Note:

The purpose of the following practice examination is to provide an opportunity for review and to provide some indication of the form, rather than the content, of the course examination.

INTERNAL AUDITING & CONTROLS [MU1] PRACTICE EXAMINATION #1 (Updated to the 2013/2014 Module Notes)

MU1
Before starting to write the examination, make sure that it is complete. 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) Examine qualities or characteristics that resemble each other. Emphasize similarities, although differences may be mentioned. Compare by observing differences. Stress the dissimilarities of qualities or characteristics. (Also Distinguish between) Express your own judgment concerning the topic or viewpoint in question. Discuss both pros and cons. 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. Provide detail on the relevant characteristics, qualities, or events. Create an outcome (e.g., a plan or program) that incorporates the relevant issues and information. Calculate or formulate a response that considers the relevant qualitative and quantitative factors. 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) 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. 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. 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. 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 Explain

Compare

Contrast

Criticize

Define

Describe Design

Determine

Diagram

Discuss

Evaluate

CGA-CANADA INTERNAL AUDITING & CONTROLS [MU1] PRACTICE EXAMINATION #1 (Updated to the 2013/2014 Module Notes) Marks Time: 4 Hours

Note:
The questions in this examination test the knowledge, skills, and professional values demonstrated in the 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.

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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.

To be used effectively, performance measures must be expressed as standards that have certain qualities. Which of the following qualities should the standards have? 1) 2) 3) 4) Attainable, realistic, and verifiable Attainable, measurable, and verifiable Attainable, measurable, and realistic Attestable, measurable, and verifiable

b. Which of the following standards is a specific standard for the performance of internal audit work? 1) The internal audit activity should be independent, and internal auditors should be objective in performing their work. 2) The internal audit activity should adopt a process to monitor and assess the overall effectiveness of the quality program. 3) The chief audit executive should establish and maintain a system to monitor the disposition of results communicated to management. 4) The chief audit executive should develop and maintain a quality assurance and improvement program that covers all aspects of the internal audit activity and continuously monitors its effectiveness.

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c.

One of the areas dealt with by standards for management of the internal audit department is the relationship that internal auditors should maintain with external auditors. Which of the following statements reflects compliance with this standard? 1) To avoid a conflict-of-interest situation, the chief audit executive should refrain from sharing information with external auditors. 2) Internal auditors may assist external auditors by suggesting the approach and methods that they should use in carrying out their engagement. 3) Internal auditors may carry out their audits so that external auditors can use the results of their work. 4) To maintain its independence, the internal audit department should refrain from performing tasks that would assist external auditors in conducting their annual audit.

d. Which of the following is most likely to affect decisions about what to audit and how frequently? 1) 2) 3) 4) e. A financially unstable supplier An activity with a low level of complexity Low employee turnover in the sales department An effective quality control system

Which of the following is an example of a typical processing control technique? 1) 2) 3) 4) Anticipatory controls such as a required field value Assigning an automated tracking of transaction sequence numbers Checking of control totals for completeness of output Use of electronic signatures to authorize the recording of a transaction

f.

Which of the following is a limitation of comprehensive auditing? 1) Comprehensive auditing does not add credibility to the assertions of public sector administrators about the quality of their stewardship and management. 2) Comprehensive auditing does not meet the criterion of independence. 3) Comprehensive auditing does not promote confidence in public sector institutions. 4) Comprehensive auditing does not question the appropriateness of programs or the decisions of an elected or governing body.

g. In order for the auditors report to persuade management to take corrective action, it must, among other things, be objective. Which of the following statements indicates that the auditors report is objective? 1) 2) 3) 4) The report is logical. The report is easily understood. The report is factual. The report is free of unnecessary technical language.

h. Which of the following statements is used in the definition of internal auditing to refer to the expression of an opinion that the organizations management understands risk exposure and implements appropriate risk management? 1) 2) 3) 4) Internal auditing evaluates and improves the effectiveness of control processes. Internal auditing evaluates and improves the effectiveness of governance processes. Internal auditing evaluates and improves the effectiveness of risk management processes. Internal auditing is an objective assurance activity.

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i.

Which of the following concepts refers to the relationship based on the obligation to demonstrate and take responsibility for performance in light of agreed-upon expectations? 1) 2) 3) 4) Accountability Corroboration Governance Replication

j.

The organizational status of the internal audit function is one of three factors that affect the degree of independence of internal auditors. Which of the following situations is the most likely to ensure the independence of internal auditing from an organizational status perspective? 1) The chief audit executive must report functionally to the board. 2) Personnel under the authority of the chief audit executive may have limited direct authority over the activities subject to audit. 3) To maintain independence, the chief audit executive must have limited access to the board of directors. 4) The resolution of control issues must not be under the direction of the chief audit executive.

k. Checking digits to ensure the validity of account numbers is an example of which of the following controls? 1) 2) 3) 4) l. System control Security control Communications network control Application control

In the context of legislative auditing, which of the following does the Auditor General of Canada not consider to be a main type of audit? 1) 2) 3) 4) Performance or value-for-money audits Special examinations of Crown corporations Financial or attest audits Forensic audits

m. Internal auditing standards require that auditors exercise due professional care in carrying out audit work. Which of the following statements best applies to the concept of due professional care? 1) Internal auditors should be alert to the significant risks that might affect objectives, operations, or resources. 2) Internal auditors should have sufficient knowledge to identify the indicators of fraud. 3) Internal auditors should have an impartial attitude. 4) Internal auditors must avoid conflicts of interest. n. How should the internal auditor react when he discovers, while monitoring progress, that nothing has been done to correct the deficiencies identified in the audit? 1) Check with the unit concerned if actions are planned that are likely to correct the deficiencies in a timely manner. 2) Alert the audit committee. 3) Inform the manager of the internal audit department. 4) Alert senior management.

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Question 2 CL Inc. is a small manufacturer of store fixtures and equipment, located in a medium-sized city. Most of the products CL sells are manufactured in the sole plant owned by the company. Recently, CL lost a major contract because it could not match the prices of its closest competitor. After analyzing CLs manufacturing costs, the controller noted an increase in the plant labour costs. Wages have been stable and the controller wonders why plant labour costs have increased. You have been hired as a consultant to investigate the problem and your first assignment is to review CLs manufacturing payroll process, which is as follows. CL INC. Manufacturing payroll procedures 1. Production workers use a timecard to record arrivals and departures. They also use a job ticket to manually record the time they spend on individual production jobs. 2. At the end of each pay period, the production manager enters the information from the timecards into the Time file and the information from the job tickets into the Jobs file before transmitting the documents to the bookkeeper. The manager uses that information to keep track of the productivity of the department and the individual employees. 3. The bookkeeper enters the data from the timecards into the Payroll file. The system calculates the remuneration of the workers and the withholdings. The employees records are updated. 4. The bookkeeper uses the job tickets to allocate labour costs as direct labour or overhead to the different jobs in the Work-in-process file, and then prepares a summary of the labour distribution to update the general ledger accounts. 5. The amount of the payroll is transferred from the main bank account to the special account from which the paycheques are drawn. The bookkeeper prepares the cheques and distributes them to employees. Using CAATs, your assistant carried out a preliminary analysis of the payroll transactions for the last five periods using some of the following tables. The results of the analysis are presented in Exhibit 2-1. TIME file EMPNUM: PRODPERIOD: HOURS: JOBS file JOB: PRODPERIOD: HOURSJOB: EMPLOYEES file EMPNUM: NAME: ADDRESS1: ADDRESS2: PROV: RATE: STATUS: TD1:

Employee ID number Production period number Number of hours worked by the employee during the period Job ID number Production period number Number of hours worked on the job during the period Employee ID number Employee name Employee civic address Employee city and postal code Employee province of residence Employee hourly rate Employee status: 1=active, 0=inactive TD1 amount Continued...

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PAYROLL file PAYPERIOD: PERIODENDING: EMPNUM: TOTHOURS: REGHOURS: OTHOURS: RATE: GROSSPAY: DEDUCTIONS: NETPAY: PAYCHKNUM:

Pay period number Ending date of the pay period Employee ID number Total hours worked by the employee during the period Number of regular hours worked by the employee during the period Number of overtime hours worked by the employee during the period Hourly rate Gross pay for the period Total deductions for the period Net pay for the period Paycheque number

DISBURSEMENTS file DISNUM: Disbursement number DISAMT: Disbursement amount DISDATE: Disbursement date CHKNUM: Cheque number VENDNUM: Vendor ID number Required 6 4 a. State the preliminary conclusions that you can draw from the results presented in Exhibit 2-1.

b. Explain the additional analyses that you would ask your assistant to perform using the information in the files, in order to obtain other indicators that would facilitate your investigation. c. Based on the information available, identify the controls that you would suggest CL implement to improve its payroll process.

EXHIBIT 2-1 Table: PAYROLL Command: SUMMARIZE ON PAYPERIOD SUBTOTAL NETPAY TOTHOURS OTHER FIELDS PERIODENDING PAYPERIOD 2013-3 2013-4 2013-5 2013-6 2013-7 Total NETPAY 42,949.83 42,305.78 43,926.55 44,292.90 44,921.93 218,396.99 TOTHOURS 4,292 4,246 4,388 4,444 4,528 21,898 PERIODENDING 1/14/2013 1/28/2013 2/11/2013 2/25/2013 3/11/2013 COUNT 54 54 55 56 57 276

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EXHIBIT 2-1 (Continued) Table: TIME Command: SUMMARIZE ON PRODPERIOD SUBTOTAL HOURS PRODPERIOD 2013-3 2013-4 2013-5 2013-6 2013-7 Total HOURS 4,292 4,246 4,308 4,284 4,288 21,418 COUNT 54 54 54 54 54 270

Table: DISBURSEMENTS Command: EXTRACT DATA FIELDS = DISAMT DISDATE VENDNUM IF VENDNUM=PAYROLL DISAMT 42,949.83 42,605.78 43,926.55 44,292.90 45,921.93 Total 219,696.99 DISDATE 1/14/2013 1/28/2013 2/11/2013 2/25/2013 3/11/2013 VENDNUM Payroll Payroll Payroll Payroll Payroll

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Question 3 Your friend John is considering enrolling in the CGA program, with the career objective of getting an internal auditor position in a large company. John has contacted his provincial association and received all the information about the CGA program requirements. However, John would like to know more on some specific aspects of the work of an internal auditor. He has contacted you hoping that you would help him by answering a few questions about the practical side of the profession. John would like to know the importance of communication skills for an internal auditor. Will he have to hold meetings and carry out interviews on a regular basis? John considers that his skills are adequate but is willing to improve them if that is going to help him in his future career. John would also like to know the role that an internal auditor is expected to play in determining risks. Your 10 years of experience as an internal auditor have convinced you that your friend is making the right choice. You decide to prepare a memo that will help John to fully understand both the importance of communications in internal auditing and the role that an internal auditor is expected to play in determining risks. In the memo, you should describe the different tasks for which internal auditors are required to communicate with others when planning and carrying out the audit and reporting its results. This description should include the need for communication skills and the individuals with whom the auditor communicates. Required 22 Write the memo to John. Note: 4 4 additional marks will be awarded for clarity, logic, and persuasiveness of the memo. Question 4 ERT Ltd. is one of the largest Canadian manufacturers of silicon chips. The company grew quickly but because of the large amounts of money that it had to invest, its cash reserves were quickly exhausted. ERT therefore applied for, and obtained, sizable grants from the various levels of government anxious to foster the development of high-tech companies. However, the grants were accompanied by conditions that the company must comply with annually for a 5-year period starting January 1, 2010. If, at the end of a fiscal period, the conditions are not met, ERT will have 5 years to repay all grants obtained. These conditions, while known and accepted by the board of directors when the agreements were signed, are a little worrisome to the companys vice-president of finance. These conditions affect certain areas of the companys operations that have always been weak, as identified below. The following two conditions are especially troubling to the vice-president of finance. 1. Art.15(a) Inventories The corporation shall at all times maintain raw material and finished goods inventories at market value equal to or greater than 50% of the total amount of grants obtained.

32

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2. Art.18(c) Other expenses The corporation shall exercise control over its expenses other than those directly related to manufacturing. These expenses include the salaries of senior executives, all managers except production managers, and administrative staff. They also include the companys financial expenses. These expenses cannot exceed 45% of total expenses and costs of any type incurred by the corporation at the fiscal period end. As an internal auditor for the company, you are well aware of the weaknesses that worry the vice-president of finance and you entirely share his concern regarding the companys ability to meet the conditions laid down by the granting agencies. During the past year, ERT has experienced several stock-outs that resulted in the loss of a number of large clients. Despite the efforts made by the sales department, the company has not been able to win back some clients who switched to ERTs competitors. You are reviewing the annual audit plan and you realize that the audit of finished goods inventories might cause you a problem. The most valuable items are generally too small to be counted manually and you will therefore have to use specialized equipment to determine the value of these inventories. Another problem is that all the items appear similar, whereas their values may differ considerably. When questioned on this subject, the vice-president of production tried to reassure you: We already have the equipment needed to determine the value of the inventories. In fact, I am surprised that you were not aware of this, considering that we have been using this equipment for more than 5 years. You can stop worrying; I know the value of every item produced in this plant. As to the reduction of expenses, you have no idea where to begin. The other-expenses-to-total-expenses ratio is currently 53%, and an 8% reduction seems impossible to you. Also, you have noticed that since it was announced that grants had been obtained, other expenses have risen substantially. The chief audit executive (CAE), to whom you have confided your concerns, is well aware of the problems that could result from a failure to meet the conditions imposed by the different granting agencies. She considers it essential to amend the annual audit plan to ensure that the conditions imposed by the granting agencies are met. However, before the plan is amended, she would like you to write a memorandum proposing a series of criteria and procedures for ensuring that the objective of complying with the conditions is met. She would first like you to develop the audit criteria and procedures that would apply to the following: 1. 2. 3. 4. Production and inventory management Purchasing Administrative expenses Treasury

In closing, the CAE reiterates that the criteria and procedures you propose must focus strictly on elements that relate to compliance with the conditions associated with the grants.

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Required 28 Write the memorandum to the CAE. Note: 4 additional marks will be awarded for clarity, logic, and persuasiveness of the memo.

END OF EXAMINATION 100

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CGA-CANADA INTERNAL AUDITING & CONTROLS [MU1] SUGGESTED SOLUTIONS #1 (Updated to the 2013/2014 Module Notes) 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.

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Question 1 Note:
2 marks each

Sources: a. 3) Topic 1.7 (Level 2)

b. 3) Topic 2.1 (Level 1) c. 3) Topic 2.6 (Level 2)

d. 1) Topic 4.3 (Level 2) e. f. 2) Topic 7.6 (Level 1) 4) Topic 10.5 (Level 2)

g. 3) Topic 6.5 Level 1) h. 4) Topic 1.1 (Level 1) i. j. 1) Topic 10.1 (Level 1) 1) Topic 2.3 (Level 1)

k. 4) Topic 7.6 (Level 1) l. 4) Topic 10.3 (Level 2)

m. 1) Topic 2.4 (Level 1) n. 1) Topic 6.6 (Level 1)

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Question 2 Source: Topics 5.6, 7.6, and 9.2 (Level 1) 6 a. Preliminary conclusions

There is a discrepancy between the number of hours in the Time file and the number of hours in the Payroll file for the last three periods (2013-5, 2013-6, and 2013-7). Overall, 480 more hours have been charged to payroll. Using an average rate of $15.00 per hour as an example, this amounts to $7,200. There is also a discrepancy in the number of records for the same periods. According to the data from the production manager, the number of workers is stable at 54; however, it increases to 55, 56, and 57 according to payroll data. The amount transferred to the payroll account is the same as the total net pay for the periods 20133, 2013-5, and 2013-6 but the amounts are different for periods 2013-4 and 2013-7. For period 2013-4, the number of records is the same for both the Time and the Payroll file but the amount transferred to the payroll account is $300 more than the total net pay for the same period.

Note:
2 marks per valid conclusion to a maximum of 6 marks

b. Recommendations for additional analyses The differences observed in the preliminary analysis can be due to a number of different factors, including fraud. The following analysis should be completed in the same order as the steps are presented. 1. Validate the data from the production manager. If the data are accurate, then the problem likely occurred in the bookkeepers work. 2. Use the data from the Time file (Hours) and the Employees file (Rate) to calculate what total gross pay should have been for each period. Compare that amount to gross pay from the Payroll file. If the amounts are different, that will indicate that fraud may exist. 3. There is no adequate separation of duties in the processing of the payroll; therefore, the bookkeeper can easily manipulate the data. For example, the amount transferred to the payroll account is $300 more than the total net pay for period 2013-4, but for the same period, the preliminary analysis shows that the number of records is the same for both the Time and the Payroll file. Has one record been falsified for one employee and the amount split between the bookkeeper and the employee? Did the bookkeeper write a cheque and cash it? Is it just a clerical error? 4. To answer the questions raised in point (3), check the Payroll file to make sure that each record corresponds to a similar record in the Time file. If not, verify that no cheque has been made to an inactive or fictitious employee. The bookkeeper can easily make a cheque to an inactive employee and cash it. Note:
2 marks per valid recommendation to a maximum of 4 marks

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c.

Recommendations for controls 1. The production manager should sign the timecards, and they are validated and entered by the bookkeeper directly into the Payroll file. 2. The bookkeeper should reconcile the time on the timecards with the time on the job tickets. 3. The paycheques can be prepared by the bookkeeper but they should be signed by the controller. 4. The paycheques should be distributed by someone not involved in the payroll process or they should be deposited directly in each employees account. Note:
2 marks per valid recommendation to a maximum of 4 marks

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Question 3 Source: Topics 3.2, 4.7, 6.3, and 6.6 (Level 1); Topic 6.1 (Level 2) Marking key Following is an outline of the issues that could be included in the memo. A sample solution is provided in good form after the outline. 14 Communicating with management and staff of the audited unit Planning the engagement

Become familiar with the operations of the audited unit through meetings with the unit staff to complete knowledge gained from available documentation. Determine the scope of the engagement in collaboration with the managers in charge of the audited unit. Discuss and reach an agreement with management of the audited unit on the criteria selected for the audit before the audit work begins. Establish the timing of the audit in collaboration with management of the audited unit.

Note:
2 marks each to a maximum of 6 marks

Performing the engagement

Interviews with operating personnel are part of the audit procedures used by the internal auditor to gather evidence. They often serve to corroborate facts observed during the course of the engagement. These interviews are particularly important in a fraud investigation and require very careful preparation and considerable skill and diplomacy on the part of the auditor. Interviews are also conducted at the end of the audit to verify information and discuss observations with the manager of the audited unit.

Note:
4 marks

Reporting audit results and follow-up

Before issuing a final report, the internal auditor should discuss audit results with those in charge of the audited unit to ensure that these individuals agree with the conclusions and recommendations. Sometimes the management of the audited unit does not take corrective action to address the issues raised in the audit report. In those cases, the internal auditor should find out why from management and, if necessary, inform the board of the situation. Continued...

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Note:
4 marks

The role of the internal auditor in risk management

Management is responsible for the organizations risk management and control processes. The internal auditor can assist the organization in managing and coordinating the risk management processes. The internal auditor can assist management in identifying the risks associated with different activities and the consequences for the organization if those risks materialize. Management is responsible for determining the level of acceptance of risk limits. The internal auditor should ascertain that, with current controls, the agreed limits are not exceeded. Management should decide, based on a cost-benefit analysis, which controls will serve to contain risks within the established limits. The internal auditor should evaluate controls to determine that they are cost effective.

Note:
2 marks each to a maximum of 8 marks

4 marks for clarity, logic, and persuasiveness.

Sample solution MEMO DATE: TO: FROM: RE: May 1, 20XX John Josie Yip, CGA Importance of communication and the role of the internal auditor in risk management

Importance of communication I was delighted to learn that you are seriously thinking about becoming an internal auditor. Based on my experience, I can assure you that communication skills are essential for an auditor. First, I will provide you with some examples of situations where an auditor has to communicate when planning, performing, and reporting the results of audit engagements. I will also provide a brief description of the role played by the internal auditor in determining risk. Communication skills and the internal auditor In engagement planning, the internal auditor must first familiarize himself or herself with the operations of the audited unit through meetings with the unit staff to complete knowledge gained from available documentation. The auditor must also determine both the scope of the audit and the criteria that will be used to determine whether the performance of the unit is acceptable. These have to be established in cooperation with the management of the audited unit. When performing the engagement, the auditor often gathers evidence by conducting interviews with the staff of the unit. At the end of the audit, the auditor should verify information and discuss observations with the manager of the audited unit to get his agreement with the conclusions and the recommendations to be included in the final version of the report.

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Role of the internal auditor in risk management The internal auditor must first identify activities or situations that pose risks for achieving the companys objectives. Once the risks have been identified, it is the responsibility of management to evaluate the possible consequences of risk realization and, for each risk, determine the limits that the company is willing to accept that is, the limit beyond which it considers the risk acceptable considering the costs that it would have to incur to reduce it further. Management should then decide which controls will serve to contain risks within the established limits. The internal auditors role is to verify that these controls are effectively keeping the risks within the limits set by management. I hope this information will help you, and if you have any further questions, please do not hesitate to contact me. Note: 4 32 4 marks for clarity, logic, and persuasiveness. Question 4 Source: Topics 5.2, 8.4, 8.6, and 9.4 (Level 1) Marking key Following is an outline of the issues that could be included in the memo. A sample solution is provided in good form after the outline. 28 Criteria and procedures Production and inventory management Criterion: The production and marketing departments must cooperate closely to determine the number of units to be manufactured and must ensure that the value of year-end finished goods inventories is sufficient to ensure compliance with the conditions imposed by the granting agencies. Procedures:

Determine whether sales forecasts and inventory maintenance requirements have been taken into account when planning production. Analyze information between the two departments, to ensure that the production department had all the information needed to meet the desired objectives. Analyze production quantity variances between plan and actual, and identify the reason for these differences and corrective actions taken by the production department.

Criterion: The production department should use methods that optimize the market value of units produced and inventories. Procedures:

Inspect a sample of quality control reports to ensure that they have been produced regularly and that, where needed, the necessary action has been taken to correct any problems noted. Observe production staff at work to make sure that they are following the established procedures for guaranteeing the quality of the units produced.

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Purchasing Criterion: Raw material requirements should be set in accordance with production forecasts and the level of inventories to be maintained, to comply with the conditions imposed by the granting agencies. Procedures:

Verify whether raw material acquisition forecasts take into account inventory maintenance requirements and production forecasts. Discuss with the purchasing manager to make sure that he is receiving clear instructions from the production manager for the purchase of raw materials.

Criterion: Reorder points should take delivery times and production requirements into account to avoid stock-outs and non-compliance with the conditions imposed by the granting agencies. Procedures:

Discuss reorder points for raw materials with the purchasing manager to make sure that he takes production requirements and desired inventory levels into account. Verify whether the purchasing manager maintains records on supplier performance in meeting delivery schedules and company specifications. Discuss with the purchasing manager the existence and frequency of times in the year when raw material inventories have fallen below the reorder point and what procedures are used to deal with such situations.

Administrative expenses Criterion: Needs related to administrative expenses should be well defined. Procedures:

Inspect documents and procedures for justification of the need for administrative expenditures, and make sure that these expenditures are based on a budget that takes the requirements of the granting agencies into account. Verify whether differences between planned and actual expenses are analyzed, to find out why these differences exist and make recommendations for eliminating them.

Criterion: Administrative expenses should be authorized to ensure that they are controlled. Procedures:

Select a sample of invoices for administrative expenses and make sure that they are duly authorized by inspecting the corresponding purchase orders. Discuss with the person responsible for authorizing purchase requisitions related to administrative expenses, to identify the procedures and criteria used to accept or reject the requisition.

Criterion: Whenever possible, administrative purchases should be made from suppliers who offer the best prices while meeting quality requirements and delivery schedules.

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Procedures:

Inspect the list of preferred suppliers and make sure that the list has been approved. Select a sample of invoices and make sure that they are from suppliers on the list of preferred suppliers. Where they are not, this should be justified.

Treasury Criterion: All budgets should take into consideration the conditions for obtaining grants. Procedures:

Inspect budgets to ensure that they take the conditions into account and include reductions of administrative expenses. Inspect budgets to ensure that they take account of inventory levels to be maintained in order to keep the grants.

Criterion: The treasury department should communicate effectively with the other departments to ensure that the conditions tied to the grants are met at all times. Procedures:

Discuss with the individual responsible for cash management, to make sure that the necessary procedures have been implemented enabling him to obtain quickly any information needed to check the status of the conditions. Inspect documents showing communication between the individual responsible for cash management and managers of other departments.

Criterion: The treasury department should draw up a contingency plan that would enable the company to deal with the loss of one or more grants. Procedures:

Discuss with the individual responsible for cash management what action would be taken if a grant is lost (for example, increasing the line of credit). Inspect the contingency plan to make sure that it takes into account all aspects of corporate operations that might be affected by the loss of a grant.

Note:
2 marks for each criterion and 2 marks for each procedure. Maximum marks for criteria and procedures are 28 marks.

4 marks for clarity, logic, and persuasiveness.

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Sample solution MEMO DATE: TO: FROM: Re: May 1, 20XX Chief audit executive Markus Nienberger, CGA
Criteria and procedures for complying with the conditions tied to grants

Following our discussion, I am pleased to provide you with a summary of the criteria and procedures for validating the measures put in place to ensure compliance with the conditions imposed by the granting agencies. I am especially concerned about meeting our obligations to maintain inventories at a level equal to or greater than 50% of all grants and to keep expenses not related to manufacturing under 45% of total expenses. Criteria and procedures Production and inventory management It is essential for the production and marketing departments to cooperate in order to determine the number of units that need to be manufactured and to ensure that the value of year-end finished goods inventories is consistent with the requirements imposed by the granting agencies. For this purpose it will be necessary to verify that production planning procedures take into account the sales forecasts prepared by the marketing department and the inventory maintenance requirements imposed by the granting agencies. It is also important to maintain the market value of the finished goods inventories through strict quality control of the units manufactured. An analysis of quality control reports will ensure that the procedures used are effective and that, where required, the necessary action is taken to correct the deficiencies observed. Purchasing The purchasing of raw materials should take into account production forecasts and the inventory level to be maintained in order to comply with the constraints imposed by the funding agencies. Purchasing should also take account of delivery schedules, so as to avoid stock-outs. A discussion with the purchasing manager will ensure that he has all the necessary information regarding the needs of the production department and the requirement to maintain the value of inventories at the level imposed by the granting agencies. It will also serve to determine whether the purchasing manager is keeping files on supplier performance in meeting delivery schedules and company specifications. Administrative expenses The conditions tied to the grants impose restrictions on the level of administration expenses in relation to total expenses incurred in a fiscal period. These expenses must therefore be justified and duly authorized at a high enough hierarchical level to ensure that they are controlled. The internal auditor should verify that appropriate procedures are used to justify all administrative expenses and that the requirements of the granting agencies are taken into account in these procedures. Further, by analyzing a sample of invoices for administrative expenses, the internal auditor can make sure that they have been properly authorized.

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Treasury It is imperative that all budgets prepared by the treasury department take into consideration the conditions tied to obtaining grants and that the treasury manager develop a plan whereby the company could repay one or more grants if obliged to do so. By reviewing the budgets, the auditor will be able to make sure that budgets take the conditions imposed by the granting agencies into account and include reductions of administrative expenses. The action planned in the event that a grant is lost should be discussed with the treasury manager to make sure that it covers all aspects of the organizations operations that could be affected by such a loss. Note:
4 marks for clarity, logic, and persuasiveness.

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PSMU1#1

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