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CONTENTS
 Page

Preface
Topic 1: The business world and corporate governance9
Topic 2: The internal auditor 33
Topic 3: The external auditor 51
Topic 4: Auditing concepts 71
Topic 5: The audit process 97
Topic 6: System and cycles within a business 115
Topic 7: The revenue and receipts cycle 125
Topic 8: The acquisition and payments cycle 155
Topic 9: The bank reconciliation 177
Topic 10: Payroll 183

AUE1501/1(III)
 

PREFACE

1 Welcome
Welcome to the world of the auditor. We are going to introduce you to business
entities, corporate governance, the internal and external auditing profession,
auditing concepts, the audit process and the business cycles.

The study material is presented in the form of topics and study units. It consists of
ten topics, each topic made up of various study units. The topics and study units
follow one another and should be studied in the correct sequence. The length of
time needed to study any study unit will depend on the volume of work it contains.

The study units will include learning activities that will give you the opportunity
to put your newly acquired knowledge into practice. All learning activities are
adequately referenced to your prescribed textbook, Jackson and Stent (refer to
Tutorial Letter 101 for the correct edition). In other words, you will find the answer
to the learning activities if and only if you refer to the study references to the
prescribed textbook. This means that you cannot study this module successfully
without the prescribed textbook.

1. Do I have a copy of the prescribed textbook? Yes No

2 Purpose of the module

The purpose of this module is to introduce you to the basic principles that apply in
the audit world. The general principles regarding the business world, the auditing
profession and the role of auditors are covered. The purpose is also to enable
students to identify business and audit risk areas in an entity and to identify control
measures to mitigate risks; all restricted to small and medium- sized enterprises.

After completing this module successfully you will be able to demonstrate an

understanding of, and describe elementary auditing/internal auditing principles
applicable to small and medium-sized enterprises.

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3 Framework of the module

Below is a schematic representation of the content of this module.

AUE1501
INTRODUCTION TO AUDITING

Topic 1 The business world and corporate governance

1. Various types of business entities
2. Corporate governance
3. Internal control

Topic 2 The internal auditor

4. Introduction to internal auditing
5. The responsibilities of the internal auditor
6. Professional conduct requirements for the internal auditor
7. Internal audit and good corporate governance

Topic 3 The external auditor

8. The development of the external auditing profession
9. Assurance by the external auditor
10. Professional conduct requirements for external auditors
11. The relationship between internal and external auditors

Topic 4 Auditing concepts

12. Assertions
13. Audit evidence
14. Materiality and audit risk
15. Risk assessment and further audit procedures

Topic 5 The audit process

16. The overall audit process
17. Planning and implementing the plan
18. Reaching conclusion and reporting

Topic 6 System and cycles within a business

19. Systems and cycles within a business entity

Topic 7 The revenue and receipts cycle

20. Ordering and warehouse/despatch functions
21. Invoicing and recording of sales functions
22. Recording of receipts and credit management functions

2 Topic 8 The acquisition and payments cycle

23. The ordering and receiving of goods functions
24. The recording of purchases and payment (preparation and actual payment) functions
 Topic 7 The revenue and receipts cycle
20. Ordering and warehouse/despatch functions
21. Invoicing and recording of sales functions 
22. Recording of receipts and credit management functions

Topic 8 The acquisition and payments cycle

23. The ordering and receiving of goods functions
24. The recording of purchases and payment (preparation and actual payment) functions

Topic 9 The bank reconciliation

25. The steps in performing a bank reconciliation

Topic 10 Payroll and personnel cycle

26. Personnel and payroll preparation

DIAGRAM 1

4 The teaching strategy

4.1 The study package

The study package for mastering this module consists of
•• the prescribed textbook that you must purchase (see Tutorial Letter 101 for
the details).
•• a printed study guide, the content of which is also on the myUnisa module
site under Study Units. The material in the guide is intended to enhance
your learning experience and is based on the prescribed textbook. Study
units contain learning activities that will enable you to further develop insights
and reveal to you how much you have actually learnt. The material has been
structured in topic and study units.
•• all the study material is also made available on the myUnisa webpage for
this module under the Official Study Material tab.
•• assignments, which are contained in Tutorial Letter 101.
•• announcements on myUnisa which contain information to which we wish to
draw your attention. You will be notified of new announcements.
•• discussion forum activities activated by the e-tutor.

2. Have I noted the due dates of the assignments on my Yes No

calendar?

4.2 Importance of study outcomes and self-assessment

Each topic will introduce you to a set of study units that belong to that particular
topic. Each study unit will contain its own study outcomes. At the end of the study
unit you will be reminded of the study outcomes and you will be asked if you are
able to achieve the study outcomes. Do not proceed to the next study unit before
you are able to answer these self-assessment criteria positively. The sequence
of the study units is important.

4.3 Study and study activities

A variety of study activities and study activities (self-assessment) are included in
each study unit. These are a combination of reading, studying, internet research,

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reflecting and discussion activities that are presented in a flexible manner through-
out the various study units. They have been designed to enable you to absorb the
content of the topic, to practise your understanding and to direct your thoughts.
This is a vital aspect of our learning approach because as you encounter these
study activities and actually do them, you will become directly involved in control-
ling the extent and quality of your learning experience. In short, how much and
how well you learn will depend on the extent of your progress through the study
activities, and the quality of your efforts.

As you page through the study guide you will notice that spaces have been left
open where you can write down your answers to some of the study activities. This
is intended to guide you to complete the answer correctly when referring to the
prescribed textbook. Your study guide thus becomes your workbook. Active
use of your prescribed textbook is essential to achieve success in this module.

I would like you to buy a blank exercise book or exam pad to use with the study
guide. In this exercise book you must respond to the study activities, reflect on
what you have learned, make your own notes or add diagrams to assist you in
the learning experience. The exercise book will become useful when revising
for the examination because all your notes are then kept at one place. There are
numerous activities in the study guide that you must complete. Besides help-
ing you to learn, writing down the answers will also assist you in improving your
writing skills.

3. Do I have a blank exercise book or exam pad to use as Yes No

workbook?

4.4 Meaning of words

Meaning of words is extremely important when attempting the assignments and
the examination. In this module we require you to understand the meaning of
certain words to enable you to interpret assessment criteria, comprehend what
various activities in the study guide require you to do and interpret assignments
and examination questions.

To indicate the length, scope and format of answers to study activities and ques-
tions, we have deliberately built limits or restrictions into the questions by using
action verbs. These action verbs give you an indication of how to tackle the given
problem and what style of writing is called for.

An analysis of the action verbs contained in a question will

•• enable you to plan the answer systematically and organise your thoughts
logically
•• ensure that you comply with the lecturer’s requirements

You will also save yourself time and trouble by eliminating irrelevant material that
falls outside the scope of the answer.

For the purposes of this module, the following meanings will be attached to the
following action words:

4
 

Word Meaning

Compare Place side by side in order to observe similarities,

relationships and differences
Complete Finish; accomplish; supply whatever is missing

Define Describe accurately; establish the exact meaning;

explain the inherent meaning; make clear; give an ac-
count of the overall character
Describe Give an account of the respective particulars or es-
sential characteristics; outline clearly; give an accu-
rate account
Determine Establish; reach a conclusion or decision
Discuss Examine; explain; examine by means of argument
Explain Make clear or comprehensible; elucidate; give the
meaning in detail
Identify Establish through consideration; recognise; pick out
Illustrate Explain; shed light on; use an example to elucidate
something
List Note/specify matters or objects that are related to one
another
Name/mention/state Specify by name; give names, characteristics, items,
elements or facts
Organise Divide into classes or groups according to certain
characteristics; place in a particular order
Prepare Make ready in advance; finish; get something ready
on the basis of previous study
Record Put in writing; set down for reference and
preservation
Substantiate Supply reasons or facts; support a view or argument
Summarise Give a brief account; briefly state the essence of a
matter
Tabulate Arrange in tabular form

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 4.5 Meaning of icons
The icons that will be used in this module are listed below, together with a de-
scription of what each means:

Icon Description

Study • Study requires you to refer to the selected sections in your

prescribed textbook and study the sections in detail. Any
section marked as “Study” may be examined and it is important
that you master those sections.
• Make good use of your prescribed textbook by highlighting
or underlining important concepts in your textbook.
• Make use of an exercise book to make notes that you can
use later on when revising and preparing for the examination.

Activity • Activities are similar to questions and are designed to assist

you to master and apply the study content.
• Activities follow a study reference; therefore first refer to the
study activity. First read the text and then attempt the activity.
• All activities can be answered if the prescribed textbook is
used.
• Space is provided in the study guide to complete the activities.
• The activities are examples of typical examination questions.

Suggested • Suggested solutions are the answers to the activities.

Solution • All of the answers are explained or can be found in the
prescribed textbook.

Internet • Internet activities require you to access the Worldwide Web.

• These links route you websites and YouTube video clips and
are very useful.

Reflection • Reflecting requires you to jot down your thoughts in your

workbook.
• Reflecting helps to link new knowledge to your existing
experiences.
• You may draw your own mind maps to assist you in your
thinking. Be creative!

Discussion • Discussion is an activity that the e-tutor will initiate on myUnisa

and you are encouraged to participate.
• The discussion forum is a public educational forum so think
carefully before you express an opinion in the public domain.
• Use suitable language writing skills, e.g. do not type a sentence
in capitals; refrain from using writing in short message style
(sms).
• Use the discussion forum as a platform to improve your
business writing and critical thinking skills.
• The discussion forum allows group work.

6
 

5 Study approach
The following are vital considerations that you should bear in mind when ap-
proaching your studies in auditing, and also some useful hints and aids that will
help you to improve your learning experience.

5.1 Allocation of time for this module

The study material for this module has been developed on the assumption that
you will have a total period of 15 weeks available to study the module. You will
need to use the final three weeks before the examination to revise and prepare
for it. You should devote a minimum of eight hours a week to your studies
for this module. Therefore plan for consistent work throughout the semester.
The following breakdown of the estimated time required to work through the dif-
ferent topics contained in the study material, including the completion of assign-
ment work, is provided. You can use it to compile your own study schedule for
this auditing module. Bear in mind that it is only a guideline. You may, however,
find certain topics more difficult and thus require more hours to master them.
Note where more time will be required and plan accordingly,

Week Topic Hours

1 Topic 1: The business world and corporate 7

governance
2 Topic 2: The internal auditor 7
3 Topic 3: The external auditor 7
4 Topic 4: Auditing concepts 10
5 Topic 5: The audit process 8
6 Topic 6: System and cycles within a business 10
7 Topic 7: The revenue and receipts cycle 10
8 Topic 8: The acquisition and payments cycle 10
9 Topic 9: Bank reconciliation 4
10 Topic 10: Payroll and personnel cycle 7
12–15 Revision 30
Completion of assignments 10
Total time 120 hours

4. Did I plot the study units on my calendar to ensure Yes No

consistent studying?

5.2 Mastering the study material

Use the study units to guide you through the study material. The prescribed
textbook contains the information you are required to master and remains the
primary source that you will need to study. Information, explanations and ques-
tions in the study units, tutorial letters and assignments are included in order to
make the information in the textbook comprehensible to you and to provide you
with an indication of how well you have mastered the study material.

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Remember to make use of an exercise book to write down your own notes and
file these notes for revision purposes. For example, use your workbook to make
notes and write down keywords and any problems that you have encountered.
You can jot down information which fits in with your particular study approach.

5.3 Self-study and self-assessment

Self-study and self-evaluation are key components of distance education. The
activities are typical examination questions. During revision use these activities
to assess yourself. Attempt these questions in your study guide and mark them.
Should you do badly, that’s okay – it just means that you need to refine your think-
ing. Analyse your mistakes in the exercise book and make a persistent effort to
get to the bottom of the uncertainty or problem. If you persevere until you have
solved the problem, you will find that you derive great satisfaction from doing so.
As indicated in the Tutorial Letter 101 for each auditing module, the auditing lec-
turers responsible for the module are available to help you solve subject-related
problems. You will also be allocated an e-tutor to assist you in your learning journey.

6 What you can expect from Unisa

You can expect us to do the following:
•• We will provide you with up-to-date and relevant learning material.
•• We will keep the learning material in line with the needs of industry and commerce
by consulting regularly with the profession.
•• We will assist you by giving you the opportunity to develop competencies and
skills at a certain level. The outcomes correspond to the National Qualifications
Framework (NQF) level 5. You will be assessed taking the level descriptors
of the NQF into account.
•• We will support you whenever you require assistance. You may contact your
lecturers by making personal appointments; contact them by phone or via e-mail
or via the internet. We understand that studying through distance education
is more challenging than attending a residential university.
•• We will provide you with clear indications of what we expect from you in terms
of your assessment.
•• We will give you timeous feedback on assignments.

7 Feedback from students

To enable us to continue improving and adapting study material in order to meet
students’ needs, we need feedback from you on any sections which are not clear
or any problems you may have experienced with the study material for this module.
If you wish to supply feedback on the study material or assignments for this mod-
ule, you can either contact us directly or in writing. Please take this opportunity
to bring problems and shortcomings to our attention.

8 Conclusion
We hope you will enjoy your studies! We are certainly looking forward to being
your partners in this endeavour.
Best wishes
Your lecturers in AUE1501

8
 

TOPIC 1
The business world and corporate governance

page

Study unit 1
Various types of business entities 12

Study unit 2
Corporate governance 20

Study unit 3
Internal control 26

AUE1501/19
TOPIC 1: THE BUSINESS WORLD AND CORPORATE GOVERNANCE

TOPIC OVERVIEW

To address the dilemma of poverty in our country we need to think in terms of

job creation. The state cannot be the only or main role player in job creation.
Why not? The tax base needs to be expanded far beyond the people working for
government. In other words, the more successful businesses that come to light
who can contribute to the state through taxes, the more successful a country
becomes. In this regard, government, in collaboration with business and labour,
will roll out a number of packages informed by the National Development Plan
(NDP) to boost economic growth and job creation in South Africa. You can read
about the plans by government by opening the following link:

http://www.southafrica.info/business/economy/policies/minibudget-231013e.htm#.
V7reWPl95Mw#ixzz4I3jeHqiP

If the tax base is not expanded, where will the state find money to pay the civil
servants, build hospitals, and improve other essential services? You cannot also
simply increase tax rates, say from 28% to 45%, to balance the books! If you do
that, what do you think will happen to that country’s investment base? Entrepre-
neurs are needed for prosperity. Perhaps you may just be that person.

Think about the current state of affairs in South Africa and the high rate of un-
employment. We have the mineral resources, for example, iron ore. We export
the raw iron ore to China and import the finished products. Where do you think
job creation takes place? Why are we not the manufacturers? That is where you,
as finance student (skilled labour), come into the equation in building a better
future for the country. Have a look at the following document to fully understand
the extent of the unemployment problem in South Africa:

http://www.statssa.gov.za/presentation/Stats%20SA%20presentation%20on%20
skills%20and%20unemployment_16%20September.pdf

Do yourself a favour, go and read up on the history of any mega business of your
choice. Many of them started out very small, housed in a small room or garage.
The Bearing Man Group was started by a housewife who sold bearings in her
garage. How did Microsoft start? Remgro started with Dr Anton Rupert manu-
facturing cigarettes in a garage! They all eventually grew into a mega businesses
listed on the stock exchange. No special favours, only vision and action! Think
about it, what stops you from growing into a successful entrepreneur?

As we work through this module I want you to visualise your own business.
Think of a business that you want to start. There must be something; you must
have a dream. You can for example aspire to become a consultant, an inventor
and manufacturer of a new gadget, or a retailer. Give your business a name. By
thinking of your own business you have become the creator of adding value to
an idea. The aim with your idea is to sell the commodity at a profit. You will be
a job creator!

10
 

As we work through the business cycles I want you to “see” the accounting systems
and internal control measures that you are going to implement to contain the risks
that apply to your own business idea. Through visualising you will be learning.

Remember: successful businesses means upliftment of society. That is why this

module is so important. Let me also add, I am talking of honest business where
the forces of supply and demand are functional. I am not talking of political fa-
vours, or hacking systems to commit fraud. It is about good business principles.

(http://www.globalethicsuniversity.com/articles/greed.htm)

The aim of this topic is to explain the various types of business entities, learn
about good corporate governance of business entities and internal control as
part of corporate governance.

This topic is divided into the following study units:

Study unit Title Page

1 Various types of business entities 12

2 Corporate governance 20
3 Internal control 26

Textual amendments and additions

Before you proceed with the study of this topic, please refer to Tutorial Letter 102
for this module to acquaint yourself with any textual amendments and additions
that have been indicated.

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1 STUDY UNIT 1

1 VARIOUS TYPES OF BUSINESS ENTITIES

IN THIS STUDY UNIT WE ARE GOING TO

• explain the advantages and disadvantages of each type of business entity
• differentiate between the various categories of companies

1.1 INTRODUCTION
Think about that business that you want to start. The first question that comes
to mind is: what form should it take?

1.2 VARIOUS BUSINESS ENTITIES

The Department of Trade and Industry in South Africa recognises that a business
can be operated through certain types of legal entities. In this study unit, we are
going to look at each of the following types of business entities:
• Sole proprietor
• Partnership
• Close corporation
• Company

ACTIVITY

Go and open the following link and read about the legal issues of the different
types of business entities. Think of the business that you have in mind and use
the questions on that page to assist you in deciding on the most appropriate
business entity. Notice the factors that you have to consider.

http://www.seda.org.za/MyBusiness/Factsheets/Pages/Whatisthebestform.aspx

12
 STUDY UNIT 1: Various types of business entities

DISCUSSION 1.1

E-tutor assistance required

Consider the following questions and post your thoughts about any of them on
the discussion forum provided for the purpose. If you do not post your own idea,
you have to respond constructively to a post by another student.

• What is the name of your business?

• Which type of business entity will suit your business now?
• If your business grows, which business entity will suit your new needs?

We have taken your idea (business idea) and we have given it a body (legal entity)!

In the the remainder of this study unit I will make reference to a useful document
published by the South African Revenue Services (SARS): The South African
Revenue Services (SARS), Tax Guide for Small Businesses: 2014/2015. If you
wish to access it for additional reading, you can open the following link:

http://www.sars.gov.za/AllDocs/OpsDocs/Guides/LAPD-IT-G10%20-%20Tax%20
Guide%20for%20Small%20Businesses%20-%20External%20Guide.pdf

The above links allow us to identify some of the advantages and disadvantages of
each type of business entity. Most businesses initially start off as a sole proprie-
tor. As soon as the entrepreneur recognises that he/she needs more expertise
or funds he/she might think in terms of a partnership or even a private company.

1.2.1 Sole proprietor

According to The South African Revenue Services (SARS), Tax Guide for Small
Businesses (2014/2015), a sole proprietorship is a business that is owned and
operated by a natural person (individual). This is the simplest form of business
entity. Only the proprietor has the authority to make decisions for the business.
The proprietor assumes the risks of the business to the extent of all of his or her
assets, whether used in the business or not.

Like everything else in life, running an entity as a sole proprietor has advantages
and disadvantages. These can be listed as follows:

Sole proprietor:

Advantages Disadvantages

Simple to set up and manage A single owner has limited skills

The owner is free to make his/her own The owner can get business capital
decisions only as an individual
There are few legal requirements for All business debts are the owner’s
setting up responsibility
The owner gets all the profits It is not a separate legal entity
It is easy to close down if you want to

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TOPIC 1: THE BUSINESS WORLD AND CORPORATE GOVERNANCE

1.2.2 Partnership
A partnership (or unincorporated joint venture) is the relationship existing be-
tween two or more persons who join together to carry on a trade, business or
profession. A partnership is also not a separate legal person or taxpayer. Each
partner is taxed on his or her share of the partnership profits and may contribute
money, property, labour or skills, and each expects to share in the profits and
losses of the partnership. It is similar to a sole proprietorship except that a group
of owners replaces the sole proprietor. As is the case for a sole proprietorship
a partnership also has advantages and disadvantages. (South African Revenue
Services (SARS), Tax Guide for Small Businesses: 2014/2015)

Partnership:

Advantages Disadvantages

• Simple to set up and manage • It is not a separate legal entity

• It has greater financial strength • Sharing the decision making can

than a sole proprietorship slow down the process

• All the partners’ skills benefit the • All business debts are each
entity partner’s responsibility

• Each partner has a personal • Lower degree of business

interest in the entity continuity as the partnership
technically dissolves every time
a partner joins or leaves the
partnership
• Number of partners restricted to
20 except in the case of certain
professional partnerships such as
accountants, attorneys, etc

1.2.3 Close corporation (CC)

As mentioned in your prescribed textbook, Jackson & Stent (2016:3/67) the idea
of a close corporation is that the members all work together for the good of the
business. Close corporations were a simplified form of business. However, with
the implementation of the Companies Act 2008, no new close corporations can
be created.

STUDY

Jackson & Stent (2016:3/67)

(1) INTRODUCTION
Important to note when studying this section is that no new close corporations
can be formed. The existing close corporations are still an acceptable business
type, but no new ones can be formed. You can buy an existing close corporation.

(2) IMPORTANT CHANGES TO THE CC ACT 1984

Jackson & Stent (2016:3/69): Part 1 Formation and juristic person

14
 STUDY UNIT 1: Various types of business entities

Note from the studied information that a CC is a separate legal entity. A CC is

similar to a private company. It is a legal entity with its own legal personality and
perpetual succession and must register as a taxpayer in its own right. The CC
has no share capital and therefore no shareholders. The owners of the CC are
the members. Members do not hold shares in the CC and, therefore, they have
a membership interest in the CC. This interest is expressed as a percentage.

ACTIVITY 1.1

Answer the following questions:

(1) Can you still form new close corporations in South Africa?
(2) If a CC is converted to a company, how will the legal status of the CC be
affected?
(3) What are the advantages and disadvantages of a CC?

SUGGESTED SOLUTION 1.1

Reference: Jackson & Stent (2016:3/69)

(1) Currently in South Africa, no new close corporation may be established.

The new Companies Act of 2008 provides that no new close corporation
may be registered and that existing close corporations may be converted
into companies or elects to remain as close corporations.
(2) Such a conversion will affect the legal status of the close corporations as
follows:
• Members of the close corporation will be entitled to become shareholders
in the converted company.
• All assets, liabilities, rights and obligations of the close corporation will
continue to be vested in the new company.
• Any legal proceedings against or instituted by the close corporation may
be continued.

(3) Advantages and disadvantages of a CC (South African Revenue Services

(SARS), Tax Guide for Small Businesses: 2014/2015)

Close corporation:

Advantages Disadvantages

• Relatively easy to establish and • There is a restriction of a maximum

operate of 10 members
• Life of the business is perpetual, • There are more legal requirements
that is, it continues uninterrupted as than for a sole proprietor or
members change partnership
• Members have limited liability

• Transfer of ownership is easy

• Fewer legal requirements than a

private company

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TOPIC 1: THE BUSINESS WORLD AND CORPORATE GOVERNANCE

1.2.4 COMPANY
A company means a juristic person incorporated in terms of the Companies Act,
a domesticated company, or a juristic person that is registered in terms of the
Companies Act (Companies Act, No 71 of 2008).
A company is therefore a separate legal entity.

The following are advantages and disadvantages of a company (See South Af-
rican Revenue Services (SARS), Tax Guide for Small Businesses: 2014/2015.)
Company:

Advantages Disadvantages
• Life of the business is perpetual, • It is subject to many legal
that is, it continues uninterrupted requirements
as shareholders change
• The shareholders loss is limited to • More difficult and expensive to
the share capital contributed establish and operate than other
forms of ownership such as a
sole proprietorship or partnership
• Shareholders are not personally
responsible for the entity’s debts
• Transfer of ownership is relatively
easy
• It is adaptable for small, medium
and large entities

1.3 CATEGORIES OF COMPANIES

STUDY

Jackson & Stent (2016:3/15): 2. Sec 8 – Categories of companies

Using the above study reference a mind map (or a summary) of the different cat-
egories of companies is generated as follows:

16
 STUDY UNIT 1: Various types of business entities

DIAGRAM 1: CATEGORIES OF COMPANIES

Companies

Profit Non- Profit

State owned Public Private Personal

Eskom Holding Sasol Ltd Tau (Pty) Ltd Abed Inc Aidsrevive NPC
SOC Ltd

Characteristics
J&S Activity 1.5 J&S Activity 1.4
note(f) note(e)

(source: Jackson & Stent 2016:3/15)

ACTIVITY 1.2

Refer to the above diagram. J & S refers to Jackson & Stent and the notes (f)
and (e) are found on page 3/15. You are required to list the characteristics of a
public and a personal company.

ACTIVITY 1.3

List four categories of profit companies that can be formed.

SUGGESTED SOLUTION 1.3

A state-owned company

REFLECTION 1.1

Did you know that the state owns companies that have a profit motive?
Google “South African state-owned enterprises” and list two examples.
and

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TOPIC 1: THE BUSINESS WORLD AND CORPORATE GOVERNANCE

ACTIVITY 1.4

Explain the characteristics of a non-profit company.

SUGGESTED SOLUTION 1.4:

Incorporated for whose benefit?

How may income and property be used?
The company name ends with?

ACTIVITY 1.5

Explain the characteristics of a private company.

SUGGESTED SOLUTION 1.5:

A private company has a Memorandum of Incorporation that

prohibits
restricts
cannot be

INTERNET ACTIVITY 1.2

Are you unsure what a Memorandum of Incorporation is?

If your answer is “yes” then google:
“Memorandum of Incorporation for South African companies”

1.4 SUMMARY AND SELF-ASSESSMENT

In this study unit we had a look at the various types of entities as well as their
advantages and disadvantages. We also had a look at the different categories
of companies.

Refer to your notes you made in your workbook when you completed the follow-
ing activities.

Activity 1.1 Discussion 1.1 Self-Reflection 1.1 Internet Activity 1.1

Activity 1.2 Internet Activity 1.2
Activity 1.3
Activity 1.4
Activity 1.5

After having worked through the study unit and the study references, are you able to
• explain the advantages and disadvantages of each type of business entity?
• differentiate between the various categories of companies?

18
 STUDY UNIT 2: Corporate governance

2 STUDY UNIT 2
2 CORPORATE GOVERNANCE

IN THIS STUDY UNIT WE ARE GOING TO

•• introduce you to corporate governance
•• define corporate governance and examine the objectives of the King IV Code
of Corporate Governance
•• describe the foundation stones of the King IV Code of Corporate Governance
•• describe the first three principles of the King IV Code of Corporate Governance

2.1 INTRODUCTION
In the previous topic we looked at the different business types. As soon as your busi-
ness grows from a small sole proprietor into a large company, more and more parties
become involved. For example, you will appoint people to work for you; you will want to
apply for a loan at a bank to expand your business; you will buy supplies on credit. As
more parties become involved more responsibility and accountability is expected from
business owners and leaders. People doing business with you will want to trust you.

The question arises: why do we read so much about fraud and corruption? This
is a worldwide problem. Major international enterprises involved in corruption are
Lehman Brothers, Enron, Worldcom, and Parmalat. In South Africa corruption is
increasing rapidly (http://www.corruptionwatch.org.za/why-is-corruption-getting-
worse-in-south-africa/). So, how can we address this world wide problem? The
aim of this study unit is to introduce you to corporate governance. Your way of
doing business (even your start-up business) should be in the spirit of good
corporate governance. An attempt to end corruption and fraud begins with your
mindset towards good business practices.

You are going to be introduced to corporate governance. This knowledge will al-
low you to argue and think about current issues because you have a framework.
When reading about bad business practices in the newspaper, you will have a
framework based on which to judge actions (Jackson & Stent 2016:4/3). You will
be able to make informed decisions. You will be able to measure people’s actions
against the principles contained in the King IV Code of Governance.

In any business organisation, corporate governance helps to strengthen the roles

and relationships between the organisation’s management, board of directors,
and its stakeholders. Such stakeholders may include the shareholders, debt
holders, trade creditors, suppliers, customers and communities affected by the
organisation’s activities, whereas the board of directors, executives, management
and other employees are regarded as the internal stakeholders (see Jackson
& Stent 2016:4/3). It further states that healthy, honest, open, competently and
responsibly controlled companies will improve the quality of modern society.

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 Corporate governance is defined as “the exercise of ethical and effective leadership by the
governing body towards the achievement of the following governance outcomes: ethical
culture; good performance; effective control, and legitimacy” (Jackson & Stent 2016:4/3).

INTERNET ACTIVITY 2.1

I want you to open this link and introduce you to the man himself, Judge Mervin
King: https://www.youtube.com/watch?v=8meq3mPthqw

2.2 BACKGROUND TO THE KING IV REPORT

Why do we need a King IV?

INTERNET ACTIVITY 2.2

https://www.youtube.com/watch?v=h7G8hQxpDrM

Corporate Governance in South Africa has been an ongoing process since 1994. To
obtain a sense of how the process evolved from the first King Report in 1994 until
King IV in 2016, you can read the relevant sections in Jackson & Stent (2016:4/3–4/4).

The 21st century has been characterised by fundamental changes in business and
society and new global realities are severely testing the leadership of companies
and other organisations. Understanding these realities will give you context to
understand the need for King IV.

ACTIVITY 2.1

Refer to Jackson & Stent (2016:4/5). List the business, society and new global
realities realities that characterise the 21st century.

SUGGESTED SOLUTION 2.1:

1. A growing societal inequality

2.
3.
4.
5.
6.
7.
8.

This brings us to the objectives of King IV (in the context of a company).

ACTIVITY 2.2

Study Jackson & Stent (2016:4/7). Describe the five main objectives of King IV.

20
 STUDY UNIT 2: Corporate governance

SUGGESTED SOLUTION 2.2:

(1) Promote responsible corporate governance as integral to running the com-

pany and delivering outcomes such as an ; ;
, and .
(2) Broaden (increase) the acceptance of the King IV Report by making it
and for implementation across

(3) Reinforce corporate governance as a and set of

arrangements to be understood and implemented in an manner.
(4) Encourage and meaningful to shareholders.

ACTIVITY 2.3

Certain concepts form the foundation stones of King IV and could be referred to
as the “philosophical underpinnings” of corporate governance. There are seven
concepts. The concepts of King IV is explained in Jackson & Stent (2016:4/8–4/12).
The foundation stones are important and the following diagram provides you
with some study structure. Make sure that you can list and explain the concepts.
DIAGRAM 2: FOUNDATION STONES OF KING IV

• Ethical leadership
1. Ethical leadership
• Responsibility
• Accountability
• Fairness
• Transparency
• Integrity
• Competence

• Effective leadership
• Goal orientation
• Ethics, values & culture

2. Company integral part

• Social context
of society

• Corporate citizen
3. Corporate citizenship
• Rights
• Obligations & responsibilities

• Primary ethical & economic imperative

4. Sustainable development
• Inclusivity of stakeholders
• Innovation, fairness & collaboration
• Social transformation

5. Stakeholder inclusivity • Best interest of company (long-term)

6. Integrated thinking • Holistic decision making

• Report meaningful to all material

7. Integrated reporting
stakeholders

Source: Jackson & Stent (2016:4/8–4/12)

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TOPIC 1: THE BUSINESS WORLD AND CORPORATE GOVERNANCE

2.3 LEADERSHIP, ETHICS AND CORPORATE CITIZENSHIP

2.3.1 Leadership

STUDY

Jackson & Stent (2016:4/19–4/21)

Principle 1. The board should lead ethically and effectively.

Principle 1 refers to the characteristics which directors should cultivate and exhibit
in their conduct.

The following activity explores these characteristics in more detail.

ACTIVITY 2.4

Refer to Jackson & Stent (2016:4/19–4/21) to expand on what is meant by the

six characteristics which directors should cultivate and exhibit in their conduct.

1. INTEGRITY:
• Directors must act in good faith in the best interests of the company.
• Directors should avoid conflict of .
• Directors should act .
• Directors should set .

2. COMPETENCE:
• The board as a whole and directors individually, assume for
the ongoing to run the company effectively.
• Directors should ensure that they have of
the company, its industry and the , and
context in which it operates, as well as of the significant

• Directors must act with due , and ,

and take

3. RESPONSIBILITY:
• Directors should assume responsibility for steering and
setting the direction of the company
• Directors should exercise and but
in a of the company.
• Directors should take responsibility for , or
the negative outcomes of the company’s activities
and outputs on the social, economic and environmental contexts in which it
operates, and on the capitals that it uses or affects.
• Directors should and devote

22
 STUDY UNIT 2: Corporate governance

4. ACCOUNTABILITY:
• Directors should be ( )
the even

5. FAIRNESS
• Directors must consider and balance the legitimate and reasonable needs,
interests and expectations of
• Directors should direct the company in a way that

6. TRANSPARENCY
Directors should be transparent in the manner in which they

2.3.2 Organisational ethics

Principle 2. The board should govern the ethics of the company in a way that
supports the establishment of an ethical culture.

The essence of this principle is that an ethical culture cannot be established and
maintained if the board does not set the tone, convey the company’s ethical norms
and values to internal and external stakeholders (Jackson & Stent 2016:4/21).

STUDY

Jackson & Stent (2016:4/21)

The recommended practices set out in Jackson & Stent (2016:4/21) emphasises
the board’s duties to establish an ethical culture.

REFLECTION 2.1

If an organisation obtains valid negative publicity due to fraudulent activities, to

what extent do you think that the board must own up?

2.3.3 Responsible corporate citizenship

Principle 3. The board should ensure that the company is and is seen to be,
a responsible citizen.

STUDY

Jackson & Stent (2016:4/22–4/24)

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TOPIC 1: THE BUSINESS WORLD AND CORPORATE GOVERNANCE

Make sure that you are able to link a factor to be considered to be an action of
a good corporate citizen in Jackson & Stent (2016:4/23).

REFLECTION 2.2

• Would you like to see leadership, ethics and corporate citizenship evident in
government, municipalities, and state-owned enterprises?
• What will eventually (in the long term) happen to a business where these
ethical values and standards are absent?

2.4 SUMMARY AND SELF-ASSESSMENT

In this study unit we introduced you to corporate governance, defined corporate
governance and examined the objectives of the King IV Code of Corporate Gov-
ernance. We described the foundation stones and the first three principles of the
King IV Code of Corporate Governance.

Refer to your notes you made in your workbook when you completed the follow-
ing activities.

Activity 2.1 Internet Activity 2.1 Self-Reflection 2.1

Activity 2.2 Internet Activity 2.2 Self-Reflection 2.2
Activity 2 3
Activity 2.4

After having worked through the study unit and the study references are you able to:
• define corporate governance and examine the objectives of the King IV Code
of Corporate Governance?
• describe the foundation stones of the King IV Code of Corporate Governance?
• describe the first three principles of the King IV Code of Corporate Governance?

In the next topic, we will discuss the role of internal control in the organisation.

24
 STUDY UNIT 3: Internal control

3 STUDY UNIT 3

3 INTERNAL CONTROL

IN THIS STUDY UNIT WE ARE GOING TO

•• form an understanding about where internal control fits into the business context
•• define internal control
•• describe the limitations of internal control
•• list the five components of internal control
•• link the elements of control to each of the five components of internal control

3.1 INTRODUCTION
Let’s summarise what you have learnt so far: You know what business you
want to set up, and you have some idea of what corporate governance is about.
However, we now have a new challenge. Let’s assume your business expands;
this means you need more resources. For example, you need to appoint people
– sales persons, accountants, drivers, cleaners, etc. You will need purchased
or lease assets to expand the business, borrow money from banks or convince
potential investors based on budgets and financial statements prepared by your
people. You cannot do all of this on your own any more; you need some way to
control what’s happening in the business. More resources mean there is more
risk and responsibility over these resources. This study unit is going to introduce
you to the concept of internal controls.

INTERNET ACTIVITY 3.1

To orientate you a little bit more view this video (although the video refers to a
non-profit organisation the aim is to introduce you to a new concept, namely
internal controls): https://www.youtube.com/watch?v=750q-ADn8Bg

3.2 DEFINITION OF INTERNAL CONTROL

Management is responsible for running all aspects of the entity. The objectives
of the business will be set, the risks relating to achieving those objectives will be
identified and suitable books, records and documents, and policies and procedures
will be put in place to address those risks.

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 The policies and procedures that are put in place will include the implementation
of effective internal controls to ensure, amongst others, the efficient effective
and economic operating of the business. As stated above, internal controls are
implemented in response to risk.

STUDY

Refer to Jackson & Stent 2016:5/3–5/5 paragraphs 1 to 3:

Use the following mind map to assist you in understanding the prescribed text.

DIAGRAM 3: INTERNAL CONTROL OVERVIEW – A BUSINESS PERSPECTIVE

Management

Run daily activities

to implement

Policies & procedures

to address
Risks
(financial)

managed through

Accounting records

Safeguard Prevent Comply with Prepare Annual

assets fraud law/regulations Financial State

Operate business
efficiently & effectively

Source: Jackson & Stent (2016:5/3–5/5)

Paragraph 1: Introduction

Paragraph 1.3 of Jackson & Stent 2016:5/4 identified interesting facts about internal
control. These facts will assist you in understanding how internal controls function.

ACTIVITY 3.1

You are required to write down these facts and reflect on them. Do you agree
with those statements?

26
 STUDY UNIT 3: Internal control

SUGGESTED SOLUTION 3.1

Internal control fact Expanding on fact Agree

1. Internal control is a It is a combination of systems, Yes

process policies….
2.
3.
4.
5.

STUDY

Study Jackson & Stent (2016:5/5). Paragraph 3: Definition of internal control.

ACTIVITY 3.2

Define the term internal control.

SUGGESTED SOLUTION 3.1

In writing down the definition ask yourself the following guiding questions:

Who makes it happen (effected by whom)? What do internal controls aim to at-
tain? Which broad categories are focuses by internal control?

Internal control is defined as a process

designed to provide reasonable assurance regarding the achievement of objec-
tives in the following categories:
•
•
•

3.3 LIMITATIONS OF INTERNAL CONTROL

STUDY

Study Jackson & Stent (2016:5/4–5/5) about the inherent limitations of internal
control. As a manager you have to be aware of these limitations.

ACTIVITY 3.3

Describe the inherent limitations of internal control.

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TOPIC 1: THE BUSINESS WORLD AND CORPORATE GOVERNANCE

SUGGESTED SOLUTION 3.3

The inherent limitations of internal control are summarised in the following diagram 4.
DIAGRAM 4: INHERENT LIMITATIONS OF INTERNAL CONTROLS

Cost vs Benefit

Possibility of Abuse of
circumvention of responsibility
internal controls Inherent
limitations of
internal
control
Controls may Procedures may
be directed at routine become inadequate
transactions rather
than non-routine
transactions
Potential of
human error

This is only a summary and you should be able to discuss the inherent limitations
in detail by referring to Jackson & Stent (2016:5/4–5/4).

3.4 COMPONENTS OF INTERNAL CONTROL

STUDY

Jackson & Stent (2016:5/5–5/6)

This section refers to the framework for internal control that consists of five internal
control components. This section is very important because if you master the
framework then you have a good foundation on which to build your understand-
ing of internal control. Studying this section will take time and may be difficult at
first, but it is very important.

ACTIVITY 3.4

Step 1: Read the elements below each component in Jackson & Stent (2016:5/6).

Step 2: Refer to the table below as part of the suggested solution. Five compo-
nents of internal control are listed in the table.

Step 3: In your own words, describe your understanding of each component

based on the elements.

SUGGESTED SOLUTION 3.4

You should be able to formulate the description of the elements in your own words
by studying the individual elements listed in Jackson & Stent (2016:5/6). However,
if you are battling then read the introductory explanatory paragraphs listed below:

28
 STUDY UNIT 3: Internal control

• Jackson & Stent (2016:5/7) Paragraph 4.1 The control environment

• Jackson & Stent (2016:5/8) Paragraph 4.2 The entity’s risk assessment process
• Jackson & Stent (2016:5/10) Paragraph 4.3 The information system and related
business processes, relevant to financial reporting
• Jackson & Stent (2016:5/12) Paragraph 4.4 Control activities
• Jackson & Stent (2016:5/17) Paragraph 4.5 Monitoring of controls

Own word description of the elements

Component The components relate to …

1. Control environment the governance and management functions

and responsibilities, attitudes and values, and
practices. This is all about the tone at the top
(management).

2. The entity’s risk assess

ment process

3. The information system

and related business pro
cesses, relevant to finan
cial reporting
4. Control activities

5. Monitoring of controls

3.5 THE ELEMENTS OF EACH COMPONENT OF INTERNAL

CONTROL
Refer to Jackson & Stent (2016:5/7–5/17) to increase your understanding of the
elements of the five components you summarised above in more detail. Once
you have studied the above reference you can attempt the following activities.
Use the diagram in Jackson & Stent (2016:5/6) to obtain a holistic view of the
material that you have to study.

ACTIVITY 3.5

Describe the characteristics of an effective control environment.

SUGGESTED SOLUTION 3.5

Refer to Jackson & Stent (2016:5/7–5/8) for characteristics of an effective control

environment.
• Communication and enforcement of integrity and ethical values
• Commitment to competence
• Participation of those charged with governance
• Management’s philosophy and operating style
• Organisational structure
• Assigning authority and responsibility
• Human resource policies and practices

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TOPIC 1: THE BUSINESS WORLD AND CORPORATE GOVERNANCE

ACTIVITY 3.6

List the stages in the risk assessment process.

SUGGESTED SOLUTION 3.6

Reference: Jackson & Stent (2016:5/6)

Risk has to be defined; risks have to be identified; and assessed, and risks
have to be responded to.

ACTIVITY 3.7

List six types of control activities.

SUGGESTED SOLUTION 3.7

Reference: Jackson & Stent (2016:5/12–5/16)

• Approval, authorisation
• Segregation (division) of duties
• Isolation of responsibility
• Access/custody (security)
• Comparison and reconciliation
• Performance reviews

ACTIVITY 3.8

Segregation of duties (activity 3.7) was one of types of control activities. The
table below sets out five functions of segregation of duties. You are required to
explain the “rule” that should be present for each of the five functions that will
ensure effective segregation of duties.

SUGGESTED SOLUTION 3.8

Refer to Jackson & Stent (2016:5/13–5/14) for an explanation of segregation of

duties.

Note that the biggest enemy of segregation of duties is collusion.

“Rule” behind the segregation

Segregation of duties function function
1. Initiation and approval The person initiating and approving
the transaction should not be the same
person.
2. Executing the transaction
3. Custody of the items
4. Recording the transaction
5. Reviewing the function

30
 STUDY UNIT 3: Internal control

3.6 SUMMARY AND SELF-ASSESSMENT

In this study unit we had a look at the definition of internal control, its limitations
and the components of internal control within the organisations.

Refer to your notes you made in your workbook when you completed the follow-
ing activities.

Activity 3.1 Internet Activity 3.1

Activity 3.2
Activity 3.3
Activity 3.4
Activity 3.5
Activity 3.6
Activity 3.7
Activity 3.8

After having worked through the study unit and the study references are you able to:
•• demonstrate an understanding where internal control fits into the business
context?
•• define internal control?
•• describe the limitations of internal control?
•• list the five components of internal control?
•• link the elements of control to each of the five components of internal control?

This topic dealt with the selected aspects of the internal control. In the next topic,
we will discuss the role of internal audit in the organisation.

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32
TOPIC 2
The internal auditors

page

Study unit 4
Introduction to internal auditing 35

Study unit 5
The responsibilities of the internal auditor 41

Study unit 6
Professional conduct requirements for internal auditors 43

Study unit 7
internal audit and good corporate governance 47

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TOPIC 2: THE INTERNAL AUDITORS

TOPIC OVERVIEW

The aim of this topic is to enable you to demonstrate an informed understanding

of the key terms, concepts, facts, general principles, rules and theories of the
internal auditing profession.

This topic is divided into the following study units:

Study Title Page

unit

4 Introduction to internal auditing 35

5 The responsibilities of the internal auditor 41

6 Professional conduct requirements for internal auditors 43
7 Internal audit and good corporate governance 47

Textual amendments and additions

Before you proceed with the study of this topic, please refer to Tutorial Letter 102
for this module to acquaint yourself with any textual amendments and additions
that have been indicated.

34
4 STUDY UNIT 4

4 INTRODUCTION TO INTERNAL AUDITING

IN THIS STUDY UNIT WE ARE GOING TO

•• discuss the basic function and organisational position of the internal auditor
•• explore internal auditing as a career

4.1 INTRODUCTION
In Study Unit 1 we spoke of you starting your own business. Assume your busi-
ness has grown and you need funding to expand. You want to list your company
on the stock exchange to raise funds through issuing shares to the public. Who do
you think will invest in your company and why? Many factors will be considered.

Now ask yourself this question: Will you invest your hard-earned money in any
business? The answer will likely be no, you don’t want to gamble. You would
probably invest in a business that is, inter alia, well managed. In other words, a
business managed in terms of the code of corporate governance principles. In
Study Unit 2 you were introduced to corporate governance. If you look at the
17 principles listed in the table of contents in Jackson & Stent (2016:4/2), you will
gather that corporate governance is about strengthening the relationship between
management (board of directors), and stakeholders (shareholders, creditors,
employees, and the general public). If you reflect on the above, management
has a huge responsibility to society.

In this study unit we are going to look at the internal audit function as a compo-
nent of ensuring good corporate governance and explore the career possibilities
of the internal auditor.

4.2 POSITIONING THE INTERNAL AUDIT FUNCTION

We realised in Study Unit 2 that a business has certain risks and the controlling
body (board of directors) and the executive management (which we will refer to as
management) are responsible for establishing the organisation and then ensuring
that it operates successfully and efficiently. The board of directors are responsi-
ble mainly for the governance process (i.e. establishes and maintains corporate
policies and provides information about its stewardship – accountability). The
executive management is responsible for conducting the risk management and
control processes. The audit committee is a subcommittee of the board oversee-
ing the internal audit activity and external auditors (Jackson & Stent 2016:4/33).

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TOPIC 2: THE INTERNAL AUDITORS

In terms of the Companies Act, state-owned companies, listed companies and

larger private companies must have an audit committee.

Diagram 5 below shows you a bigger picture of the management structure in a

large organisation. The diagram will assist you to better understand the important
role that the internal auditor fulfils within the organisation. Study the diagram. The
board of directors reports financial information to external interested parties in an
organisation. The external interested parties include the shareholders, and other
stakeholders for example banks, creditors and regulators. However, someone
must see to it that the information reported by the directors is creditable. This is
the duty of the audit committee.

The audit committee oversees and monitors the audit process. In terms of King
IV Part 5, paragraph 50, the audit committee “should provide independent over-
sight of auditing and assurance requirements; independence of the auditor and
other assurance providers; audit quality, and integrity, also known as the reliability
and usefulness of reports.” Therefore, the audit committee, in its independent
oversight role, fulfils a pivotal role between the external auditor, the internal audi-
tor, executive management and the board of directors to achieve its objectives.

The executive management (Chief Executive Officer or CEO and Chief Financial
Officer or CFO) fulfil an operational function (day-to-day operations) with the
assistance of the internal audit function. Notice that the internal audit function is
on the same level as that of the executive management and not on a lower level.
Therefore, the internal audit function operates at executive level. One would now
ask a very important question: How “independent” can the internal auditors operate
in an organisation that pays its salaries? Besides the Code of Ethics for internal
auditors requiring the internal auditor to function independently, the internal audit
function maintains its independence by reporting to the audit committee.

Notice the interaction between the internal auditor, external auditor and the au-
dit committee. In the study units to follow, we will examine the interaction between
the external and internal auditor.

36
 STUDY UNIT 4: Introduction to internal auditing

DIAGRAM 5: POSITIONING THE INTERNAL AUDIT FUNCTION

Stakeholders

Shareholders Banks Other

Board of directors

External audit
Audit committee
Assurance

Chief Executive
Officer (CEO)
Chief Audit Chief Financial
Executive (CAE) Officer (CFO)

Executive Management
Internal audit

Management must set goals; plan what has to be done and what means are to be
used; organise to have the necessary means/people available at the right time;
give guidance (direct), and exercise control to ensure that objectives are met;
and keep records of all activities so that they are able to give account of their
curatorship over the interests of the stakeholders (Jackson & Stent 2016:4/8).

The overall objective of an internal audit is determined by the needs of the board
and executive management, and the internal auditor must ensure that these
needs are satisfied by the internal audit report, which he or she submits to the
board and the audit committee.

4.3 THE AUDIT COMMITTEE

To enhance your understanding of the audit committee let us examine some of
its duties within the organisation.

STUDY 4.1

Jackson & Stent (2016:4/33) – Responsibilities and function

Complete the following section:

The role of the audit committee is to provide independent oversight of:

• The effectiveness of
• The integrity of
• The audit committee carries ultimate
• The management of financial and
• The audit committee should meet

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TOPIC 2: THE INTERNAL AUDITORS

TAKE NOTE
(Note the oversight function that the internal audit fulfils between the external and
internal auditors.)

4.4 DEFINITION OF INTERNAL AUDITING

Let us begin with a definition of internal auditors. In order to understand their
field of specialised knowledge, we need to describe (define) it clearly so that you
have an accurate idea of the basic objective(s) and limiting factors relating to it,
as well as the methodology followed to attain the objective(s). The definition of
internal auditing is the cornerstone of internal auditing practice. It explains what
internal auditing is and what internal auditors should do.

The Institute of Internal Auditors (IIA) in terms of their International Standards for
the Professional Practice of Internal Auditing (the Standards) (2012), accepted
the following definition:

Internal auditing is an independent, objective assurance and consulting

activity designed to add value and improve an organisation’s operations. It
helps an organisation accomplish its objectives by bringing a systematic,
disciplined approach to evaluate and improve the effectiveness of risk
management, control, and governance processes.

In order to properly grasp any definition it is important to have a comprehensive

understanding of all the components that make up the definition. The differ-
ent components of the definition are described in the Collins English dictionary
of 1998 as follows:

INDEPENDENT: free from the control or influence of others

OBJECTIVE: aim or purpose; when used as an adjective, not biased
ASSURANCE: promise or guarantee (assure: convince; make certain)
OPERATION: method or procedure of working
SYSTEMATIC: methodical; according to a plan
DISCIPLINED: able to behave and work in a controlled way
APPROACH: begin to deal with; make a proposal or suggestion to
EVALUATE: find or judge the value of
IMPROVE: make or become better
EFFECTIVENESS: producing the desired result
RISK: hazard, for example, loss or damage
CONTROL: power to direct something; regulate
GOVERNANCE: government, control or authority; the action, manner or
system of governing

Analysing the meaning of all the different concepts or words in the definition
should enhance your understanding of the definition. Do you see that the defini-
tion is very powerfully packed with meaning?

From the above definition you can conclude that one expects certain behaviour
of the internal auditor. Imagine if you cannot trust the internal auditors! There-
fore, one expects a code of ethics. The code of ethics states the principles and
expectations governing the behaviour of individuals and organisations in the
conduct of internal auditing. It describes the minimum requirements for conduct

38
 STUDY UNIT 4: Introduction to internal auditing

and behavioural expectations rather than specific activities. We will look at the
code of ethics in the next study unit.

In addition one expects the internal auditor when performing their assurance ac-
tivities to conform to certain standards. Therefore, the internal auditor is subject
to the International Standards for the Professional Practice of Internal Auditing
(the Standards). Standards are principle-focused and provide a framework for
performing and promoting internal auditing. The Standards provide guidance for
the conduct of internal auditing at both the organisational and individual auditor
levels. They are the result of careful study, consultation and deliberation about
the basic principles for providing internal audit services.

4.5 THE ROLE OF THE INSTITUTE OF INTERNAL AUDITORS

IN SOUTH AFRICA (IIA-SA)

INTERNET ACTIVITY 4.1

Open the “Home” page of The Institute of Internal Auditors South Africa (IIA SA)
on the following link http://www.iiasa.org.za/ and read their welcoming page. Open
“About us” to reinforce your understanding of the role of the internal auditor. Also
open http://www.iiasa.org.za/?page=CareerPath and read about the education
and training requirements of the internal auditor. Some of you may be working at
the Auditor-General or in an environment where you were exposed to the internal
auditors. This is definitely a career path to explore if you enjoy auditing.

From the http://www.iiasa.org.za/ website you can gather that the Institute of Inter-
nal Auditors South Africa (IIA SA) is part of an international network representing
the interests of internal auditors worldwide. As a part of this international network,
the IIA SA upholds and supports the fundamental tenets of the profession – the
Code of Ethics and the International Standards for the Professional Practice of
Internal Auditing. The IIA SA supports the profession by providing a wide range
of services dedicated to the education and advancement of internal auditors and
dynamically promoting and developing the profession in South Africa. The IIA
SA’s objectives are to build the profession, its credibility and a thriving business
environment in South Africa. The IIA SA serves internal auditors in South Africa
by offering Technical Guidance, Professional Training Programs, Certification
Programs, Continuing Professional Development Opportunities, Conferences
and Networking Opportunities.

The Institute of Internal Auditors South Africa (IIA SA) facilitates the advancement
of the profession through an on-the-job training program (professional training
program), a test of competence (internal audit technicians (IAT)), general internal
audit training (GIA) and certified internal auditors (CIA)). Accordingly, all these
professional offerings help the internal auditor’s competence and accountability
towards a code of ethics.

The professional level of competencies of internal auditors can be categorised

into the following levels:

Internal Audit Technician (IAT)

This is the entry-level designation and indicates that an IAT should be able to
perform routine audit tasks, execute audit programs, prepare working papers
and draft audit findings.

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TOPIC 2: THE INTERNAL AUDITORS

General Internal Audit (GIA)

This is the next step in the career path. The GIA is a supervisory level desig-
nation and the format of this program is the same as for the IAT – comprising
training modules and structured workplace training. The focus is on being able
to perform some senior and supervisory tasks, and conducting multiple audit
duties. A GIA should be able to perform duties with limited or no supervision.
Entrance to the GIA program is by two means – having successfully completed
the IAT program, or having being assessed as competent against the IAT training
logbook specifications.

Certified Internal Auditor (CIA)

The CIA is the premier global designation of the internal auditing profession. The
CIA is recognised by individuals and organisations throughout the world as “The
Global Mark of Excellence in Internal Auditing”.

The professional elements in internal auditing are developed and maintained by

the Institute of Internal Auditors to offer the internal audit practitioners a full range
of internal audit guidance. The Code of Ethics and the professional standards
are the exemplary to the guidance.

REFLECTION 4.1

Talk to friends or colleagues in the workplace who are internal auditors about
their role in the organisation and appreciate the important and responsible task
that they perform.

4.6 SUMMARY AND SELF-ASSESSMENT

Refer to your notes you made in your workbook when you completed the follow-
ing activities.

Study 4.1 Internet Activity 4.1 Reflection 4.1

After having worked through the study unit and the study references are you able to:
• discuss the basic function and position of the internal auditor?
• make a more informed decision about becoming an internal auditor?

In the next study unit we are going to look at the role of the internal auditor in
more detail.

40
5 STUDY UNIT 5

THE RESPONSIBILITIES OF THE INTERNAL

5

AUDITOR

IN THIS STUDY UNIT WE ARE GOING TO

• describe the duties associated with internal auditing

5.1 INTRODUCTION
The IIA has made an informative document of nine pages available, titled All in a
day’s work: A look at the varied responsibilities of internal auditors. You will find the
document under Additional Resources or you can open the following link https://
na.theiia.org/about-ia/PublicDocuments/06262_All_In_A_Days_Work-Rev.pdf.

We are going to refer to this document in this study unit. Please access this
document before continuing.

5.2 OBJECTIVES OF INTERNAL AUDITING

STUDY 5.1

Open and read All in a day’s work: A look at the varied responsibilities of internal
auditors.

Refer to page 2 & 3: What is internal auditing?

ACTIVITY 5.1

What is internal auditing?

Complete the following sentence:
At its simplest, internal auditing involves identifying the that
could keep an organisation from achieving its ,
making sure the organisation’s know about
these , and proactively recommending improvements
to help reduce the .

The organisation’s leaders must be open to discussing tough issues and seiz-
ing the opportunities to make necessary changes for improvement. The internal

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TOPIC 2: THE INTERNAL AUDITORS

auditor must have an independent reporting line to the highest governing body.
This body is the .
Internal audit add value to their organisation. Internal audit = A +
I +O .

ACTIVITY 5.2

Refer to page 4 & 5: Who are internal auditors?

Who are internal auditors?

Study the main differences between the internal and external auditor. The dif-
ference between the internal and external auditor is significant. Notice that the
internal auditor has a broad focus and uses historical information (backward-
looking) but is very concerned with future events (forward-looking).

ACTIVITY 5.3

Refer to page 6 & 7: Internal audit responsibilities

Internal audit responsibilities

The internal auditors may perform some or all of the following tasks:
(1) Offer insight and advice.
(2)
(3)
(4)
(5)
(6)
(7)
(8)
(9)
(10)

After reading the pamphlet and completing the activities you should have a basic
idea what the internal auditor’s career is about.

5.3 SUMMARY AND SELF-ASSESSMENT

In this study unit we learned about the important role of the internal auditor in an
organisation and advantages of the internal audit activity.
Refer to your notes you made in your workbook when you completed the follow-
ing activities.

Study 5.1 Activity 5.1

Activity 5.2
Activity 5.3

After having worked through the study unit and the study references are you able to:
• describe the responsibilities of internal auditing?
42
6 STUDY UNIT 6

PROFESSIONAL CONDUCT
6

REQUIREMENTS FOR INTERNAL

AUDITORS

IN THIS STUDY UNIT WE ARE GOING TO

•• explain the professional conduct principles and rules for internal auditors

6.1 INTRODUCTION
We know that the internal auditor performs independent assignments on behalf of
the board of directors of the company (Jackson & Stent 2016:1/3). In the previous
study unit we examined the various functions performed by the internal auditor.
We will now examine the professional conduct of internal auditors.

Like for soccer, there must be rules for the team players in an audit team. The
internal auditor has to behave a certain way so that reliance can be placed on the
assurance he/she provides to management, the board and the audit committee.
Remember: corporate governance is as strong as its weakest link. Therefore, if
the internal auditors behave unethical then their important function that they are
supposed to fulfil in corporate governance collapses.

The code of ethics of the Institute of Internal Auditors (IIA) comprises the principles
relevant to the profession and practice of internal auditing and rules of conduct
that describe the behaviour expected of internal auditors. This study unit presents
the purpose of the IIA’s code of ethics, applicability, principle and rules of conduct.

6.2 PURPOSE OF THE CODE OF ETHICS

The IIA Code of Ethics is found on the IIA’s website (www.theiia.org).You can
access the Code of Ethics at https://na.theiia.org/standards-guidance/Public%20
Documents/IPPF_Code_of_Ethics_01-09.pdf. The Code of Ethics is recognised
in terms of the International Standards for the Professional Practice of Internal
Auditing (the Standards). The purpose of the Institute’s Code of Ethics is to pro-
mote an ethical culture in the profession of internal auditing. A code of ethics is
necessary and appropriate for the profession of internal auditing, founded as it
is on the trust placed in its objective assurance about governance, risk manage-
ment and control.

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TOPIC 2: THE INTERNAL AUDITORS

The Institute’s Code of Ethics extends beyond the definition of internal auditing
to include two essential components:
(1) principles that are relevant to the profession and practice of internal auditing
(2) rules of conduct that describe behavioural norms expected of internal auditors

These rules are an aid to interpreting the principles into practical applications
and are intended to guide the ethical conduct of internal auditors.

“Internal auditors” refers to Institute members, recipients of or candidates for IIA

professional certifications, and those who perform internal audit services within
the definition of internal auditing.

6.2.1 Applicability and enforcement of the Code of Ethics

This Code of Ethics applies to both entities and individuals that perform internal
audit services.

For IIA members and recipients of or candidates for IIA professional certifications,
breaches of the Code of Ethics will be evaluated and administered according
to the Institute’s bylaws and administrative directives. The fact that a particular
conduct is not mentioned in the Rules of Conduct does not prevent it from being
unacceptable or discreditable, and therefore, the member, certification holder,
or candidate can be liable to disciplinary action.

6.3 PRINCIPLES
Internal auditors are expected to apply and uphold the following principles:

6.3.1 Integrity
The integrity of internal auditors establishes trust and thus provides the basis for
reliance on their judgment.

6.3.2 Objectivity
Internal auditors exhibit the highest level of professional objectivity in gathering,
evaluating and communicating information about the activity or process being
examined. Internal auditors make a balanced assessment of all the relevant
circumstances and are not unduly influenced by their own interests or by others
in forming judgments.

DISCUSSION 6.1

E-tutor assistance required

• Discuss whether or not an internal auditor can be objective in the organisation
it works for.
• What can happen if management refuses to take corrective action on a
reported finding?

44
 STUDY UNIT 6: Professional conduct requirements for internal auditors

6.3.3 Confidentiality
Internal auditors respect the value and ownership of information they receive and
do not disclose information without appropriate authority unless there is a legal
or professional obligation to do so.

6.3.4 Competency
Internal auditors apply the knowledge, skills and experience needed in the per-
formance of internal audit services.

Based on the above principles, the rules of conduct are formulated.

6.4 RULES OF CONDUCT

6.4.1 Integrity
Internal auditors
•• Shall perform their work with honesty, diligence, and responsibility.
•• Shall observe the law and make disclosures expected by the law and the profession.
•• Shall not knowingly be a party to any illegal activity, or engage in acts that
are discreditable to the profession of internal auditing or to the organization.
•• Shall respect and contribute to the legitimate and ethical objectives of the organization.

6.4.2 Objectivity
Internal auditors
•• Shall not participate in any activity or relationship that may impair or be
presumed to impair their unbiased assessment. This participation includes
those activities or relationships that may be in conflict with the interests of
the organisation.
•• Shall not accept anything that may impair or be presumed to impair their
professional judgment.
•• Shall disclose all material facts known to them that, if not disclosed, may distort
the reporting of activities under review.

6.4.3 Confidentiality
Internal auditors
•• Shall be prudent in the use and protection of information acquired in the course
of their duties.
•• Shall not use information for any personal gain or in any manner that would
be contrary to the law or detrimental to the legitimate and ethical objectives
of the organisation.

6.4.4 Competency
Internal auditors
•• Shall engage only in those services for which they have the necessary
knowledge, skills, and experience.
•• Shall perform internal audit services in accordance with the International
Standards for the Professional Practice of Internal Auditing (Standards).

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TOPIC 2: THE INTERNAL AUDITORS

• Shall continually improve their proficiency and the effectiveness and quality
of their services.

(Source: International Professional Practice Framework of the Institute of Internal Auditors, 2009)

DISCUSSION 6.2

E-tutor assistance required

Discuss the practical application of the rules of conduct.
For example:
• Explain how integrity affected you this week in decisions that you had to make.
• Explain the meaning of diligence and how you have applied it.
• Discuss/share examples that reflect objectivity.
State, with reasons, whether or not the following action of the internal auditor is
a breach of the Code of Ethics:

John Khumalo, a junior internal audit staff member, discussed with his friends the
incidence of fraud he had discovered during his audit of the company’s debtors.

SUGGESTED SOLUTION 6.1

This is a violation of the Integrity and Confidentiality principles in the Code of

Ethics. Mr Khumalo is guilty of misconduct.
Integrity – Internal auditors shall perform their work with honesty, diligence, and
responsibility.
Confidentiality – Internal auditors shall be prudent in the use and protection of
information acquired in the course of their duties.

This was a violation since John had no legal obligation to divulge this information.

6.5 SUMMARY AND SELF-ASSESSMENT

In this study unit we had a look at the professional conduct of the internal auditor.
We also had a look at its applicability to the individual and organisations practic-
ing internal auditing.

Refer to your notes you made in your workbook when you completed the follow-
ing activities.

Activity 6.1 Discussion 6.1

Activity 6.2 Discussion 6.1

After having worked through the study unit and the study references are you able to:
• explain the professional conduct principles and rules for internal auditors?
In the next study unit, we will discuss the role of internal audit in good corporate
governance.

46
 STUDY UNIT 7: Internal audit and good corporate governance

7 STUDY UNIT 7

INTERNAL AUDIT AND GOOD CORPORATE

7

GOVERNANCE

IN THIS STUDY UNIT WE ARE GOING TO

• explain role of internal audit in terms of good corporate governance
• list the attributes of the Chief Audit Executive (CAE)

7.1 INTRODUCTION
In Study Unit 2, we looked at leadership, organisational ethics and responsible
corporate citizenship (the first three principles of King IV). We also focussed on
the board and its directors. I think that by now you have a good understanding
of the objectives and value that internal auditors add to business and how they
should behave. In this study unit we are going to refer back to the King Code IV
and we will focus on Jackson & Stent (2016:4/51), that covers principle 15 of King
IV dealing with assurance that relates to the internal auditor.

Principle 15: The board should ensure that assurance services and function
enable an effective control environment and that these support the integrity of
information for internal decision making and of the organisation’s external reports.

As part of good governance, the internal auditor is commonly known to be in-

volved in measuring the compliance with the entity’s policies and procedures.
The internal auditor advises management and the board of directors with its com-
mittee structures regarding how to better execute their oversight responsibilities
(Jackson & Stent 2016:4/53).

7.2 THE EIGHT RECOMMENDED PRACTICES PERTAINING

TO INTERNAL AUDIT

ACTIVITY 7.1

Study Jackson & Stent (2016:4/53–4/55). With the aid of diagram 6, write an
essay explaining the role of the internal audit function.

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 ACTIVITY 7.2

You are responsible for writing the advertisement for the Chief Audit Executive
(CAE) of a listed company. List the required attributes of a CAE.

SUGGESTED SOLUTION 7.2

Jackson & Stent (2016:4/55) Note (g)

48
 STUDY UNIT 7: Internal audit and good corporate governance

7.3 SUMMARY AND SELF-ASSESSMENT

In this study unit we had a look at the role of internal audit in good corporate
governance. The discussion in this study unit focused on the need for and the
role of internal audit.

Refer to your notes you made in your workbook after completing the following
activities.

Activity 7.1
Activity 7.2

After having worked through the study unit and the study references, are you
able to:
•• explain the role of internal audit in terms of good corporate governance?
•• list the attributes of the CAE?
In the next topic, we will discuss the external auditor.

BIBLIOGRAPHY FOR TOPIC 2

Institute of Directors Southern Africa (IODSA). 2016. Draft King IV Report on
Corporate Governance for South Africa 2016. Johannesburg: South Africa.

The Institute of Internal Auditors (IIA). 2012. International Standards for the
Professional Practice of Internal Auditing (Standards). Altamonte Springs: USA.

The Institute of Internal Auditors (IIA). 2009. Code of Ethics. www.theiia.org.

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50
TOPIC 3
The external auditor

Study unit 8
The development of the external auditing profession 53

Study unit 9
Assurance by the external auditor 58

Study unit 10
Professional conduct requirements for external auditors 52

Study unit 11
The relationship between internal and external auditors 66

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TOPIC 3: THE EXTERNAL AUDITOR

TOPIC OVERVIEW

The aim of this topic is to guide you in acquiring an informed understanding of the
key terms, concepts, facts, general principles, rules and theories of the external
auditing profession.

This topic is divided into the following study units:

Study Title Page

units

8 The development of the profession of external auditing 53

9 The role of the external auditor 58

10 Professional conduct requirements for external auditors 62

11 The relationship between internal and external auditors 66

Textual amendments and additions

Before you proceed with the study of this topic, please refer to Tutorial Letter 102
for this module to acquaint yourself with any textual amendments and additions
that have been indicated.

52
8 STUDY UNIT 8

The development of the external auditing

8

profession

IN THIS STUDY UNIT WE ARE GOING TO

• discuss basic aspects regarding the external auditing profession

8.1 INTRODUCTION
This study unit presents an overview of the development of the profession of
external auditing. In the previous study unit we worked with the King Code of
Governance Principles, in particular the internal audit. In Study Unit 4 we looked
at the role of the audit committee in the appointment and overseeing the planning
and execution of the external audit. Now go back to Study Unit 4 diagram 5. Let’s
recap: Where are we now in the operational business environment represented in
diagram 5? You have learned about the audit committee (go and tick it), internal
audit (go and tick it), and operational management (go and tick it). We are going
to look at the independent auditor (external auditor).

8.2 THE EXTERNAL AUDITING PROFESSION

DISCUSSION 8.1

E-tutor assistance required

Consider the following question and post your thoughts about it on the discus-
sion forum provided for the purpose. If you do not post your own idea, you have
to respond constructively to a post by another student.

Refer back to diagram 5 in Study Unit 4. Do we really need external auditors

and why?

Reference: Jackson & Stent (2016:1/5)

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TOPIC 3: THE EXTERNAL AUDITOR

8.2.1 The Auditing Profession Act

The Auditing Profession Act (Act 26 of 2005) (APA) regulates the External Au-
diting Profession by instituting the Independent Regulatory Board for Auditors
(IRBA), which has the responsibility of controlling the auditing profession in South
Africa. In other words, the APA created IRBA. An external auditor has to complete
the education, training and professional requirements before he/she can register
as a Registered Auditor (RA) with IRBA.

The South African Institute of Chartered Accountants (SAICA) (https://www.

saica.co.za/Default.aspx) is an accredited professional body. IRBA outsources
the education, training and professional requirements to SAICA. Remember,
there is a difference between a Registered Auditor (RA) and a Chartered Ac-
countant (South Africa) (CA(SA)). The CA(SA) is a professional accounting (not
auditing) designation. A prospective RA has to undergo all the CA(SA) education
and training requirements and an additional specialised auditing professional
development period of 18 months before he/she can register as a RA. Therefore,
a CA(SA) is not automatically a RA.

Go and explore the IRBA website at http://www.irba.co.za/.

DIAGRAM 7: THE EXTERNAL AUDITING PROFESSION

The Companies Act Good Corporate Governance External users of AFS

require require require

External Auditors

improve

Creditability of AFS

Independent Regulatory
outsource
Education &
Board for Auditors Training

accredited
requires
South African Institute
of Chartered Accountants
Auditing
Profession Act

8.2.2 Accounting bodies

There are a number of accounting bodies in South Africa and you can explore
each body’s website if you are interested in an accounting career. Remember,
members of the accounting bodies may not be public auditors.
•• The South African Institute of Chartered Accountants (SAICA):
https://www.saica.co.za/Default.aspx
•• The Association of Chartered Certified Accountants (ACCA):
http://www.accaglobal.com/za/en/qualifications/glance/acca/overview.html

54
 STUDY UNIT 8: The development of the external auditing profession

• The Charted Institute of Management Accountants (CIMA):

http://www.cimaglobal.com/Our-locations/Africa/South-Africa/
• The South African Institute of Professional Accountants (SAIPA):
http://www.saipa.co.za/

DIAGRAM 8: EXTERNAL AUDITOR AND ACCOUNTING BODIES

External Audit Registered Auditor

Independant Regulatory Board
RA for Auditors

South African Institute of

CA (SA) Chartered Accountants

Accounting
Bodies CIMA

ACCA
SAIPA

Only RA can perform external audit functions

8.3 THE NATURE OF PROFESSIONAL STATUS

Up to now you have noticed that internal auditors, registered auditors, chartered
accountants are referred to as professionals. What does it mean to obtain pro-
fessional status?

ACTIVITY 8.1

List six attributes describing professional status.

SUGGESTED SOLUTION 8.1

Refer to Jackson & Stent (2016:1/10–11).

1. Specialised skills 4.
2. 5.

3. 6.

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TOPIC 3: THE EXTERNAL AUDITOR

8.4 PRONOUNCEMENTS WHICH REGULATE THE AUDITING

PROFESSION
Auditors have to behave in a certain way and perform their work in terms of
internationally recognised standards.

STUDY

Refer to Jackson & Stent (2016:1/12) and note all the legal and professional
requirements that the auditing profession is subject to. Throughout this module
we will make reference to the International Standards on Auditing (ISAs), Rules
regarding Improper Conduct and the Code of Professional Conduct for Regis-
tered Auditors, the Companies Act, and the Auditing Profession Act. The audit-
ing profession is thus highly regulated and the South African auditors are very
sought after internationally.

ACTIVITY 8.2

Answer the following questions:

(1) What does the designation CA (SA) stand for?
(2) Can all CA (SA)s perform auditing services in terms of the Auditing Profes-
sion Act?
(3) What is the responsibility of the IRBA?
(4) What are the requirements to register as a member of the IRBA?
(5) What designation can be used by individuals registered with the IRBA?
(6) What is meant by the term “designated auditor”?
(7) What is the role of the ISAs?

SUGGESTED SOLUTION 8.2

Reference: Jackson & Stent (2016:1/11–12)

(1) Designation CA(SA) stands for Chartered Accountant (South Africa).

(2) No. Offering accounting services such as bookkeeping, taxation, manage-
ment or financial advice is not restricted to members of SAICA. As indicated
above, there are other accounting bodies such as SAIPA, ACCA or CIMA who
also offer these services, but if an individual or firm wishes to offer auditing
services they must be, in terms of the Auditing Profession Act, registered
with the Independent Regulatory Board for Auditors (IRBA).
(3) The IRBA has the responsibility of looking after the professional interests
of auditors. It deals with such matters as registration, education and train-
ing, accrediting professional bodies (such as SAICA) for membership, and
prescribing standards of competence and ethics. The IRBA is also there to
protect the public in their dealings with registered auditors, and to discipline
IRBA members who “break the rules”.
(4) Currently to register as a member of the IRBA, an individual must in essence
do the following:
• Satisfy the educational requirements of SAICA (see note below), i.e.
obtain a recognised qualification from an accredited university, and pass
the Initial Test of Competence (ITC) and the Assessment of Professional
Competence (APC).

56
 STUDY UNIT 8: The development of the external auditing profession

• Complete a training contract in public practice (in a registered training office).

• Obtain an audit specialist qualification.
(5) The official designation for individuals registered with the IRBA, is “registered
auditor” (RA).
(6) The Act also stipulates that the individual who is responsible for the audit is
identified and named the “designated auditor” (APA, Sec 44(1)).
(7) The ISAs provide the standards which the auditor must attain and provide guid-
ance on how this should be done. The ISAs do not provide detailed lists of audit
procedures; this is left up to the individual auditor or audit firm, for example, au-
diting firm A will have their particular methods of doing things and auditing firm
B will have their own methods. Auditing is not an exact science and provided
the ISAs are complied with, an audit of the appropriate quality will be achieved.
The ISAs cover the entire audit process. They provide guidance ranging
from preliminary engagement activities, through planning the audit, gathering
sufficient appropriate evidence, and deciding on the appropriate audit opinion.

8.5 SUMMARY AND SELF-ASSESSMENT

In this study unit we had a look at the external auditing profession. We also had
a look at the pronouncements that regulate the external auditing profession.

Refer to your notes you made in your workbook after having completed the fol-
lowing activities.

Activity 8.1 Discussion 8.1

Activity 8.2

After having worked through the study unit and the study references are you able to
•• discuss the basic aspects regarding the external auditing profession?
In the next study unit, we will discuss the role of the external auditor.

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9 STUDY UNIT 9

9 Assurance by the external auditor

IN THIS STUDY UNIT WE ARE GOING TO

•• explain the objective of an audit
•• identify the level of assurance provided by external auditors
•• identify organisations subject to an financial statement audit

9.1 INTRODUCTION
In the previous study unit we looked at the auditing profession and noticed that
it is highly regulated through legislation, standards and codes. Although external
auditors perform many different functions in practice (non-assurance engage-
ments), for the purposes of this module the main function of the external auditor
registered with the IRBA is to perform the external audit of financial statements
(assurance engagements). So, what do auditors really do when they audit finan-
cial statements? All of the auditor’s work is summarised in an audit report that
accompanies the annual financial statements. The end product of the auditor’s
work is reflected in the audit report.

9.2 THE EXTERNAL AUDITOR

INTERNET ACTIVITY 9.1

We all have bought something from Shoprite, so let’s go to their annual financial
statements. Google “annual financial statements Shoprite” and then select and
open an example of their latest annual financial statements. Scroll through the
document (heavy stuff) but I want you to read the page titled “Independent Auditor’s
Report to the Shareholders of Shoprite Holdings Limited”. Note that the report sets
out the director’s responsibilities, the auditor’s responsibilities and the audit opinion.

As stated in Jackson & Stent (2016:1/2) registered external auditors are auditors
who express an independent opinion on whether the annual financial statements
of a company fairly present the financial position and results of the company’s
operations. The external auditor is not an employee of the company. The external
auditor enhances the degree of confidence which users of the financial statements
will have in the information in those financial statements. Registered auditors offer
their services to the public. They are described as being “in public practice” and
must be registered with the Independent Regulatory Board for Auditors.

58
 STUDY UNIT 9: Assurance by the external auditor

9.3 LEVELS OF ASSURANCE

In terms of the International Framework for Assurance Engagements, an assur-
ance engagement is one in which the professional accountant (registered audi-
tor) “expresses a conclusion designed to enhance the degree of confidence of
the intended users, other than the responsible party, about the outcome of the
evaluation or measurement of a subject matter against the criteria”.

The work performed by the auditor can be divided into levels of assurance.

STUDY

Jackson & Stent (2016:1/8-9) – Levels of assurance

DIAGRAM 9: LEVELS OF ASSURANCE

Absolute assurance eg. Certifying

st
e “100%”
gh
hi

Reasonable assurance eg. Standard

audit “Fairly present”
Levels of Assurance
Limited assurance eg. Reviews
“Nothing came to our attention”
low
es
t

Non-assurance eg. Taxation and

advisory services

ACTIVITY 9.1

Refer to the Shoprite annual financial statements. Identify the level of assurance
provided by their auditors.

ACTIVITY 9.2

You are required to:

(1) describe what the level of assurance in an audit of financial statements entails
(2) explain the meaning of reasonable assurance in an auditing context

SUGGESTED SOLUTION 9.2

Reference: Jackson & Stent (2016:1/5–1/9)

(1) In an audit as a reasonable assurance engagement, a registered auditor gath-

ers sufficient appropriate evidence to be in a position to express an opinion
on whether the directors, who are responsible for the financial statements,
have applied the International Financial Reporting Standards (or other suitable

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TOPIC 3: THE EXTERNAL AUDITOR

reporting framework) appropriately in presenting fairly the financial position,

financial performance and cash flow information and accompanying notes
of the company for the financial year.
(2) The auditor does not certify or confirm the absolute correctness of financial
information, but rather, expresses an opinion on its fair presentation. The audit
is designed to provide reasonable assurance that the financial statements,
taken as a whole, are free of material misstatement, not that they are one
hundred per cent correct. The International Standards of Auditing, defines
reasonable assurance as a “high but not absolute” level of assurance.

9.4 BUSINESSES SUBJECT TO AN AUDIT

Determining which businesses are subject to an audit depends on the extent to
which the annual financial statements will affect or influence the general public.
Therefore, all public companies and state-owned companies will automatically be
subject to an audit. What about the private companies and close corporations?
The audit of financial statements is legislated to protect the general public. For
example, it will be senseless for a very small company (low turnover), with one
shareholder and three employees to be subjected to an audit. In this case, an
independent review will be adequate.

STUDY

• Jackson & Stent (2016:1/13–14) – The public interest and public interest scores
• Jackson & Stent (2016:1/14) – Chart summary

ACTIVITY 9.3

A private company or close corporation with a public interest (PI) score of 350
points and above is subject to an audit in terms of the Companies Act.

List the four elements that make up the public interest score calculation.

SUGGESTED SOLUTION 9.3

1. The average number of employees per year equals the same number of points.

2.
3.
4.

9.5 THE FINANCIAL STATEMENT AUDIT ENGAGEMENT

Close corporations and private companies with a public score of 350 points and
more are subject to a financial statement audit. All public and state-owned compa-
nies, regardless of their public interest score, are subject to a financial statement

60
 STUDY UNIT 9: Assurance by the external auditor

audit. Private companies with a public score between 100 to 349, who compile
their own annual financial statements, are also subject to an audit. As mentioned
earlier in this study unit, the level of assurance provided by a financial statement
engagement is one of “reasonable assurance”.

ACTIVITY 9.4

Describe the overall objectives of the auditor in a financial statement audit.

SUGGESTED SOLUTION 9.4

Reference: Jackson & Stent (2016:1/7)

The overall objectives of the external auditor are to:

• obtain reasonable assurance about whether the financial statements as a whole
are free from material misstatement, due to fraud or error, thereby enabling
the auditor to express an opinion on whether the financial statements are
prepared in all material respects in accordance with an applicable financial
reporting framework
• report on the financial statements and communicate as required by the
International Standards on Auditing (ISA), in accordance with the auditor’s
findings (SAICA, Handbook: Volume 2)

9.6 SUMMARY AND SELF-ASSESSMENT

In this study unit we discussed the role of the external auditor.

Refer to your notes you made in your workbook after completing the following
activities.

Activity 9.1 Internet Activity 9.1

Activity 9.2
Activity 9.3

After having worked through the study unit and the study references are you able to:
• explain the objective of an audit?
• identify the level of assurance provided by external auditors?
• identify organisations subject to a financial statement audit?

In the next study unit we will discuss the professional conduct requirements for
external auditors.

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10 STUDY UNIT 10

PROFESSIONAL CONDUCT
10

REQUIREMENTS FOR EXTERNAL

AUDITORS

IN THIS STUDY UNIT WE ARE GOING TO

•• explain the professional conduct requirements for external auditors

10.1 INTRODUCTION
In the previous study unit we gathered that all public, state-owned and private com-
panies, subject to the public interest score, are subject to an audit. The duty to
perform an audit is legislated by law (Companies Act) to protect the general
public. Due to the nature of the auditor’s duties it is essential that the auditor be
seen (perceived) by the public as being a professional. If auditors were to lose
their professional status then the profession would become as extinct as the di-
nosaurs. A financial scandal like Enron resulted in the collapse of an international
audit firm. Therefore, both SAICA and IRBA will guard their professional status
with all that they have. The professional conduct of their members is considered
in a very serious light and has codes of conduct to govern their members’ be-
haviour. Therefore, it is very important to understand these principles. Although
these principles apply to auditors and CAs, you can adapt it to your own life by
embedding them in your lifestyle.

10.2 THE SAICA AND IRBA CODES OF PROFESSIONAL

CONDUCT
As stated in Jackson & Stent (2016:2/3), there are two Codes of Professional
conduct which provide ethical guidance to professional accountants and auditors
in South Africa respectively, namely the South African Institute of Chartered Ac-
countants (SAICA) Code of Professional Conduct and the Independent Regula-
tory Board for Auditors (IRBA) Code of Professional Conduct. These codes are
very similar and we are going to examine some of the principles, threats and
safeguards.

62
 STUDY UNIT 10: Professional conduct requirements for external auditors

10.3 INTRODUCTION TO THE FUNDAMENTAL PRINCIPLES

STUDY

Jackson & Stent (2016:2/5–2/8)

ACTIVITY 10.1

This activity is very important. While completing the table below reflect on the
meaning of each word. Use a dictionary if you are uncertain of the meaning of
some of the words. If you do not own a dictionary or do not have one close by,
you can access the Oxford Learner’s Dictionary here: http://www.oxfordlearners-
dictionaries.com/.

There are five fundamental principles. List and describe each of the principles.

SUGGESTED SOLUTION 10.1

Principle Description

1. Integrity • Be straightforward, honest, fair and truthful.

• Should not be associated with false or misleading
information (including omission or obscurity).
• Take steps to be disassociated from false or misleading
information
2.
3.
4.
5. Professional • Avoid any action that will discredit the profession.
behaviour • Examples: Bad advertising; sign your own reports;
manners when recruiting; responsibilities to colleagues,
and discrimination.

DISCUSSION 10.1

E-tutor assistance required

Consider the following questions and post your thoughts about any of them on
the discussion forum provided for the purpose. If you do not post your own idea,
you have to respond constructively to a post by another student.

• Working students: Share your practical experiences where you comply with
these principles.
• Non-working students: Share your practical experiences where you comply
with these principles as a Unisa student.
• Refer to Study Unit 6. Identify the similarities and differences (if any) in the
fundamental ethical principles between internal and external auditors.

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TOPIC 3: THE EXTERNAL AUDITOR

10.4 THREATS AND SAFEGUARDS

10.4.1 Threats
Based on the above principles the code went further and identified some practical fac-
tors that need to be considered by the auditor. These factors are referred to as threats.

STUDY

Jackson & Stent (2016:2/10–2/11)

ACTIVITY 10.2

This activity is also very important.

List the five threats identified by the code which can threaten compliance with
the fundmental principles and summarise the core concept of each threat, giving
one example for each. Link the example with a principle.

SUGGESTED SOLUTION 10.2

Threat Core concept

1. Self-interest Financial interests that may inappropriately influence

judgement
Example: Holding shares in the client’s business: Objectivity
2.
3.
4.
5.

10.4.2 Safeguards
Rather be safe than sorry! The auditor is obliged to apply measures that will reduce
the threat to an acceptable level. Safeguards are divided into two categories, namely:
• safeguards created by the profession, legislation or regulation
• safeguards in the work environment

The first category is regulatory measures brought about the profession and legisla-
tion, For example, the auditor must rotate after five years to enhance objectivity.
These are rules and must be complied with.

The second category is how the auditor manages his/her business that will con-
tribute to good management procedures.

STUDY

Jackson & Stent (2016:2/12)

64
 STUDY UNIT 10: Professional conduct requirements for external auditors

ACTIVITY 10.3

The following activity is an example of applying the knowledge you have mas-
tered above.

Mr Bodibe Mathabe CA (SA) qualified as a chartered accountant five years ago.

He is a partner at Anders Arthur (firm of auditors). He encountered the following
situation in his current audit assignment:

Gregory Italiano is the financial director of Italian Pizzas (Pty) Ltd and requested
Mr Mathabe to disclose financial information on one of this audit client’s business
affairs to him.

Required
Describe which fundamental principle is involved and explain with reasons how
Mr Mathabe, in terms of the Code of Professional Conduct, should react to the
above matter.

SUGGESTED SOLUTION 10.3

Reference: Jackson & Stent (2016:2/7)

Mr Gregory Italiano’s case

In terms of the Code of Professional Conduct, members have an obligation to
respect the confidentiality of information about client’s business affairs. Confi-
dentiality should always be observed unless specific authority has been given
by the client to disclose information or there is a legal or professional duty to dis-
close. In this case there is no legal or professional duty to disclose the information.

Mr Mathebe should refuse to disclose the financial information of his audit cli-
ent unless specific authority has been granted by the audit client involved for
disclosure of information.

10.5 SUMMARY AND SELF-ASSESSMENT

In this study unit we discussed the professional requirements of external auditors.
The SAICA and IRBA codes of professional conducts were also emphasised.

Refer to your notes you made in your workbook after completing the following
activities.

Activity 10.1 Discussion 10.1

Activity 10.2
Activity 10.3

After having worked through the study unit and the study references are you able to:
• explain the professional conduct requirements for external auditors?

In the next study unit we will discuss the relationship between internal and ex-
ternal auditors.

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11 STUDY UNIT 11

THE RELATIONSHIP BETWEEN INTERNAL

11

AND EXTERNAL AUDITORS

IN THIS STUDY UNIT WE ARE GOING TO

discuss the relationship between internal and external auditors

11.1 INTRODUCTION
In topic 2 you were introduced to the internal auditor. In this topic you were in-
troduced to the external auditor. You would have gathered that there are some
similarities between the two professions. One could argue that the external audi-
tor can rely on some of the work performed by the internal auditor. The internal
auditor would probably know more about the daily operations of a business than
the external auditor.

There are also important differences between the internal and external auditors.
In this study unit we are first going to identify the most important differences.
Thereafter we are going to look at some rules in terms of the International Stand-
ards of Auditing (ISAs), should the external auditor wish to use or rely on the work
of the internal auditor. Think of the benefits of relying on the work of the internal
auditor, for example the operational knowledge of the internal auditor, flagging
of high-risk areas identified by the internal auditor that the external auditor could
consider when planning an audit, and saving on the audit fees, to name but a
few. It is important, however, to realise that the relationship is based on the co-
ordination of internal audit activities with external audit activities.

11.2 DIFFERENCES BETWEEN THE EXTERNAL AND

INTERNAL AUDITOR
Understanding the differences allows us to understand and appreciate the respec-
tive professions better. You would have come across some of these differences
while you studied topics 2 and 3.

66
 STUDY UNIT 11: The relationship between internal and external auditors

STUDY

Jackson & Stent (2016:1/2–1/3)

ACTIVITY 11.1

List the differences between internal and external auditors.

SUGGESTED SOLUTION 11.1

Reference: Jackson & Stent (2016:1/2–1/3)

Internal auditors External auditors

Obtain a mandate from management/ Obtain a mandate through legislation

the audit committee
Perform a management function Perform an external attestation function
(auditing function)
Are contracted by the company they Work for an independent audit firm
are working with
Function independently in the organi- Function independently from the
sation, but remain part of it
organisation
Report to management (including the Report to the shareholders
audit committee)

Internal audit covers all the organisa- External audit works primarily with
tion’s operations those financial systems that have a
bearing on the final accounts
Internal audit performs audits through- External audit tends to be a year-end
out the year process, even though some testing may
be carried out during the year
Registered with the Institute of Internal Registered with the Independent Regu-
Auditors (IIA) latory Board for Auditors (IRBA)

11.3 USING THE WORK OF INTERNAL AUDITORS

As stated in Jackson & Stent (2016:16/5), certain parts of the internal audit work
may be useful to the external auditor.

Before the external auditor can rely on the work of the internal audit department,
certain requirements must be met for external audit to be in a position to make
use of the internal audit department’s work (see Jackson & Stent 2016:16/4).

STUDY

Jackson & Stent (2016:16/5–16/7) – ISA 610 Using the work of internal auditors

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TOPIC 3: THE EXTERNAL AUDITOR

The introduction and definition of the internal audit function in Jackson & Stent
(2012:16/5) serves as revision of topic 2.

Jackson & Stent (2016:16/6) paragraph 5: Evaluating the internal audit function
deals with the considerations that the external auditor must consider before he/
she can rely on the work of the internal auditor. This section is important and is
divided into three categories:
• objectivity of the internal auditor (operational environment)
• competence of the internal auditors (the people)
• systematic and disciplined approach, including quality control (the process
followed)

Make sure that you are able to describe the aspects for each category.

ACTIVITY 11.2

Describe the aspects that the external auditor should consider to evaluate the
adequacy of the work of internal audit for the external auditor’s purposes.

SUGGESTED SOLUTION 11.2

Reference: Jackson & Stent (2016:16/6)

To determine the adequacy of specific work performed by the internal auditors

for the external auditor’s purposes, the external auditors shall evaluate whether
• the work was performed by internal auditors having adequate technical training
and proficiency
• the work was properly supervised, reviewed and documented
• adequate audit evidence has been obtained to enable the internal auditors to
draw reasonable conclusions
• conclusions reached are appropriate in the circumstances and any reports
prepared by the internal auditors are consistent with the results of the work
performed by the external auditors
• any exceptions or unusual matters disclosed by the internal auditors are
properly resolved

11.4 COORDINATION BY INTERNAL AUDITORS

It is further important to note that not all aspects of coordination comes from the
external auditor’s point of view; the internal auditors may also benefit from the
coordination of work with the external auditors by ensuring proper coverage and
minimising duplication of efforts.

The Institute of Internal Auditors: Standard 2050 – Coordination, indicates the

following steps:

The chief audit executive (CAE) takes the steps necessary to understand the
work performed by the external auditors, including:
• the nature, extent and timing of work planned by external auditors, to be
satisfied that the external auditors’ planned work, in conjunction with the
internal auditors’ planned work

68
 STUDY UNIT 11: The relationship between internal and external auditors

•• the external auditor’s assessment of risk and materiality

•• the external auditors’ techniques, methods, and terminology to enable the
CAE to:
• coordinate internal and external auditing work
• evaluate, for purposes of reliance, the external auditors’ work
• communicate effectively with external auditors
•• access to the external auditors’ programs and working papers, to be satisfied
that the external auditors’ work can be relied upon for internal audit purposes.
Internal auditors are responsible for respecting the confidentiality of those
programs and working papers.

Therefore, the CAE is responsible for regular evaluations of the coordination

between internal and external auditors. Such evaluations may also include as-
sessments of the overall efficiency and effectiveness of internal and external audit
activities, including aggregate audit cost. The CAE communicates the results of
these evaluations to senior management and the board, including relevant com-
ments about the performance of external auditors.

11.5 SUMMARY AND SELF-ASSESSMENT

In this study unit we discussed the relationship between internal and external
auditors. We have seen that it is important that the internal and external auditors
meet periodically to discuss issues of common interests that could help them
to benefit from each other in terms of skills, expertise and also to minimise the
duplication of efforts.

Refer to your notes you made in your workbook after completing the following
activities.

Activity 11.1
Activity 11.2

After having worked through the study unit and the study references are you able to
•• discuss the relationship between internal and external auditors?
In the next topic we will discuss certain auditing concepts.

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70
TOPIC 4
Auditing concepts

Study unit 12
Assertions73

Study unit 13
Audit evidence 78

Study unit 14
Materiality and audit risk 84

Study unit 15
Risk assessement and futrher audit procedures 89

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TOPIC 4: THE EXTERNAL AUDITOR

TOPIC OVERVIEW

Any profession, for example a medical doctor, lawyer, and scientist uses a certain
vocabulary. This is necessary to ensure that communication between colleagues
and record keeping of events is concise. There is no room for misunderstanding
in a profession. Everyone in that particular profession will know the meaning of
a certain term without someone explaining it to them. In the previous topics we
concluded that internal and external auditors are professionals. Therefore, we
can expect them to use certain terms in their day to day activities. In this topic
you will be introduced to certain auditing concepts and methods, procedures and
techniques that auditors use. The next time the auditor visits the business where
you are employed, you will be able to form a good understanding about some of
the questions that they ask.

This topic is divided into the following study units:

Study unit Title Page

12 Assertions 73

13 Audit evidence 78
14 Materiality and audit risk 84
15 Risk assessment procedures, test of controls and 89
substantive procedures

Textual amendments and additions

Before you proceed with the study of this topic, please refer to Tutorial Letter 102
for this module to acquaint yourself with any textual amendments and additions
that have been indicated.

72
12 STUDY UNIT 12

12 ASSERTIONS

IN THIS STUDY UNIT WE ARE GOING TO

•• list the two main categories of assertions
•• describe the various assertions
•• interpret an assertion

12.1 INTRODUCTION
In Study Unit 9 we gathered that the end product of the external auditor is the
audit report. Why is the audit report important? To provide assurance to the share-
holders and other interested parties that the annual financial statements (AFSs)
prepared by management fairly present the financial position and results. More
to the point, in the audit report the auditor expresses an opinion addressed to the
shareholders, that the annual financial statements fairly present, in all material
respects the financial position of a company on a particular date (financial year-
end) and its performance (results) and cash flows (movements) for that particular
financial year. You can deduce that everything revolves around the AFS. In this
study unit we are going to examine how the AFS are made up of various “asser-
tions” implied by management. Why does the auditor want to assess the asser-
tions? During the planning of an audit the auditor will assess each assertion and
consider the risk or likelihood of material misstatement applicable to that particular
assertion. Once the assertions at risk are identified the auditor can focus his/her
audit procedures to address those risk areas. Does this make sense?

INTERNET ACTIVITY 12.1

The following YouTube clip gives a good overview of assertions and I recommend
you watch it before continuing with this study unit. From 15 December 2016 the
International Standards Auditing Standards have amended their definition for as-
sertions and if you use older textbooks they will not incorporate these changes.

https://www.youtube.com/watch?v=TmgcCwE1wtE

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TOPIC 4: THE EXTERNAL AUDITOR

12.2 THE ANNUAL FINANCIAL STATEMENTS

The focus of the external auditor is on examining the annual financial statements.
From your accounting studies you know exactly what a set of annual financial state-
ments looks like. Please refer to you accounting module to refresh your knowledge.

Remember: the directors (management) are presenting financial reports to the

shareholders of the business through annual financial statements (AFS). Are the
AFS a fair presentation of financial results and position? The auditors have the
function to report to the shareholders of a business that these financial statements
presented by the directors are a fair presentation of the financial position and results.

Let’s assume the reporting period of a business entity is from 1 January to 31

December of a particular year. You have a “snapshot” at year-end, reflecting the
financial position on a particular date, in our case 31 December. This snapshot
is referred to as the statement of financial position at 31 December. You also have
a “documentary” of events or results for a year from 1 January to 31 December
and this is referred to as the statement of comprehensive income and retained
earnings for the year ended 31 December. The net results from the statement
of comprehensive income is captured as retained income in the statement of
financial position. Financial statements have to presented and disclosed in terms
of an acceptable financial reporting framework and standards, for example IFRS.
Presentation and disclosure is extremely important for shareholders and analysists.
Proper presentation and disclosure allow one to know exactly what assumptions
are used and therefore “apples can be compared with apples”.

INTERNET ACTIVITY 12.2

For an example of a statement of financial position open the following link:

http://accounting-simplified.com/financial/statements/statement-of-financial-
position.html
For an example of a statement of comprehensive income open the following link:
http://accounting-simplified.com/financial/statements/income-statement-profit-
and-loss.html

To refresh your knowledge about presentation and disclosure open the following link:
http://accounting-simplified.com/financial-accounting accounting-concepts-and-principles/

12.3 CATEGORIES OF ASSERTIONS

When presenting the annual financial statements the directors are making certain
statements or assertions to the shareholders. These assertions are divided into
two major categories:
• assertions about classes of transactions and events, and related disclosures
for the period under audit (statement of comprehensive income activities)
• assertions about account balances, and related disclosures at the period end
(financial position)

STUDY

Jackson & Stent (2016:5/23-5/25) – Financial Statement Assertions

74
 STUDY UNIT 12: Assertions

After completing activities 12.1 to 12.3 you must be able to list and describe the financial
statement assertions for classes of transactions and events and for account balances
and their related disclosures including the notes and policies accompanying the AFS.

ACTIVITY 12.1

List the assertions for transactions and events, and related disclosures with the
implied meaning made by directors with the particular assertion.

SUGGESTED SOLUTION 12.1

Assertions about transactions and events, and related disclosures

(statement of comprehensive income activities)
Assertion Implied meaning made by directors
1. Occurrence That all the transactions and events that have been recorded
or disclosed, have occurred, and such transactions and
events pertain to the entity.
2.
3.
4.
5.
6. Presentation That transactions and events are appropriately aggregated
or disaggregated and clearly described, and related disclo-
sures are relevant and understandable in the context of the
requirements of the applicable financial reporting framework.

ACTIVITY 12.2

List the assertions for account balances with the implied meaning made by direc-
tors with the particular assertion.

SUGGESTED SOLUTION 12.2

Assertions about account balances, and related disclosures (financial

position)
Assertion Implied meaning made by directors
1. Existence That the assets, liabilities and equity interests exist.
2.
3.
4.
5. Classification That assets, liabilities and equity interests have been recorded
in the proper accounts.
6. Presentation That assets, liabilities and equity interests are appropriately ag-
gregated or disaggregated and clearly described, and related
disclosures are relevant and understandable in the context of
the requirements of the applicable financial reporting framework.

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TOPIC 4: THE EXTERNAL AUDITOR

ACTIVITY 12.3

Complete the following table of assertions and categories. For each given asser-
tion you are required to mark (“x”) the category that that assertion applies to. For
example, the assertion occurrence is applicable to transactions and presentation
and disclosure but not to account balances.

SUGGESTED SOLUTION 12.3

Balances (assets,
Transactions, events liabilities, eq-
Assertion and related disclosure uity) and related
disclosures

Occurrence x
Completeness
Accuracy
Cut-off
Classification
Existence
Accuracy, rights and
obligations
Valuation and allocation
Presentation

Compare your entries with the table in Jackson & Stent (2016:5/24). Did you
notice that some assertions are only applicable to transactions and others to
balances? Are you able to recognise the assertions for each category?

DISCUSSION 12.1

E-Tutor assistance required

Consider the following question and post your thoughts about it on the discus-
sion forum provided for the purpose. If you do not post your own idea, you have
to respond constructively to a post by another student.

Your friend presents you with a set of annual financial statements (AFS) of
his company Tau (Pty) Ltd and he wants you to loan him R30 000. You open the
AFS, the page titled Statement of financial position at 31 December 20XX. A line
item catches your eye:

Trade Accounts Receivables R136 145

Required
Discuss what your friend is actually asserting with the above line item in the AFS.

(Jackson & Stent 2016:1/18 – Financial statement assertions)

76
 STUDY UNIT 12: Assertions

ACTIVITY 12.4

In each of the following situations, indicate which category of assertions applies

to the situation and list the assertions associated with that category:
(1) Inspect a sales invoice recorded in the sales journal of a company during
the financial year.
(2) Agree the inventory balance disclosed in the annual financial statements of
a company to the inventory control account balance in the general ledger.
(3) Examine the purchase contract of a motor vehicle purchased during the
financial year, which is included in the motor vehicle balance in the state-
ment of financial position of a company at year-end.

SUGGESTED SOLUTION 12.4

Reference: Jackson & Stent (2016:5/24)

(1) The inspection of a sales invoice refers to assertions about classes of trans-
actions and events, as a sales invoice is made out for a sales transaction
which took place. The assertions about classes of transactions and events
are occurrence, completeness, accuracy, cut-off and classification and
presentation.
(2) Agreeing the inventory balance disclosed in the annual financial statements
refers to assertions about account balances at the period end. The asser-
tions for account balances at period end are existence, rights and obliga-
tions, completeness, accuracy valuation and allocation, classification and
presentation.
(3) Examining the purchase contract of a motor vehicle purchased during the
year refers to assertions about classes of transactions and events, as the
purchase of a motor vehicle is a transaction which took place during the
financial year. The assertions about classes of transactions and events are
occurrence, completeness, accuracy, accuracy, cut-off and classification
and presentation.

12.4 SUMMARY AND SELF-ASSESSMENT

In this study unit we stressed that the financial statements assertions are important
to assist the auditor to gather audit evidence about the transactions and events
and account balances and the related disclosures.
Refer to your notes you made in your workbook after completing the following activities.

Activity 12.1 Discussion 12.1 Internet Activity 12.1

Activity 12.2 Internet Activity 12.2
Activity 12.3
Activity 12.4

After having worked through the study unit and the references to the prescribed
study material, are you be able to
• list the two main categories of assertions?
• describe the various assertions?
• interpret an assertion?

In the next study unit, we will discuss audit evidence.

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13 STUDY UNIT 13

13 AUDIT EVIDENCE

IN THIS STUDY UNIT WE ARE GOING TO

•• discuss the nature, reliability, sufficiency and relevance of audit evidence
•• recognise the various sources of audit evidence
•• explain audit evidence which can be collected through tests of controls and
substantive procedures

13.1 INTRODUCTION
In the previous study unit we learned about management’s assertions embedded
in the AFS prepared for the shareholders and that the auditors must express an
opinion on these AFS. As stated in Jackson & Stent (2016:5/20), before the audi-
tor can express an opinion, evidence must be collected and examined to support
his/her opinion. You cannot just grab an opinion out of thin air. The day-to-day
activities of the auditor is collecting and examining evidence. If you ask me how
I picture an auditor, I would say a person with a formal wardrobe carrying a huge
magnifying glass!

In this study unit we will be examining audit evidence. Audit evidence has to com-
ply with certain criteria to be of any value.

13.2 SUFFICIENT APPROPRIATE AUDIT EVIDENCE

In Jackson & Stent (2016:5/20) reference is made to ISA 500 – Audit evidence.
This international auditing standard defines the objective of audit evidence as
follows: “The objective of the auditor is to design and perform audit procedures
in such a way as to enable the auditor to obtain sufficient, appropriate audit
evidence to be able to draw reasonable conclusions on which to base the audi-
tor’s opinion.” If audit evidence is not sufficient then the auditor may not draw a
conclusion. If audit evidence is not appropriate then the auditor may not draw a
conclusion. So, what do these two terms mean?

78
 STUDY UNIT 13: Audit evidence

DIAGRAM 10: SUFFICIENT APPROPRIATE EVIDENCE

Audit Evidence

Sufficient evidence Appropriate evidence

Relates to the quantity of Relates to the quality of
audit evidence gathered audit evidence gathered

Reliability Relevance
There is a hierarchy of Relevance to the
reliability for audit evidence assertion being audited

We are going to examine the above diagram in more detail.

13.2.1 Sufficient evidence

STUDY

Jackson & Stent (2016:5/20) – Sufficient evidence

ACTIVITY 13.1

Complete the following statements/questions:

• The sufficiency of audit evidence relates to the of audit evidence.
• Can one expect the auditor to examine all the evidence of a client? Yes/No
Substantiate your answer.
• The quantity of audit evidence relates to the of testing which is
a of the audit plan.

13.2.2 Appropriate evidence

STUDY

Jackson & Stent (2016:5/21) – Appropriate evidence

ACTIVITY 13.2

Complete the following statements/questions:

• The appropriateness of audit evidence relates to the of evidence.
This can be further broken into the of the evidence and the
of the evidence to the assertion which is being audited.
• Select the most reliable source of evidence.
A. The director tells you that equipment was purchased from Limpopo
Pumps for R120 000 on 1 September 20XX.

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TOPIC 4: THE EXTERNAL AUDITOR

B. You examine the tax invoice reflecting the information of the purchase
of the pump.
• Relevance of audit evidence means that it is relevant to the which
is being audited.

ACTIVITY 13.3

The following activity is very important for you to see how assertions and rel-
evance of audit evidence works. The following is an example of a credit sales
invoice issued by the company Africa Computers Ltd for commodities sold by
the company on credit.

Africa Computers Ltd

Tax invoice
INV 1001
Date: 30 May 20XX
Africa Computers Ltd
PO Box 1234
Polokwane
To Vendor:
B Beautiful
PO Box 25031
Durban

Description Quantity Price Total

Laptop computers 2 13 500 27 000.00

Genius mouse 1 100 100.00

Envelopes 1 125 125.00

Debtors statements 1 370 370.00

Total 27 595.00

Approved by: H Moale VAT 3 863.30

Received by: B Beautiful
Paid 31 458.3

Required:
Describe how the information shown on the above credit sales invoice could be
used by the company auditor in support of the following assertions:
(a) Occurrence
(b) Completeness
(c) Accuracy
(d) Cut-off
(e) Classification
(f) Presentation

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 STUDY UNIT 13: Audit evidence

SUGGESTED SOLUTION 13.3

Reference: Jackson & Stent (2016:5/21)

Information on the credit sales invoice that can be used by the company’s auditor
in support of the assertions.

(a) Occurrence
• By inspecting the sales journal to see whether the sales invoice has been
recorded, the auditor obtains an indication that the transaction actually took
place.
• By inspecting to see that the name of XY Ltd does appear on the invoice and
that the name of the other party to the transaction (B Beautiful) was correctly
accounted for in the accounting records, the auditor can satisfy him or herself
that a valid transaction was concluded between the two parties.
• By inspecting that the responsible person authorised the transaction under his
or her signature, the auditor gets assurance that the transaction did actually
take place.
• Inspecting to see whether the other party signed for the receipt of the goods
provides an additional assurance that a valid transaction did actually occur.

(b) Completeness
• By inspecting the date on the sales invoice, the auditor can ensure that the
transaction was recorded at the time it was carried out.
• By inspecting the sequential recording of sales invoices and ensuring that the
number of the sales invoice in question has been sequential accounted for,
the auditor can ensure that all the sales invoices have been recorded in the
accounting records.

(c) Accuracy
• By recalculating the accuracy of the calculation of quantities and prices on
the sales invoice and also checking the addition of the amounts on the invoice
and the resultant total, the auditor is able to satisfy him or herself about the
amount (value) of the transaction.
• By inspecting that the total amount of the invoice has been accounted for in
the accounting records, the auditor is able to satisfy him or herself that the
transaction was recorded at the correct amount.

(d) Cut-off
• By comparing the date on the invoice with the date of recording in the accounting
records, the auditor can obtain satisfaction that the transaction was accounted
for in the correct accounting period.

(e) Classification
• By inspecting that the transaction has been correctly allocated in the accounting
records according to the particulars that appear on the sales invoice (credit
sales), it is possible to obtain satisfaction that the sales transaction was correctly
classified in the sales journal.
• By inspecting that the sales invoice has been posted to the correct ledger
account and that the total of the credit sales account has been correctly
reflected in the trial balance, the auditor can satisfy him or herself that the
sales transaction has been correctly classified in the accounting records.

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TOPIC 4: THE EXTERNAL AUDITOR

(f) Presentation
• Although this cannot be determined from inspection of the credit sales invoice
alone, sales are eventally appropriately aggregated or disaggreated and
clearly described as turnover in the AFS. The accounting policies to account
for turnover is set out as an understandable note in the AFS.

13.3 SOURCES OF AUDIT EVIDENCE

Where does the auditor find audit evidence? Think of a business. You have the
accounting records, for example the purchases journal and the general ledger.
You have the source documents generated by the business used to initiate trans-
actions for example the order and goods received note. You have the documents
provided by third parties, for example the invoice and bank statements. You have
evidence generated by personnel of the business, for example budgets and ratio
analysis. Minutes of meetings and explanations by management are also examples
of audit evidence. That is why the concept of reliable evidence is so important.

13.4 AUDIT PROCEDURES FOR OBTAINING AUDIT

EVIDENCE
We know the criteria for good audit evidence. We know the sources of audit evi-
dence. We now have to examine the audit procedures for obtaining audit evidence.

STUDY

Jackson & Stent (2016:5/22) – Audit procedures for obtaining audit evidence

ACTIVITY 13.4

Drawing reasonable conclusions on which to base the auditors’ opinion is ob-

tained by performing audit procedures. The following entails the audit procedures
followed by the auditor to obtain audit evidence:

Step 1: The auditor performs a risk assessment to determine where to focus.

Step 2: The auditor performs “further” audit procedures and this entails:
A. and
B.
We will focus on the above steps in more detail in Study Unit 14.

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 STUDY UNIT 13: Audit evidence

13.5 SUMMARY AND SELF-ASSESSMENT

In this study unit you learned about the nature, reliability, sufficiency and relevance
of audit evidence, and how audit evidence is obtained through test of controls
and substantive procedures.

Refer to your notes you made in your workbook after completing the following
activities.

Activity 13.1
Activity 13.2
Activity 13.3
Activity 13.4

After having worked through the study unit and the references to the prescribed
study material, are you be able to
•• discuss the nature, reliability, sufficiency and relevance of audit evidence?
•• recognise the various sources of audit evidence?
•• explain audit evidence which can be collected through test of controls and
substantive procedures?

In the next study unit we are going to look at two important auditing concepts,
namely materiality and audit risk.

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14 STUDY UNIT 14

14 MATERIALITY AND AUDIT RISK

IN THIS STUDY UNIT WE ARE GOING TO

discuss materiality and audit risk and the relationship between them

14.1 INTRODUCTION
Materiality and audit risk are the auditor’s magic formulas. In this study unit you
are going to learn how auditors think when collecting audit evidence. If a busi-
ness was small and there were no costs involved in auditing then one could have
audited each and every transaction and certify (opposed to fairly present) the
annual financial statements. But in practice this cannot happen. Imagine if the
auditors were to examine each and every transaction of Standard Bank – you
will never see the audit report because their work will never end! With the limited
resources on the one hand and reporting on the fair presentation of the annual
on the other, one can expect a formula to reach a balance. That is exactly where
materiality and audit risk plays a vital role in the daily life of the auditor.

Users of the AFS want to be satisfied that the audited financial statements on
which they are relying, are free of material misstatement and their reliance is an
implied acceptance that the auditor has performed his or her function properly.
However, there is always the risk that the auditor will “get it wrong” and give an
incorrect opinion. Therefore the auditor must plan and perform audit procedures
so they do not get it wrong. In other words the auditor must plan and perform
audit procedures so that the audit risk is at an acceptable level. We will first be
looking at the term materiality and then the term audit risk and how these con-
cepts make up the magic formula.

14.2 MATERIALITY
If you search the word “material” in this study unit you would notice that it ap-
peared several times. What does this term mean? Let’s take an practical example.
Assume you are a waiter at a restaurant and the practice is that if you serviced
your guests well you would probably earn a gratuity (tip) of 10% of the account
value. Assume the bill of the table you served was R1 200. How would you feel if
the client added a tip of R115 instead of your expected R120? You would probably
think it’s okay. On the other hand, how would you feel if they left you with only a
R10 note? Your reaction would now be different. What we are effectively saying
is that the R5 difference in the tip was immaterial – it resulted in no emotions.
However, undertipping of R110 becomes material and you would feel cheated.

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 STUDY UNIT 14: Materiality and audit risk

STUDY

Jackson & Stent (2016:7/22) – Introduction

ACTIVITY 14.1

Define the term materiality in an auditing context.

SUGGESTED SOLUTION 14.1

Refer to Jackson & Stent (2016:7/22) for the definition of materiality in an audit-
ing context.

Note that your answer should refer to:

• an omission or misstatement
• the influence of such an omission or misstatement on the economic decisions
of users/shareholders
• based on the information in the financial statements

14.3 AUDIT RISK

What is audit risk?

INTERNET ACTIVITY 14.1

To orientate yourself go to the following link and watch the explanation of audit risk:
https://www.youtube.com/watch?v=Ry7dmbUnNLo

Audit risk is the risk that the auditor will express an inappropriate opinion when the
financial statements are materially misstated. As illustrated in diagram 9 below,
audit risk has three elements, namely control risk (that which management does
– Study Unit 3); inherent risk (a weakness or exposure to error), and detection
risk (that which the auditor does and controls).

Study the diagram in Jackson & Stent (2016:7/6-7/7) and note the differentition
between risk of material misstatement and detection risk to form audit risk.

14.4 THE COMPONENTS OF AUDIT RISK

Let us begin by understanding and describing the components of audit risk.

STUDY

Jackson & Stent (2016:7/5–7/7)

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TOPIC 4: THE EXTERNAL AUDITOR

14.4.1 Inherent risk

ACTIVITY 14.2

Define the term inherent risk.

SUGGESTED SOLUTION 14.2

Inherent risk is the susceptibility of an account balance or class of transactions

to misstatements that could be material, either individually or when aggregated
with misstatements in other balances or classes of transactions, assuming that
there were no related internal controls.

• What does susceptibility mean? (Use a dictionary.)

• Provide three examples of inherent risk.

Example 1: complex lease agreement calculations compared to a cash purchase

Example 2:
Example 3:

14.4.2 Control risk

ACTIVITY 14.3

Define the term control risk by completing the sentence:

Control risk is the risk that a misstatement that could occur in an account bal-
ance or class of transactions that could be material, either individually or when
aggregated with misstatements in other balances or classes of transactions, will
not be prevented

Describe control risk in your own words.

When considering control risk one must remember that internal controls do have
their own limitations. In Study Unit 3 we examined the inherent limitations of inter-
nal control. To refresh your memory, list six limitations inherent to internal control.

1. Cost versus benefit

2.
3.
4.
5.
6.

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 STUDY UNIT 14: Materiality and audit risk

14.4.3 Detection risk

ACTIVITY 14.4

Define the term control risk by completing the sentence:

Detection risk the is risk that the auditors will not

detect a misstatement that exists in an account balance or class of transactions
that could be material, either individually or when aggregated with misstatements
in other balances or classes of transactions.
• Detection risk relates to the , timing and of
the auditor’s procedures.
• Who is in control of detection risk?
• List five examples how the auditor constructively reduce detection risk.
(1) by complying with the relevant International Standards of Auditing
(2) sound planning
(3)
(4)
(5)

14.5 RELATIONSHIP BETWEEN THE DIFFERENT

COMPONENTS OF AUDIT RISK
Understanding the relationship of AR = (IR + CR) + DR is the ultimate goal of
this study unit.

STUDY

Jackson & Stent (2016:7/5–7/7)

ACTIVITY 14.5

During your planning of the audit of Laduma (Pty) Ltd, you assessed the pre-
liminary reliance that could be placed on the company’s internal controls as low.
Explain the influence of your preliminary reliance on the internal controls on
your assessment of control risk and the impact on the test of controls, as well as
substantive procedures which you should carry out.

SUGGESTED SOLUTION 14.5

Reference: Jackson & Stent (2016:7/5)

Control risk would be rated as high, as you can place less reliance on the com-
pany’s internal control systems. The auditor is compelled to accept a lower level
of detection risk. In order to achieve this, the auditor would have to increase the
extent of his or her substantive procedures.

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TOPIC 4: THE EXTERNAL AUDITOR

14.6 SUMMARY AND SELF-ASSESSMENT

In this study unit you learned about the nature of materiality and audit risk, as
well as the relationship between materiality and audit risk.

Refer to your notes you made in your workbook after completing the following
activities.

Activity 14.1 Internet Activity 14.1

Activity 14.2
Activity 14.3
Activity 14.4
Activity 14.5

After having worked through the study unit and the references to the prescribed
study material, are you able to:
•• discuss materiality and audit risk and the relationship between them?
In the next study unit we will discuss how the auditor can identify and assess the
risks of material misstatement.

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15 STUDY UNIT 15

RISK ASSESSMENT AND FURTHER AUDIT

15

PROCEDURES

IN THIS STUDY UNIT WE ARE GOING TO

•• explain risk assessment procedures to assess the risk of material misstatement
•• explain test of controls and substantive procedures as further audit procedures

15.1 INTRODUCTION
Without knowing it you are performing risk assessment procedures daily and
you act according your assessment of the risk. I too was a student once, so let’s
look at this example to illustrate the point. When studying for an examination you
want to pass – passing is your objective (for the auditor = audit report). You have
limited time. What do you do? You identify the topics that you think the examiner
would most likely assess in the examination and focus on those areas (auditor =
risk assessment). If you identified the wrong topics then you fail. (auditor = inap-
propriate or wrong audit opinion i.e. audit risk). You have control over what you
study. The auditor has control over their audit procedures (auditor = detection
risk). To reduce your audit risk or examination risk, what do you do? You master
more study units! Thereby you are reducing your chances of failure. Think of any
other aspects in your life where you are in fact assessing risk, acting thereon to
manage that risk to meet your objective. Do you see the auditing principles are
not that complex as you thought?

In this study unit we are going to examine how the auditor obtains audit evidence
by performing risk assessment procedures and then performing “further audit
procedures” to reduce audit risk. Further audit procedures comprise tests of
control and substantive procedures.

15.2 UNDERSTANDING THE CONTEXT OF RISK

ASSESSMENT PROCEDURES
The following diagram is a simplified overview of identifying and assessing the
risks of material misstatements. Use the diagram when reading the following
study text.

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TOPIC 4: THE EXTERNAL AUDITOR

DIAGRAM 11: OVERVIEW OF THE RISK ASSESSMENT PROCESS

The auditor:

Understand the business

allows

Identify areas of material misstatements

broad focus

Determine materiality

specific focus

Plan audit procedures and sample sizes

field work

Collect audit evidence

auditor evaluates evidence

Problems identified?

NO YES

Focus on
specific areas

More audit
procedures

Conclude

Reference: Jackson & Stent (2016:7/7)

ACTIVITY 15.1

Define the objective of the auditor.

SUGGESTED SOLUTION 15.1

Reference: Jackson & Stent (2016:7/7): Introduction paragraph

The objective of the auditor is to identify

, whether due to fraud or error at the
through the entity and its ,

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 STUDY UNIT 15: Risk assessment and further audit procedures

including the entity’s , thereby providing a basis for

to the assessed risks of
.

ACTIVITY 15.2

Why is understanding of the client’s business so important to the auditor?

SUGGESTED SOLUTION 15.2

Reference: Jackson & Stent (2016:7/7): Introduction paragraph

Without proper understanding of the client’s business the auditor is not able to
identify and assess the .

15.3 CONDITIONS AND EVENTS THAT MAY INDICATE RISKS

OF MATERIAL MISSTATEMENTS
The list that you are going to study may become very important in your accounting
career. This will help develop an instinct to know that something may be wrong
and needs to be investigated.

STUDY

Jackson & Stent (2016:7/8)

ACTIVITY 15.3

List the 15 conditions and events that may indicate a risk of material misstatement.

REFLECTION 15.1

Next to each item consider/argue why you think that the condition and event may
indicate a risk of material misstatements.

15.4 RISK ASSESSMENT PROCEDURES

How does the auditor go about to gather information about the client to identify
and assess risks of material misstatements? Study Jackson & Stent (2016:7/9).

ACTIVITY 15.4

List methods used by the auditor to obtain useful information about the client.

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TOPIC 4: THE EXTERNAL AUDITOR

SUGGESTED SOLUTION 15.4

Reference: Jackson & Stent (2016:7/9)

(1) Client acceptance of continuance procedures

(2) .
(3) .
(4) .
(5) .
(6) .
(7) Discussion among the audit team
(8)

ACTIVITY 15.5

Give an example of using the inspection procedure to obtain information about

the client.

SUGGESTED SOLUTION 15.5

Reference: Jackson & Stent (2016:7/10)

Along with enquiry, inspection will be a major provider of information in gaining

an understanding of the entity. At this stage of the audit, we are not carrying
out a detailed inspection of “everyday” documents such as sales invoices or
purchase orders. This is more likely to be a detailed review of the following kinds
of documents:
• Business plans and strategies
• Internal control procedure manuals, flow charts, organisational charts
• Management reports, minutes of board meetings and board committee meetings
• The company’s integrated report and prior year financial statements
• Relevant trade and financial journals and internet sites
• Important contracts

15.5 FURTHER AUDIT PROCEDURES

Activities 15.4 and 15.5 were examples of how the auditor obtains information
to understand the business in order to identify the areas of material misstate-
ments (risk assessment procedures). Once this stage is completed the auditor is
ready to do the audit field work, referred to in auditing literature as “further audit
procedures”. We are going to look at what these further audit procedures entail.

Examine diagram 12. You will notice that there are two main types of audit
procedures. Tests of controls enables the auditor to determine if he/she can rely
on the internal controls implemented by management. If the outcome of the tests
of controls is positive it means that the auditor can rely on the internal controls.
Substantive procedures are procedures that test assertions e.g. completeness,
accuracy, etc. Substantive procedures consist of analytical procedures and tests
of detail.

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 STUDY UNIT 15: Risk assessment and further audit procedures

DIAGRAM 12: THE NATURE OF FURTHER AUDIT PROCEDURES

Main classes of
further audit
procedures

Test of control Substantive procedures

Testing an internal Audit procedure designed
control measure to detect material
throughout the period misstatement at the
of reliance assertion level

Tests designed to evaluate

the operating effectiveness
of controls in preventing Tests of detail of:
or detecting and correcting Analytical - classes of transactions
material misstatements procedures - account balances
at the assertion level - disclosures

STUDY

Jackson & Stent (2016:5/25–5/29)

Note that the the procedures of inspection, observation, external confirmation,
recalculation, reperformance, analytical procedures and inquiry are to be used
when performing risk assessment procedures, carrying out test of controls or
carrying out substantive procedures.

ACTIVITY 15.6

Define test of controls.

Reference: Jackson & Stent (2016:5/27)

SUGGESTED SOLUTION 15.6

Test of controls are performed to obtain evidence of whether controls are

material misstatements and these
controls operated effectively throughout the period being audited.

ACTIVITY 15.7

Is it possible to only perform tests of controls?

SUGGESTED SOLUTION 15.7

Reference: Jackson & Stent (2016:5/27–5/28)

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TOPIC 4: THE EXTERNAL AUDITOR

No, even if the auditor finds that the accounting system and related control activi-
ties are excellent, he or she must realise that
• all internal control systems have inherent limitations which make them less
than 100% efficient (see study unit 3)
• the internal control system may have been excellent at the time the auditor
performed his/her tests but not at other times during the year
• there will still be inherent risk to consider

Successful test of controls will reduce the extent, and possibly change the nature
of substantive tests, but cannot eliminate the need to perform substantive tests.

ACTIVITY 15.8

Define the term substantive procedures.

SUGGESTED SOLUTION 15.8

Reference: Jackson & Stent (2016:5/28)

Substantive procedures may be broadly distinguished as and

procedures. Substantive procedures seek to provide evi-
dence to support the financial statement .

ACTIVITY 15.9

Describe why the auditor performs substantive procedures?

SUGGESTED SOLUTION 15.9

Reference: Jackson & Stent (2016:5/28)

Substantive procedures seek to provide evidence to support the financial state-

ment assertions. When performing substantive tests the auditor is interested in
the following:
• Balances
•
•

ACTIVITY 15.10

Explain the types of procedures that can be used for carrying out risk assess-
ment procedures, tests of controls and substantive tests.

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 STUDY UNIT 15: Risk assessment and further audit procedures

SUGGESTED SOLUTION 15.10

Reference: Jackson & Stent (2016: 5/26)

Essentially the procedures that the auditor carries out during risk assessment or
when testing controls or performing substantive tests are described as follows:
• Inspection: involves examining records or documents, whether internal or
external, in paper form, electronic form or other media, or a physical examination
of an asset.
• Observation: consists of looking at a process or procedure being performed
by others, or at the performance of control activities.
• External confirmation: obtaining a direct written response from a third party
to a request/query from the auditor to that third party in paper form or by
electronic or other medium.
• Recalculation: consists of checking manually or electronically, the mathematical
accuracy of documents or records.
• Reperformance: involves the auditor’s independent execution of procedures
or controls that were originally performed as part of the entity’s internal control.
• Analytical procedures: evaluating financial information through analysis of
plausible relationships among both financial and non-financial information.
• Inquiry: seeking information of knowledgeable persons, both financial and
non-financial, within the entity or outside the entity.

It is not possible to categorise each of the above procedures as simply either

a risk assessment procedure, a tests of controls procedure or a substantive
procedure. The procedure will be categorised in terms of what the auditor is try-
ing to achieve, therefore the objective.

Refer to the following example to explain this.

Example 1 (Jackson & Stent 2016:5/26)
• Inquiry – risk assessment
The auditor inquires of the head of internal audit as to his assessment of the
likelihood of material misstatement of inventory.

What is the objective of this procedure?

To gather information about the client so that the identification and assessment
of risks of material misstatement at the financial statement and assertions level
can take place.

• Inquiry – test of controls

The auditor inquires of the credit controller as to exactly what functions each
member of her department carries out and what control procedures are in place.

What is the objective of this procedure?

To determine how the internal control measure in question should be evaluated.

• Inquiry – substantive test

The auditor makes inquiries of the factory manager as to the impairment writ-
edowns for a particular machine.

What is the objective of this procedure?

To obtain audit evidence to detect material misstatements in the financial state-
ments relating to the valuation of machinery.

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TOPIC 4: THE EXTERNAL AUDITOR

15.6 SUMMARY AND SELF-ASSESSMENT

In this study unit we discussed risk assessment procedures, tests of controls
and substantive procedures and why should they be performed by the auditor.

Refer to your notes you made in your workbook after completing the following
activities.

Activity 15.1 Reflection 15.1

Activity 15.2
Activity 15.3
Activity 15.4
Activity 15.5
Activity 15.6
Activity 15.7
Activity 15.8
Activity 15.9
Activity 15.10

After having worked through the study unit and the study references are you able to:
•• explain risk assessment procedures to assess the risk of material misstatement?
•• explain test of controls of controls and substantive procedures as further audit
procedures?

In the next topic we are going to look at steps in performing an audit, that is, the
audit process.

96
TOPIC 5
The audit process

Study unit 16
The overall audit process 99

Study unit 17
Planning and implementing the plan 105

Study unit 18
Reaching conclusion and reporting 112

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TOPIC 5: THE AUDIT PROCESS

TOPIC OVERVIEW

In this topic we are going to examine the stages of performing an audit. In litera-
ture this is referred to as the audit process. What are the steps that you follow
everyday from the time you wake up until you go to bed? Similar to your routine,
the auditor also follows certain steps in the conduct of an audit.

This topic is divided into the following study units:

Study unit Title Page

16 The audit process 99

17 Planning and implementing the plan 105
18 Reaching conclusions and reporting 112

Textual amendments and additions

Before you proceed with the study of this topic, please refer to Tutorial Letter 102
for this module to acquaint yourself with any textual amendments and additions
that have been indicated.

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16 STUDY UNIT 16

16 THE OVERALL AUDIT PROCESS

IN THIS STUDY UNIT WE ARE GOING TO

• describe the stages of the audit process that an auditor would follow to complete
an audit

16.1 INTRODUCTION
In this study unit we will introduce you to the audit process and the stages within
each process. This will give you a very good idea of what happens in the conduct
of an audit.

16.2 THE AUDIT PROCESS

STUDY

Jackson & Stent (2016:6/6)

The diagram in the above study reference gives a bird’s eye view of the audit
process. Study the diagram and notice that there a four stages and various activi-
ties within each stage. Let us begin with an overview of the process as described
in the diagram below (based on Jackson & Stent 2016:6/6). The auditor has to
decide whether or not to accept the audit. Once the audit engagement has been
accepted, the audit has to be very carefully planned. The audit risk is assessed
and further audit procedures are carried out. The auditor evaluates the audit
evidence and concludes and issues the appropriate audit report.

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TOPIC 5: THE AUDIT PROCESS

DIAGRAM 13: STAGES OF THE AUDIT PROCESS

Preliminary
engagement activities

Planning

Responding to
assessed risk

Concluding stage

Now let’s compare the stages of the audit process to the stages of your studies.
Notice the similarities!

Audit stages Studying stages

Preliminary engagement Apply for registration.

activities

Planning activities Planning of assignment dates, study unit allo-

cation in calendar, do activities, self-reflection
activities etc.

Responding to assessed In your case, you study everything!

risk

Concluding stage Revise your notes in your workbook; textbook

and study guide.
Consider what you know and which areas need
more attention.
Write the exam.
Get the results.

Now that you have been introduced to the audit process let’s study this follow-
ing section in detail. Bear in mind that the stages of the audit process are not
“standalone units” but interrelated and dependent on each other (Jackson &
Stent 2016:6/6).

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 STUDY UNIT 16: The overall audit process

STUDY

Jackson & Stent (2016:6/6-6/8) – The audit process

This section will allow you to complete all of the activities unless an additional
study reference is provided.

16.3 THE PRELIMINARY STAGE

As stated in Jackson & Stent (2016:6/6) this stage consists of preliminary en-
gagement activities which take place before an audit engagement is accepted.

DIAGRAM 14: THE ACTIVITIES INVOLVED IN THE PRELIMINARY

ENGAGEMENT STAGE

Assess the
Prospective
firm’s
clients/ Consider Formulate
competence
continuance ethical terms of
and
with an requirements engagement
availability of
existing client
resources

ACTIVITY 16.1

Preliminary stage: List the aspects considered by the auditor in the preliminary
stage of an audit.

SUGGESTED SOLUTION 16.1

Reference: Jackson & Stent (2016:6/6–6/7)

(1) Establishing whether any pre-conditions for an audit are present.

(2)
(3)
(4)
(5)

REFLECTION 16.1

Do you notice that an auditor cannot just accept any client?

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TOPIC 5: THE AUDIT PROCESS

STUDY

Jackson & Stent (2016:6/3) – Acceptance of client relationships

ACTIVITY 16.2

List the three key aspects that an engagement partner must continuously evalu-
ate before accepting or continuing an existing client relationship.

SUGGESTED SOLUTION 16.2

(1) The integrity of the principle owners, key management and those charged
with governance of the entity
(2)
(3)

Note that the preliminary engagement activities do not apply to internal auditors.
Internal auditors will gain an understanding of the division he or she is going to
audit. Internal auditors cannot choose whether they wish to accept an audit or
not, as they are employees of the company.

DISCUSSION 16.1

E-tutor assistance required

Consider the following questions and post your thoughts about any of them on
the discussion forum provided for the purpose. If you do not post your own idea,
you have to respond constructively to a post by another student.
• Discuss why the preliminary stage of an audit is important.
• Provide practical examples of possible mishaps that can be avoided with a
properly implemented preliminary stage.
• Describe possible reasons why an audit firm may not wish to accept an audit
engagement.

16.4 THE PLANNING STAGE

ACTIVITY 16.3

Planning stage: List the aspects considered by the auditor in the planning stage
of an audit.

SUGGESTED SOLUTION 16.3

Reference: Jackson & Stent (2016:6/7)

(1) Establishing an audit strategy.

(2)
(3)

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 STUDY UNIT 16: The overall audit process

(4)
(5)

DISCUSSION 16.2

E-tutor assistance required

Consider the following questions and post your thoughts about any of them on
the discussion forum provided for the purpose. If you do not post your own idea,
you have to respond constructively to a post by another student.

Discuss why the planning stage of an audit is important.

Provide practical examples of possible mishaps that can be avoided with a prop-
erly planning stage.

16.5 RESPONDING TO ASSESSED RISK STAGE

ACTIVITY 16.4

Responding to assessed risk stage: List the aspects considered by the auditor
in the responding to assessed risk stage of an audit.

SUGGESTED SOLUTION 16.4

Reference: Jackson & Stent (2016:6/8)

(1) Respond in a general sense at financial statement level.

(2)
(3)

16.6 CONCLUDING STAGE

ACTIVITY 16.5

Concluding stage: List the aspects considered by the auditor in the concluding
stage of an audit.

SUGGESTED SOLUTION 16.5

Reference: Jackson & Stent (2016:6/8)

(1) Evaluate and conclude on the audit evidence gathered.

(2)

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REFLECTION 16.2

In this study unit you have been introduced to the four stages of the audit process.
Go to your workbook and create your own spider diagram that connects all the
elements of each stage so that you create your own bigger picture.

Google “spider diagram” and look at examples of images of spider diagrams. Be

creative and design your own unique spider diagram. Use colours if you want to.
If you complete this study unit properly then this is all you need to learn when
revising for the exams!

16.7 SUMMARY AND SELF-ASSESSMENT

In this study unit we discussed the overall audit process and how it assists the
auditor to achieve his or her objectives.

Refer to your notes you made in your workbook after completing the following
activities.

Activity 16.1 Discussion 16.1 Reflection 16.1

Activity 16.2 Discussion 16.2 Reflection 16.2
Activity 16.3
Activity 16.4
Activity 16.5

After having worked through the study unit and the study references are you able to:
• describe the stages of the audit process that an auditor would follow to complete
an audit?

In the next study unit, we will discuss the planning and implementing of the plan.

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17 STUDY UNIT 17

17 PLANNING AND IMPLEMENTING THE PLAN

IN THIS STUDY UNIT WE ARE GOING TO

• explain the planning of an audit
• explain how the plan is implemented

17.1 INTRODUCTION
In Study Unit 16.4 we looked at the steps in planning an audit. In this study unit,
we are going to expand on the planning stage of an audit. We need to understand
why planning is important and how the plan is implemented. Planning is a concept
that we need to apply in our daily lives. Again this illustrates that auditing is not
as abstract as students perceive it to be. View this short motivational clip https://
www.youtube.com/watch?v=RZ45Rlu_TS8 to illustrate the point.

17.2 IMPORTANCE OF PLANNING

REFLECTION 17.1

Why would you say planning is so important for the auditor?

Remember: the auditor wants to express an opinion on the fairness of an entity’s

annual financial statements. On the one hand the auditor does not want to be held
liable for negligence. Time is limited. On the other hand the auditing practice is
a business and the partners want to make a profit. Therefore, balancing the two
extremes’ effectiveness is the deciding factor (Jackson & Stent 2016:6/13). The
auditor must be smart and therefore aim to plan and perform an audit effectively.

INTERNET ACTIVITY 17.1

Google the word “effective” and write down its meaning in your workbook.

Effective Meaning:

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17.3 PLANNING
In this section we begin by looking at the importance of the planning of the audit.
Then we look at the overall audit strategy. This section is followed by the charac-
teristics and matters to be considered in formulating the audit strategy. Finally,
we look at the audit plan itself.

STUDY

Jackson & Stent (2016:6/13–6/15) – Planning

If you work through the above study reference you will be able to do all the activities.

17.3.1 Importance of planning an audit

ACTIVITY 17.1

Explain why it is important to plan an audit.

SUGGESTED SOLUTION 17.1

Reference: Jackson & Stent (2016:6/13) – Introduction

(1) To ensure that appropriate attention is devoted to important areas of the

audit (significant risk).
(2) To
(3) To assemble a competent and capable audit team (experts).
(4) To
(5) To

REFLECTION 17.2

Do you notice the above answer fits into the definition of the word effectiveness?

17.3.2 Difference between the overall audit strategy and the audit plan
As stated in Jackson & Stent (2016:6/15), the audit strategy and audit plan are
interlinked, but the audit plan is far more detailed than the overall strategy. The
audit strategy focuses on the bigger picture of the client and based on that the
audit plan focusses on the nitty gritty of the audit.

The objective of the overall audit strategy is to set the scope, timing and direc-
tion of the audit and to guide the development of the audit plan (Jackson & Stent
2016:6/14). Let us look at these terms to understand the objective better.

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 STUDY UNIT 17: Planning and implementing the plan

INTERNET ACTIVITY 17.2

Google the word “scope” and write down its meaning in your workbook.

Scope Meaning:

17.3.3 Characteristics and matters to be considered in formulating the audit

strategy

17.3.4 Characteristics of the engagement which define its scope

ACTIVITY 17.2

List four characteristics that define the scope of an audit engagement.

SUGGESTED SOLUTION 17.2:

Reference: Jackson & Stent (2016:6/14)

(1) The financial reporting standards applicable to the client

(2) The number of branches and locations of the client
(3) The specialised knowledge required to do the audit
(4) The effect of IT on the client

REFLECTION 17.3

Do you notice the above answer fits into the definition of the word scope?

Let us now look at time and direction. Direction in this context means the focus.

17.3.5 Matters to be considered in formulating the audit strategy

ACTIVITY 17.3

List the factors that define the timing and direction of an audit engagement.

SUGGESTED SOLUTION 17.3

Reference: Jackson & Stent (2016:6/14)

(You may add more to the list by referring to your prescribed activity text)

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TOPIC 5: THE AUDIT PROCESS

Timing Direction (focus)

1. The financial year-end 1. Account headings

2. Interim statements 2. High risk areas
3. Scheduled meetings with audit committee 3. Discussions with managers
4. Reporting deadlines

From the above activities you should have formed a good idea what an audit strategy is
all about. We are now going to look at the audit plan. Remember we said the strategy
provides the auditor with the big picture and the audit plan then goes into the detail.

17.3.6 The audit plan itself

ACTIVITY 17.4

What aspects must the audit plan contain?

SUGGESTED SOLUTION 17.4

Reference: Jackson & Stent (2016:6/15)

The audit plan must contain:
• a description of the nature, timing and extent of planned risk assessment
procedures, sufficient to assess the risks of material misstatement
• a description of the nature, timing and extent of planned further audit
procedures at the assertion level for each material class of transactions,
account balance and disclosure
• any other audit procedures which may be required to comply with the ISAs

17.4 PLANNING AND CONDUCTING RISK ASSESSMENT

PROCEDURES
Planning and conducting risk assessment procedures happen at two levels,
namely at the financial statement level and at the assertion level.

STUDY

Jackson & Stent (2016/15-6/17) – Planning and conduction risk assessment

procedures

17.4.1 Risk at financial statement level

ACTIVITY 17.5

Describe the concept of risk at financial statement level.

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 STUDY UNIT 17: Planning and implementing the plan

SUGGESTED SOLUTION 17.5

Reference: Jackson & Stent (2016:6/16)

Risk at the financial statement level is the risk which affects
which make up the financial statements.

An example of risk at financial statement level is if the client’s management

lacks integrity, the audit as a whole is inherently more risky than for the audit of
a client whose management has a proven record of integrity. The effect of man-
agement’s lack of integrity may filter down into the financial statements as they
attempt to manipulate the account balances and totals to suit their own purposes.

What does the auditor do when he/she assesses that the risk of material mis-
statement exists at the financial statement level?

ACTIVITY 17.6

Describe the auditor’s overall response to assessed risk of material misstate-

ments at the financial statement level.

SUGGESTED SOLUTION 17.6

Reference: Jackson & Stent (2016:6/21)

Overall responses may be summarised as follows:

• Emphasise professional scepticism.
• Assign more experienced staff with special skills or use experts.
• Provide more supervision.
• Incorporate elements of unpredictability into the audit procedures adopted (do
things in a manner which the client may not expect), e.g. surprise visits to client.
• Make general changes to the nature, timing and extent of audit procedures
conducted in the past.

REFLECTION 17.4

Do you notice that the way in which the auditor adjusts to risk assessment will
affect the audit plan?

17.4.2 Risk at assertion level

ACTIVITY 17.7

Describe the concept of risk at assertion level.

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SUGGESTED SOLUTION 17.7

Reference: Jackson & Stent (2016:6/17)

Risk at the assertion level relates to the risk of material misstatement at assertion
level for classes of , and .

An example of risk at assertion level is inclusion of sales which have not actu-
ally occurred or which do not pertain to the entity i.e. the occurrence assertion
relating to a class of transaction.

17.4.3 Response to assessed risk

What does the auditor do when he/she finds risk to exist during the planning
stage of the audit?

The answer is to plan further audit procedures. This will entail developing a plan
which describes the nature, timing and extent of further audit procedures, both
tests of control and substantive tests, which will be conducted to reduce the risk
of material misstatement relating to the assertions remaining undetected. Diagram
15 explains the auditor’s response to assessed risk.

DIAGRAM 15: AUDITOR’S RESPONSE TO ASSESSED RISK

Auditor’s response to
assessed risks

Response to assessed risks:

Auditor to design and perform further
Overall responses:
audit procedures whose nature, timing
Auditor to design and implement overall
and extent are based on the assessed
responses to address the assessed risks
risks of material misstatement at the
of material misstatement at the financial
assertion level for each class of
statement level
transaction, account balance or
disclosure

General actions include the following:

- assign more experienced staff with
Audit procedures:
special skills
The auditor must respond to the risks by
- assign experts
ensuring that the nature, timing and
- emphasise to the audit team the
extent of tests of control and substantive
importance of professional scepticism
tests are correct to reduce audit risk to
- incorporate elements of unpredictability
an acceptable level
- make general changes to the nature,
timing and extent of audit procedures

Substantitive
Test of control
procedure

Source: Jackson & Stent (2016:6/21)

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 STUDY UNIT 17: Planning and implementing the plan

17.5 SUMMARY AND SELF-ASSESSMENT

In this study unit the focus was on audit planning, the overall audit strategy and
audit plan, risk assessment and responding to assessed risk.

Refer to your notes you made in your workbook after completing the following
activities.

Activity 17.1 Internet 17.1 Reflection 17.1

Activity 17.2 Internet 17.2 Reflection 17.2
Activity 17.3 Reflection 17.3
Activity 17.4 Reflection 17.4
Activity 17.5
Activity 17.6
Activity 17.7

After having worked through the study unit and the study references are you able to:
•• explain the planning of an audit?
•• explain how the plan is implemented?
In the next study unit, you will learn about the concluding stage of the audit process.

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18 STUDY UNIT 18

REACHING CONCLUSIONS AND

18

REPORTING

IN THIS STUDY UNIT WE ARE GOING TO

• explain how you will report the outcomes of the audit tests performed

18.1 INTRODUCTION
Throughout this module we indicated that the outcome of an auditor’s work is
the audit report. Remember: on the one hand we have management that run a
business on behalf of the shareholders. Management prepares annual financial
statements for the shareholders to report on the financial position and results.
On the other hand we have the owners of the business: the shareholders. The
shareholders need to know how their business performed and if the results pre-
pared and presented by management can be relied on. The auditor performs this
assurance function and formulates an audit report that accompanies the annual
financial statements. In this study unit we are going to look at the final stage of
the audit process, namely the concluding stage.

18.2 EVALUATING, CONCLUDING AND REPORTING

In the planning stage we focussed on performing audit procedures based on
the risk assessment. Once the evidence is collected the auditor examines the
evidence. The auditor asks him/herself: Have I collected sufficient audit evidence
to reduce the audit risk to an acceptable level? The auditor keeps trying until
sufficient audit evidence is obtained. The question arises, what happens if the
auditor is unable to obtain sufficient audit evidence after retrying? This is where
the audit report fulfils an important function. The auditor issues a modified opinion
which can be either an adverse opinion or a disclaimer of opinion.

STUDY

Jackson & Stent (2016:6/23- 6/25) – Evaluating, concluding and reporting

Diagram 16 provides on overview of the evaluating, concluding and reporting

stage of the audit process. Use the diagram to assist you in learning the ap-
plicable content.

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 STUDY UNIT 18: Reaching conclusions and reporting

DIAGRAM 16: EVALUATING, CONCLUDING AND REPORTING

Perform audit procedures

Evaluate audit evidence

Material misstatements found?

NO YES

Request management
to adjust

Management Management
adjusts refuses

Unmodified
audit opinion Modified audit
opinion
“Fairly present” “Except for”
(ok....but)
“Adverse”
(do not fairly present)
“Disclaimer”
(do not know)

Reference: Jackson & Stent (2016:7/7)

18.3 THE MODIFICATIONS

If the auditor is satisfied with the audit procedures and sufficient appropriate audit
evidence was obtained to reduce the assessed audit risk to an acceptable level,
the auditor can issue an unmodified (unqualified) audit opinion. The opinion
mainly says “In our opinion the annual financial statements present fairly, in all
material respects….” This means that the shareholders and analysts can rely on
the annual financial statements.

There are various levels of modified audit opinions.

•• We have the except for opinion, describing the effect of the error that
management did not adjust. Users can then make those adjustments on the
AFS and then “read” the AFS.
•• We have an adverse opinion that says that financial statements are not fairly
presented. The users cannot even make their own adjustments. This should
result in legal steps against management.

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TOPIC 5: THE AUDIT PROCESS

•• We have a disclaimer in opinion that says I do not know. This could for
example happen when no backups were made and there are no records to
audit. This too should result in legal steps against management.

18.4 SUMMARY AND SELF-ASSESSMENT

In this study unit we discussed how the auditor reaches conclusions and under-
takes reporting.

After having worked through the study unit and the study references are you able to:
•• explain how you will report the outcomes of the audit tests performed?
In the next topic we will discuss control activities within the various business cycles.

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TOPIC 6
Systems and cycles within a business entity

Study unit 19
Systems and cycles within a business entity 117

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TOPIC 6: THE AUDIT PROCESS

TOPIC OVERVIEW

In this topic you will familiarise yourself with the various business cycles that
normally forms part of the accounting system of a business undertaking.

This topic is comprised of the following study unit:

Study unit Title Page

19 Systems and cycles within a business entity 117

Textual amendments and additions

Before you proceed with the study of this topic, please refer to Tutorial Letter 102
for this module to acquaint yourself with any textual amendments and additions
as indicated in the tutorial letter.

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19 STUDY UNIT 19

SYSTEMS AND CYCLES WITHIN A

19

BUSINESS ENTITY

IN THIS STUDY UNIT WE ARE GOING TO

•• identify the different business cycles
•• explain the sequence of events in the revenue and receipts cycle and the
acquisitions and payments cycle
•• explain the purpose of inventory and the payroll and personnel cycle

19.1 INTRODUCTION
The aim of this study unit is to introduce you to the business cycles as part of
the accounting system. Once you grasp the activities within each cycle and
the sequence of events, then understanding the risks and control activities will
become easier to learn (subsequent study units). Remember to always integrate
the knowledge that you have gained from your other accounting subjects.

19.2 SYSTEMS AND CYCLES WITHIN A BUSINESS ENTITY

One of the outcomes of an accounting system is to compile financial information
that is complete, accurate and valid and – from this information – prepare annual
financial statements (AFS). To this end, a business entity establishes procedures
and records to:
•• initiate, record, process and report transactions
•• capture events and conditions other than transactions
•• accumulate, record, process and summarise information for the preparation
of the AFS
(Jackson & Stent 2016:5/10)

The above procedures and events can be designated to systems and cycles
within a business entity. If you refer to the table of contents of Jackson & Stent,
you will notice that the designated cycles are the following:
•• Revenue and receipts cycle (chapter 10)
•• Acquisitions and payments cycle (chapter 11)
•• Inventory and production cycle (chapter 12)
•• Payroll and personnel cycle (chapter 13)
•• Finance and investment cycle (chapter 14)
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TOPIC 6: THE AUDIT PROCESS

In this module we are going to examine a retailing business and not a manufac-
turing (production) business. We are also not going to examine the finance and
investment cycle.

Refer to diagram 17 to obtain an understanding of how the five business cycles

function. Goods (inventory) are purchased (acquisitions) and paid for through the
bank account (payments). The idea is to sell (revenue) the inventory at a profit
and deposit (receipts) the money into the bank account. To execute the functions
you need employees (payroll) and they too get paid from the bank account.

As a business expands it may need additional long-term financing. The need

arises for example to buy furniture and fittings or build a bigger warehouse. A
loan is negotiated and obtained and the money is deposited into the bank ac-
count. Over time, as the business makes profits it starts accumulating money in
its bank. Instead of leaving it in the bank where it earns no interest the business
saves or invests it to earn interest, dividends or capital growth. The investment
enables the business to expand its operations over time.

DIAGRAM 17: REPRESENTATION OF THE FIVE BUSINESS CYCLES IN RELA-

TION TO THE ACCOUNTING SYSTEM

Inventory [profit motive]

to buy to sell

Aquisitions Revenue
(creditors) (debtors)

Payment Deposit (receipts)

Bank
account
Payment
Payroll
[expansion]

Finance/Investment

eg Buy machinery/property
Invest surplus funds

In the introduction to this module you were required to visualise your own busi-
ness. We are going to take your own business idea and design the functions,
identify the risks and design control activities to reduce risks.

Let us begin by first obtaining a bird’s eye view of the revenue and receipts cycle
and the acquisition and payments cycle. In the study units that follow we will ex-
amine the functions, documents, risks and controls of each cycle in more detail.

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 STUDY UNIT 19: Systems and cycles within a business entity

19.3 REVENUE AND RECEIPTS CYCLE

As explained in section 19.2, the revenue and receipts cycle is about selling
inventory (at a profit) and collecting the money for the inventory sold.

STUDY

Jackson & Stent (2016:10/2) – Basic functions for any revenue and receipts
cycle

DIAGRAM 18: OVERVIEW OF THE SEQUENCE OF EVENTS IN THE REVENUE

AND RECEIPTS CYCLE

Credit management

Approved
2 3
Order
department
Order processed
1
4
Customer
Picking Invoice

Warehouse 5
5
& Despatch
Sales journal

6
Debtor’s
ledger
7 12
Statement of
account 9

Bank 11
Receipt

8 10

Payment

9
Customer receives
statement of account

From the above study reference you should have gathered that six basic functions
were identified. After studying the study reference, refer to diagram 18 to assist
you to understand the sequence of events. (Follow the numbering in the diagram.)

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TOPIC 6: THE AUDIT PROCESS

We are starting this cycle on the assumption that we have inventory in the
warehouse to sell and that we are selling the goods on credit (30 days). We are
therefore not looking at cash sales.

A customer has a need for inventory that your business sells and places an order
that will be handled by the order department. Before an internal sales order is
processed by your business you need to establish if the customer will be able
to pay you for the goods after 30 days. Therefore, your credit manager exam-
ines the credit profile of the customer (credit management). If the customer is
creditworthy and within his/her existing credit limits, the order is processed. In
processing an order, the goods are picked from the warehouse and despatched
to the customer. The order is accounted for by initiating an invoice. The invoice
is recorded in the sales journal and posted to the debtors’ ledger. The account-
ing treatment in the general ledger: revenue account is credited and the debtors
account debited. At the end of the month a statement of account is issued to
the customer. The statement of account is extracted from the debtors’ ledger.
The customer receives the statement of account and pays the account. As soon
as the money is received your business issues a receipt. The receipt is used
to record the payment from the customer and allocating the payment to his/her
debtor’s account in the debtors’ ledger. The accounting treatment in the general
ledger: bank account is debited and the debtors account credited. The money is
deposited and your bank account balance increases.

REFLECTION 19.1

You have completed an overview of the sequence of events in the revenue and
receipts cycle.

Involve a friend and tell him/her of your business idea.

• Take them step by step through the sequence of events of the revenue and
receipts cycle.

19.4 AQUISITIONS AND PAYMENTS CYCLE

As explained in section 19.2, the acquisitions and payment cycle is about buying
inventory (at the best price) and paying the creditor within 30 days.

STUDY

Jackson & Stent (2016:11/2–11/3) – Basic functions for any acquisitions and
payments cycle

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 STUDY UNIT 19: Systems and cycles within a business entity

DIAGRAM 19: OVERVIEW OF THE SEQUENCE OF EVENTS IN THE ACQUISI-

TIONS AND PAYMENTS CYCLE

Returns Receiving 3
2

Price 3
4
Order
for goods Purchase Creditor’s
Quality journal ledger

5
1
Warehouse
• Requisition Statement of
account

Payment
preparation

Payment

Bank

From the above study reference you should have gathered that five basic functions
were identified. After studying the study reference, refer to diagram 19 to assist
you to understand the sequence of events. (Follow the numbering in the diagram.)

Again, let us assume that this is your business. Your warehouse needs inventory
to sell to customers. A requisition is placed by the warehouse at the ordering for
goods department. The ordering for goods department must purchase the best
quality goods at the best price. They place the order at the appropriate supplier.
The goods arrive at your premises and are checked against the order and delivery
note. A goods received note is made out to acknowledge receipt of the goods.
The goods are moved to the warehouse. The accounting department uses the
goods received note, the purchase order and the supplier’s invoice to record the
transaction in the purchases journal and the creditor’s ledger. The accounting
treatment in the general ledger: cost of sales account is debited and the credi-
tor’s account is credited.

At the end of the month the supplier statement arrives and preparation of the
payment begins. From your creditor’s ledger in your books of account a state-
ment of account of the creditor is extracted. This is used to reconcile it with the
supplier’s statement of account. As soon as the reconciliation is completed the
payment is made. The accounting treatment in the general ledger: creditor’s ac-
count is debited and the bank account is credited.

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TOPIC 6: THE AUDIT PROCESS

REFLECTION 19.2

You have completed an overview of the sequence of events in the acquisitions

and payments cycle.

Involve a friend and tell him/her of your business idea.

• Explain to them step by step the sequence of events of the acquisitions and
payments cycle.

19.5 INVENTORY.
Refer to diagram 17. Both the acquisitions cycle and revenue cycle connect to
the inventory cycle. Goods are received for resale in the warehouse and goods
are despatched from the warehouse and sold at a profit.

STUDY

Jackson & Stent (2016:12/2) – Characteristics of the cycle (2.1–2.3)

The above study reference requires you to study three paragraphs to reaffirm
what we have learned so far on where inventory fits into the business cycles.

19.6 PAYROLL
According to Jackson & Stent (2016:13/2) the payment of salaries and wages is
an integral part of any business. Since it is a cycle which results in an outflow
of funds from the business, it is extremely important that the accounting system
and related control activities are sound, so as to prevent potential significant
misappropriation of funds.

19.7 FINANCE AND INVESTMENT CYCLE

According to Jackson & Stent (2016:14/2) this cycle essentially deals with those
transactions which a company enters into to raise finance, for example by raising
start-up capital to hire a business premises, purchase equipment and inventory.
The cycle also deals with the investment the company makes, whether it is in
property, plant and equipment, making long-term loans or investing surplus funds.

STUDY

Jackson & Stent (2016:14/2) – Introduction

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 STUDY UNIT 19: Systems and cycles within a business entity

19.8 SUMMARY AND SELF-ASSESSMENT

In this study unit we identified the various business cycles and introduced you to
the sequence of events in the revenue and receipts cycle and the acquisitions
and payments cycle.

Refer to your notes you made in your workbook after completing the following
activities.

Reflection 19.1
Reflection 19.2

After having worked through the study unit and the study references are you able to:
•• identify the different business cycles?
•• explain the sequence of events in the revenue and receipts cycle and the
acquisitions and payments cycle?
•• explain the purpose of inventory and the payroll and personnel cycles?

In the next topic we will identify the accounting functions (including documents)
within the revenue and receipts business cycle, identify the risks within each
function and design controls to reduce the identified risks.

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124
TOPIC 7
The revenue and receipts cycle

Study unit 20
Ordering and warehouse/despatch functions 127

Study unit 21
Invoicing and recording of sales functions 141

Study unit 22
Recording of receipts and credit management functions 148

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TOPIC 7: THE REVENUE AND RECEIPTS CYCLE

TOPIC OVERVIEW

In Study Unit 19 we briefly looked at the revenue and receipts cycle. We are go-
ing to split the revenue and receipts units in three study units. The purpose of
this topic is to introduce you to the documents, risks and controls for credit sales
and receipts. Although sales can consist of credit and/or cash sales, in this topic
only the part that relates to credit sales and receipt of payments from debtors
are being dealt with.

This topic is divided into the following study units:

Study unit Title Page

20 Ordering and warehouse/despatch functions 127

21 Invoicing and recording of sales functions 141

22 Recording of receipts and credit management 148
functions

Textual amendments and additions

Before you proceed with the study of this topic, please refer to Tutorial Letter 102
for this module to acquaint yourself with any textual amendments and additions
as indicated in the tutorial letter.

126
20 STUDY UNIT 20

ORDERING AND WAREHOUSE/DESPATCH

20

FUNCTIONS

IN THIS STUDY UNIT WE ARE GOING TO

•• explain the overall risk of the revenue and receipts cycle
•• identify the six functions within revenue and receipts cycle
•• identify the activities and purpose of the ordering and warehouse/despatch
functions
•• identify the documents involved in the ordering and warehouse/despatch
functions
•• identify the risks involved in the ordering and warehouse/despatch functions
•• describe the controls to mitigate (reduce/prevent) the risks in the ordering and
warehouse/despatch functions

20.1 INTRODUCTION
In Study Unit 19 you were introduced to the five business cycles. In this topic, com-
prising three study units, we are going to examine the revenue and receipts cycle.

We will follow a certain structure (four steps) that we can apply to all the cycles.
This will simplify your learning experience. For an overview of how we are going
to unpack the content, refer to Jackson & Stent (2016: 10/10 to 10/17).

We are going to do the following:

Step 1: Identify the activities and purpose of each function.
Step 2: Identify the documents involved in each function and their purpose
Step 3: Identify the risks involved in each function.
Step 4: Describe the controls to mitigate (reduce/prevent) the risks.

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20.2 THE OVERALL RISK OF THE REVENUE CYCLE

REFLECTION 20.1

You have a business and you sell your products on credit (account) to your
customers. What is the overall risk arising from selling to customers on account
(credit sales)?

STUDY

Jackson & Stent (2016:10/2) paragraph 2.3

ACTIVITY 20.1

Use the above study reference and complete the following statement:

When a company allows a customer to buy on account (opposed to cash sales)

there is a risk that the customer will not ,
.

20.3 FUNCTIONS FOR THE REVENUE AND RECEIPTS

CYCLE
Let us first look at the bigger picture of the revenue and receipts cycle and all
of the functions. In Study Unit 19 we discussed the sequence of events in the
revenue and receipts cycle. In doing so, we touched on the functions for credit
sales. Refer to diagram 18 to refresh your memory.

STUDY

Jackson & Stent (2016:10/2)–Basic functions for revenue and receipts cycle

20.3.1 Identify the activities within the revenue and receipts cycle
In terms of the above study reference, six functions are identified for the revenue
cycle. If you refer to diagram 20 below, it may appear at first that there are seven
functions. However, if you study the diagram carefully you will notice that the credit
management function has been split into two functions, namely approving credit
at the beginning of the sales transaction and collecting amounts due afterwards.

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 STUDY UNIT 20: Ordering and warehouse/despatch functions

DIAGRAM 20: SCHEMATIC REPRESENTATION OF THE FUNCTIONS IN THE

ACCOUNTING SYSTEM FOR CREDIT SALES AND RECEIPT TRANSACTIONS
(JACKSON & STENT 2016:10/2–10/3)

1. Order department • Receiving customer orders

2. Credit Management • Evaluating creditworthiness (Authorising the

(at the beginning of the sale) sale, granting or confirming credit)

• Processing the order

3. Warehouse despatch
• Despatch

• Notifying customer of the amounts owed for

4. Invoicing goods purchased

5. Recording the sales and • Creating records of the sales that have been
raising the debtor made as well as who owes the company money

• Processing the order

6. Warehouse despatch
• Despatch

7. Credit Management • Collecting amounts owed

(at the end of the sale)

If you have difficulty in relating to the activities you can read the e description in
Jackson & Stent (2016:10/3–10/5) for a more practical explanation.

REFLECTION 20.2

Are you able to list the six functions of the revenue and receipts cycle?

Are you able to briefly describe the activity within each function?

In this study unit we are going to examine the order department comprising the
receiving customer order function and sales authorisation function.

20.4 THE ORDER DEPARTMENT

In terms of Jackson & Stent (2016:10/2) the order department consists of two
functions; the first being the receiving of a customer order and the second au-
thorising the sales function.

20.4.1 Receiving customer orders function

We begin with the receiving of the customer orders function.

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Step 1: Identify the activities and purpose of the receiving of orders function

To achieve this step you are required to refer to the study reference below
and complete the activity.

STUDY

Jackson & Stent (2016:10/10) – Function column

ACTIVITY 20.2

Use the above study reference and complete the following sentences:

The objective of the order receiving function is to record and

to fill them.

Persons receiving the order need to establish that the customer is a

customer and that the details of the order are
and in every respect.

Step 2: Identify the documents used in the order receiving function and their purpose

To achieve this step you are required to refer to the two study references below
and complete the activity.

STUDY

Documents/records: Jackson & Stent (2016:10/10) – Documents/records column

Purpose of the document: Jackson & Stent (2016:10/6) – Documents used in

the cycle

ACTIVITY 20.3

The documents used in the order receiving function are listed in the table below.
Use the above study reference to describe the purpose of each document.

SUGGESTED SOLUTION 20.3

Document/ The purpose of the document

Records

Customer order Serves as the customer’s instruction as to what goods

are required.

Internal sales order

Price list

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 STUDY UNIT 20: Ordering and warehouse/despatch functions

Step 3: Identify the risks involved in the order receiving function

To complete the above step you are required to refer to the study reference below.

STUDY

Jackson & Stent (610/10) – Risks column

ACTIVITY 20.4

Use the above study reference and list three risks associated with the order
receiving function.

SUGGESTED SOLUTION 20.4

(1) An order may be accepted from a non-account holder (no credit authorisation).
(2)
(3)

Now that we know what the risks are we can build in controls to mitigate the risks.
This is the area that you as business owner, manager or auditor are interested in.

Step 4: Describe the controls to mitigate (reduce/prevent) the risks

To achieve this step you are required to refer to the study reference below
and complete the activity.

STUDY

Jackson & Stent (2016:10/10) – Control activities

ACTIVITY 20.5

Use the above study reference to complete this activity.

Describe the control activities that can help mitigate the risks associated with
the order receiving function.

SUGGESTED SOLUTION 20.5

(1) Record all orders on sequentially numbered internal sales orders (ISOs).
(2) No orders to be accepted if the customer is not .
(3) Attach the customer order to the and have a second
staff member detail.
(4) For phone orders, order clerk
• request
• request
• confirm all order details.

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(5) Order clerk to sign all ISOs to indicate performance of .

(6) On a regular basis, ISOs to be sequence checked (for ),
and matched to delivery notes to identify .

DISCUSSION 20.1

E-tutor assistance required

Consider the following question and post your thoughts about it on the discus-
sion forum provided for the purpose. If you do not post your own idea, you have
to respond constructively to a post by another student.

Consider the risks (step 3) and discuss whether or not the control activities (step
4) are appropriate to mitigate the risks for the receiving customer orders function.

Let’s summarise. You know what the purpose of the order receiving function is,
the documents they use, the risks involved and the control activities to mitigate
the risks.

20.4.2 The sales authorisation function (credit management)

Remember we are dealing with credit sales. Cash sales would not be a problem
in terms of collection because you sell and receive the money immediately
(Jackson & Stent (2016:10/2). For credit sales, before a customer can open an
account for credit a detailed credit check is performed. The customer’s credit
history is checked based on the information in the credit application form (Jack-
son & Stent 2016:10/6). Credit bureaus have access to a person’s business’s
history because today’s technology accesses many databases (Jackson & Stent
2016:10/11). With technology it is scary what one can establish with just a per-
son’s identity number. Once you have a bad credit record, it is almost impossible
to buy something on account (credit) like a car or house. Therefore, always pay
your debts when they are due.

From your own business perspective, you don’t want customers that are unlikely
to pay their debts.

Step 1: Identify the activities and purpose of the sales authorisation function
To achieve this step you are required to refer to the study reference below
and complete the activity.

STUDY

Jackson & Stent (2016:10/11) – Function column

ACTIVITY 20.6

Use the above study reference and complete the following sentences:

The objective of the sales authorisation function is to assess whether orders

be .

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 STUDY UNIT 20: Ordering and warehouse/despatch functions

The intention is to determine whether the customer is and has

not .

Step 2: Identify the documents used in the sales authorisation function and their
purpose

To achieve this step you are required to refer to the two study references below
and complete the activity.

STUDY

Documents/records: Jackson & Stent (2016:10/11) – Documents/records column

Purpose of the document: Jackson & Stent (2016:10/6) – Documents used in the cycle

ACTIVITY 20.7

The documents used in the sales authorisation function are listed in the table
below. Use the above study reference to describe the purpose of each document.

SUGGESTED SOLUTION 20.7:

Document/ The purpose of the document

Records

Credit application Filled in by the customer so that the customer’s

can be established. Incudes
trades references, income and expenditure details,
bankers, etc.
Debtors ledger Transactions are recorded in the debtors ledger to es-
tablish current balance due by the customer.

Step 3: Identify the risks involved in the sales authorisation function

To achieve this step you are required to refer to the study reference below.

STUDY

Jackson & Stent (2016:10/11) – Risks column

ACTIVITY 20.8

Use the above study reference and list the risks associated with the sales au-
thorisation function.

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SUGGESTED SOLUTION 20.8

A sale will be made to a customer who is

resulting in

Step 4: Describe the controls to mitigate (reduce/prevent) the risks

To achieve this step you are required to refer to the study reference below
and complete the activity.

STUDY

Jackson & Stent (2016:10/11) – Control activities

ACTIVITY 20.9

Use the above study reference to complete this activity.

Describe the control activities that can help mitigate the risks associated with the
sales authorisation function.

SUGGESTED SOLUTION 20.9

(1) Before processing an order, checks should be carried out by the credit
controller to establish:
•
•
(2) ISOs (picking slip) to be authorised by of
the before .
(3) The credit application procedures must include:
• banking details, trade references, income and expense details
• The credit controller must follow up by
• must be set by the and
approved by the .

DISCUSSION 20.2

E-tutor assistance required

Consider the following question and post your thoughts about it on the discus-
sion forum provided for the purpose. If you do not post your own idea, you have
to respond constructively to a post by another student.

Consider the risks (step 3) and discuss whether or not the control activities (step
4) are appropriate to mitigate the risks for the sales authorisation function.

Let’s summarise. You know what the purpose of the sales authorisation function
is, the documents they use, the risks involved and the control activities to
mitigate the risks.

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 STUDY UNIT 20: Ordering and warehouse/despatch functions

20.5 THE WAREHOUSE/DESPATCH FUNCTION

In terms of Jackson & Stent (2016:10/3), the warehousing function is picking
(gathering) the goods from the stores to fill the order and to despatch the goods
to the customer. We will first deal with the warehouse function and then the
despatch function.

20.5.1 The warehouse function

Step 1: Identify the activities and purpose of the warehouse function
To achieve this step you are required to refer to the study reference below
and complete the activity.

STUDY

Jackson & Stent (2016:10/12) – Function column

ACTIVITY 20.10

Use the above study reference and complete the following sentences:

• The objective of the warehouse function is to fill orders and

and to ensure that only .
• This is a manual function of picking the goods from the using
a signed copy of the and creating a
.
• Goods which cannot be picked because they are “ ”
will be and a created.

Step 2: Identify the documents used in the warehouse function and their purpose
To achieve this step you are required to refer to the two study references below
and complete the activity.

STUDY

Documents/records: Jackson & Stent (2016:10/12) – Documents/records column

Purpose of the document: Jackson & Stent (2016:10/6) – Documents used in

the cycle

ACTIVITY 20.11

The documents used in the warehouse function are listed in the table below. Use
the above study reference to describe the purpose of each document.

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SUGGESTED SOLUTION 20.11

Document/ The purpose of the document

Records

Picking slip
Delivery note
Back order note

Step 3: Identify the risks involved in the warehouse function

To achieve this step you are required to refer to the study reference below.

STUDY

Jackson & Stent (2016:10/12) – Risks column

ACTIVITY 20.12

Use the above study reference and list the risks associated with the warehouse
function.

SUGGESTED SOLUTION 20.12

(1) Valid ISOs may not be acted upon.

(2) Goods may be removed from inventory for .
(3) and may
be picked.
(4) and delivery
notes may be made out.
(5) Out of stock items .
(6) Customer not resulting in loss
.

Step 4: Describe the controls to mitigate (reduce/prevent) the risks

To achieve this step you are required to refer to the study reference below
and complete the activity.

STUDY

Jackson & Stent (2016:10/12) – Control activities

ACTIVITY 20.13

Use the above study reference to complete this activity.

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 STUDY UNIT 20: Ordering and warehouse/despatch functions

Describe the control activities that can help mitigate the risks associated with
the warehouse function.

SUGGESTED SOLUTION 20.13

(1) Picker to initial the picking slip for each item picked and on
the picking slip items that (out of stock).
(2) Supervisory checks should be carried out by the warehouse foreman to
ensure that .
(3) Warehouse clerk to do the following:
• Check goods picked to
• Prepare from picking slip.
• Prepare from picking slip and cross reference
to the to the
customer.
• Send copy of the to the .
(4) The order clerk to follow up back orders and
.
(5) Delivery notes and picking slips to be . Un-
matched picking slips .

DISCUSSION 20.3

E-tutor assistance required

Consider the following question and post your thoughts about it on the discus-
sion forum provided for the purpose. If you do not post your own idea, you have
to respond constructively to a post by another student.

Consider the risks (step 3) and discuss whether or not the control activities (step
4) are appropriate to mitigate the risks for the warehouse function.

Let’s summarise. You know what the purpose of the warehouse function is, the
documents they use, the risks involved and the control activities to mitigate
the risks.

20.5.2 The despatch function

Step 1: Identify the activities and purpose of the despatch function

To achieve this step you are required to refer to the study reference below
and complete the activity.

STUDY

Jackson & Stent (2016:10/13) – Function column

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TOPIC 7: THE REVENUE AND RECEIPTS CYCLE

ACTIVITY 20.14

Use the above study reference and complete the following sentences:
• To ensure that only goods supported by and
accompanied by and delivery
notes, are despatched.
• To ensure despatch of goods which have been
to the customer.

Step 2: Identify the documents used in the despatch function and their purpose
To achieve this step you are required to refer to the two study references below
and complete the activity.

STUDY

Documents/records: Jackson & Stent (2016:10/13) – Documents/records Column

Purpose of the document: Jackson & Stent (2016:10/6) – Documents used in the
cycle

ACTIVITY 20.15

The documents used in despatch function are listed in the table below. Use the
above study reference to describe the purpose of each document.

SUGGESTED SOLUTION 20.15

Document/ The purpose of the document

Records
To detail the , description and
of goods despatched to the
Delivery note
customer and is by the customer to
acknowledge receipt of the goods

A list of deliveries contains a column for the delivery

List of deliveries note and physical goods loaded onto the vehicle

Step 3: Identify the risks involved in the despatch function

To achieve this step you are required to refer to the study reference below.

STUDY

Jackson & Stent (2016:10/13) – Risks column

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 STUDY UNIT 20: Ordering and warehouse/despatch functions

ACTIVITY 20.16

Use the above study reference and list the risks associated with the despatch
function.

SUGGESTED SOLUTION 20.16

(1) Theft may be facilitated by .

(2) Despatch errors may occur
• or despatched
• Goods delivered to
(3) Customers may having received goods.
(4) Goods released from the warehouse are never .

Step 4: Describe the controls to mitigate (reduce/prevent) the risks

To achieve this step you are required to refer to the study reference below
and complete the activity.

STUDY

Jackson & Stent (2016:10/13) – Control activities

ACTIVITY 20.17

Use the above study reference to complete this activity.

Describe the control activities that can help mitigate the risks associated with
the despatch function.

SUGGESTED SOLUTION 20.17

(1) On receipt of the goods, picking slip and delivery notes from the warehouse,
the despatch clerk should:
• check
• sign
• retain two copies of the
(2) The goods picked should be .
(3) The despatch clerk should prepare a list of deliveries and the list should be
matched to the delivery notes and the physical goods loaded to the vehicle.
(4) The delivery staff should supervise the of the truck
and sign a copy of the
(5) Gate control should check .
(6) On delivery, the customer should

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DISCUSSION 20.4

E-tutor assistance required

Consider the following question and post your thoughts about it on the discus-
sion forum provided for the purpose. If you do not post your own idea, you have
to respond constructively to a post by another student.

Consider the risks (step 3) and discuss whether or not the control activities (step
4) are appropriate to mitigate the risks for the despatch function.

Let’s summarise. You know what the purpose of the warehouse function is, the
documents they use, the risks involved and the control activities to mitigate
the risks.

20.6 SUMMARY AND SELF-ASSESSMENT

In this study unit we examined the ordering department and the warehouse/
despatch function as part of the revenue and receipts cycle. We identified the
objective, risks and control activities to mitigate risks within each function. We
briefly introduced you to tests of controls.

Refer to your notes you made in your workbook after completing the following
activities.

Activity 20.1 Activity 20.10 Reflection 20.1 Discussion 20.1

Activity 20.2 Activity 20.11 Reflection 20.2 Discussion 20.2
Activity 20.3 Activity 20.12 Discussion 20.3
Activity 20.4 Activity 20.13 Discussion 20.4
Activity 20.5 Activity 20.14
Activity 20.6 Activity 20.15
Activity 20.7 Activity 20.16
Activity 20.8 Activity 20.17
Activity 20.9

After having worked through the study unit and the study references are you able to:
• explain the overall risk of the revenue and receipts cycle?
• identify the six functions within the revenue and receipts cycle?
• identify the activities and purpose of the ordering and warehouse/despatch
functions?
• identify the documents involved in the ordering and warehouse/despatch
functions?
• identify the risks involved in the ordering and warehouse/despatch functions?
• describe the controls to mitigate (reduce/prevent) the risks in the ordering and
warehouse/despatch functions?

In the next study unit we are going to examine the invoicing and recording of
sales functions.

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21 STUDY UNIT 21

INVOICING AND RECORDING OF SALES

21

FUNCTIONS

IN THIS STUDY UNIT WE ARE GOING TO

• identify the activities and purpose of the invoicing and recording of sales
functions
• identify the documents involved in the invoicing and recording of sales functions
• identify the risks involved in the invoicing and recording of sales functions
• describe the controls to mitigate (reduce/prevent) the risks in the invoicing and
recording of sales functions

21.1 INTRODUCTION
In the previous study unit we learned how a customer’s order is recorded and
approved. The picking slip was used to pick the goods from the stores and goods
were despatched for delivery. In this study unit we will examine the invoicing and
recording of sales functions. We are going to continue using the four steps to
unpack each function.

21.2 THE INVOICING FUNCTION

According to Jackson & Stent (2016:10/3) the invoicing function involves notifying
the customer of the amounts owed for goods purchased. The sooner a customer
receives an invoice, the sooner the invoice can get paid.

Step 1: Identify the activities and purpose of the invoicing function

To achieve this step you are required to refer to the study reference below
and complete the activity.

STUDY

Jackson & Stent (2016:10/14) – Function column

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ACTIVITY 21.1

Use the above study reference and complete the following sentences:

The invoicing function is to the customer of

amounts due for goods supplied.

On return of the signed from the customer it should be

with the and an should
be generated.

Step 2: Identify the documents used in the invoicing function and their purpose
To achieve this step you are required to refer to the two study references below
and complete the activity.

STUDY

Documents/records: Jackson & Stent (2016:10/14) – Documents/records Column

Purpose of the document: Jackson & Stent (2014:10/6 & 7) – Documents used
in the cycle

ACTIVITY 21.2

The documents used in the invoicing function are listed in the table below. Use
the above study reference to describe the purpose of each document.

SUGGESTED SOLUTION 21.2:

Document/
Records The purpose of the document

Sales invoice Document sent to the customer to notify them of the

and of the goods
sold to them, the of the sale, discounts
and VAT

Price lists Documents containing process and discounts of

the company’s products

Step 3: Identify the risks involved in the invoicing function

To achieve this step you are required to refer to the study reference below.

STUDY

Jackson & Stent (2016:10/14) – Risks column

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 STUDY UNIT 21: Invoicing and recording of sales functions

ACTIVITY 21.3

Use the above study reference and list the risks associated with the invoicing
function.

SUGGESTED SOLUTION 21.3

(1) Goods despatched .

(2) Invoices may be ( , ,
, , ).

Step 4: Describe the controls to mitigate (reduce/prevent) the risks

To achieve this step you are required to refer to the study reference below
and complete the activity.

STUDY

Jackson & Stent (2016:10/14) – Control activities

ACTIVITY 21.4

Use the above study reference to complete this activity.

Describe the control activities that can help mitigate the risks associated with
the invoicing function.

SUGGESTED SOLUTION 21.4

(1) A copy of the ISO should be held in order in a temporary

file in the invoicing section of the accounting department.
(2) As delivery notes are received they should be matached
to their and filed sequentially by number.
(3) On a frequent and regular basis, remaining on the temparary
file should be .
(4) The invoice clerk should:
• compare details on the and
• check quoted to the customer, and entered on the
, against official and discount schedules
• prepare and cross reference it to the
(5) Second employee to check and sign invoice after checking:
• , ,
• and
•

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DISCUSSION 21.1

E-tutor assistance required

Consider the following question and post your thoughts about it on the discus-
sion forum provided for the purpose. If you do not post your own idea, you have
to respond constructively to a post by another student.

Consider the risks (step 3) and discuss whether or not the control activities (step
4) are appropriate to mitigate the risks for the invoicing function.

Let’s summarise. You know what the purpose of the warehouse function is, the
documents they use, the risks involved and the control activities to mitigate the risks.

21.3 RECORDING OF SALES

According to Jackson & Stent (2016:10/3) the recording of sales and raising the
debtor function involves creating the records of the sales that have been made
as well as who owes the company money, i.e. debtors.

Step 1: Identify the activities and purpose of the recording of sales function
To achieve this step you are required to refer to the study reference below
and complete the activity.

STUDY

Jackson & Stent (2016:10/15) – Function column

ACTIVITY 21.5

Use the above study reference and complete the following sentences:

The purpose of this function is to and to the

corresponding debtor .

Invoices must be recorded and entered against the

debtor in the debtors ledger. Total sales for the
period must also be posted to the and in
the general ledger.

Step 2: Identify the documents used in the recording of sales function and their purpose
To achieve this step you are required to refer to the two study references below
and complete the activity.

STUDY

Documents/records: Jackson & Stent (2016:10/15) – Documents/records column

Purpose of the document: Jackson & Stent (2014:10/6 & 7 and 10/5) – Docu-
ments used in the cycle

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 STUDY UNIT 21: Invoicing and recording of sales functions

ACTIVITY 21.6

The documents used in the recording of sales function are listed in the table be-
low. Use the above study reference to describe the purpose of each document.

SUGGESTED SOLUTION 21.6

Document/ The purpose of the document

Records
Invoice Document sent to the customer to notify them of the
and of the goods sold to them,
the of the sale, discounts and VAT
Sales journal A record in which the invoices are written up
Debtors ledger The individual invoices are to the relevant debtors
account
General ledger The total of the sales journal to the debtors control ac-
count in the general ledger

Step 3: Identify the risks involved in the recording of sales function

To achieve this step you are required to refer to the study reference below.

STUDY

Jackson & Stent (2016:10/15) – Risks column

ACTIVITY 21.7

Use the above study reference and list the risks associated with the despatch
function.

SUGGESTED SOLUTION 21.7

(1) Invoices are omitted from the sales journal.

(2)
(3) .
(4)

Step 4: Describe the controls to mitigate (reduce/prevent) the risks

To achieve this step you are required to refer to the study reference below
and complete the activity.

STUDY

Jackson & Stent (2016:10/15) – Control activities

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ACTIVITY 21.8

Use the above study reference to complete this activity.

Describe the control activities that can help mitigate the risks associated with the
recording of sales function.

SUGGESTED SOLUTION 21.8

(1) Invoices to be entered in the sales journal in numerical sequence

•
• .
(2) Control totals of a days sales with the sales recorded in the sales journal
(batch control system).
(3) Independent staff member to:
•
•
•
(4) Reconciliation

DISCUSSION 21.2

E-tutor assistance required

Consider the following question and post your thoughts about it on the discus-
sion forum provided for the purpose. If you do not post your own idea, you have
to respond constructively to a post by another student.

Consider the risks (step 3) and discuss whether or not the control activities (step
4) are appropriate to mitigate the risks for the recording of sales function.

Let’s summarise. You know what the purpose of the warehouse function is, the
documents they use, the risks involved and the control activities to mitigate the
risks.

21.4 SUMMARY AND SELF-ASSESSMENT

In this study unit we examined the invoicing and recording of sales functions as
part of the revenue cycle. We identified the objective, risks and control activities
to mitigate risks within each function.

Refer to your notes you made in your workbook after completing the following
activities.

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 STUDY UNIT 21: Invoicing and recording of sales functions

Activity 21.1 Discussion 21.1

Activity 21.2 Discussion 21.2
Activity 21.3
Activity 21.4
Activity 21.5
Activity 21.6
Activity 21.7
Activity 21.8

After having worked through the study unit and the study references are you able to:
•• identify the activities and purpose of the invoicing and recording of sales
functions?
•• identify the documents involved in the invoicing and recording of sales functions?
•• identify the risks involved in the invoicing and recording of sales functions?
•• describe the controls to mitigate (reduce/prevent) the risks in the invoicing and
recording of sales functions?

In the next study unit we are going to examine the credit management function
and the recording of receipts function as part of the revenue and receipts cycle.
We will also examine the bank reconciliation process.

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22 STUDY UNIT 22

RECORDING OF RECEIPTS AND CREDIT

22

MANAGEMENT FUNCTIONS

IN THIS STUDY UNIT WE ARE GOING TO

•• identify the activities and purpose of the recording of receipts and credit
management functions
•• identify the documents involved in the recording of receipts and credit
management functions
•• identify the risks involved in the recording of receipts and credit management
functions
•• describe the controls to mitigate (reduce/prevent) the risks in the recording of
receipts and credit management functions
•• explain the concept behind the design of tests of controls

22.1 INTRODUCTION
In the previous study units we examined the receiving of the customer order, the
sales authorisation, warehouse/despatch, invoicing and recording of sales. We
finished with Study Unit 21, where amounts due by the debtor were recorded in
the debtors ledger and debtors control account in the general ledger. In this study
unit we are going to examine what happens when the debtor (the customer) pays
their account or is slow to pay their account (credit management).

You are also going to be introduced to how auditors design test of controls.

22.2 THE FUNCTIONS OF THE ACCOUNTING SYSTEM FOR

RECEIPTS
Refer to diagram 18 so that you can follow where we are in the cycle. The cus-
tomer receives a debtor’s statement with all of the month’s invoices and based
on the statement they make a payment. In the past cheques were used to pay
accounts. Today most businesses make use of electronic fund transfers (EFTs).
Therefore we are not going to examine receipts in the mail room for receiving
cheques as explained in Jackson & Stent (2016:10/16). We will, however, examine
the recording of EFTs.

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 STUDY UNIT 22: Recording of receipts and credit management functions

22.2.1 Recording electronic fund transfers

With EFTs, funds are transferred from the customer’s bank account to the seller’s
bank account through internet banking. With EFTs the payment from the debtor
will appear directly on the bank statement as a credit. Therefore, numerous credit
entries (deposits) will appear on the seller’s bank statement.

Step 1: Identify the activities and purpose of the recording EFTs

Numerous credit entries (deposits) will appear on the seller’s bank statement.

These deposits need to be allocated to the correct debtors account. Therefore,

it is very important that the customer uses the account reference on the debtor’s
statement when making the EFT. The debtor will sometimes e-mail a remittance
advice to assist the debtor’s clerk to allocate the payment. Once a deposit is
identified on the bank statement a receipt must be created. The receipt is used
to allocate the payment to the debtor’s account. The bank account must be rec-
onciled to the bank statement before the end of the next working day.

The accounting system for receipts consists of the following activities and func-
tions (Jackson & Stent 2014:10/5):
• Print and e-mail the debtor’s statements.
• Identify the EFTs (deposits) on the bank statement.
• Issue a receipt for the customer for the identified EFT.
• Issue a receipt for the identified EFT.
• Write up the cash receipts journal.
• Allocate the receipt by crediting the debtor’s account in the debtor’s ledger.
• Reconcile the debtor’s ledger with the debtors control account.
• Reconcile the bank statement with the cash book (containing both cash receipts
journal and cash payment journal).
• Follow up customer queries, unpaid invoices and unallocated receipts.
• Manage accounts not paid at month-end (credit management).

The purpose of this function is to promptly and accurately allocate payments to

the debtors’ accounts.

Step 2: Identify the documents used in the recording of receipts

To achieve this step you are required to refer to the two study references below
and complete the activity.

STUDY

Purpose of the document: Jackson & Stent (2016:10/5, 6 & 7) – Documents

used in the cycle

ACTIVITY 22.1

The documents used in the warehouse function are listed in the table below. Use
the above study reference to describe the purpose of each document.

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SUGGESTED SOLUTION 22.1

Document/ The purpose of the document

Records

EFT register A list of the day’s payments deposited directly into

the business’s bank account
EFT receipt Records the details of the EFT payment from the
EFT register
Cash receipts The EFT receipts are recorded in CRJ
journal
Debtors ledger The individual receipts are transferred to the relevant
debtor’s account

Step 3: Identify the risks involved in the recording of receipts function

The following risks are identified (Jackson & Stent 2016:10/17):
(1) EFTs are not recorded timeously.
(2) Recorded EFTs may be inaccurate, overstated, credited to the wrong debtor.

Step 4: Describe the controls to mitigate (reduce/prevent) the risks

The following controls are necessary to mitigate the risks involved with the re-
cording of EFTs.

Reference: Jackson & Stent 2016:10/16–10/17

(1) The EFT register and EFT receipts should subsequently be reconciled with
the bank account by an independent supervisory employee.
(2) The cash receipts journal should be written up on a daily basis by date and
receipts number.
(3) Supervisory staff should review the cash receipts journal for missing dates
and gaps in sequence of receipts. They should also test posting to the
debtors ledger.
(4) The cash book containing the cash receipts journal and cash payments
journal should be reconciled with the bank statement on a daily basis.
(5) Queries from debtors should be investigated by an employee independent
of debtors and banking.
(6) Reconciliation of the debtors ledger to the debtors control account in the gen-
eral ledger should be conducted on a regular basis by the financial accountant.

DISCUSSION 22.1

E-tutor assistance required

Consider the following question and post your thoughts about it on the discus-
sion forum provided for the purpose. If you do not post your own idea, you have
to respond constructively to a post by another student.

Consider the risks (step 3) and discuss whether or not the control activities (step
4) are appropriate to mitigate the risks for the recording of receipts function.

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 STUDY UNIT 22: Recording of receipts and credit management functions

Let’s summarise. You know what the purpose of the warehouse function is, the
documents they use, the risks involved and the control activities to mitigate the risks.

22.3 THE CREDIT MANAGEMENT FUNCTION

Do you recall from Study Unit 20 that when an order was placed by a customer
it had to be approved for credit before it could be processed? We are now going
to examine the credit management function in more detail. The credit manage-
ment function plays an important role in a business. The first role is not to allow
credit to customers who will not be in a position to repay debts (Study Unit 20).
The second role is to collect the money owing by the debtor as reflected on the
debtor’s monthly statement as soon as possible (receipts). If debtors do not pay
their accounts within the 30 day period, it will seriously affect the cash flow of
your business. Remember, to make the sale you had to buy the goods (inven-
tory) on credit. If you do not pay your creditors in time, they will withdraw your
account facility. Where will you get the money to pay for stock? Therefore, paying
businesses what is due to them within the 30 day credit period is essential for
the sustainability of businesses.

Step 1: Identify the activities and purpose of the credit management function
To achieve this step you are required to refer to the study reference below
and complete the activity.

STUDY

Jackson & Stent (2016:10/19) – Function column

ACTIVITY 22.2

Use the above study reference and complete the following sentences:

The purpose of this function is to the from

and to encourage debtors to .

Credit management should also identify debtors to be and

subsequently if necessary.

Step 2: Identify the documents used in the credit management function and
their purpose

To achieve this step you are required to refer to the two study references below
and complete the activity.

STUDY

Documents/records: Jackson & Stent (2016:10/19) – Documents/records column

Purpose of the document: Jackson & Stent (2016:10/6) – Documents used in

the cycle

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ACTIVITY 22.3

The documents used in the credit management function are listed in the table
below. Use the above study reference to describe the purpose of each document.

SUGGESTED SOLUTION 22.3:

Document/ The purpose of the document

Records

Monthly statements A summary of all the

Age analysis A summary of debtors accounts setting out the age of

the accounts e.g. current, 30 days, 60 days, 90 days
and older.
Credit bureau A data basis collected by credit bureau that identifies
information businesses that are blacklisted, handed over for col-
lection, etc.

Step 3: Identify the risks involved in the credit management function

To achieve this step you are required to refer to the study reference below.

STUDY

Jackson & Stent (2016:10/19) – Risks column

ACTIVITY 22.4

Use the above study reference and list the risks associated with the credit man-
agement function.

SUGGESTED SOLUTION 22.4

The risks associated with the credit management function are:

(1) Debtors do not .
(2) Debtors are .
(3) Debts are .

Step 4: Describe the controls to mitigate (reduce/prevent) the risks

To achieve this step you are required to refer to the study reference below
and complete the activity.

STUDY

Jackson & Stent (2016:10/19) – Control activities

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 STUDY UNIT 22: Recording of receipts and credit management functions

ACTIVITY 22.5

Use the above study reference to complete this activity.

Describe the control activities that can help mitigate the risks associated with the
credit management function.

SUGGESTED SOLUTION 22.5

(1) Credit application controls as discussed under sales authorisation apply.

(2)
(3)
(4)
(5)
(6)
(7)
(8)

DISCUSSION 22.2

E-tutor assistance required

Consider the following question and post your thoughts about it on the discus-
sion forum provided for the purpose. If you do not post your own idea, you have
to respond constructively to a post by another student.

Consider the risks (step 3) and discuss whether or not the control activities (step
4) are appropriate to mitigate the risks for the credit management function.

Let’s summarise. You know what the purpose of the warehouse function is, the
documents they use, the risks involved and the control activities to mitigate the risks.

22.4 INTRODUCING THE FORMULATION OF TEST OF CONTROLS

In Study Unit 17 we indicated that the auditor performs tests of controls and
substantive procedures. A test of control is simply identifying the controls like we
did in step 4: Describe the controls to mitigate (reduce/prevent and then testing if
those controls were implemented as designed. In other words, tests of controls
describe instructions to audit personnel as contained in an audit programme on
how the internal control measure in question should be evaluated. If there are
no controls, then no tests of controls can be performed.

There are mainly four types of test of controls (Jackson & Stent 2016:5/26):
(1) Inspection: Consists of examining the documents which provide the auditor
with evidence as to whether a control procedure did occur. For example, the
auditor would inspect the signature of the order clerk indicating the perfor-
mance of control activities.

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(2) Reperformance: This procedure involves the auditor’s repeating, either

wholly or in part, the same control procedures that the client performed. For
example, reperforming a creditor’s reconciliation performed by the client.
(3) Enquiry: Consists of seeking information from knowledgeable persons inside
the entity. For example, enquire from management as to the procedures
followed by ordering clerks to record phone orders.
(4) Observation: This might involve watching a client’s employee performing a
control procedure. For example, the auditor would inspect the order recording
process that all orders are on sequentially internal sales orders.

From the above methods you can gather that tests of controls are merely asserting
whether or not the control activities that have been prescribed by management/
owner have indeed been implemented by personnel.

You will not be required to formulate tests of controls in this module.

22.5 SUMMARY AND SELF-ASSESSMENT

In this study unit we examined the function of the accounting system for record-
ing receipts. We identified the objective, risks and control activities to mitigate
risks for receipts.

Refer to your notes you made in your workbook after completing the following
activities.

Activity 22.1 Discussion 22.1

Activity 22.2 Discussion 22.2
Activity 22.3
Activity 22.4
Activity 22.5

After having worked through the study unit and the study references are you able to
•• identify the activities and purpose of the recording of receipts and credit
management functions?
•• identify the documents involved in the recording of receipts and credit
management functions?
•• identify the risks involved in the recording of receipts and credit management
functions?
•• describe the controls to mitigate (reduce/prevent) the risks in the recording of
receipts and credit management functions?
•• explain the concept behind the design of tests of controls?

In the next topic we are going to examine the acquisitions and payments cycle.

154
TOPIC 8
The acquisitions and payments cycle

Study unit 23
The ordering and receiving of goods functions 157

Study unit 24
The recording of purchases and payment (preparation and actual
payment) functions 167

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TOPIC OVERVIEW

In Study Unit 19 we briefly looked at the acquisitions and payments cycle. In

this topic we are going to examine the acquisitions and payments cycle in more
detail. The topic will be split into two study units. The purpose of this topic is to
introduce you the activities, documents, risks and controls for the acquisitions
and payments cycle.

This topic is divided into the following study units:

Study unit Title Page

23 The ordering and receiving of goods functions 157

24 The recording of purchases and payment (prepara- 167
tion and actual payment) functions

Textual amendments and additions

Before you proceed with the study of this topic, please refer to Tutorial Letter 102
for this module to acquaint yourself with any textual amendments and additions
as indicated in the tutorial letter.

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23 STUDY UNIT 23

THE ORDERING AND RECEIVING OF

23

GOODS FUNCTIONS

IN THIS STUDY UNIT WE ARE GOING TO

•• explain the overall risk of the acquisitions and payments cycle
•• identify the five functions within the acquisitions and payments cycle
•• identify the activities and purpose of the ordering and receiving of goods
functions
•• identify the documents involved in the ordering and receiving of goods functions
•• identify the risks involved in the ordering and receiving of goods functions
•• describe the controls to mitigate (reduce/prevent) the risks in the ordering and
receiving of goods functions

23.1 INTRODUCTION
In Study Unit 19 you were introduced to the five business cycles. In this top-
ic comprising of two study units, we are going to examine the acquisitions and
payments cycle.

We are going to follow the same structure (four steps) as for the previous busi-
ness cycle that applies to all the cycles. This will make your learning easier. For
an overview of how we are going to unpack the content, refer to Jackson & Stent
and page through pages 11/9 to 11/13.

We are going to do the following:

Step 1: Identify the activities and purpose of each function.
Step 2: Identify the documents involved in each function and their purpose
Step 3: Identify the risks involved in each function.
Step 4: Describe the controls to mitigate (reduce/prevent) the risks.

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23.2 THE OVERALL RISK OF THE ACQUISITIONS AND

PAYMENTS CYCLE
As explained Jackson & Stent (2016:11/2–11/3), the acquisitions and payment
cycle deals with three major activities which are linked but which are also quite
distinct, i.e. the:
•• ordering and receiving of goods (or services) from suppliers (this study unit),
•• recording of purchases (Study Unit 24) and
•• payment of amounts due for the goods ordered and received (Study Unit 24).
Let us revert back to our business idea. In the previous topic your business sold
goods on credit to your customers. Before you can sell the goods, you either have
to buy goods or manufacture something from raw materials that you purchased
from suppliers. In this module we focus only on retailing (buying and selling)
and not on manufacturing. This study unit is all about the acquisitions cycle, i.e.
buying goods.

According to Jackson & Stent (2016:11/2) the consequences of a poor acquisi-

tions cycle will have a very negative effect on the business. If the correct prod-
ucts are not available, sales will be lost. It will not be long before the business
gets a reputation for being unreliable and customers will go and buy their goods
elsewhere. Purchasing the wrong goods that does not resell or buying goods of
an inferior quality can result in losses. The aim with the acquisitions (purchasing)
cycle is to buy the best quality goods at the best prices to be able to resell the
goods at a profit.

Remember: under the Consumer Protection Act, 2008 customers have the right
to goods that are free of any defects and of acceptable quality (http://www.gov.
za/sites/www.gov.za/files/32186_467_0.pd). Therefore, it is important to do your
homework very carefully when ordering goods from your suppliers that you want
to resell at a profit.

Another risk to be considered is that the cycle involves the outflow of funds from
the business. Thus, the payment of fictitious creditors can be affected if inadequate
controls are not implemented (Jackson & Stent 2016:11/2).

23.3 FUNCTIONS FOR CREDIT PURCHASES TRANSACTIONS

Refer to diagram 21 in Study Unit 19, which gives an overview of the credit pur-
chases and payments cycle. The diagram serves as a map to help you find your
way through this study unit.

Identifying and understanding the distinct functions in the accounting system for
acquisitions and payments transactions is crucial for the identification of risks
and designing controls. Therefore, study diagram 21 carefully and make sure that
you can list and describe the various functions of this cycle.

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 STUDY UNIT 23: The ordering and receiving of goods functions

DIAGRAM 21 SCHEMATIC REPRESENTATION OF THE FUNCTIONS IN THE

ACCOUNTING SYSTEM FOR CREDIT PURCHASES & PAYMENT CYCLE

• Receiving the requisition

1. Ordering of goods
• Processing the purchase order

• Receiving the goods and

2. Receiving of goods
• Acknowledge receipt of goods

• Raise purchase in purchases journal

3. Recording of purchases
& creditors

4. Payment preparation • Determining amount to be paid to creditors

• Preparing payment
5. Actual payment (Bank)
• Recording payment

Source: Jackson & Stent (2014:11/17-11/18)

If you have difficulty in relating to the activities you can read the description in
Jackson & Stent (2016:11/3–11/5) for a more practical explanation.

REFLECTION 23.1

• Are you able to list the five functions of the acquisitions and payments cycle?
• Are you able to briefly describe the activity within each function?

23.4 ORDERING OF GOODS

Assume your business has a designated receiving section for the goods you
ordered and a storeroom where inventory is stored. The storeman on his account-
ing system identifies that the stock level of an item is low and that this product
must be ordered. The storeman issues a stock requisition note to the ordering
department.

Step 1: Identify the activities and purpose of the ordering of goods function
The ordering department is essentially responsible for obtaining the correct type
and quantity of goods at the best price and desired quality (Jackson & Stent
2016:11/3).

To achieve this step you are required to refer to the study reference below
and complete the activity.

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STUDY

Jackson & Stent (2016:11/9) – Function column

ACTIVITY 23.1

Use the above study reference and complete the following sentences:

The purpose of this function is to orders so that items/services re-

quired to maintain optimum conditions within the organisation, .

This function is also responsible for placing with

supplier, having established that , ,
and requirements have been satisfied.

Step 2: Identify the documents used in the ordering of goods function and their
purpose
To achieve this step you are required to refer to the two study references below
and complete the activity.

STUDY

Documents/records: Jackson & Stent (2016:11/9) – Documents/records column

Purpose of the document: Jackson & Stent (2016:11/5) – Documents used in

the cycle

ACTIVITY 23.2

The documents used in the ordering of goods function are listed in the table be-
low. Use the above study reference to describe the purpose of each document.

SUGGESTED SOLUTION 23.2

Document/ The purpose of the document

Records

Requisition Used to convey to the department that

goods are

Purchase order form Completed by the department, record

the and of
the goods to be purchased and are addressed to the
.

Step 3: Identify the risks involved in the ordering of goods function

To complete the above step you are required to refer to the study reference below.

160
 STUDY UNIT 23: The ordering and receiving of goods functions

STUDY

Jackson & Stent (2016:11/9) – Risks column

ACTIVITY 23.3

Use the above study reference and list three risks associated with the ordering
of goods function.

SUGGESTED SOLUTION 23.3

(1) Ordering of or , resulting in and

.
(2) Ordering goods resulting in to
the company through fraud.
(3) Requisitions not or orders not or at all.
(4) Obtaining goods.
(5) Paying unnecessarily for goods.
(6) Orders placed with suppliers not or not filled.
(7) Order forms .

Step 4: Describe the controls to mitigate (reduce/prevent) the risks

To achieve this step you are required to refer to the study reference below
and complete the activity.

STUDY

Jackson & Stent (2016:11/9) – Control activities

ACTIVITY 23.4

Use the above study reference to complete this activity.

Describe the control activities that can help mitigate the risks associated with the
ordering of goods function.

SUGGESTED SOLUTION 23.4

(1) The order clerks should not place an order without receiving an
• The order should cross-reference to the .
(2) Before the order is placed, a supervisor/ senior buyer should
• check the order to the for and

• review the order for , reasonableness of

and , and the .

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(3) The company should preferably have an to which

the buyer should refer when ordering.
• If the company does not have an approved supplier, the buyer should seek
from a number of before
• If the company does have an approved supplier, the buyer should contact
the to confirm and .
(4) The ordering department should file and should
review the files for .
(5) A copy of the order should be filed and the file should be
and frequently cross-referenced to , to
confirm that .
(6) Blank order forms should be subject to sound .

DISCUSSION 23.1

E-Tutor assistance required

Consider the following question and post your thoughts about it on the discus-
sion forum provided for the purpose. If you do not post your own idea, you have
to respond constructively to a post by another student.

Consider the risks (step 3) and discuss whether or not the control activities (step
4) are appropriate to mitigate the risks for the ordering of goods function.

Let’s summarise. You should now know what the purpose of the order receiving
function is, the documents they use, the risks involved and the control activities
to mitigate the risks.

23.5 RECEIVING OF GOODS

The role of the receiving function is to accept goods from suppliers and acknowl-
edge receipt thereof (Jackson & Stent 2016:11/10). Once you acknowledge receipt
(ownership) you are legally obliged to pay for those goods. Therefore your busi-
ness must only accept goods for which valid purchase orders have been placed.

Step 1: Identify the activities and purpose of the receiving of goods function
To achieve this step you are required to refer to the study reference below
and complete the activity.

STUDY

Jackson & Stent (2016:11/10) – Function column

ACTIVITY 23.5

Use the above study reference and complete the following sentences:

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 STUDY UNIT 23: The ordering and receiving of goods functions

The purpose of the function is to and deliveries of

orders from suppliers and to (goods received note).

Prior to acceptance, on , and

of goods should be carried out.

Step 2: Identify the documents used in the receiving of goods function and their purpose
To achieve this step you are required to refer to the two study references below
and complete the activity.

STUDY

Documents/records: Jackson & Stent (2016:11/10) – Documents/records column

Purpose of the document: Jackson & Stent (2016:11/5) – Documents used in

the cycle

ACTIVITY 23.6

The documents used in the receiving of goods function are listed in the table
below. Use the above study reference to describe the purpose of each document.

SUGGESTED SOLUTION 23.6

Document/ The purpose of the document

Records

Supplier delivery note Made out by the supplier and the goods
which have been supplied. Cross-referenced to the
purchasing company’s and on delivery
of the goods, will be by the purchas-
ing company to receipts of the goods.

Goods received note Completed by the company when the

(GRN) goods are by the supplier. Records
the goods received and will be cross-
referenced to the .

Step 3: Identify the risks involved in the receiving of goods function

To complete the above step you are required to refer to the study reference below.

STUDY

Jackson & Stent (2016:11/10) – Risks column

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ACTIVITY 23.7

Use the above study reference and list four risks associated with the receiving
of goods function.

SUGGESTED SOLUTION 23.7

(1) Acceptance of
• as full deliveries
• and items
• items
• goods not of the required or quality
(2) Goods received notes not made out and .
(3) No
(4) by employees or outside parties.

Step 4: Describe the controls to mitigate (reduce/prevent) the risks

To achieve this step you are required to refer to the study reference below
and complete the activity.

STUDY

Jackson & Stent (2016:11/9) – Control activities

ACTIVITY 23.8

Use the above study reference to complete the following activity.

Describe the control activities that can help mitigate the risks associated with the
receiving of goods function.

SUGGESTED SOLUTION 23.4

(1) The responsibility for receiving goods should be to a

which should be physically secured and access controlled.
(2) On arrival of the delivery vehicle, goods should be offloaded in the presence
of a goods receiving clerk who should do the following:
• Obtain the from the delivery personnel by referring to the
order number thereon, and locate the .
• Check the and of goods delivered against the
and customer .
• Perform at least a superficial test of the of the goods delivered.
• Reject all and clearly rejections on both
copies of the .
• Accept goods short delivered but such goods clearly on
the and .
• Include on the , only those goods which have
been accepted.

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 STUDY UNIT 23: The ordering and receiving of goods functions

• Ensure that the suppliers’ personnel sign both copies of the in-
cluding all .
• Sign the supplier .
(3) On transfer of the goods to the warehouse, the warehouse clerk should com-
pare the to the and acknowledge
receipt by signing the . Any discrepancies should be
reported to the warehouse controller immediately.

DISCUSSION 23.2

E-tutor assistance required

Consider the following question and post your thoughts about it on the discus-
sion forum provided for the purpose. If you do not post your own idea, you have
to respond constructively to a post by another student.

Consider the risks (step 3) and discuss whether or not the control activities (step
4) are appropriate to mitigate the risks for the receiving of goods function.

ACTIVITY 23.5

The following is an example of an order form issued by Sweetie Pie Bakery (Pty)
Ltd (Sweetie Pie Bakery) for goods ordered by the company.

Sweetie Pie Bakery (Pty) Ltd

PURCHASE ORDER
ORDER NUMBER 1001
Date: 30 May 20xx
Sweetie Pie Bakery
PO BOX 33445
PRETORIA

To Vendor:
PO BOX 25031
DURBAN
ID company registration number: 342/003344/06

Description Code Quantity

12 x 1 kg bags of flour FLO01 11

5 x 250 g of butter BUT01 5

1000 packs of chocolate chips CCH 01 1 000

Authorised:
_________

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REQUIRED:
Identify and list the information that should be reflected on a purchase order that
was not included in Sweetie Pie Bakery’s order.

SUGGESTED SOLUTION 23.5

Reference: Jackson & Stent (2016:11/3)

The following information should have been reflected on the purchase order but
was not:
• The order form is not addressed to the supplier, as the name of the supplier
is not included on the order form.
• The price of the goods to be purchased is not on the order form.
• The order form is not authorised/signed.
• The quantity of the bags of flour ordered was 12 kg and not 11 kg.

Let’s summarise. You should now know what the purpose of the receiving of
goods function is, the documents they use, the risks involved and the control
activities to mitigate the risks.

23.6 SUMMARY AND SELF-ASSESSMENT

In this study unit we examined ordering of goods and receiving of goods func-
tions of the acquisitions and payments cycle. We identified the objective, risks
and control activities to mitigate risks within each function.

Refer to your notes you made in your workbook after completing the following
activities.

Activity 23.1 Discussion 23.1 Reflection 23.1

Activity 23.2 Discussion 23.2
Activity 23.3
Activity 23.4
Activity 23.5

After having worked through the study unit and the study references are you able to:
• explain the overall risk of the acquisitions and payments cycle?
• identify the five functions within the acquisitions and payments cycle?
• identify the activities and purpose of the ordering and receiving of goods
functions?
• identify the documents involved in the ordering and receiving of goods functions?
• identify the risks involved in the ordering and receiving of goods functions?
• describe the controls to mitigate (reduce/prevent) the risks in the ordering and
receiving of goods functions?

In the next study unit we will examine the recording of purchases and payment
(preparation and actual payment) functions.

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24 STUDY UNIT 24

THE RECORDING OF PURCHASES AND

24

PAYMENT (PREPARATION AND ACTUAL

PAYMENT) FUNCTIONS

IN THIS STUDY UNIT WE ARE GOING TO

• identify the activities and purpose of the recording of purchases and payment
functions
• identify the documents involved in the recording of purchases and payment
functions
• identify the risks involved in the recording of purchases and payment functions
• describe the controls to mitigate (reduce/prevent) the risks in the recording of
purchases and payment functions

24.1 INTRODUCTION
Let us recap: the goods have been ordered and received. The next step is to
record the transaction. According to Jackson & Stent (2016/11/3) the recording
of the transaction function entails raising the purchases in the purchases journal
and the corresponding liability (creditor) in the accounting records. The payment
preparation function is responsible for determining the amount to be paid to the
creditor. Payment preparation involves the inspection of documents to determine
that the purchase was valid. Once the payment has been approved the actual
payment takes place.

24.2 RECORDING OF PURCHASES

Step 1: Identify the activities and purpose of the recording of purchases function
To achieve this step you are required to refer to the study reference below
and complete the activity.

STUDY

Jackson & Stent (2016:11/11) – Function column

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TOPIC 8: THE REVENUE AND RECEIPTS CYCLE

ACTIVITY 24.1

Use the above study reference and complete the following sentences:

The purpose of this function is to the purchase and corre-

sponding in the accounting records.

The recording of purchases and trade liabilities should be

carried out by the ( ) so that controls are
not .

Step 2: Identify the documents used in the recording of purchases function and
their purpose
To achieve this step you are required to refer to the two study references below
and complete the activity.

STUDY

Documents/records: Jackson & Stent (2016:11/11) – Documents/records column

Purpose of the document: Jackson & Stent (2016:11/5) – Documents used in
the cycle

ACTIVITY 24.2

The documents used in the recording of purchases function are listed in the table
below. Use the above study reference to describe the purpose of each document.

SUGGESTED SOLUTION 24.2

Document/ The purpose of the document

Records
Purchase invoice The document is sent by the

and VAT.
Credit note This is a supplier document which records any
to the purchasing company’s account
other than payment for damaged or unwanted goods.

Creditors Produced by the on a basis.

statement This document summarises the between the
and company for the month.

Purchases journal A record in which all purchased are recorded in terms of

the order, supplier delivery note and GRN.

Creditors ledger The individual purchases are allocated to the relevant

creditor’s account in the creditors ledger.

General ledger The total of the purchases journal are allocated to the
creditors control account in the general ledger

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 STUDY UNIT 24: The recording of purchases and payment (preparation and actual payment) functions

Step 3: Identify the risks involved in the recording of purchases function

To complete the above step you are required to refer to the study reference below.

STUDY

Jackson & Stent (2016:11/11) – Risks column

ACTIVITY 24.3

Use the above study reference and list three risks associated with the recording
of purchases function.

SUGGESTED SOLUTION 24.3

(1) The recording of amounts arising from invoices

• , and type not as or
• of goods not as
• errors e.g. , , VAT.
(2) The raising of purchases/creditors by the of
which are for goods received or
by the company.
(3) Delays, and errors when entering details into
accounting records resulting in problems and failure to make
use of favourable terms (discounts).

Step 4: Describe the controls to mitigate (reduce/prevent) the risks

To achieve this step you are required to refer to the study reference below
and complete the activity.

STUDY

Jackson & Stent (2016:11/11) – Control activities

ACTIVITY 24.4

Use the above study reference to complete this activity.

Describe the control activities that can help mitigate the risks associated with the
recording of purchases function.

SUGGESTED SOLUTION 24.4

(1) The purchases invoices received from the suppliers should be

1.1 matched to the corresponding ,
and for
• and of goods

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• prices and
1.2 R to confirm that amounts on the invoice have been
to the correct accounts e.g. , con-
sumables, stationery.
(2) When a requisition is made out to initiate an order, the to
which the purchase must be in the should
be selected from the “official list of accounts” and entered onto the
and then transferred to the . (If this is
not done, .)
(3) All , and on the invoice should
be .
(4) A specific employee should be designated the responsibility of ensuring, by
scrutiny of of and in the pending
file, that purchases are and recorded in the
and correctly posted to the .

DISCUSSION 24.1

E-tutor assistance required

Consider the following question and post your thoughts about it on the discus-
sion forum provided for the purpose. If you do not post your own idea, you have
to respond constructively to a post by another student.

Consider the risks (step 3) and discuss whether or not the control activities (step
4) are appropriate to mitigate the risks for the recording of purchases function.

Let’s summarise. You now should know what the purpose of the recording of
purchases function is, the documents they use, the risks involved and the control
activities to mitigate the risks.

24.3 PAYMENT PREPERATION

Step 1: Identify the activities and purpose of the payment preparation function
To achieve this step you are required to refer to the study reference below
and complete the activity.

STUDY

Jackson & Stent (2016:11/12) – Function column

ACTIVITY 24.5

Use the above study reference and complete the following sentences:

The role of this function is to ensure that only creditors are

and that they are paid the , on
. The function will produce and EFT requisition.

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 STUDY UNIT 24: The recording of purchases and payment (preparation and actual payment) functions

The EFT requisition will initiate the preparation of the EFT on the online bank
account.

Step 2: Identify the documents used in the payment preparation function and
their purpose
To achieve this step you are required to refer to the two study references below
and complete the activity.

STUDY

Documents/records: Jackson & Stent (2016:11/12) – Documents/records column

Purpose of the document: Jackson & Stent (2016:11/5) – Documents used in
the cycle

ACTIVITY 24.6

The documents used in the payment preparation purchases function are listed
in the table below. Use the above study reference to describe the purpose of
each document.

Note: Cheque payments are replaced by Electronic Fund Transfers (EFTs).

SUGGESTED SOLUTION 24.6

Document/ The purpose of the document

Records
Remittance advice A document prepared by the purchasing company sent
to the supplier containing a breakdown of the invoices
are paid with the EFT.

EFT requisition A form completed by the creditors section of the pur-

chasing company requesting that an EFT be made to
a particular creditor.

Step 3: Identify the risks involved in the payment preparation function

To complete the above step you are required to refer to the study reference below.

STUDY

Jackson & Stent (2016:11/12) – Risks column

ACTIVITY 24.7

Use the above study reference and list three risks associated with the payment
preparation function.

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SUGGESTED SOLUTION 24.7

(1) Payment to
(2) Payment of
(3) U payments
(4) D lost to late payments

Step 4: Describe the controls to mitigate (reduce/prevent) the risks

To achieve this step you are required to refer to the study reference below
and complete the activity.

STUDY

Jackson & Stent (2016:11/12) – Control activities

ACTIVITY 24.8

Use the above study reference to complete this activity.

Describe the control activities that can help mitigate the risks associated with the
payment preparation function.

SUGGESTED SOLUTION 24.8

(1) The monthly creditors statement sent by the supplier should be to

the supporting documentation, e.g. , etc, and
the creditors clerk should ensure that the were subjected to
controls before being ,
(2) The creditor’s accounts in the should be
with the monthly sent by the suppliers.
(3) A creditors clerk should identify those creditors who must be paid at
end to comply with the and
to ensure that available for early , are
.
(4) EFT requisitions (cheques) should be and unused requisi-
tions subject to sound .
(5) EFT requisitions (cheques) should include details of the EFT being requested
and should be by the preparer of the requisition.
(6) The EFT requisitions (cheques) and documentation should
be presented for signatories of approval.

DISCUSSION 24.2

E-tutor assistance required

Consider the following question and post your thoughts about it on the discus-
sion forum provided for the purpose. If you do not post your own idea, you have
to respond constructively to a post by another student.

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 STUDY UNIT 24: The recording of purchases and payment (preparation and actual payment) functions

Consider the risks (step 3) and discuss whether or not the control activities (step
4) are appropriate to mitigate the risks for the payment preparation function.

Let’s summarise. You know what the purpose of the order receiving function is,
the documents they use, the risks involved and the control activities to mitigate
the risks.

24.4 ACTUAL PAYMENT AND RECORDING

Note: instead of paying with a cheque we are nowadays paying by EFT.

Step 1:Identify the activities and purpose of the actual payment and recording
function
To achieve this step you are required to refer to the study reference below
and complete the activity.

STUDY

Jackson & Stent (2016:11/13) – Function column

ACTIVITY 24.9

Use the above study reference and complete the following sentences:

The purpose of this function is to produce a , and

authorised EFT and to all EFT payments and
in the records.

Step 2: Identify the documents used in the actual payment and recording func-
tion and their purpose
To achieve this step you are required to refer to the two study references below
and complete the activity.

STUDY

Documents/records: Jackson & Stent (2016:11/13) – Documents/records column

Purpose of the document: Jackson & Stent (2016:11/5) – Documents used in

the cycle

ACTIVITY 24.10

The documents used in the actual payment and recording function are listed in
the table below. Use the above study reference to describe the purpose of each
document.

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SUGGESTED SOLUTION 24.10

Document/ The purpose of the document

Records
EFT This is an electronic online bank payment that replaces
cheques.
Bank statement Statements received from the bank. The bank state-
ment shows payments (debits), receipts (credits) and
bank charges.
Cash payments jour- A record in which all payments are recorded
nal (CPJ)
Creditors ledger A record in which the individual payments are allocated
to the relevant creditors account in the creditors ledger

General ledger The total of the CPJ are allocated to the creditors control
account (debit) and bank account (credit).

Step 3:Identify the risks involved in the actual payment and recording function
To complete the above step you are required to refer to the study reference below.

STUDY

Jackson & Stent (2016:11/13) – Risks column

ACTIVITY 24.11

Use the above study reference and list three risks associated with the actual
payment and recording function.

SUGGESTED SOLUTION 24.11

(1) EFTs may be incorrectly issued (e.g. wrong beneficiary, amount).

(2) I payments may be made ( e.g. ,
).
(3) Payments may be recorded ( ) or may be
intentionally to hide .

Step 4: D escribe the controls to mitigate (reduce/prevent) the risks

To achieve this step you are required to refer to the study reference below
and complete the activity.

STUDY

Jackson & Stent (2016:11/13) – Control activities

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 STUDY UNIT 24: The recording of purchases and payment (preparation and actual payment) functions

ACTIVITY 24.12

Use the above study reference to complete this activity.

Describe the control activities that can help mitigate the risks associated with the
actual payment and recording function.

SUGGESTED SOLUTION 24.12

Note: Cheques are replaced by EFTs therefore the suggested solution for the
actual payment will differ from Jackson & Stent (points 1 to 7 and 11). However,
the recording section is in terms of the study reference (points 8 to 10).

(1) There must be authorised access control processes to perform the EFT
payment.
(2) All EFT requisitions should be marked paid and recorded in numerical se-
quence in CPJ (point 8).
(3) The should be reviewed regularly by management for miss-
ing EFT requisition numbers and payments. (point 9)
(4) Reconciliation of the to the should be per-
formed and monthly, by employees who are of
the banking functions, and creditors department. (point 10)

DISCUSSION 24.3

E-tutor assistance required

Consider the following question and post your thoughts about it on the discus-
sion forum provided for the purpose. If you do not post your own idea, you have
to respond constructively to a post by another student.

Consider the risks (step 3) and discuss whether or not the control activities (step 4)
are appropriate to mitigate the risks for the actual payment and recording function.

Let’s summarise. You now should know what the purpose of the payment prepa-
ration function is, the documents they use, the risks involved and the control
activities to mitigate the risks.

24.5 SUMMARY AND SELF-ASSESSMENT

In this study unit we examined the recording of purchases, payment preparation
and the actual payment functions of the acquisitions and payments cycle. We
identified the objective, risks and control activities to mitigate risks within each
function.

Refer to your notes you made in your workbook after completing the following
activities.

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TOPIC 8: THE REVENUE AND RECEIPTS CYCLE

Activity 24.1 Discussion 24.1

Activity 24.2 Discussion 24.2
Activity 24.3 Discussion 24.3
Activity 24.4
Activity 24.5
Activity 24.6
Activity 24.7
Activity 24.8
Activity 24.9
Activity 24.10
Activity 24.11
Activity 24.12

After having worked through the study unit and the study references are you able to:
•• identify the activities and purpose of the recording of purchase and payment
functions?
•• identify the documents involved in the recording of purchase and payment
functions?
•• identify the risks involved in the recording of purchase and payment functions?
•• describe the controls to mitigate (reduce/prevent) the risks in the recording of
purchase and payment functions?

In the next topic we are going to examine the reconciliation of the bank account.

176
TOPIC 9
The bank account: receipts and payments

Study unit 25
The steps in performing a bank reconciliation 179

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TOPIC 9: THE REVENUE AND RECEIPTS CYCLE

TOPIC OVERVIEW

In topic 7 we examined the risks and controls for receipts as part of the revenue
receipts cycle and in topic 8, the payments as part of the acquisition and payment
cycle. Both receipts and payments form part of the bank account. In this topic we
are going to explain the steps to be followed in performing a bank reconciliation.

This topic is divided into the following study units:

Study unit Title Page

The steps in performing a bank

25 179
reconciliation

178
25 STUDY UNIT 25

THE STEPS IN PERFORMING A BANK

25

RECONCILIATION

IN THIS STUDY UNIT WE ARE GOING TO

•• identify the objectives (assertions) for a bank reconciliation
•• identify the documents/records used in a bank reconciliation
•• describe the steps in performing a bank reconciliation

25.1 INTRODUCTION
Refer to diagram 17 in topic 6. Transactions revolve around the bank account.
You have learned in topic 7 that EFTs received from customers will need to be
deposited into the bank account (see Jackson & Stent 2016:10/5). In topic 8 you
learned that creditors (credit purchases) are paid via EFTs from the bank ac-
count (see Jackson & Stent 2016:11/4). The transactions that relate to the bank
account therefore form part of the revenue and receipts cycle and the purchases
and payments cycle. In order to check the actual balance of the cash receipts
and payments journal (cash book), it will be necessary to check both the receipts
and the payments against the bank statement.

25.2 OBJECTIVE OF THE BANK RECONCILIATION

In terms of Jackson & Stent (2016:10/71) reperforming a bank reconcilation is a
substantive procedure for the assertions of rights, existence and completeness,
and valuation. Although susbstantive procedures are not examined in this module
you must be able to prepare a bank reconciliation for the auditors to perform their
substantive procedures.

The objective of preparing a bank reconciliation is to prove the above assertions.

When a bank reconciliation is carried out, amounts deposited and paid out as
shown in the cash receipts and payments journal are agreed with the particulars
shown on the bank statement(s).

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25.3 DOCUMENTS REQUIRED FOR THE BANK

RECONCILATION
Document/ The purpose of the document
Records

Bank statement Supplied by the bank. The bank statement has an open-
ing balance (beginning of the month), a list of all the
debits and credits transacted during the month, and a
closing balance (end of the month).
Cash receipts A book of prime entry maintained by the business account-
and payments ing all receipts (Study Unit 21) and payments (Study Unit 24).
journal (cash
book)
General ledger The balance of the cash book is reflected in the bank ac-
count in the general ledger.

25.4 THE STEPS IN PERFORMING A BANK RECONCILATION

ACTIVITY 25.1

You are the bookkeeper of Mpo (Pty) Ltd. One way of reducing risk in bank trans-
actions is to perform regular bank reconciliations. You are going to perform the
bank reconciliation for the month ended 28 February 20XX.

You have the following records:

• Bank statements for 1 to 28 February 20XX
• The bank reconciliation for the previous month 31 December 20XX
• The cash receipts and payments journal (cash book)

REQUIRED
Describe the steps that you will follow to perform the bank reconciliation on 28
February 20XX.

SUGGESTED SOLUTION 25.1

Reference: Jackson & Stent (2016:10/5) section 5.5

Jackson & Stent (2016:11/4–11/5) – from section 5.5
Jackson & Stent (2016:10/71–10/72)

(1) Obtain the previous month’s reconciliation (December 20XX).

(2) Obtain the cash book and balance for the month under review (28 February
20XX).
(3) Obtain the bank statements for the month under review (1–28 February 20XX).
(4) Agree the previous month’s reconciliation with the opening balance of the
cash book and bank statements.
(5) Tick off the month’s bank statements with the cash book and the reconciling
items of the previous month’s reconciliation.
(6) Identify the reconciling items:

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 STUDY UNIT 25: The steps in performing a bank reconciliation

• Outstanding payments not yet reflected on the bank statement

• Outstanding deposits not yet reflected on the bank statement
• Bank charges on the bank statement not yet reflected on the cash book.
(7) Make the necessary adjustments to the cashbooks e.g. entering the bank
charges not yet reflected on the cash book.
(8) Compile the reconciliation by setting it out as follows:
• Balance per cashbook
• Add: Outstanding payments
• Deduct: Outstanding deposits
• Balance per bank statement

ACTIVITY 25.2

How is it possible for a year-end bank reconciliation to include a number of EFTs

as reconciling items?

SUGGESTED SOLUTION 25.2

Reference: Jackson & Stent (2016:10/70)

This will happen where the company prepares the EFTs, enters them in the cash
book, but does not “release” the payments until after year-end. As the EFT has
not been processed by the bank at year-end, the cash book and bank account
balances will not agree.

25.5 SUMMARY AND CONCLUSION

In this study unit we examined the bank reconciliation.

Refer to your notes you made in your workbook after completing the following
activities.

Activity 25.1
Activity 25.2

After having worked through the study unit and the study references are you able to:
• identify the objectives (assertions) for a bank reconciliation?
• identify the documents/records used in a bank reconciliation?
• describe the steps in performing a bank reconciliation?

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182
TOPIC 10
Payroll and personnel cycle

Study unit 26
Personnel and payroll preparation 185

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TOPIC 10: PAYROLL AND PERSONNEL CYCLE

TOPIC OVERVIEW

In this topic we are going to examine the payroll and personnel cycle – in par-
ticular, salaries. The payment of salaries is an integral part of any business and
therefore it is important to prevent the potential significant misappropriation of
funds (Jackson & Stent 2016:13/2).

This topic is divided into the following study unit:

Study unit Title Page

26 Personnel and payroll preparation 185

184
26 STUDY UNIT 26

26 PERSONNEL AND PAYROLL PREPARATION

IN THIS STUDY UNIT WE ARE GOING TO

•• explain the overall risk of the payroll and personnel cycle
•• identify the activities and purpose of the personnel and payroll preparation
functions
•• identify the documents involved in the personnel and payroll preparation
functions
•• identify the risks involved in the personnel and payroll preparation functions
•• describe the controls to mitigate (reduce/prevent) the risks in the personnel
and payroll preparation functions

26.1 INTRODUCTION
In this study unit we will focus on salaries (not wages). According to Jackson &
Stent (2016/13/2) salaries are expressed as a fixed monthly amount, whereas
wages are calculated based on the hours worked by an employee. Furthermore,
salaries are paid by a direct transfer into the employee’s bank account.

This study unit will focus on two payroll functions, namely personnel (human
resources) and payroll preparation.

26.2 THE OVERALL OBJECTIVE OF THE PAYROLL AND

PERSONNEL CYCLE
The objective of the payroll and personnel cycle is to avoid payments to fictitious
employees and to comply with the legal requirements e.g. income tax deductions,
dismissals, etc. (Jackson & Stent 2016:13/3)

We are going to examine the personnel (human resources), payroll preparation

and pay out and deductions functions.

We are going to follow a certain structure (four steps) that we can apply to all
the cycles. This will make your learning easier. For an overview of how we are
going to unpack the content, refer to Jackson & Stent and page through pages
13/9 and 13/11. We will be excluding the aspects relating to wages.

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We are going to do the following:

Step 1: Identify the activities and purpose of each function.
Step 2: Identify the documents involved in each function and their purpose.
Step 3: Identify the risks involved in each function.
Step 4: Describe the controls to mitigate (reduce/prevent) the risks.

26.3 THE PERSONNEL (HUMAN RESOURCES)

Step 1: Identify the activities and purpose of the personnel (human resources) function
To achieve this step you are required to refer to the study reference below
and complete the activity.

STUDY

Jackson & Stent (2016:13/9) – Function column

ACTIVITY 26.1

Use the above study reference and complete the following sentences:

The purpose of this function is to assist with all personnel matters so as to ensure
from the workforce, by controlling:
•
•
•
•
•
and to maintain , and
records for all employees.

Step 2: Identify the documents used in the personnel (human resources) func-
tion and their purpose
To achieve this step you are required to refer to the two study references below
and complete the activity.

STUDY

Documents/records: Jackson & Stent (2016:13/9) – Documents/records column

Purpose of the document: Jackson & Stent (2016:13/5) – Documents used in the cycle

ACTIVITY 26.2

The documents used in the payroll function are listed in the table below. Use the
above study reference to describe the purpose of each document.

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 STUDY UNIT 26: Personnel and payroll preparation

SUGGESTED SOLUTION 26.2

Document/ The purpose of the document

Records

Payroll amendment This document is used to and

form changes made in the employer register
which will affect the workforce, e.g. ,
(PAF)
, promotions and changes to pay rates.

Employee’s file Formal terms and conditions of employment are kept

in the employee file.

List of employees/ This is a list (register) of employees

employee register and their , necessary for calculating
salaries provided by personnel.

Step 3: Identify the risks involved the personnel (human resources) function.
To complete the above step you are required to refer to the study reference below.

STUDY

Jackson & Stent (2016:13/9) – Risks column

ACTIVITY 26.3

Use the above study reference and list the risks associated with the personnel
(human resources) function.

SUGGESTED SOLUTION 26.3

(1) Recruiting/retaining or employees.

(2) I dismissal procedures.
(3) U amendments to emplyee records
• f
• u
(4) I or records.

Step 4: Describe the controls to mitigate (reduce/prevent) the risks

To achieve this step you are required to refer to the study reference below
and complete the activity.

STUDY

Jackson & Stent (2016:13/9) – Control activities

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TOPIC 10: PAYROLL AND PERSONNEL CYCLE

ACTIVITY 26.4

Use the above study reference to complete this activity.

Describe the control activities that can help mitigate the risks associated with the
personnel (human resources) function.

SUGGESTED SOLUTION 26.4

(1) All for or of employ-

ees should originate from the section making the request and should be in
and a provided.
(2) Requests should be signed by the and by
the section manager after reference to the . Specifica-
tions of the position and required will be agreed by the
and the department.
(3) Changes to pay , to higher employment
grades and any other changes in , should be decided
upon by the personnel committee after
• due with parties
• consideration of relevant and
(4) Such changes should be and by the
authorising body.
(5) All of the above amendments should be commited
to sequenced (PAFs) which should be
to documentation and
by a member of the personnel
section.
• From time to time the file of s should be for
and in .
(6) Sound personnel practices should be followed to obtain ,
personnel by performimg interviews, background checks, etc.
(7) A file should be kept for each employee and should include the following:
•
•
•
•

26.4 PAYROLL PREPARATION

Step 1: Identify the activities and purpose of the payroll preparation function
To achieve this step you are required to refer to the study reference below
and complete the activity.

STUDY

Jackson & Stent (2016:13/11)

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 STUDY UNIT 26: Personnel and payroll preparation

The activity texts have been adjusted to only address salaries (wages are ex-
cluded in this module).

ACTIVITY 26.5

Use the above study reference and complete the following sentences:

The purpose of this function is to gross salaries and make

from employees which must be subsequently ,
to arrive at net salaries i.e. create a payroll.

The employee’s authorised salary scale should be used. The appropriate deduc-
tions e.g. PAYE, must be extracted from authrised up to date tax tables.

Step 2: Identify the documents used in the payroll preparation function and their
purpose
To achieve this step you are required to refer to the two study references below
and complete the activity.

STUDY

Documents/records: Jackson & Stent (2016:13/11) – Documents/records column

Purpose of the document: Jackson & Stent (2016:13/5) – Documents used in the cycle

ACTIVITY 26.6

The documents used in the ordering of goods function are listed in the table be-
low. Use the above study reference to describe the purpose of each document.

SUGGESTED SOLUTION 26.6

Document/ The purpose of the document

Records

Deduction tables These are schedules or returns for deductions provided

by entities e.g. PAYE tables provided by SARS.
Updated list of The updated list. Refer to activity 26.2 for the description.
employees
Payroll journal This journal is a spreadsheet which lists employees’
, their work section, their gross pay, deduc-
tions, and net pay.
Salary advice Notifies the employees of how their remuneration is made
up.

Step 3: Identify the risks involved the payroll preparation function.

To complete the above step you are required to refer to the study reference below.

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TOPIC 10: PAYROLL AND PERSONNEL CYCLE

STUDY

Jackson & Stent (2016:13/11) – Risks column

ACTIVITY 26.7

Use the above study reference and list the risks associated with the payroll
preparation function.

SUGGESTED SOLUTION 26.7

(1) Inclusion of employees.

(2) Use of or salary rates or deduction
tables.
(3) C and errors.

Step 4: Describe the controls to mitigate (reduce/prevent) the risks

To achieve this step you are required to refer to the study reference below
and complete the activity.

STUDY

Jackson & Stent (2016:13/11) – Control activities

ACTIVITY 26.8

Use the above study reference to complete this activity.

Describe the control activities that can help mitigate the risks associated with the
payroll preparation function.

SUGGESTED SOLUTION 26.8

(1) The salary clerk should prepare the payroll, salary advices and a reconcili-
ation of the difference between the prior month’s salaries and the current
period’s salaries for the number of employees and amounts for net wages
and deuctions.
(2) A supervisor should authorise the above payroll preperation.
(3) The head of payroll preparation should review and sign the payroll and monthy
reconciliation and verify amendments to the authorised PAFs and vice versa.
(4) The salary advices should be prepared and the EFT shedule should be
authorised and presented for payment.

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 STUDY UNIT 26: Personnel and payroll preparation

26.5 SUMMARY AND CONCLUSION

In this study unit we examined two payroll functions, namely personnel (human
resources) and payroll preparation.

Refer to your notes you made in your workbook after completing the following
activities.

Activity 26.1
Activity 26.2
Activity 26.3
Activity 26.4
Activity 26.5
Activity 26.6
Activity 26.7
Activity 26.8

After having worked through the study unit and the study references are you able to:
•• explain the overall risk of the payroll and personnel cycle?
•• identify the activities and purpose of the personnel and payroll preparation
functions?
•• identify the documents involved in the personnel and payroll preparation
functions?
•• identify the risks involved in the personnel and payroll preparation functions?
•• describe the controls to mitigate (reduce/prevent) the risks in the personnel
and payroll preparation functions?

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