To come up with a comprehensive audit plan, it is necessary to first identify the kind of risks that way lay this process using the audit-risk model. To map out the risks, this paper will look at the control risks as well as the detection risk. The two risks will be assessed to ensure that the audit process will meet the expected standards. To effectively mitigate the risks, this audit team has made inroads with PGM’s industry as well as operations through analytical procedures.
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Control risks exist primarily where material misstatements fail to be detected or prevented on a timely fashion by the organization’s control systems. In the audit of PGM, the risk exists especially because this our initial engagement with the company and the knowledge of PGM’s internal controls might not be satisfactory. Further, the risk might be brought about if the organization has weak internal control systems that could fail and expose the audit process to control risks as discussed by Cannon and Bedard (2016).
To be properly furnished with information with regards to control risks, PGM will be required to present evidence through inquiries. Specifically, the CFO will be put to task to give the company’s internal control procedures that the company has installed and the level of adherence to such controls. The integrity of the internal control procedures will then be tested to determine how reliable they are through the inspection of a broad sample of transactions. Conformity to Sarnanes-Oxley Regulations will also be determined at such a point. Sarbanes-Oxley regulations require that public companies should install internal controls for all financial statement cycles and that such controls should entail the following control activities; separation of duties, proper authorization, adequate records, physical control of assets and records, and independent checks. This audit will be interested with PGMs procurement and payment cycles, inventory cycle, payroll and personnel cycle.
There is a possibility of an audit not being in a position to detect one or several material misstatements. Some misstatements in the reporting framework of a company might occur trivially and when such misstatement are accumulated, they become critical to levels that cannot be accepted. To collect information about the detection risk, the CEO and the CFO will be required to explain how often they check transactions from start to finish to identify how errors in reporting such transactions can be minimized. As explained by Newman et al. (1998), the CEO should allocate sufficient resources to the internal auditors to ensure that they have sufficient detection capabilities. The CEO will be required to show allocation of such resources. The auditor will also ask for evidence in form of correspondence between the CEO and CFO as well as with other staff that are concerned with the transactions. Such staff will be required to show how well the recommendations were implemented to ensure that detection of misstatements is heightened or the misstatements themselves were curtailed.
To address the detection risk, various procedures will be employed to ensure that such a risk is kept at the bare minimum. For instance, classification testing will be conducted. It checks whether all transactions were correctly classified during reporting. The other means is the completeness testing where reports are checked to determine if there were any transactions that were omitted in the accounting records. The bank statement will be useful here. Occurrence testing will be done to confirm that all transactions that have been recorded actually occurred by checking sales ledgers and shipping documentations. Valuation testing is important in determining whether the assets and liabilities have been accurately recorded.
Acquisition and Payment Cycle
The acquisition and payment cycle requires the following appropriate controls.;
Authorization of payments. Disbursments to vendors need multilevel approvals with clearly spelt out roles such as confirming delivery, payment release and confirming that the disbursement is correct.
Authorization of purchases. There should be proper purchase orders that are dully approved in accordance to the thresholds determined by the company. Roles should be separated to ensure that no compromising activity can occur. For instance, the person issuing a purchase order should not be the one approving or receiving the same order.
Recording and independent review of transactions should be timely. GAAP regulations should be observed when recording accounts payables. A designated authority should approve invoices after inspecting other supporting documents. All information in such documents should tally.
Asset custody and other functions should be separated. The person responsible for acquisition of an asset should not be tasked with control or custody of such an asset. Custody of assets should be left to warehouse personnel.
Security of records and their retention. The law stipulates that, for instance, accounts payable documents be retained for up to seven years. This requires a secure location. Accessing the documents should be done by authorized people.
Payroll and Personnel cycle
On this, this audit assumes that the payroll and personnel issues are not outsourced. The internal controls include,
Proper authorizations. Arens et al. (2012) explains that the HR department should approve personnel issues such as rates, overtimes, and terminations. The HR as well as other relevant departments should authorize specific staff to handle specific matters such as, access to information, authority to disburse payment or to receive inventory among many others.
Separation of duties. There should be clearly spelt out roles for each individuals. The person who prepares the payroll should not disburse as well as authorize. For PGM, the roles can stretch from the HR department to the Accounting department. Clear responsibilities for those involved should be made clear. As insisted by Arens et al. (2012), the last person to sign the paychecks should countersign and ensure that information provided is tallying.
Independent checks. After the payroll has been finalized, there should be sufficient reviewing of such a payroll by senior management to ensure that the payroll is error free.
Control of access to records. Only authorized employees should be allowed access to the payroll and for specified reasons. Paychecks should be trusted to authorized persons who are strictly allowed to hand the paychecks to their respective owners.
Record retention. The payroll and other personnel documentation should be safely kept in secure locations for the stipulated amounts of time.
Inventory and warehouse cycle
The necessary controls for the inventory and warehouse cycle should be as follows,
Access. Access should be limited to only authorized personnel. In the case of PGM, the warehouse manager should hold the control and as such should regulate access by incoming inventory staff as well as outgoing inventory staff.
Documentation. The incoming inventory should be physically counted against the documentation. Proper labeling and storage should be emphasized for easy identification during retrieval. Outgoing inventory should be accompanied by properly authorized and verified by physical counting.
Scheduling. Inventory should be extracted from the warehouse in accordance to a previously prepared and authorized production schedule. The scheduling should be done by the warehouse manager, the sales manager, and the production manager. Proper requisitions should be made and moved to the responsible manager for action.
Independent checks. There should be an internal auditor to confirm that whatever is in the books as inventory brought in, inventory inside the warehouse, and outgoing inventory is actually correct. The internal auditor should also confirm that all the quantities of inventory that are going out actually reach where they are intended.
After a comprehensive understanding of control and detection risks, and identifying internal controls as well as where such controls should be placed, a testing plan can be discussed. The three financial cycles that have been discussed there above will be considered.
The Accounts Payable Account
The AP account will stand for the acquisition and payment cycle. To have a sufficient testing plan for this account, parties involved in the account will be stratified to ensure that non is over or under-represented so as to minimize the detection risk. The strata will include, related party invoices over material threshold, related party invoices under material threshold, non-related parties over material threshold, and non-related parties under material threshold. To confirm assurance, all the strata will be part of testing. 150 invoices will be reviewed but the number will be adjusted in case there will be failure of the intended internal control. The invoices will be useful for the following tests.
Evaluate the processes leading to recording of a transaction under accounts payable. Confirm that there are no loopholes, for instance, recording invalid or cancelled transactions.
Confirm that the paying voucher has proper internal verification as well as its classification, accuracy, and dating.
Confirm that supporting documents such as purchase orders and receiving reports tally with the invoice and paying voucher in terms of date and accuracy of amounts.
Inspect the posting of the transaction from the general ledger to the final books of account.
Confirm that the transaction has been correctly classified in accordance to the chart of account.
Ask staff to confirm that all transactions are recorded and that they are collectively timed.
Spot unusual transactions, either by amount.
Check that such unusual transactions were initiated correctly, authorized sufficiently and have all the necessary documentation.
Follow the payment trail starting with requisitioning documents, receiving documents and invoices to confirm occurrence and completeness.
Confirm that dates and quantities, classification, and amounts are correct in all documents for a particular transaction.
Confirm the totals in journals tally to the totals in financial statement.
Inspect cancelled transactions for authorizations and if such transactions were paid.
Reconcile the bank statement to the cash disbursement journal.
Seek clarity in case the bank statement and the cash disbursement journal don’t match.
Compare accounts payable closing balances with corresponding expense account balances for the current and previous years.
Confirm and seek clarity in case of an unusual non-vendor or both related and unrelated parties.
Calculate ratios relating to accounts payable to and evaluate the trend.
Test of account details and balances
Trail vendor invoices to the ledger and to the bank statement to confirm details like name, amount and the date.
Confirm that the transactions in the ledger are in the invoices to confirm existence.
Request statements from vendors and confirm that there are corresponding transactions in terms of amounts and dates.
Payroll Expense Account
To test this account, the bank statement, the payroll master file will be needed as well as randomly selected paychecks. PGM has 46 employees, 20 paychecks for each alternating month will be used, again, if these paychecks fail, the number will be adjusted. That means that if we decide to start the audit on February, we shall have the next month as April. In total, we shall have 6 different months and each financial quarter will be represented to have assurance for the entire audit period. The following tests will be done.
Inspect time logs for the employees to confirm that such employees actually clock in.
Inspect the payroll for reported errors and if such errors are repeated in the following month.
Observe the payroll processing process from initiation to completion and be keen on potential loopholes.
Confirm that the paychecks are correct in terms of dating and correctness in terms of amounts.
Inspect the posting of payroll transactions and confirm that it is correct.
Check for sequence of the paychecks. The salary amounts are always similar unless there are specific events such as pay rise, demotion etc. that should be supported with documents.
Compare the general ledger and the payroll master for unusual transactions especially on amounts or number of employees.
Check the payroll against HR records to verify authorized amounts, and other payroll particulars such as deductions to confirm accuracy.
Confirm that the names, amounts and dates are similar in the payroll as well as in the ledger and bank statement.
Reconcile the payroll disbursement and the bank statement
Reconcile the time cards with the general ledger
Trail the time cards to labor distribution in the warehousing, production and administration schedules.
Confirm reimbursements are supported by properly authorized documents and that events being reimbursed occurred.
Confirm that terminated employees do not appear on the payroll.
Inspect cancelled checks to confirm that they were duly authorized and not effected on the bank statement.
Calculate taxes expensed due to the payroll and compare the same with the previous years. Justify the variance.
Compare the payroll expense account and the payroll tax account with the previous years.
Test of account details and balances
Inspect the HR records and compare these records to salaries journal. Confirm the same amounts do no exceed the budget and if it does, necessary approvals should be there.
Reconcile the payroll with the bank statement and seek clarification if two differs.
Re-compute bonuses and compare them with HR records for authorization, timeliness, and accuracy.
A sample of Inventory transfer documents that relate to addition, reduction, and transfer will be used on top of the inventory master file to conduct necessary tests. Physical inspections as well as computations will also be included as methodologies of testing for inventory to deliver assurance. With inventory, material misstatements can be critical and this can only be curtailed through the use of Monetary Unit Sampling as a means for statistical sampling. High monetary value items are mostly favored by this sampling method and as such, detection errors are effectively nabbed. 100 transactions will be sufficient for the period but if failure rates are high the number will be adjusted upwards. The following tests will be conducted.
Observe inventory processes such as on-loading and off-loading and transfer of inventory in the warehouse.
Determine how well the separation of responsibilities such as requisition, authorization of purchase, receiving and custody of inventory to give assurance that there is no conflict of interest.
Confirm that there is an established storage sequence that can be worked on backwards in case of inventory problems such as how contaminated inventory can be linked to a particular supplier with certainty.
Compare inventory files to general ledger to confirm that transactions are duly posted.
Compare physical quantities to recordings in the inventory files.
Confirm that there are no unusual amounts or vendors. If the same exist, seek clarification supported with necessary documents and authorizations.
Confirm from the inventory movement documents the correctness of details such as dates, quantities, and dates.
Trace the movement of inventory to movement documents and finally to master file to confirm occurrence.
Confirm that costs such as direct labor costs as well as material costs are included as acquisition costs.
Using the industry or company’s raw material conversion ratios, use the completed or manufactured goods to estimate raw materials used. Check if the same is true from the inventory records.
Determine inventory rations for the year under investigation and compare with previous years. Establish the trend.
Adjust for inflation and compare the cost of goods manufactured with costs of the previous years.
Test of account details and balances
Re-compute physical inventory in terms of units to confirm and compare the totals to what is indicated in the inventory books.
Confirm correct labeling of inventory in accordance to established classification.
Follow up on the most recent outward shipment and confirm the shipping document as well as labels.
Confirm that the closing balance value is correct by comparing it to the physical count multiplied by the agreed value.
Confirm that devalued inventory through obsoleteness is deducted from the records and the transaction recorded.
Conduct price tests on inventory at different times to confirm that there is consistency.
The tests described above on the accounts payable account, payroll expense account and inventory account in addition others will give sufficient light on the financial health of PGM. With regards to whether the financial statements will be qualified or unqualified. The opinion of the auditor in terms of the fairness of the statements as well as the compliance with GAAP will also be determined by such tests.
Arens, A. A., Elder, R. J., & Mark, B. (2012). Auditing and assurance services: an integrated approach. Boston: Prentice Hall.
Cannon, N. H., & Bedard, J. C. (2016). Auditing challenging fair value measurements: Evidence from the field. The Accounting Review, 92(4), 81-114.
Newman, D. P., Park, J., & Smith, J. R. (1998). Allocating internal audit resources to minimize detection risk due to theft. Auditing, 17(1), 69.
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