mu1 practice exam

EMU1D12 ©CGA-Canada, 2012 of 9

CGA-CANADA

INTERNAL AUDITING & CONTROLS [MU1] EXAMINATION December 2012

Marks Time: 4 Hours

Note:

The questions in this examination test the knowledge, skills, and professional values demonstrated in this course. Marks are given for reasoned and persuasive arguments, and for clarity and impact of presentation. You must provide practical illustrations for the use of concepts and analytical methods in the circumstances described in each question. Read the specific requirements of each question carefully, and ration your time across all questions.

20 Question 1

Select the best answer for each of the following unrelated items. Answer each of these items in your examination booklet by giving the number of your choice. For example, if the best answer for item (a) is (1), write (a)(1) in your examination booklet. If more than one answer is given for an item, that item will not be marked. Incorrect answers will be marked as zero. Marks will not be awarded for explanations. Note:

2 marks each a. Which of the following standards describes the nature of internal audit services?

1) Attribute standards 2) Performance standards 3) Engagement standards 4) Implementation standards b. Which of the following regarding audit interviews is true?

1) When it is possible to arrange, interviewing a group is preferred as it is a more efficient use of time.

2) Audits should rely on auditees to suggest specific persons for interviews. 3) The auditor’s focus should be to verify if the conditions stated in the checklist are satisfied. 4) Checklists are usually written with yes or no questions to facilitate note taking and to link

questions to requirements. c. Which of the following is an example of a good question for an audit interview?

1) When a customer calls, do you have to record the details on form xx? 2) How do you know this equipment is measured correctly? 3) Do you record the test results in the laboratory logbook? 4) Is this drawing correct (current)? d. Which of the following can be considered the most important phase of the internal audit process?

1) Planning 2) Examination 3) Reporting 4) Monitoring

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e. Which of the following regarding internal audit reports is true?

1) Usually, managers of audited units agree with the auditor on all important points in the report. 2) Internal auditors should not provide macro-level opinions to the board and management. 3) The audit report is an evaluation of past operational practices and the performance of a unit for the

period determined in the audit scope. 4) An audit report should motivate management to take action and therefore should only show areas

that need improvement. f. Which of the following regarding internal audit reports is true?

1) The final draft audit report should first be presented in a meeting of the audit committee (before presenting to the board), during which senior management and the chief executive present their views on the issues.

2) Auditors should never delegate a first draft report to support staff to make modifications to comply with the proper format of the final draft audit report.

3) In some situations, the auditor may have to consider reporting to someone outside the organization.

4) In rare situations, the auditor may have to consider reporting only to senior management. Such action should only be undertaken after seeking professional and legal advice.

g. Which of the following concerning the effect of information technology (IT) on internal controls is

true?

1) Computers performing repetitious tasks reduce the possibility of systematic error. 2) Computerized processing has resulted in more visible evidence for the internal auditor. 3) The lack of senior management expertise adversely affects senior managers’ ability to understand,

use, and control IT. 4) Rapid developments in IT result in a need for changes in controls. h. Integrated auditing may not work in today’s environment of sophisticated systems because the

approach can lead to which of the following?

1) Inadequate testing of automated controls 2) Unwarranted reliance on computer-generated information 3) Less visible or physical evidence for the auditor 4) Over-reliance on application-based control techniques i. Which of the following is true regarding general IT controls?

1) General IT controls govern role-based security. 2) General IT controls govern the maintenance of systems and how applications co-exist. 3) General IT controls can reduce manual input errors, but cannot eliminate them. 4) General IT controls dictate how the application processes information and passes it to subsequent

applications. j. The configuring and testing of system security features is a characteristic of which of the following

phases in the IT systems development life cycle (SDLC)?

1) Implementation 2) Development or acquisition, risk assessment 3) Initiation 4) Operation or maintenance

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30 Question 2 Last year, R&G Furniture reported revenues of $142 million, which made it the third largest manufacturer of office furniture in Canada. Due to a weak economy and innovative and cost-efficient competitors, R&G Furniture’s revenues and market share are shrinking year over year. R&G Furniture is known throughout the industry for its high-quality furniture and customized designs; however, its product costs and lead time are much higher than the industry average. Several months ago, Larry, the CEO and president, met with the vice-president manufacturing, Howard, and the vice-president sales and marketing, Petra, to set a strategic plan to increase company sales by 15% over the next fiscal year. They decided that R&G Furniture should attempt to increase its market share in the low-end office furniture market by offering a separate product line that is less customized and has a lower manufacturing cost. The CEO asked Howard to work on new furniture designs and to supply the estimated manufacturing costs to Petra so that she can establish pricing and prepare the sales team for the launch of the new products. After the meeting, Petra mentioned to the CEO that the best way to ensure the sales team will focus on selling the lower-end products would be to increase the commissions and bonuses associated with these products. The CEO agreed that the sales team would likely concentrate on selling the higher-end products if the incentive structure remained the same. Therefore, Petra proposed two changes: an increase of 8% for sales commission on the new product line (a portion of which she receives as vice-president) and a restructuring of the sales and marketing department bonuses to include the revenues generated by the new product line. A couple of weeks later, Petra had not received the cost estimates from Howard. Anxious to start the pricing and advertising process for the new product line, Petra called her friend who works in the manufacturing department. After some persuasive arguments, Petra convinced her friend to give her the preliminary manufacturing costs and sample designs that were circulating in the manufacturing department. Her friend reminded Petra that these costs and designs were not final and that she should get the final costs and designs from Howard. Petra thanked her friend and was content to have everything she needed to get her team started. Based on the manufacturing costs acquired, Petra set the marketing and sales strategies and R&G Furniture announced its new office furniture product line. When Howard heard this, he was quite alarmed and immediately advised the CEO that he had not provided his final costs for the new line of furniture. He noted that the costs being used were preliminary; however, Larry advised that the company had to proceed as sales orders were already being processed. He also stated that there should not be a huge deviation in the preliminary costs compared to the actual costs. Howard, still unsure as to how the preliminary costs were released, accepted his CEO’s final decision. A few months passed and Larry had heard nothing but great news. He was looking forward to reviewing the quarterly results. At a glance, he noticed that revenues increased by 22% over last year’s numbers; however, the smile on his face quickly faded when he saw that the company profits did not increase. As he is questioning these numbers, Larry received a phone call from the customer service vice-president explaining that they have been receiving a large number of complaints from customers concerning late deliveries and a high number of defective products. Extremely concerned, Larry first called Petra to discuss the situation. Petra quickly pointed out that her employees have done their job as sales have increased substantially. If there is a problem with the profit margins being too low she believes it is due to costs, which are the responsibility of the manufacturing department. She further explained that the pricing was based on costs provided to her by the vice-president manufacturing and that Larry should contact him for further explanation.

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Larry then called the vice-president manufacturing to discuss the customer complaints and the increased manufacturing costs. Howard explained that the deviation between the estimated and final costs calculated by manufacturing was only 6% and this would not entirely account for the reduced profit margins. He further outlined problems in producing the new line by explaining that they are using the same equipment to produce both the low-end and high-end product lines. Because there is set-up time required to reconfigure the machines between each production run, the process is time consuming. This constant change could explain the increase in the frequency of machine failures. Howard added that the sales team kept giving rush orders regardless of which product line was currently being produced, resulting in scheduling conflicts and reduced efficiency. Howard added that when he raised the issue about the rush orders being a problem, Petra indicated that it was the CEO who approved them and instructed that they be pushed through as quickly as possible. Furthermore, the sales forecasts are rarely reported to his unit, possibly explaining why they are encountering frequent shortages of raw materials. All these factors have caused much inefficiency. The CEO, somewhat surprised by the explanations he received, quickly realized there was a conflict between the two vice-presidents and wanted an independent assessment. He asked the internal audit department to review this matter and report on the risks faced by R&G as well as recommendations regarding the new product line. You, a CGA, are assigned to lead the review and report back to the CEO. Required

24 a. Based on the information provided, write a preliminary memo to the CEO as requested.

Note:

4 marks are allocated for clarity, logic, and persuasiveness 6 b. Separate from the memo, describe any ethical issue(s) observed in the launch of the new product line

at R&G Furniture.

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22 Question 3 N&B Limited is a private company that manufactures and distributes nuts and bolts. It employs over 500 people in 2 plants situated in Burlington, Ontario and Quebec City, Quebec. The human resources department (HR) is responsible for the production of N&B’s full-time employee payroll. A separate computerized payroll system, called flexible payroll system (FPS), is maintained by HR to handle casual employee’s wages, as well as other payments for full-time staff such as overtime, bonuses, and payments for completing special projects. The FPS was created in-house by the HR director in the early years of the company when the staff size was relatively small. The company has experienced rapid growth over the past ten years and as a result has significantly increased the size of the workforce. In that time, the FPS has not undergone any significant changes or upgrades. HR staff contends that the FPS system, once a means to simplify and facilitate payroll operations, has become cumbersome. This is due to an increase in manual intervention needed to support a greater number of transactions. In addition, HR has indicated that the FPS has compatibility issues with the main payroll system. HR management has therefore concluded that the FPS is inefficient and may be prone to error or even fraud. However, this conclusion is not shared by all senior administration staff. The current policies regarding the FPS are the following:

Any employee can initiate a payment request (not exclusive to HR); however, approval is required by a supervisor before the transaction can be finalized.

Vacation pay represents 4% of the total salary paid and is only calculated for full-time employees. Casual employees are not allowed to work overtime. Casual employees are paid 4% of their wages in addition to their regular pay but do not receive any

actual time off.

To address HR’s concerns, senior administration has asked you, a CGA, to examine the FPS and its output. The following table contains a reduced set of records from FPS transactions for the month of July. A table with employee information and a look-up table with the pay type descriptions are also provided. Required

16 a. Using the information provided in the following tables, describe the procedures that you would employ using analytical software such as ACL. Each audit procedure must be followed by a related conclusion based on the resultant data. You should also explain the significance of the observation.

Note:

Some conclusions may be drawn by direct observation of the raw data. This is a consequence of the limited size of the data set. However, you must describe proper procedures that will yield a data set to support the corresponding conclusion, in order to demonstrate your ability to formulate audit procedures for data analysis. In real-life situations, the data set would contain a far larger number of records, and a simple visual observation will not be effective in the analysis.

6 b. Identify control weaknesses in the FPS process based on the information provided in the case and the

following tables. Explain the impact of each weakness and provide recommendations for improvement.

Continued...


FPS

FPS_ID EMP_ID PAY_START PAY_END PAY_TYPE OT HOURS RATE VAC GROSS PAY_DATE APPROVER

1009 5102 7/2/2012 7/15/2012 C 1 40 $25 4% $1,040.00 7/8/2012 5109

1010 5103 7/2/2012 7/6/2012 OT 2 30 $30 0% $1,800.00 7/6/2012 5109

1011 5107 7/6/2012 7/6/2012 C 1 10 $18 4% $187.20 7/9/2012 5109

1012 5103 7/9/2012 7/13/2012 OT 2 30 $30 0% $1,800.00 7/20/2012 5109

1013 5108 7/20/2012 7/31/2012 OT 2 15 $45 0% $1,350.00 7/31/2012 5108

1014 5106 7/2/2012 7/2/2012 C 1 20 $25 4% $520.00 7/2/2012 5108

1015 5105 7/30/2012 7/31/2012 OT 2 20 $20 0% $800.00 7/31/2012 5109

1016 5109 7/23/2012 7/27/2012 MI 1 4% $3,120.00 7/27/2012 5109

1017 5103 7/16/2012 7/20/2012 OT 2 30 $30 0% $1,800.00 7/20/2012 5108

1018 5102 7/20/2012 7/24/2012 C 1 20 $25 4% $520.00 7/6/2012 5109

1019 5107 7/20/2012 7/20/2012 C 1 5 $18 4% $93.60 7/20/2012 5109

1020 5104 7/3/2012 7/15/2012 C 1 20 $20 4% $416.00 7/15/2012 5108

1021 5103 7/23/2012 7/27/2012 OT 2 30 $30 0% $1,800.00 7/27/2012 5108 FPS_ID: A unique number for each FPS payment transaction EMP_ID: A unique number for each employee PAY_START: The beginning date of the period in which the FPS payment was earned PAY_END: The ending date of the period in which the FPS payment was earned PAY_TYPE: A code representing a specific type of FPS payment OT: Overtime factor to be applied to FPS payment HOURS: Number of hours worked RATE: The pay rate to be applied to calculate gross pay VAC: Vacation factor to be applied to FPS payment GROSS: The gross amount to be paid PAY_DATE: The date when FPS payment is to be made APPROVER: The EMP_ID of the employee who approves the transaction

PAY_TYPE

PAY_TYPE PAY_TYPE_DESC

C Casual

OT Overtime

MI Miscellaneous PAY_TYPE: A code representing a specific type of FPS payment PAY_TYPE_DESC: Description of FPS payment type

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EMPLOYEE

EMP_ID EMP_NAME POSITION

5102 Ann Anderson Office assistant

5103 Ben Bose Office assistant

5104 Cathy Cole Line operator

5105 Dean Deeb Office assistant

5106 Elen Elm Line operator

5107 Fiona Fung Cleaner

5108 Cathy Cole Factory supervisor

5109 George Gio Office director EMP_ID: A unique number for each employee EMP_NAME: Name of the employee POSITION: The job position of the employee

Continued...


28 Question 4 WelcomeAid is a charitable organization dedicated to raising funds to help underprivileged people in different countries. The organization is a large charity with annual donations of hundreds of millions of dollars. It has head offices in various countries with its North American head office in downtown Toronto, Ontario. One of the main reasons for WelcomeAid’s continued success is its pledge to minimize overhead costs while maximizing the percentage of donations to be distributed to those in need. The public perception of the organization has been very positive, resulting in a consistent stream of annual donations. Recently, the Toronto office of WelcomeAid was involved in a contentious matter regarding two former high-ranking employees. After their dismissals, these employees made allegations to the media of excessive spending and abuse of power at WelcomeAid. These allegations were in the news for several days and may adversely affect the public’s perception of the charitable organization. As a result, the board of governors and members of senior administration met to discuss how best to mitigate the damage caused by these allegations. The board consists of members from private industry external to WelcomeAid. The meeting took place in the recently renovated boardroom. During the meeting many board members commented on the extravagance of the boardroom as they noticed the large display monitors, new furniture, artwork, and other amenities. After the meeting, the chair of the board, Jack, asked the vice-president of finance, Johanne, about the cost of the boardroom and why he was not aware of it. Johanne responded that the total cost was over $1 million, but she would have to get back to him with final costs. She immediately explained that the cost of this boardroom was to be funded by donations made expressly for this purpose. Johanne also explained that some of the equipment, such as the 3 large display monitors, was donated by suppliers, therefore reducing the cost of the boardroom. She further explained that the president of the North American office of WelcomeAid (who could not attend the meeting) felt that the organization needed a boardroom to match its size and stature, and hence the renovation. Several days later, Jack received some information regarding the boardroom from a credible inside source. Apparently the cost of the boardroom was originally set at $500,000; however, two budget increases resulted in a final cost of $2.5 million. The inside source alleges that the approvals regarding the budget increases as well as for other expenses were not always obtained or documented and therefore should be reviewed. The inside source further alleges that the funding has not yet been obtained and the cost was paid from the capital budget, which is funded by regular donations. Jack immediately contacted the director of the internal audit department of WelcomeAid, Vikram, to discuss the boardroom and to share his recently acquired information. Jack felt that this boardroom indicated poor judgment with regard to economy of expenditures and supports the allegations made by the dismissed employees. He asked that an audit be performed immediately to determine how this renovation project was completed relative to controls and with respect to value for money. Vikram agreed and asked if he should advise Johanne, since he reported administratively to her. Jack advised to do whatever was necessary to conduct the audit. Vikram then suggested that a comprehensive audit be performed to address Jack’s requests and asked you, a CGA, to complete the audit. As a preliminary step you have acquired information regarding the expenses incurred for the boardroom as well as some of the relevant controls:

1. The original contract for the renovation of the boardroom, set at $500,000, went to tender and a general contractor was selected to perform the renovations. There was a subsequent change order to increase the budget to $1.7 million and a second one to $2.5 million.

2. The documentation is available for the original contract and it was clearly approved by the president

of WelcomeAid North America. The subsequent change orders are also available and were approved by the VP, Johanne. There is also an email from Johanne sent to the project manager urging the contractor to proceed without delay and stating that the president has given his approval for the budget increases. The email further addresses concerns from the project manager over the source of funding, stating that the special donations will be obtained and to proceed as planned.

Continued...


3. Other relevant expenditures for consideration include:

Display monitors @ $80,000 — It was discovered that the 3 display monitors were not donated but instead were paid for by WelcomeAid. The documentation indicated that the supplier would give an annual volume rebate of 10% on all future purchases for the next 3 years. You have conducted an analysis and the historical expenditures with this vendor averaged approximately $160,000 per year (mostly computers and peripherals).

Furniture and fixtures @ $49,000 — Though the furniture in the boardroom was fairly new it was decided that to match the style of the newly renovated boardroom, new furniture would be acquired.

Artwork @ $67,000 — To commemorate the new boardroom, modern art was purchased to replace the portraits of former governors.

For all purchases described above, the supporting documentation was approved by the project

manager. 4. The relevant procurement controls state the following:

Contracts from $500,000 to $1,000,000 must be approved by the president; contracts over $1,000,000 must be approved by the board of governors.

Similarly, change orders from $500,000 to $1,000,000 require approval by the president; change orders greater than $1,000,000 must be approved by the board of governors.

Purchases totalling more than $50,000 must be approved by the VP Finance. Required

22 a. Jack has asked for a memo describing comprehensive audits in the context of this situation and what components are applicable. In addition, he would like an outline of an audit plan (objectives, scope, criteria, and procedures) to better understand how the components of a comprehensive audit will be completed. He would also like you to present any preliminary findings that you may have identified to date. Write the memo to the chair.

Note:

4 marks for clarity, logic, and persuasiveness

6 b. Define objectivity and independence of internal auditors and explain the difference between them. Describe how either of these may have been affected in the context of WelcomeAid.

END OF EXAMINATION 100

INTERNAL AUDITING & CONTROLS [MU1] EXAMINATION

MU1

Before starting to write the examination, make sure that it is complete and that there are no printing defects. This examination consists of 9 pages. There are 4 questions for a total of 100 marks.

READ THE QUESTIONS CAREFULLY AND ANSWER WHAT IS ASKED.

To assist you in answering the examination questions, CGA-Canada includes the following glossary of terms.

Glossary of Assessment Terms

Adapted from David Palmer, Study Guide: Developing Effective Study Methods (Vancouver: CGA-Canada, 1996). Copyright David Palmer. Calculate Mathematically determine the

amount or number, showing formulas used and steps taken. (Also Compute).

Compare Examine qualities or characteristics that resemble each other. Emphasize similarities, although differences may be mentioned.

Contrast Compare by observing differences. Stress the dissimilarities of qualities or characteristics. (Also Distinguish between)

Criticize Express your own judgment concerning the topic or viewpoint in question. Discuss both pros and cons.

Define Clearly state the meaning of the word or term. Relate the meaning specifically to the way it is used in the subject area under discussion. Perhaps also show how the item defined differs from items in other classes.

Describe Provide detail on the relevant characteristics, qualities, or events.

Design Create an outcome (e.g., a plan or program) that incorporates the relevant issues and information.

Determine Calculate or formulate a response that considers the relevant qualitative and quantitative factors.

Diagram Give a drawing, chart, plan or graphic answer. Usually you should label a diagram. In some cases, add a brief explanation or description. (Also Draw)

Discuss This calls for the most complete and detailed answer. Examine and analyze carefully and present both pros and cons. To discuss briefly requires you to state in a few sentences the critical factors.

Evaluate This requires making an informed judgment. Your judgment must be shown to be based on knowledge and information about the subject. (Just stating your own ideas is not sufficient.) Cite authorities. Cite advantages and limitations.

Explain In explanatory answers you must clarify the cause(s), or reasons(s). State the “how” and “why” of the subject. Give reasons for differences of opinions or of results. To explain briefly requires you to state the reasons simply, in a few words.

Identify Distinguish and specify the important issues, factors, or items, usually based on an evaluation or analysis of a scenario.

Illustrate Make clear by giving an example, e.g., a figure, diagram or concrete example.

Interpret Translate, give examples of, solve, or comment on a subject, usually making a judgment on it.

Justify Prove or give reasons for decisions or conclusions.

List Present an itemized series or tabulation. Be concise. Point form is often acceptable.

Outline This is an organized description. Give a general overview, stating main and supporting ideas. Use headings and sub-headings, usually in point form. Omit minor details.

Prove Establish that something is true by citing evidence or giving clear logical reasons.

Recommend Propose an appropriate solution or course of action based on an evaluation or analysis of a scenario.

Relate Show how things are connected with each other or how one causes another, correlates with another, or is like another.

Review Examine a subject critically, analyzing and commenting on the important statements to be made about it.

State Clearly provide a position based on an evaluation, e.g., Agree/Disagree, Correct/Incorrect, Yes/No. (Also Indicate)

Summarize Give the main points or facts in condensed form, like the summary of a chapter, omitting details and illustrations.

Trace In narrative form, describe progress, development, or historical events from some point of origin.

SMU1D12 ©CGA-Canada, 2012 Page 1 of 9

CGA-CANADA


SUGGESTED SOLUTIONS

Marks Time: 4 Hours

Note:

The questions in this examination have been set to test the knowledge, skills, and professional values demonstrated in this course. The emphasis is much more on a reasoned and persuasive argument, on clarity and impact of presentation, and responding specifically to the case or situation presented, than on the mere recall of material from the Module Notes or readings.

20 Question 1

Note:

2 marks each

Sources:

a. 2) Topic 2.1 (Level 1) b. 4) Topic 6.1 (Level 2) c. 2) Topic 6.1 (Level 2) d. 3) Topic 6.2 (Level 1) e. 1) Topic 6.2 (Level 1) f. 3) Topic 6.2 (Level 1) g. 4) Topic 7.1 (Level 2) h. 1) Topic 7.1 (Level 2) i. 2) Topic 7.1 (Level 2) j. 1) Topic 7.3 (Level 1)

Continued…


30 Question 2 24 a. Source: Topics 3.3, 8.1, and 8.6 (Levels 1 and 2)

MEMORANDUM

Date: December 1, 2012 To: Larry Betts, CEO and President From: John Smith, CGA Re: Investigation into loss of profits As requested, I have spent the last week investigating the reasons behind the lack of profit despite a

significant increase in sales. I have interviewed several employees from the manufacturing and sales and marketing departments and believe that I have collected sufficient information to identify the business risk in each department and provide you with recommendations on how to mitigate these risks.

The sales and marketing team have done an excellent job in promoting and selling our new furniture

line, as evidenced by the 22% increase in sales. However, I believe that there are several key steps that have been neglected. My findings are the following:

1. Observation — manufacturing costs: One of the key functions of marketing is to provide the sales team with accurate pricing of its products. It appears that in the rush to get the new products to market, estimated manufacturing costs were used to determine the product price. The manufacturing costs of the final designs of the new product line were never taken into consideration in the product prices. Furthermore, there was no attempt, after the product line launch, to incorporate the actual manufacturing costs into the price. Therefore, any deviations in actual costs could affect the profitability of the product line. In this case it has negatively affected the profit margins.

Recommendation: The final manufacturing costs should have been used to calculate the pricing of

the new product line. However, to properly address this issue I would recommend that the marketing team regularly update the product costs based on the actual costs provided by the manufacturing team. This process should be performed at least quarterly, and the price will better reflect the actual costs. This should stabilize the profit margins to an acceptable and desirable level.

The costs should be available to the marketing group, who can then use them to re-evaluate the

pricing. Once this is done there should be a review with all the departments to formally approve these costs before marketing communicates the price changes to the sales team. This will ensure that the R&G Furniture is not selling the products for less than they cost.

2. Observation — sales forecasts: Another important function of the marketing department is to

provide accurate sales forecasts. This is important since many other functions in the company, such as purchasing and manufacturing, rely on this information. It appears that the raw material orders are not taking into account the increases in sales. If the forecast is never adjusted for the actual sales, it will be very difficult to determine how much material is needed. This explains the shortage of materials, which in turn have caused costly delays.

Recommendation: The marketing team must provide a forecast for each product line and regularly

update the forecasts to ensure that purchasing and manufacturing have enough lead time to calculate and obtain all the raw material needs. These forecasts must be clearly communicated to the appropriate units in R&G to allow for proper planning. This should place manufacturing in a better position to produce the products more cost efficiently.

Continued…


3. Observation — production scheduling: The manufacturing department has difficulty coping with the increased demand as well as the production of a second product line. Both product lines are being produced by the same machines and this is creating bottlenecks because there is set-up time required to configure the machinery for each product line. In addition, the flow of orders into the systems is not organized for efficiency, but instead is based on priorities dictated by sales. Therefore, manufacturing is reacting to meet rush orders to avoid potential loss of business. All these factors result in the machinery being configured several times in the course of a day’s operations instead of scheduling for longer production runs of both product lines. Frequent switching of the machine configuration is the cause of increased machine failures. This results in an inefficient manufacturing process.

Recommendation: The manufacturing department needs to implement a production schedule that

manages both product lines more efficiently. The production schedule should take into account the sales forecasts and allow flexibility for rush orders. The schedule will then, in addition, drive the quantity and lead times for all the raw material necessary to produce the products. Another consideration may be to purchase more machinery; however, production scheduling remains an important aspect that must be addressed whether or not new machines are available.

Overall I believe that we can rectify the problems affecting the profit margins by instituting strategic

planning and effectively communicating quality information between all departments. Timely sharing of information will allow for better pricing and forecasting, which will be important when making procurement decisions. Sufficient materials on hand will facilitate the preparation and execution of an effective production schedule thus avoiding the risk of costly delays. This approach, if implemented properly, should contribute to aligning costs to result in a more reasonable rate of return for the new product line.

Please let me know if you have any questions concerning these recommendations. Note:

3 marks for each identified risk to a maximum of 9 marks 3 marks for a recommendation to a maximum of 9 marks 2 marks for a conclusion 4 marks for clarity, logic, and persuasiveness

Continued…


6 b. Source: Topic 1.9 (Level 1) In reviewing the launch of the new product line at R&G Furniture, there were a few issues that may

have been problematic. The vice-president sales and marketing had suggested that a bonus and commission incentive program be set up to help motivate sales staff to focus on the new product line. This in itself is not necessarily an issue; however, her action to rush to obtain the manufacturing costs may have adversely affected the company. In addition, she bypassed the normal reporting channels in order to obtain the costs (which were not final). The costs she used in pricing were never finalized or approved by the vice-president manufacturing, and to further complicate matters, she falsely indicated otherwise to the CEO. This false explanation deflected responsibility for the reduced profit margins and placed the blame on the manufacturing department.

In addition, the vice-president marketing misrepresented the CEO’s wishes to the vice-president

manufacturing in order to push through rush sales orders, which would ultimately increase her bonus. These actions are unethical and are most likely motivated by greed as her compensation was directly linked to the amount of sales generated. To make matters worse, her actions, though beneficial to her, were financially detrimental to the company. When faced with tough questions regarding her accountability she lied to avoid any consequences.

These actions warrant further scrutiny and require immediate corrective action to avoid such situations

from recurring. Note:

2 marks for each description of a breach of ethics to a maximum of 4 marks 2 marks for explaining the impact on the company

Continued…


22 Question 3 16 a. Source: Topic 5.6 (Level 1)

Procedure: Extract records from table FPS where PAY_DATE < PAY_END. Join the resulting table

to table EMPLOYEE by matching EMP_IDs in both tables.

Conclusion: Transaction FPS_ID 1009 – employee Ann Anderson paid one week before the pay period ended. Company paid for work that was not complete.

Procedure: Extract records from table FPS where EMP_ID = APPROVER. Join the resulting table

to table EMPLOYEE by matching EMP_IDs in both tables.

Conclusion: Transaction FPS_ID 1013 and 1016 – Employees approved payments to themselves. Both employees, Cathy Cole and George Gio, are supervisors.

Procedure: Summarize table FPS, group by EMP_ID, and obtain the SUM of GROSS. Join the

resulting table to table EMPLOYEE by matching EMP_IDs in both tables.

Conclusion: Employee 5103, Ben Bose, received a total of $7,200 for 120 hours of overtime in July. The amount of overtime seemed excessive and questionable.

Procedure: Extract records from table FPS where (PAY_TYPE = ‘OT’ or ‘MI’) AND (VAC > 0).

Join the resulting table to table EMPLOYEE by matching EMP_IDs in both tables.

Conclusion: Employee 5109, George Gio, received an additional miscellaneous payment with vacation pay applied. This is against company policy, which only allows vacation to be applied to regular and casual salary.

Procedure: Summarize table EMPLOYEE group by EMP_NAME and obtain COUNT of records.

Conclusion: The system has employee name Cathy Cole in two separate employee records. They may be different persons with the same name, but it will warrant verification.

Note:

1 mark for each procedure to a maximum of 4 marks 2 marks for each conclusion to a maximum of 8 marks 1 marks for each procedure that supports the corresponding conclusion to a maximum of 4 marks

Continued…


6 b. Source: Topic 9.3 (Level 2)

Weakness: System allows wages to be paid before the end of the pay period. Impact: Company risked losing pay to employees, especially in the case of casual workers, who may leave the company without completing their work. Recommendation: The system should have application controls to check if the pay date is before the end date of the pay period and reject such entries.

Weakness: Policy requires supervisors to approve FPS payments. This is a prudent control.

However, system allows supervisors to approve their own FPS payments. Impact: This control weakness puts employees in a conflict of interest and provides opportunities for fraud. Recommendation: Company policy should require the approval from the immediate superior in the case when a supervisor is to be paid through the FPS. The system should also compare the employee ID to the approver ID and reject the transaction if the two are the same.

Weakness: There is no description on FPS payments. As a result, there is no efficient way to

examine and justify the payment records. Impact: The lack of description makes it more difficult to detect improper payments, whether they are approved by mistake or are results of fraudulent acts. The consequence will be an increase in the likelihood of loss from extra labour costs. Recommendation: An additional field should be added to the FPS table to record the reason for the payments.

Note:

1 mark for each weakness to a maximum of 2 marks 1 mark for each impact to a maximum of 2 marks 1 mark for each recommendation to a maximum of 2 marks

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28 Question 4 22 a. Source: Topics 4.2, 5.7, and 10.5 (Levels 1 and 2)

MEMORANDUM Date: December 1, 2012 To: John Wilson, Chair Board of Governors From: John Smith, CGA Re: Comprehensive Audits and Planning As mandated, I have prepared this memo to outline comprehensive auditing, including all of its

components, in the context of the renovation of the boardroom located at the Toronto office of WelcomeAid North America. There have been recent allegations in the media that pose a serious reputational risk and, worse yet, may negatively affect the financial well-being of the organization. It is in this environment that I will be conducting the audit, but I have first prepared this memo to address your request.

Comprehensive auditing is often described as the public sector version of external auditing. Though it

is traditionally employed in audits of government activities, it certainly can be applied to a not-for-profit organization. Comprehensive generally consists of three components:

1. Attest audit — An audit of financial statements to determine whether financial statements are presented fairly in accordance with the regulated accounting frameworks. In our case this will not be applicable as this is covered by our annual external audit.

2. Compliance audit — To assess whether operations and expenditures are properly authorized and

in compliance with the relevant controls. As discovered during my preliminary review, there were a number of compliance issues with procurement controls. Therefore, further compliance testing will be required.

3. Performance audit — Also known as value-for-money audits, the objective is to assess the extent

to which the organization’s resources are managed with due regard for:

Effectiveness — refers to the achievement of the objectives of the operations or activities of the organization.

Efficiency — refers to the use of financial, human, and physical resources, such that output is maximized for any given quantity and quality of output provided.

Economy — refers to the acquisition of the appropriate quality and quantity of financial, human, and physical resources at the appropriate times and at the lowest cost.

In the context of WelcomeAid, performance auditing is well suited to address your requests, primarily through evaluating the economical aspect of these purchases. The overall cost of the boardroom could be considered excessive at $2.5 million. In addition, display monitors were purchased at an excessive cost; though furniture was already available, new furniture was purchased for aesthetic reasons; and artwork was similarly purchased to modernize the look of the boardroom. These purchases not only did not appear to be economical but in addition did not enhance the efficiency or effectiveness of the organization.

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As a result, an audit plan that I propose would focus on compliance testing and evaluating purchases for value for money. An outline of the plan is as follows:

Audit scope:

Review all expenditures and supporting documentation associated with the renovation of the boardroom at the Toronto office.

Audit objectives:

To determine if contracts, change orders, and all other relevant purchases were made in compliance with the policies of the organization.

To evaluate the contract, change orders, and purchases to determine if they were completed with due regard for economy with the goal of increasing the effectiveness and efficiency of the organization.

Audit criteria:

Contracts and change orders greater than $500,000 must be properly documented and approved by the president.

Contracts and change orders greater than $1,000,000 must be properly documented an approved by the board of governors.

Purchases totalling more than $50,000 must be documented and approved by the vice-president of finance.

Purchases made should be in respect of economic considerations. Audit procedures:

Review renovation contract and change orders greater than $500,000 but less than $1,000,000 to determine if they are supported by documentation and approved by the president.

Review renovation contract and change orders greater than $1,000,000 to determine if they are supported by documentation and approved by the board of governors.

Review documentation for purchases greater than $50,000 to determine if they are properly authorized.

Review purchases of artwork, display monitors, and furniture and do comparative pricing where possible to determine if the best pricing was obtained.

The plan outlined above is not exhaustive. As I continue to gather more information and conduct

further analysis, we may wish to incorporate further procedures and criteria or add audit objectives. This plan is based in part on some of the preliminary conclusions from reviewing the documentation.

Most troubling was the contention made regarding the display monitors. These items were never donated and even the volume rebates may never be fully realized. A simple calculation confirms that a 10% annual rebate based on the average purchases would only result in a $48,000 recovery. This is far less than the anticipated $80,000. The vendor effectively guaranteed themselves sales over the next three years at WelcomeAid’s expense.

In reviewing some of the procurement contracts, there were issues as well. The initial contract was

approved by the president. However, the change orders also subject to the policy were approved by the vice-president finance. According to the policy these should have been approved by the president and the board of governors, but these approvals were never obtained. In addition, purchases were made that should have been approved by the vice-president finance but instead were approved the project manager. The email from Johanne is not sufficient to address the required approval for the purchases, nor does it show documented approval from the president, though it likely was received.

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In closing, there are a number of non-compliant issues and disregard for economic purchases that warrant further investigation. Controls appear to have been bypassed, which, in addition to the recent bad publicity, may adversely affect WelcomeAid’s ability to procure donations. Upon completion of the overall audit you can expect a full report and my final conclusion on the matter.

Note:

1 mark for each audit objective to a maximum of 2 marks 1 mark for each criterion to a maximum of 3 marks 1 mark for each procedure to a maximum of 3 marks 2 marks for evaluating volume rebates and identifying shortcoming 1 mark for each non-compliance issue relative to procurement to a maximum of 2 marks 1 mark for describing an attest audit 2 marks for describing a compliance audit 3 marks for describing a performance audit and its components 4 marks for clarity, logic, and persuasiveness

6 b. Source: Topic 2.3 (Level 1)

In the context of the internal audit department, independence is the freedom from conditions that

threaten the ability of the internal audit activity to carry out internal audit responsibilities in an unbiased manner. Objectivity is an unbiased mental attitude that allows internal auditors to perform engagements in such a manner that they believe in their work product and no quality compromises are made. Safeguards can be implemented to ensure independence, such as reporting relationships, segregation of duties, and restrictions on responsibilities. However, individual auditors have ultimate accountability for their objectvity.

In this case, there may be an impairment of independence. The internal audit department has been

asked to investigate a boardroom renovation. This project was in part under the direction of the vice-president finance, who may have made some questionable decisions regarding the purchases and certainly appears to have had knowledge and willingly circumvented controls. This is a problem because the internal audit department reports to the vice-president finance. Even if objectivity is maintained, the perception remains of a potential impairment of independence. It is important to note that this may also have been the case had the internal audit department reported to the president. Therefore, it is important in this case to make the distinction that any report or direction of audit work should be made directly to/from the board of governors.

Note:

2 marks for each definition of independence and objectivity to a maximum of 4 marks 2 marks for identifying impairment

END OF SOLUTIONS 100

MU1D12 ©CGA-Canada, 2012

CGA-CANADA


EXAMINER’S COMMENTS

General Comments Candidates’ overall performance was borderline satisfactory. This is a slight improvement in comparison to the previous examination average in September 2012. Candidates’ performance on Question 1 remains unsatisfactory. This has been addressed in previous examiner comments as the degree of difficulty of multiple-choice questions is set high. It requires candidates to prepare by studying all recommended course material, including the readings. The end result has been lower overall average marks for the past three sessions. Despite Question 1, candidates performed satisfactorily on all other questions. Candidates were able to identify risks in a business case and provide reasonable recommendations for corrective action. Candidates were able to satisfactorily assess controls regarding an IT-based system and provide meaningful recommendations. Furthermore, the majority of candidates were successfully able to outline an audit program for the purchasing function of the fictional corporation. Areas for improvement include defining comprehensive audits and properly identifying and demonstrating an understanding of ethical issues. Additionally, candidates must improve their understanding of how to use audit software such as ACL and its basic functionality.

Specific Comments Question 1 Multiple choice (Levels 1 and 2)

Overall candidate performance was unsatisfactory. Candidates had difficulty with questions relating to basic concepts such as interviewing skills and understanding the risks in an information technology (IT) environment. Candidates must also improve their understanding of the purpose and objectives of internal audit reporting. The report represents the key communication of identified areas for improvement as well as management’s acknowledgement and agreement to undertake corrective action. Candidates must be able to demonstrate a thorough understanding of this topic to be able to succeed as internal auditors. Based on the results, an analysis of candidates’ performance relative to the difficulty of the multiple-choice questions was completed and was factored into the final marking of the examination.

Question 2 Risk assessment process — marketing and production context (Levels 1 and 2) Candidates’ performance was satisfactory. The majority of candidates were successfully able to identify the risks facing the company in question and provide reasonable recommendations. However, in part (b) many could not identify which specific behaviour was unethical given the case scenario. Many candidates identified the compensation program as an ethical issue as opposed to the individual’s behaviour. It was the individuals who unfairly manipulated the processes in order to gain an advantage and ultimately more money. Candidates must be able to identify potential pitfalls regarding ethical behaviour in order to help them avoid these issues in their respective careers.

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MU1D12 ©CGA-Canada, 2012

Question 3 Analysis of data (output from audit software) and computer-assisted audit techniques (Levels 1 and 2)

Candidates’ performance was satisfactory. The level of understanding with regard to data analysis with the use of audit software has been steady and on the whole satisfactory. However, as was the case in the previous examination session, improvement is required in understanding the basic and most common functions (as well as their use) employed by most audit software programs.

Question 4 Internal audit planning process and comprehensive auditing (Levels 1 & 2) Candidates’ performance on this question was satisfactory. Candidates did very well in presenting an audit program for the purchasing function. However, improvement is required in demonstrating their understanding of comprehensive auditing. Furthermore, in part (b) candidates did well in defining objectivity and independence but were not consistent in identifying the breach of independence presented in the case. Similar to the ethics issue in Question 2, improvement is required as candidates, in order to be successful, must be able to navigate through any situations that may pose an impairment of their objectivity or a breach of their independence.