Topic: Risk Assessment and Internal Control

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  • 9 Marks

AA – May 2016 – L2 – Q7b – Risk Assessment and Internal Control

Identify business risks for Moovy Magic’s procurement and suggest control strategies.

You are the internal auditor of Moovy Magic Limited, which runs a chain of video rental stores.

The company guarantees that if a video is not available for rental, the customer will get a free rental when that video comes back into inventory. It is not possible for customers to pre-book videos. The company purchases a number of copies of each video, taking the above policy into account, but has no way of monitoring whether their procurement strategy is effective. Procurement decisions are made and auctioned locally, and no central budgets are produced.

You have been asked by the directors to review the procurement and other strategies of the company.

Required:

Identify and explain the potential business risks arising from the above procurement and other strategies. Suggest controls and strategies that the management of Moovy Magic could instigate to mitigate those business risks. (9 Marks)

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  • 20 Marks

AA – May 2016 – L2 – Q2 – Planning an Audit

Planning and identifying audit risks for a new client with an increased demand for products, using a standard costing system for inventory valuation.

Sweet Dreams, a limited liability company, is a new audit client and you are at the
planning meeting for the forthcoming audit. The company has grown rapidly and has
May 31 as year-end. The financial statements have not been audited in previous years
since the organization has only just converted from a partnership to a company.
The company’s bankers have requested that an audit be undertaken on the financial
statements for the year ending May 31, 2016. Higher levels of inventory required to
meet the increasing demand for its products have necessitated a request for an increase
in the bank’s overdraft facility.
The company makes beds, buying its materials directly. At the year-end, inventory
comprises raw materials, work-in-progress and finished goods. It does not undertake
continuous inventory counting but does intend to perform a full inventory count on
May 31, 2016. It uses standard costing system to value finished products and work-inprogress.

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  • 30 Marks

AA – Nov 2014 – L2 – Q1 – Risk Assessment and Internal Control

Analyze audit risks and ethical considerations for a new audit engagement with a telecommunication firm.

You are the Principal Partner in charge of a four-partner firm of Chartered Accountants. Your firm has been invited to tender for the audit of Poles Apart Limited for the year ended 31 December 2013.

Poles Apart Limited was established two years ago and provides mobile phone service for individuals and businesses. The system established by the company comprises:

  1. Small portable mobile phones, which allow subscribers to contact or be contacted by any other telephone.
  2. The mobile phones can be used within the range of a local relay station that receives and sends calls to the mobile phone.
  3. The local relay stations are linked to a central computer that connects the calls to other users, often through a computer telephone network.
  4. Currently, the local relay stations cover one large city with a population of about 1,000,000. In the next year, the system will expand to all cities in Nigeria with populations over 250,000. By 2017, it will cover all motorways and cities with populations over 100,000, which will involve substantial capital expenditure and require additional borrowings.
  5. The cost of the relay stations and central computer is capitalized and amortized over six years.
  6. The mobile phones are manufactured by other companies and sold through retailers. Poles Apart Limited pays ₦2,000 to the retailer for each phone sold, which is capitalized and amortized over four years.
  7. Subscribers are invoiced monthly with a fixed line rental and a variable call charge. Charges for calls from other operators are also calculated by the company’s main computer.
  8. All shares are owned by three wealthy individuals who serve as non-executive directors. They receive a fixed allowance and do not plan further investment in the company.
  9. Establishing the network of relay stations and subscribers will result in losses for at least three years, with current borrowings at about 20% of shareholders’ funds. It is expected that the company will be highly geared by 2016.
  10. As the company will not be immediately profitable, executive directors receive a basic salary and a bonus based on the number of subscribers.
  11. The owners plan to float the company on the local Stock Exchange in 2016. The flotation will involve issuing new shares to the public and the three non-executive directors selling some of their shares.
  12. Poles Apart Limited has several large competitors, each with comprehensive coverage of over 90% of the population.

Required:

a. Consider the risks associated with the audit of Poles Apart Limited. (12 Marks)

b. Describe the ethical matters you should consider in deciding whether your audit firm should accept the audit engagement. This should include considering whether your firm has the technical and logistical ability to carry out the audit. (12 Marks)

c. Advise on whether you should accept or decline the audit assignment, giving your principal reasons for coming to this decision. (6 Marks)

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  • 20 Marks

AA – May 2021 – L2 – Q2 – Risk Assessment and Internal Control

Analysis of substantive procedures, risk assessment purposes, and categories of audit assertions.

Your partner invited you and other colleagues to a pre-audit meeting and informed you that the audit of Why Worry Agro Chemical Company Limited will soon commence. He stated that based on experience, the internal control system is not reliable. Therefore, it will be a transaction-based audit approach involving a high level of substantive testing.

He further informed the engagement team that arrangements will be made for a brainstorming session on risk assessment and how to address the risk, using relevant audit assertions. The internal specialists on information technology and tax were invited to the meeting, and two new audit trainees were attached to you on the audit.

As the proposed audit senior personnel on the audit team:

You are required to explain:

a. Substantive audit procedures (2 Marks)

b. Purpose of risk assessment (6 Marks)

c. Categories of financial statements audit assertions (6 Marks)

d. Examples of substantive testing (6 Marks)

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  • 15 Marks

PM – May 2023 – L2 – SA – Q5 – Risk Assessment and Internal Control

Evaluate which project (A or B) the company should invest in, based on projected cash flows and cost of capital.

A company is considering whether or not to invest in any of the two projects where the initial cash investment would be ₦13,000,000 for Project A and ₦14,000,000 for Project B. The project would have a five-year life, and the estimated annual cash flows are as follows:

Project A

Year Cash inflows (₦) Cash outflows (₦)
1 6,000,000 3,000,000
2 8,000,000 4,000,000
3 10,000,000 4,000,000
4 9,000,000 3,000,000
5 6,000,000 3,000,000
Total 39,000,000 17,000,000

Project B

Year Cash inflows (₦) Cash outflows (₦)
1 10,000,000 5,000,000
2 9,000,000 4,000,000
3 8,000,000 3,000,000
4 8,000,000 3,000,000
5 4,000,000 2,000,000
Total 39,000,000 17,000,000

The company cost of capital is 10%.

The estimates of cash outflows are considered fairly reliable. However, the estimates of cash inflows are much more uncertain. Several factors could make the annual cash flows higher or lower than expected.

  • Factor 1: There is a 20% probability that government measures to control the industry will reduce annual cash inflows by 25%.
  • Factor 2: There is a 30% probability that another competitor will also enter the market; this would reduce the estimated cash inflows by 10%.
  • Factor 3: There is a 40% probability that demand will be stronger than expected. The company would not be able to supply more products to the market, but it would be able to sell at higher prices and cash inflows would be 5% higher than estimated.

Required:

a. Calculate the expected net present value of the two projects. (10 Marks)
b. Which of the projects will be more profitable? (5 Marks)

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  • 15 Marks

AA – May 2023 – L2 – SC – Q7 – Risk Assessment and Internal Control

Addressing the impact of record loss on business continuity and methods to manage data recovery.

Indorise Limited has been in business for about 20 years. The company has divisional offices in three locations. The accounting records are kept mainly at the head office, with backup in an adjacent building to the office. The office is located close to a petrol station.

An unfortunate incident occurred in a certain year when the petrol station caught fire, engulfing most offices in the area. The company lost most of the properties in the building, including important accounting records. Consequently, the company relocated its office to another street. However, many of the accounting records were not backed up, leading to disputes from the tax office, customers, and suppliers over balances, with some parties even initiating litigation claims.

Required:

a. Explain the importance of maintaining adequate backup for accounting records. (5 Marks)

b. Identify measures that Indorise Limited could implement to prevent future data loss. (5 Marks)

c. Discuss the role of internal controls in ensuring business continuity in cases of disaster. (5 Marks)

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  • 15 Marks

AA – Nov 2018 – L2 – Q4a and Q4b – Risk Assessment and Internal Control

Describes factors for obtaining entity and environmental information for risk assessment and procedures to perform risk assessment.

The independent auditor identifies and assesses the risk of material misstatements through understanding the entity and its environment.

Required:
a. Describe the factors the auditor should consider while obtaining information on the entity and its environment.
(10 Marks)

b. Explain why the auditor needs to perform risk assessment and the procedures.
(5 Marks)

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  • 9 Marks

AA – May 2016 – L2 – Q7b – Risk Assessment and Internal Control

Identify business risks for Moovy Magic’s procurement and suggest control strategies.

You are the internal auditor of Moovy Magic Limited, which runs a chain of video rental stores.

The company guarantees that if a video is not available for rental, the customer will get a free rental when that video comes back into inventory. It is not possible for customers to pre-book videos. The company purchases a number of copies of each video, taking the above policy into account, but has no way of monitoring whether their procurement strategy is effective. Procurement decisions are made and auctioned locally, and no central budgets are produced.

You have been asked by the directors to review the procurement and other strategies of the company.

Required:

Identify and explain the potential business risks arising from the above procurement and other strategies. Suggest controls and strategies that the management of Moovy Magic could instigate to mitigate those business risks. (9 Marks)

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  • 20 Marks

AA – May 2016 – L2 – Q2 – Planning an Audit

Planning and identifying audit risks for a new client with an increased demand for products, using a standard costing system for inventory valuation.

Sweet Dreams, a limited liability company, is a new audit client and you are at the
planning meeting for the forthcoming audit. The company has grown rapidly and has
May 31 as year-end. The financial statements have not been audited in previous years
since the organization has only just converted from a partnership to a company.
The company’s bankers have requested that an audit be undertaken on the financial
statements for the year ending May 31, 2016. Higher levels of inventory required to
meet the increasing demand for its products have necessitated a request for an increase
in the bank’s overdraft facility.
The company makes beds, buying its materials directly. At the year-end, inventory
comprises raw materials, work-in-progress and finished goods. It does not undertake
continuous inventory counting but does intend to perform a full inventory count on
May 31, 2016. It uses standard costing system to value finished products and work-inprogress.

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  • 30 Marks

AA – Nov 2014 – L2 – Q1 – Risk Assessment and Internal Control

Analyze audit risks and ethical considerations for a new audit engagement with a telecommunication firm.

You are the Principal Partner in charge of a four-partner firm of Chartered Accountants. Your firm has been invited to tender for the audit of Poles Apart Limited for the year ended 31 December 2013.

Poles Apart Limited was established two years ago and provides mobile phone service for individuals and businesses. The system established by the company comprises:

  1. Small portable mobile phones, which allow subscribers to contact or be contacted by any other telephone.
  2. The mobile phones can be used within the range of a local relay station that receives and sends calls to the mobile phone.
  3. The local relay stations are linked to a central computer that connects the calls to other users, often through a computer telephone network.
  4. Currently, the local relay stations cover one large city with a population of about 1,000,000. In the next year, the system will expand to all cities in Nigeria with populations over 250,000. By 2017, it will cover all motorways and cities with populations over 100,000, which will involve substantial capital expenditure and require additional borrowings.
  5. The cost of the relay stations and central computer is capitalized and amortized over six years.
  6. The mobile phones are manufactured by other companies and sold through retailers. Poles Apart Limited pays ₦2,000 to the retailer for each phone sold, which is capitalized and amortized over four years.
  7. Subscribers are invoiced monthly with a fixed line rental and a variable call charge. Charges for calls from other operators are also calculated by the company’s main computer.
  8. All shares are owned by three wealthy individuals who serve as non-executive directors. They receive a fixed allowance and do not plan further investment in the company.
  9. Establishing the network of relay stations and subscribers will result in losses for at least three years, with current borrowings at about 20% of shareholders’ funds. It is expected that the company will be highly geared by 2016.
  10. As the company will not be immediately profitable, executive directors receive a basic salary and a bonus based on the number of subscribers.
  11. The owners plan to float the company on the local Stock Exchange in 2016. The flotation will involve issuing new shares to the public and the three non-executive directors selling some of their shares.
  12. Poles Apart Limited has several large competitors, each with comprehensive coverage of over 90% of the population.

Required:

a. Consider the risks associated with the audit of Poles Apart Limited. (12 Marks)

b. Describe the ethical matters you should consider in deciding whether your audit firm should accept the audit engagement. This should include considering whether your firm has the technical and logistical ability to carry out the audit. (12 Marks)

c. Advise on whether you should accept or decline the audit assignment, giving your principal reasons for coming to this decision. (6 Marks)

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  • 20 Marks

AA – May 2021 – L2 – Q2 – Risk Assessment and Internal Control

Analysis of substantive procedures, risk assessment purposes, and categories of audit assertions.

Your partner invited you and other colleagues to a pre-audit meeting and informed you that the audit of Why Worry Agro Chemical Company Limited will soon commence. He stated that based on experience, the internal control system is not reliable. Therefore, it will be a transaction-based audit approach involving a high level of substantive testing.

He further informed the engagement team that arrangements will be made for a brainstorming session on risk assessment and how to address the risk, using relevant audit assertions. The internal specialists on information technology and tax were invited to the meeting, and two new audit trainees were attached to you on the audit.

As the proposed audit senior personnel on the audit team:

You are required to explain:

a. Substantive audit procedures (2 Marks)

b. Purpose of risk assessment (6 Marks)

c. Categories of financial statements audit assertions (6 Marks)

d. Examples of substantive testing (6 Marks)

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  • 15 Marks

PM – May 2023 – L2 – SA – Q5 – Risk Assessment and Internal Control

Evaluate which project (A or B) the company should invest in, based on projected cash flows and cost of capital.

A company is considering whether or not to invest in any of the two projects where the initial cash investment would be ₦13,000,000 for Project A and ₦14,000,000 for Project B. The project would have a five-year life, and the estimated annual cash flows are as follows:

Project A

Year Cash inflows (₦) Cash outflows (₦)
1 6,000,000 3,000,000
2 8,000,000 4,000,000
3 10,000,000 4,000,000
4 9,000,000 3,000,000
5 6,000,000 3,000,000
Total 39,000,000 17,000,000

Project B

Year Cash inflows (₦) Cash outflows (₦)
1 10,000,000 5,000,000
2 9,000,000 4,000,000
3 8,000,000 3,000,000
4 8,000,000 3,000,000
5 4,000,000 2,000,000
Total 39,000,000 17,000,000

The company cost of capital is 10%.

The estimates of cash outflows are considered fairly reliable. However, the estimates of cash inflows are much more uncertain. Several factors could make the annual cash flows higher or lower than expected.

  • Factor 1: There is a 20% probability that government measures to control the industry will reduce annual cash inflows by 25%.
  • Factor 2: There is a 30% probability that another competitor will also enter the market; this would reduce the estimated cash inflows by 10%.
  • Factor 3: There is a 40% probability that demand will be stronger than expected. The company would not be able to supply more products to the market, but it would be able to sell at higher prices and cash inflows would be 5% higher than estimated.

Required:

a. Calculate the expected net present value of the two projects. (10 Marks)
b. Which of the projects will be more profitable? (5 Marks)

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  • 15 Marks

AA – May 2023 – L2 – SC – Q7 – Risk Assessment and Internal Control

Addressing the impact of record loss on business continuity and methods to manage data recovery.

Indorise Limited has been in business for about 20 years. The company has divisional offices in three locations. The accounting records are kept mainly at the head office, with backup in an adjacent building to the office. The office is located close to a petrol station.

An unfortunate incident occurred in a certain year when the petrol station caught fire, engulfing most offices in the area. The company lost most of the properties in the building, including important accounting records. Consequently, the company relocated its office to another street. However, many of the accounting records were not backed up, leading to disputes from the tax office, customers, and suppliers over balances, with some parties even initiating litigation claims.

Required:

a. Explain the importance of maintaining adequate backup for accounting records. (5 Marks)

b. Identify measures that Indorise Limited could implement to prevent future data loss. (5 Marks)

c. Discuss the role of internal controls in ensuring business continuity in cases of disaster. (5 Marks)

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  • 15 Marks

AA – Nov 2018 – L2 – Q4a and Q4b – Risk Assessment and Internal Control

Describes factors for obtaining entity and environmental information for risk assessment and procedures to perform risk assessment.

The independent auditor identifies and assesses the risk of material misstatements through understanding the entity and its environment.

Required:
a. Describe the factors the auditor should consider while obtaining information on the entity and its environment.
(10 Marks)

b. Explain why the auditor needs to perform risk assessment and the procedures.
(5 Marks)

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