TECHNICAL UNIVERSITY OF MOMBASA

SCHOOL OF BUSINESS
DEPARTMENT OF ACCOUNTING AND FINANCE
BACHELOR OF COMMERCE

NAME: FAWAZ FIROZ ALI

REG NO: BCOM/106J/2016

UNIT: AUDITING II

UNIT CODE: BAC 4306

ASSIGNMENT ON:

1. WHEN ACCOUNTING DATA IS BEING PROCESSED FOR HIS CLIENT BY A

SERVICE BUREAU, WHAT ARE THE PRINCIPAL MATTERS THAT AN

AUDITOR WILL TAKE INTO ACCOUNT IN EVALUATING THE SYSTEM OF

INTERNAL CONTROL?

2. THE DIRECTORS OF YOUR CLIENT A LIMITED, HAVE DISMISSED ITS

CASHIER FOR FRAUD. THEY WISH YOU TO CARRY OUT AN INVESTIGATION

TO DISCOVER THE EXTENT OF THE DEFALCATIONS, AND TO RECOMMEND

IMPROVEMENT IN THEIR SYSTEM OF INTERNAL CONTROL. EXPLAIN THE

WORK YOU WOULD PERFORM, AND THE RECOMMENDATIONS YOU

WOULD MAKE.

SUBMITTED TO: DR. BANA

QUESTION ONE

INTERNAL CONTROL SYSTEM

Internal control system may be defined as “the whole system of control, financial or otherwise,
established by the management in order to carry on the business of the enterprise in an orderly
and efficient way, ensure adherence to the management policies, and safeguard the assets and
secure as far as possible the completeness and accuracy of records”

THE PRINCIPAL MATTERS THAT AN AUDITOR WILL TAKE INTO ACCOUNT IN

EVALUATING THE SYSTEM OF INTERNAL CONTROL

a) Control environment - This refers to the overall attitude, awareness and actions of directors
and management regarding the internal control system and its importance in the entity. The
control environment has an effect on the effectiveness of the specific control procedures. A
strong control environment, for example, one with tight budgetary controls and an effective
internal audit function can significantly complement specific control procedures.

Factors reflected in the control environment include:

a. The function of the board of directors and its committees.
b. Management’s philosophy and operating style.
c. The entity’s organizational structure and methods of assigning authority and responsibility.
d. Personnel policies and procedures and segregation of duties.

This sets the tone for the organization providing the foundation for all other components of the
Internal Control. Control Environment includes the integrity, ethical values and the competence
of the staff.

b) Risk Assessment - This is the identification and analysis of relevant risks, internal and
external, that affects the achievement of the organization objectives and forming a basis for
determining how the risk should be managed.
c) Control Activities - These help to ensure that the necessary actions are taken to address risks
relating to the achievement entity’s objectives. Control activities occur throughout the
organization, at all levels and in all functions.

d) Information and Communication - Internal and external information must be identified,

captured and communicated in a form and timeframe that enable people to take opportunities
carry out their responsibilities. Effective communication also must occur in a broader sense,
flowing down, across and up the organization.

e) Monitoring - Internal Control Systems need to be monitored, a process that assesses the
quality of the system’s performance over time. This is accomplished through ongoing monitoring
activities, separate evaluation or a combination of the two.

QUESTION TWO

HOW TO CARRY OUT AN INVESTIGATION TO DISCOVER THE EXTENT OF THE

DEFALCATIONS.

The following procedures could be applied as general leads to where frauds have taken place:

a) Compare the company’s balance sheet with those of previous two years.
b) Compare previous year’s figures with the current figure and ascertain that all changes are
in order and authentic.
c) Cast the trial balance figures and ensure they balance.
d) Check the names of the accounts in ledgers and those recorded in the trial balance to
ensure that there are no omissions.
e) Compare debtors and creditors from ledgers and those in trial balances. Debtors and
creditors accounts are easily a source of confusion for incompetent staff especially when
they involve many transactions.
f) Ensure that the totals of self-balancing accounts agree.
g) Count items in trial balance in the current account and compare those in the previous
account. Investigate any differences.
 h) Check totals of subsidiary books.
i) Calculate ratios from the two balance sheets. The ratios to be calculated can be leverage
ratio, activity ratios, performance ratio and profitability ratios.
j) Audit in depth such that the audit trail is established. Audit trail facilitates the checking a
transaction recording process from the initial stage to the final stage of a transaction. For
example an item like debtors one checks the date the sale took place, the invoice issued,
the cash received at the date of sale, any other cash receipts after the date of sale and the
balance. The balance the auditor gets should correspond with the one in the accounts.
k) Consult third parties in and out of the firm for example by use of debtor’s circularization
or lawyer’s letters.
l) Compare budgeted and actual results. Investigate in-depth the cause of any variances.

RECOMMENDATIONS TO IMPROVE IN THEIR SYSTEM OF INTERNAL

CONTROL.

1. Management supervision: This will serve to prevent frauds by boosting the awareness of
senior employees who will refrain from committing frauds by virtue of the constant review of
activities. Also the periodic review of Company operations makes it difficult or impossible for
Company’s employees to perpetrate frauds: constant review of actual performance against
budget will deter perpetration of errors and frauds. In addition, management will prevent errors
and frauds by supervising other controls such as division of duties within the accountancy
departments, providing routine and automatic checks supplemented by the use of the internal
audit function to continuously review the level of such internal checks.

2. Physical controls: The controls are used such that they limit access to Company’s portable,
exchangeable, desirable assets, which would have been misused, for personal gains. They work
as follows:

a) Use of strong locks or doors to limit access to Company’s assets.

b) Use of cash registers to increase accountability and ensure all cash receipts are recorded.
c) Use of pre-numbered documents kept under lock and key to avoid their misuse for
personal gains and consequent misappropriation of Company’s assets.
 d) Use of closed circuit TVs to warn off would be fraudulent individuals who will then keep
away from misappropriating the Company’s assets.

All physical controls make it difficult to misuse the Company’s assets by limiting access. These
may enable management to detect frauds. Some of these controls such as automatic bells,
automatic alarm systems, closed circuit TV will reveal frauds during the process of their
perpetration.

3. Segregation of duties: Various duties are segregated to minimize chances of frauds by

boosting automatic checks, accountability and supervision e.g. the employee receiving cash
should not be the same one banking the cash collected. Authorization and approval should not be
in the hands of a person who will execute that duty. Recording should not be done by a person
who authorized the transaction.

However, this segregation of duties should be done so that appropriate duties are given only to
those with competence and necessary qualification to enforce such controls effectively.

In the process of executing transactions frauds will be revealed by personnel checking their
colleagues and this will be brought to the attention of the senior management. By segregating
duties company personnel are made aware of their duties and responsibilities, they will be
motivated to advise their supervisors as soon as irregularities are discovered, and not cover them
hoping that they will pass without notice.

4. Arithmetic and accounting controls: Proper recording of transactions in accordance to IAS

will prevent frauds such as manipulation of accounts. Periodic balancing of entries, that is
reconciliation, will boost the awareness of accounting staff who may then refrain from
committing frauds. It will also include the continuous review of monthly accounting statements
which will serve to prevent frauds as exorbitant expenditure should be identified and
investigated.

5. Personnel: Any ICS should be implemented by qualified, competent and efficient personnel
as they are less likely to perpetrate frauds if they have such personal qualities. The Company’s
employees should be motivated and properly remunerated - two features that serve well to
prevent frauds. The careful selection of employees taking into account human qualities (honesty
and integrity) serve to prevent fraud as such virtues will increase the quality of the management
team. Career development prospects will also be important factor in this regard.

6. Routine and automatic checks: This control will minimize frauds through:
a) Boosting awareness that work will be continuously checked.
b) Increasing accountability by reducing the possibilities of successful deception.
c) Boosts the importance of being honest within the business.

In so far as these are on a surprise basis, they may reveal frauds in their initial stages. The checks
are made at a time least expected by the employees and they are caught unawares. This lowers
the possibility of initiating a fraud.

7. Control of documents: Sensitive documents will be kept under lock and key and this serves
as a deterrent measure against frauds because it limits access to assets that these documents
represent. The documents should be serially numbered or pre-numbered to avoid their misuse
and to monitor the movement of receipts and other documents. Also controlled authorization of
the use of the documents makes fraudulent conversion much harder for the aspiring criminal who
will be forced to produce sophisticated plans in order to overcome internal controls of the
business.

8. Rotation of duties: This control works to prevent frauds by ensuring a sense of responsibility
among the personnel to be rotated and also increasing visibility of their work to their supervisory
management as an indirect check on the employee concerned. Additionally, he will also be
checked by the person taking over from him who will additionally serve to prevent fraud.

This is effective in detection of frauds because the personnel taking over from their colleagues
will necessarily report existing irregularities if they wish not to be blamed for them. This ensures
that errors are discovered at early stages rather than when they are already advanced.

9. Compulsory Leave: The period of absence can be used by the management to assess the
volume of work in a particular position and through the report of the employee temporarily
working in that position any corrupt practice can be independently revealed.
10. Authorization & Approval: Authority limits are used to define the authority of an
individual to execute or approve a specific transaction. If such authority is abused, then it is
possible to identify who was responsible for any fraudulent conversion of frauds or misuse of
assets that may have taken place.

REFERENCES

1) Kumar Ravinder (2008), Auditing: Principles and Practice, Prentice-hall Of India Pvt
Ltd.
2) A. H. Millichamp (2002), Auditing 8th Ed, Thomson Learning Bower sox.
3) Ray Whittington, (2003), Principles of Auditing and Other Assurance Services, McGraw-
Hill College.
4) William C. Boynton, Raymond N. Johnson and Walter G. Kell, (2001), Modern Auditing,
Wiley