Model Manufacturing Limited (MML) assembles cell phones which comprises of up to 150 different parts. MML has maintained a list of 50 authorized vendors. MML’s accounting system is partly computerized bearing the following integrated attributes:
a) Software for designing various models of cell phone.
b) Vendor Database System (VDS)
c) Manually recording and transferring information of goods inwards to accounts department for making payment to vendors.
d) Payables ledger system maintained by the accounts department for on-line payments to the suppliers.
e) General ledger system which gets input from payable ledger system
A batch consists of 500 cell phones and the design software produces a list of parts whenever a new batch is planned for the production. The purchase department place orders using electronic data interchange (EDI) with the authorized vendors after receiving list of parts in official email which vendors confirmed using the same system.
The inventory department of MML receives the ordered parts and check against the orders before accepting the delivery. Manual GRN is prepared mentioning the goods received along with order number and date. This GRN is submitted to the accounts department for further processing for payment.
Invoice is received through courier service from the vendor after the successful delivery of the parts. In Accounts department, the invoice details are checked against the GRN by the accountant who also signs it to confirm its entry into the payables ledger system.
After the expiry of 30 days, the payables ledger system automatically generates an email to the chief accountant containing a list of payments to be made. The chief accountant approves the listed invoices and forwards that email to the accounts assistant who pays the vendor(s) using online banking system.
(a) Which audit procedures will be carried out to confirm the creditors balance in MML’s financial statements? Also explain the purpose of each procedure. (8 Marks)
Solution: Auditor shall verify the creditors of the following way :
1. The auditor will check the accounts of the creditors and will compare the it with the purchase ledger.
2. He will compare the accounts with the invoices, receipts, credit notes and the statements.
3. He will verify their balances and will trace them to the list of creditors.
4. Auditor will check the addition in list.
5. He will find the differences if any between figures of the creditors statement and the balance of ledger.
6. For the confirmation of balances auditor may send the balance statements to the creditors.
7. Auditor will also check the entries of the goods inward book and compare it with the purchase ledger.
(b) Which substantive audit procedures will confirm the assertions of occurrence, cut-off and completeness for purchases of MML? Also explain the purpose of each procedure. (12 Marks)
Substantive procedures are tests to obtain audit evidence to detect material misstatements in the
financial statements. Substantive procedures generally include analytical procedures and test of detail
of transactions, account balances and disclosures.
Presentation and disclosures (or Classification and understandability)
Records completeness, accuracy, cut-off (correct accounting period)
Obligation (or rights and obligation)
Valuation and allocation
For example, an auditor may: physically examine inventory as evidence that inventory shown in the accounting records actually exists (existence assertion); inspect supporting documents like invoices to confirm that sales did occur (occurrence); arrange for suppliers to confirm in writing the details of the amount owing at balance date as evidence that accounts payable is a liability (rights and obligation assertion); and make inquires of management about the collectibility of customers’ accounts as evidence that trade debtors are accurate as to its valuation. Evidence that an account balance or class of transaction is not complete, valid or accurate is evidence of a substantive misstatement but only becomes a material misstatement when it is large enough that it can be expected to influence the decisions of the users of the financial statement.