financial ABC Ltd as at 31 December, 2016, and of their
statements. financial performance and their cash flows for
the year then ended. OR
In our opinion, because of the omission of the
matter discussed in the Basis for adverse
opinion section, above, the financial
statements do not give a true and fair view of
the financial position of ABC Ltd as at 31
December, 2016, and of their financial
performance and their cash flows for the year
then ended.
Disclaimer of opinion: This is issued when Because of the significance of the matter
the auditor is unable to obtain sufficient described in the Basis for disclaimer of opinion
appropriate audit evidence on which to base section, we have not been able to obtain
the opinion, and concludes that the possible sufficient appropriate audit evidence to
effects on the financial statements of provide a basis for an audit opinion.
undetected misstatements, if any, could be Accordingly, we do not express an opinion on
both material and pervasive. This is the case the financial statements.
where most of the accounting records have
been destroyed or are hidden by management.
1 mark for each opinion and 1 mark for mode of writing the opinion up to 6 marks
ii) The difference between emphasis of matter paragraph and other matter paragraph
84
An Emphasis of matter paragraph refers to a matter appropriately disclosed in the financial

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statements that is of such importance that it is fundamental to users’ understanding of the

financial statements. Examples of circumstances that may lead the auditor to use an Emphasis
of matter paragraph include: Going concern as covered in ISA 570 (Revised); An uncertainty
relating to the future outcome of exceptional court case or regulatory action; A significant
subsequent event that occurs before the date of the auditor’s report.; Early application (where
permitted) of a new IFRS that has a material effect on the financial statements; A major
catastrophe like a fire that has significant effect on the entity’s financial position. (2 marks)
An Other matter paragraph refers to a matter other than those disclosed in the financial
statements that is relevant to users’ understanding of the audit, the auditor’s responsibilities or
the auditor’s report, provided it is not a key audit matter in ISA 701. The paragraph includes
matters where: There is material inconsistency between the financial statements and the other
information in the financial report e.g. the chairman’s report; The prior period’s financial
statements were not audited or were audited by another auditor who expressed an unmodified
opinion; The auditor is unable to withdraw from an engagement due to a limitation on the
scope of the audit imposed by management that is pervasive, like in the public sector. (2 marks)
c) Bank balance confirmation procedures

i) Review the need to obtain a bank confirmation letter by considering factors like the materiality
of the bank balance, the volume of activity and degree of reliance on internal control.
ii) Prepare a standard bank letter in the format agreed with banks – it may: List the bank balances
and other information requesting confirmation of their accuracy and completeness, or, Request
details of their balances and other information, which can be compared to the client’s records.
iii) The external auditors obtain written authority from the client for the bank to disclose
information to them. The letter may be countersigned by the client or may be accompanied by
a specific authority letter.
iv) The letter should reach the bank manager at least a month before the accounting period end
and should state the period end date.
v) The auditors send the letter directly to the client’s bank with a request to send the reply directly
back to them and a pre-addressed envelope is enclosed.
Question Four
Substantive procedures to obtain evidence on completeness of income for Lira charity, trade
payables and trade receivables for Picafari Industries Limited
Completeness of income – Lira Charity Uganda

i) Obtain a schedule of all Lira charity’s income and cast to confirm completeness and
accuracy of the balance
ii) Compare individual categories of income against prior year and investigate any
significant differences
iii) For monthly donations, trace a sample of donations received in the bank statements to
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the cashbook to ensure that they are recorded completely and accurately.
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iv) For a sample of new subscribers in the year, agree from their completed subscription
form the monthly sum and start date, trace to the monthly donations received account
and agree to the cash book and bank statements.
v) For donations received in the post, review correspondence from donors, agree to the
donations account and trace sums received to the cashbook and bank statements to
ensure all completely recorded.
vi) For the charity events, undertake a proof in total calculation of the number of tickets
sold multiplied by the ticket price, compare this to the income recorded and discuss any
significant differences with management.
Trade payables - Picafari Industries Limited

i) Calculate the trade payables days for Picafari Industries Limited and compare to prior years
and investigate any significant difference, in particular any decrease for this year due to the
payment run on 3 November
ii) Compare the total trade payables and list of accruals against prior year and investigate any
significant differences
iii) Discuss with management the process they have undertaken to quantify the misstatement
of trade payables due to the late payment run and the cut-off error of purchase invoices and
consider the materiality of the error in isolation as well as with other misstatements found.
iv) Select a sample of purchases invoices received between the period 1 to 7 November,
ascertain through reviewing goods received notes (GRNs) if the goods were received pre
or post year end; if post year end, then confirm that they have been excluded from the
ledger or follow through to the correcting journal entry.
v) Review after-date payments; if they relate to the current year, then follow through to the
purchase ledger or accrual listing to ensure they are recorded in the correct period.
vi) Obtain supplier statements and reconcile these to the purchase ledger balances, and
investigate any significant differences.
vii) Select a sample of payables balances and perform a trade payables circularization, follow
up any non-replies and any reconciling items between the balance confirmed and the trade
payables balance
viii) Select a sample of GRNs before the year end and after the year end and follow through to
inclusion in the correct period’s payables balance, to ensure correct cutoff.
Trade receivables – Picafari Industries Limited

i) Review the aged receivables listing to identify any slow- moving or old receivables
balances; discuss the status of these balances with the finance director to assess whether
they are likely to pay.
ii) Review customer correspondence to identify any balances which are in dispute or unlikely
to be paid.
iii) Review whether there are any after – date cash receipts for slow-moving / old receivables
balances.
iv) Review board minutes to identify whether there are any significant concerns in relation to
86
payments by customers
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v) Calculate the potential level of receivables which are not recoverable assess whether this
is material or not and discuss with management.
vi) Recalculate the allowance for receivables and compare to the potentially irrecoverable
balances to assess is the allowance is adequate.
vii) Inspect post yearend sales returns / credit notes and consider whether an additional
allowance against receivables is required.
a) Why balances on supplier statement differ from the payable ledger accounts
The balances on the suppliers’ statements may be different from those on the payables ledger
accounts due to:
 Timing differences e.g. Goods in transit: Check whether the goods were received before the
year-end by inspecting GRNs and are included in closing inventory and purchase accruals;
If not, it would be a cut-off error that should be investigated; If the goods were received
after the year-end, the difference with the statement would be correct OR Cash-in-transit –
check the dates of the cheques and when they were credited in the cash book and debited on
the bank statements after the year-end.
 Errors by the client that should be adjusted, or if they are by the suppliers, they are
reconciling items till they are corrected by the suppliers.
 Disputes between the client and the suppliers e.g. check that they are resolved as quickly as
possible.
 Window dressing e.g. where the: Cheques were prepared simply to reduce payables at the
end of the period and were kept in the safe and should therefore be reversed or Invoices
were not posted deliberately in order to reduce the level of payables.
b) Factors considered in determining sample size

i) The desired assurance level (confidential level) is the desired level of assurance that the
sample results will support a conclusion that the control in the population is operating
effectively. For example, 95% confidence level indicates that if a test was performed 100
times, the results would be accurate 95 times out of 100 tests. This means the auditor is
willing to accept 5% detection risk (sampling risk) of accepting the control as effective
when it is not. The higher the assurance level, the larger the sample size. The confidence
level required in a particular test will be based on factors such as: Evidence obtained from
other sources such as analytical procedures, other substantive procedures, and testing the
operational effectiveness of related controls; the importance of the financial statement
assertion or line item compared with overall materiality. Generally, when the auditor has
decided to rely on controls, the confidence level is set at: 95% (acceptable sampling risk is
5%) - where the primary audit evidence is to be obtained from tests of controls; 90%
(acceptable sampling risk is 10%) - where the tests of controls are to be combined with
substantive procedures to address a particular assertion.
ii) The tolerable rate of deviation – this is the maximum rate of deviation an auditor is
willing to accept and still conclude that the control is effective when planning tests of
87
controls. The lower the tolerable rate of deviation, the larger the sample size. Tolerable rate
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of deviation is based on control risk and importance of the control. The tolerable rate of
deviation is likely to be very small, often allowing for no deviations or possibly only one.
iii) The expected rate of deviation – this is the deviation rate the auditor expects to exist in
the population. The larger the expected population deviation rate, the larger the sample size
needs to be so that the auditor is in position to make a reasonable estimate of the actual rate
of deviation.
iv) Control risk – the lower the control risk, the larger the sample size, i.e. the higher the
assurance from tests of controls.
v) Population size – for large populations (e.g. above 500 items), size has little or no effect
on sample size when performing tests of controls. The auditor should determine a sample
size sufficient to reduce sampling risk to an acceptably low level. Sample sizes for tests of
controls are often small because they are based on no exceptions being found.
Sample size = Confidence factor
Tolerable deviation rate
(2 marks each factor up to 8 marks)
SECTION C
Question Five
a) The accountants Act

i) Membership to ICPAU
The Institute has the following categories of members:
 Full members – one is eligible to be a full member if he/she:
- Passes the qualifying CPA(U) examinations and completes practical training of three
years or
- Is a member of an accountancy body approved by the ICPAU Council.
Full members use the title CPA (U), Certified Public Accountant of Uganda.
 Associate members – these are persons:
- Who were in audit practice by August, 7 1992 when the Accountants Act came into
force, but were not professional accountants at that time.
- Who have passed CPA(U) examinations but do not have practical training prescribed
by the Council.
Associate members may use the title, Associate Accountant of Uganda (AAU).
 Retired members.
 Any other category of members, as may be determined by the Council of the Institute.
(2 marks for each category up to 6 marks)
ii) The fundamental principles to the code of ethics

Professional accountants must comply with the following five fundamental principles:
 Integrity means to be honest and straight forward in all professional and business
88
relationships. A professional accountant should not knowingly provide information that is

materially false or misleading in reports, returns or statements.
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 Objectivity means not to allow bias, conflict of interest and undue influence of others to
override professional or business judgments. A professional accountant should not provide a
service if there is a circumstance or relationship that is likely to bias or unduly influence his/her
professional judgement.
 Professional competence and due care means to:
- Maintain knowledge and skill based on based on current developments in practice,
legislation to ensure that a client or employer receives competent professional service.
- Act diligently in accordance with the requirements of an assignment, carefully, thoroughly
and timely. Staff working under the accountant should be trained and properly supervised.
 Confidentiality means not:
- Disclose information acquired as a result of professional and business relationships to third
parties without proper authority, unless there is a legal or professional right or duty to
disclose.
- Use the information to their personal advantage or the advantage of third parties.
The obligation of confidentiality continues even after the professional relationship has ended.
An accountant may disclose a client’s confidential information in the following circumstances:
- When disclosure is authorized by a client or employer.
- When disclosure is required by law (obligatory disclosures), e.g. where auditors are required to:
 Produce documents or provide evidence during court proceedings.
 Disclose information to appropriate public authorities of the violation of the law by the
client, for example, where the client is suspected to have committed treason, terrorism,
drug trafficking or money laundering offences.
- Where there is a professional duty or right to disclose client’s information when not
prohibited by law (voluntary disclosures) in order to:
 To comply with the quality review of a member body or professional body like the
ICPAU.
 To respond to an investigation of a regulatory body e.g. by bank supervision of Bank
of Uganda.
 To protect the accountant’s interests in legal proceedings against a client e.g. when
defending himself/herself against a negligence action, disciplinary proceedings or if
suing for unpaid fees.
 To comply with technical standards and ethics requirements.
However, members are advised to seek legal advice before giving information to third parties.
 Professional behavior means to comply with relevant laws and regulations and avoid any
action that may discredit the profession. Professional accountants should not make:
- Exaggerated claims on the services they may offer, the qualifications they possess or the
experience they have gained
- Unsubstantiated comparisons with the work of others.
(2 marks each principle up to 8 marks)
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b) Reliance on the work of internal auditors by external auditors

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The external auditor in assessing whether to rely on the work of internal auditors considers the
following factors:

 Objectivity – whether:
- Internal audit reports to directors directly.
- There are any constraints or restrictions placed on the internal audit function by
management.
- And to what extent, management acts on the recommendations of the internal audit
function.
 Technical competence – whether internal auditors are members of professional bodies and
have relevant qualifications and experience.
 Due professional care – whether activities of the internal audit function are properly planned,
supervised, reviewed and documented e.g. have detailed audit manuals and internal audit
documentation. AUDITING
 Communication – whether:
- Internal and external auditors are free to communicate openly throughout the accounting
period.
- The external auditor has access to relevant internal audit reports.
The presence of an effective internal audit affects the external auditor’s assessment of internal
control and audit risk and influences the way the audit is done.
(2 marks each up to 6 marks)
Question Six
a) Independence of the Auditor General and indicators of Independence of the Auditor General
The national Audit Act of 2008 stipulates that the Auditor General in performing his or her
functions shall not be under the direction or control of any person or authority. (2 marks)
The indicators of independence of the Auditor General include the following;

 Special procedures for appointment i.e. appointed by the President on recommendation of the
Speaker of Parliament
 Special procedures for removal. Legal safeguards exist in the constitution to ensure that he is
not arbitrarily removed from office.
 Reports to Parliament and the constitution requires parliament to debate his report within six
month of submitting it to parliament, and to take action on his recommendations. PAC – Public
accounts Committee etc
 Is not subject to the direction of any person/party as to the manner in which functions are
carried out; powers are exercised; or priority given to a particular matter.
 All reports of the AG are reports of Parliament, hence no civil or criminal proceedings shall be
instituted against the AG on the basis of any report published by him or her for the benefit of
parliament.
 The AG and his staff are also protected from liability by law. They are not personally liable
for any act or omission done or omitted to be done in good faith in the exercise of the functions
of the OAG.
 The constitution requires the accounts of the office of the auditor general to be audited and
90
reported upon by another auditor appointed by Parliament.

 Assured salary as a charge from the Consolidated fund
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 While the President (on advice of cabinet) , the Parliament and the minister may (in writing)
at any one time request the AG to conduct a special audit and to make a special audit report on
a public body, it is however at the discretion of the AG to determine whether or not to undertake
such an audit
 Immunity /protection from actions by others in performance of his duties
(1 mark each indicator up to 6 marks)
b) The tenure and remuneration of Auditor General as per the National Audit Act, 2008
The Auditor General may retire at any time after attaining the age of 60 years, and shall
vacate office on attaining the age of 70 years. (2 marks)
The remuneration and other conditions of service of the Auditor General, including post-
retirement benefits, shall be determined by Parliament. The salary and allowances payable to
the Auditor General shall be charged on the consolidated fund. (2 marks)
c) Powers of the Auditor General

 Have access to all books and accounts, money, stores, vouchers, stamps and securities subject
to its audit and to any place where any such books and accounts, money or stores are kept;
 Require any person to supply any information or answer any question relating to books and
accounts, money or stores subject to audit
 At any convenient time, cause a search to be made of, and extracts taken from any books or
accounts relating to money or stores subject to its audit, without paying any fee.
 Have access to electronic information relating to the audit as he or she has to other documents
 Have access to any government property
 Station his or her staff at the premises of the organization being audited, and that organization
shall provide those staff with adequate office space and facilities during the period under audit
 Request for the opinion of the Attorney General in writing s to any question regarding the
interpretation of any Act, regulations or agreements concerning the powers of the Auditor
General, or the discharge of his or her duties, and the Attorney General shall give his or her
opinion within a reasonable time.
(2 marks each up to 8 marks)
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TOPIC 4: INTERNAL CONTROL

4.1 Components, Importance and Limitations of Internal Control

 Effectiveness and efficiency of operations.

Bcom Auditing Notes 2021

Internal control objectives can be broadly grouped into four categories:

4.1.3 Understanding the client’s internal control

 Observing the application of specific controls e.g. attending a wages payout.

4.1.4 Components of internal control

Bcom Auditing Notes 2021

Control Environment has the following elements:

iii) Information system relevant to financial reporting

Bcom Auditing Notes 2021

iv) Control activities

Bcom Auditing Notes 2021

Bcom Auditing Notes 2021

Monitoring of controls  Management’s monitoring of control is often done by the

4.1.6 Prerequisites for an effective internal control

iii. The resources available.

iv. The quality of internal audit.

Bcom Auditing Notes 2021

Bcom Auditing Notes 2021

Receive purchase order

 they do not show functions properly and have to be accompanied by notes

Bcom Auditing Notes 2021

d. Internal Control Evaluation questionnaires (ICEQs)

Bcom Auditing Notes 2021

Auditor expects effective controls Auditor expects ineffective

Perform tests of controls (TOCs)

Perform reduced substantive

procedures to obtain evidence

Issue an audit report & Communicate deficiencies

4.4.1 Need for tests of controls

Bcom Auditing Notes 2021

4.6 Audit of the sales system

how the computerised system works.

Bcom Auditing Notes 2021

Bcom Auditing Notes 2021

4.6.2 Control activities and Common controls in sales

increases the risk detection and therefore is less likely to occur.

Bcom Auditing Notes 2021

Transaction  Credit check

Supervion  Supervison compensates for the indequate segregation of duties or improves

4.6.3 Assertion / control objectives, key controls and tests of controls

Bcom Auditing Notes 2021

prices and sales terms.

Bcom Auditing Notes 2021

–offs of uncollectable debts by the due receivables and

debts by the board of directors.

Bcom Auditing Notes 2021

Bcom Auditing Notes 2021

ledger section in the accounting department, pending the arrival of

Bcom Auditing Notes 2021

4.7.2 Control activities and common controls

 Limit access to the accounting records above.

Bcom Auditing Notes 2021

4.7.3 Assertions, objectives, controls and tests of controls

 Select a sample of GRNs and

Bcom Auditing Notes 2021

general ledger by the purchase ledger clerk.