CGA-CANADA INTERNAL AUDITING & CONTROLS [MU1] EXAMINATION June 2013 Marks

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.

Time: 4 Hours

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 areas is likely to involve the largest fraud risk to most firms? 1) 2) 3) 4) Human resources Marketing Purchasing Production

b. Low inventory turnover is an indicator of weaknesses in which of the following areas of purchasing activities? 1) 2) 3) 4) c. Determining needs Acquiring goods Receiving goods Paying goods

Which of the following is true? 1) Assurance services generally involve two parties: the internal auditor and the engagement client. 2) The nature and scope of the assurance engagement must be approved by the engagement client. 3) The chief audit executives direct and unrestricted access to senior management and the board can be achieved with a dual-reporting relationship. 4) Personal conflict of interest is the only cause of impairment to organizational independence and individual objectivity.

d. Which of the following is true concerning information technology (IT) audits? 1) For any computer system audit, it is necessary to evaluate the programmed controls in the computer to determine if they are adequate and effective. 2) Computer-assisted audit techniques (CAATs) may be required because of the absence of output documents. 3) Timing may be affected if data are not retained for the whole period covered by the audit engagement. 4) Unlike external auditors, internal auditors do not need to understand the IT environment to plan the audit. Continued...
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e.

Which of the following is an impact of IT on internal controls? 1) 2) 3) 4) Lack of visible output Increased segregation of duties Reduced risk of unauthorized access to, and alteration of, data and programs Consistency of performance, reducing the chance of persistent errors

f.

The 4Ps in marketing strategies are all manifested in a central focus on which of the following? 1) 2) 3) 4) Profitability Customer service Opportunities to introduce products and services Overall business and economic environment

g. Which of the following is an audit criterion regarding the objective to determine whether pricing and advertising activities are being carried out economically, efficiently, and effectively? 1) Determine whether there is an appropriate control framework for marketing by checking that roles, responsibilities, policies, and procedures are clearly defined. 2) Review controls to monitor budget performance throughout the campaign by, for example, comparing budget with actual costs monthly or quarterly. 3) Perform necessary analytical procedures to identify any indicators of apparent weaknesses or problems in marketing systems or practices. 4) Clearly define and document the role, responsibilities, and authority of the marketing function. h. Which of the following is also referred to as an attest audit? 1) 2) 3) 4) i. Legislative audit Performance audit Value-for-money audit Financial audit

In Canada, which of the following will governments do to supplement internal audit services for small public sector entities? 1) Outsource internal audit functions to private companies. 2) Provide centralized services, usually under the management of the Federal or Provincial Office of the Comptroller General. 3) Assign additional staff to the internal audit departments of public sector entities, usually from the Federal or Provincial Office of the Auditor General. 4) Nothing; each public sector entity must manage its own internal audit. If there is a lack of expertise, internal audit functions may be outsourced to an external service provider.

j.

Which of the following regarding the Treasury Board of Canadas policy on internal audit for the Government of Canada is true? 1) Deputy heads are accountable to their Ministers, and to the Prime Minister through the Comptroller General Office, for the management of systems in their departments. 2) The President of the Treasury Board has the authority to amend, issue, and rescind directives pursuant to the Policy. 3) Public sector internal auditors can only provide assurance services to maintain objectivity. 4) The Auditor General will provide guidance and standards necessary to ensure the effective implementation and support of the Policy.

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Question 2 Sherman Shoes is a local business that has been in the Sherman family for several generations. After the recent death of his father, Fred took over as president of the company. Both he and his father had been managing the company for several years. Several key roles were assumed by either Fred or his father. Fred managed the purchasing, manufacturing, and logistics departments, while his father managed human resources, marketing, and the sales department. After many years of successful growth, Sherman Shoes has its own outlet store and distribution centre, and has expanded its production to include a larger variety of mens and womens shoes. With the continued success of the company, the plan to open more outlet stores, and the loss of his father, Fred realized that the company could not continue with this current organizational structure. He decided to hire managers to oversee all of the major functions, which would allow Fred to continue to oversee the company as a whole without having to manage the daily operations of each department. Since he is not familiar with the departments his father had managed, Fred wanted to better understand the current situation and issues faced by the departments before searching for suitable managers. He hired you, a CGA and an internal audit consultant, to evaluate the human resources function of Sherman Shoes, outline the risks, and make recommendations to mitigate them. The following Monday, you report to Sherman Shoes and are greeted by Amrita, Freds administrative assistant. Amrita shows you to an office that you will be able to use and advises that she will provide you with any documentation or set up any meetings that you may require. Amrita has also provided you with human resources information regarding the current staff at Sherman Shoes and the turnover rates for the past year (Exhibit 2-1). You ask Amrita to set up interviews for the next day with the supervisor of each department identified in the exhibit. Shortly thereafter, the manufacturing supervisor arrives at your office. Despite being a day early and not being fully prepared, you ask him to have a seat. You begin by asking about the average age of employees of the department, which appears to be quite high. The manufacturing supervisor replies that almost all of the plant employees have worked for Sherman Shoes for at least 25 years. He explains that occasionally they hire a new employee to replace someone who has retired, but that it is not that easy to fill the positions. Intrigued, you ask him to describe the training process. The manufacturing supervisor explains that there is no formal process, but they usually train new employees to use all the machines through rotational shifts. He further comments that it takes approximately a year before a new employee can comfortably use all the machines with minimal supervision. He adds that the order and length of the learning process depends on who they are replacing, but once the employees learn to use all the machines they are extremely productive. As the manufacturing supervisor is talking there is a knock on your door; its the shipping group leader and he is rather busy. You apologize to the manufacturing supervisor and ask to stop the interview early, but thank him for his cooperation. The shipping group leader, a young man in his mid-twenties, sits down and, sensing his urgency, you immediately ask if he can explain the high turnover rate in the shipping department. He answers that the department consists mainly of students, including him, who work at Sherman Shoes to pay for their education. He states it is not difficult to find new employees; whenever they need someone, one of the shipping staff recommends a friend. Out of curiosity, you ask if he plans to stay at Sherman Shoes after he completes his studies. He replies that he would consider staying at Sherman Shoes if he knew he could move up in the company. He adds that it is very difficult to get information regarding available positions within the company, and he feels it has never been communicated effectively. Understanding that the shipping group leader was busy, you end the interview and thank him for his cooperation.

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The next morning, you receive a phone call from the new sales and marketing supervisor. She explains that she was told you wanted to talk with her; however, she cannot leave the outlet store. You decide to proceed with the interview over the phone. You ask her about staffing, and she quickly explains that there are currently too many employees for her departments needs. However, they are reluctant to terminate any of the employees as once the new outlet store opens they will transfer many over, and thus not need to hire and train new staff. Until then they are trying to keep everybody happy, despite having more employees than they actually need. She adds that the customers seem to be happier since there is always someone free to serve them and the checkout lines are short. Feeling that you have gathered enough information, you thank the sales and marketing supervisor for her time and begin preparing your report for Fred. EXHIBIT 2-1 Number of Employees 60 20 45 Average Age 53 22 48 Number of Vacant Positions 10 2 0 Turnover Rate 6% 15% 1%

Department Manufacturing Shipping Sales and marketing Note:

Employees are eligible for their company pension at age 55.

Required 22 a. Write a draft memo to the president of Sherman Shoes, evaluating the human resources function, outlining the risks, and making recommendations to mitigate them. Note:
4 marks for clarity, logic, and persuasiveness.

b. Separate from the memo, define the important guidelines for the interview process and identify where the internal auditor may have deviated from those guidelines.

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Question 3 Cave Art Foundation (CAF) is a charitable organization promoting the appreciation of prehistoric art. It was founded by a philanthropist in Montreal in the 1960s but has since gathered much enthusiasm around the country. Today, it owns and operates three museums located in Montreal, Ottawa, and Vancouver. CAF also organizes workshops and conferences and directly funds research and archeological expeditions of its staff researchers in subjects of related interest. Revenue from its operations are diverse, including sales of museum tickets, workshop and conference registrations, art replicas, DVDs of documentaries produced in-house, and a variety of popular theme-based action games for gaming consoles and social networks. CAF also receives considerable donations from private philanthropists and funding from the provincial and municipal governments, thanks to its success in attracting tourism. Its operating budget was $1.5 billion for the fiscal year ended March 31, 2013. Due to the decentralized nature of the organization, CAF provides flexible ways for its staff to acquire goods and services. Recently, the vice-president of finance received information from an anonymous employee that the expense report reimbursements in the development and communications department in the Ottawa office are out of control. The vice-president decided to ask the chief audit executive (CAE) of internal audit to conduct a preliminary investigation to see if there is any evidence to support the allegation. The CAE consequently assigns you, a CGA, to perform an analysis to determine if there is reason to proceed with an expanded investigation. In particular, your objective is to determine if the unit is compliant with the controls governing the expense reimbursement process and if there is any evidence of deliberate wrongdoing. The following is the policy regarding expense report reimbursements at CAF: 1. Expenses incurred for local purchases as well as for overnight out-of-town trips can be claimed by filing expense reports. 2. Employees can request cash advances to pay expenses in advance of their trips. However, an expense report must be filed subsequently to account for the advance. Excess cash advances must be paid back; expenses exceeding the advance will be reimbursed to employees by the accounting department. 3. In the case of local purchases, an expense report must be submitted no later than two weeks after the first purchase is made, and in the case of overnight trips no later than two weeks after the claimant returns. 4. In place of receipts for meal expenses while traveling abroad, a per diem of $100 per day can be claimed. 5. All expense reimbursement and cash advance requests must be approved by the claimants supervisor. 6. An expense report filed for a trip should only include the expenses incurred for that trip. All expenses related to a trip should be included in one single expense report. 7. The following tables provide information regarding the expense report and related cash advance filings in the Ottawa development and communication department in March 2013. Required 16 a. Using the information provided in the following tables, describe the procedures that you would employ using analytical software such as ACL to fulfill the CAEs request. State the conclusions that you would reach as a result of these procedures. Note:
Some conclusions may be drawn by direct observation of the raw data. This is a consequence of the limited size of data set feasible in an examination question. However, you must describe the 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 a real life situation, the data set would contain a far larger number of records, and a simple visual observation would not be effective in the analysis.

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b. Identify two control weaknesses in the CAF process based on the information provided in the case and the tables. Explain the impact of each weakness and provide recommendations for improvement. c. Define programmed controls and briefly describe the two types of programmed control procedures. Give one example of a control procedure that could have been implemented in this case.

EMPLOYEE EMP_ID 5102 5103 5104 5105 5106 5107 5108 5109 EMP_NAME Ann Anderson Ben Bose Cathy Cole Dean Deeb Ellen Elm Fiona Fung George Gio Hank Helm POSITION Development associate Development coordinator Development supervisor Communication officer Event coordinator Development associate Development associate Development director

EMP_ID: A unique number for each employee EMP_NAME: Name of the employee POSITION: The job position of the employee EXR EXR_ID 1016 1026 EXR_DATE 3/5/2013 3/12/2013 REQUESTOR 5106 5104 EXR_DESC Business lunch Travel to Vancouver to meet potential donors (4 days) Supplies for office Entertainment expenses donor development Expenses donor development Travel to Montreal to attend a professional workshop APPROVER 5104 5109 ADV_ID 0866 0859

1034 1058

3/16/2013 3/22/2013

5106 5108

5104 5104

0722

1069 1088

3/25/2013 3/31/2013

5106 5107

5104 5104

0834

EXR_ID: A unique number for each expense report filed EXR_DATE: The date when expense report is submitted REQUESTOR: The EMP_ID of the claimant EXR_DESC: A description of the expense report APPROVER: The EMP_ID of the person who approves the expense report ADV_ID: The ADV_ID of cash advanced related to this expense report filing

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EXR_DETAIL EXR_DETAIL_ID 2311 2411 2412 2413 2414 2512 2513 2558 2559 2601 2602 2645 2646 2647 EXR_DETAIL_ID: EXR_ID: ITEM_DATE: ITEM_DESC: ITEM_AMT: ADV ADV_ID 0722 0834 0859 0866 ADV_DATE 7/20/2012 1/8/2013 1/14/2013 2/24/2013 REQUESTOR 5106 5106 5104 5106 ADV_DESC Supplies for office Entertainment expense donor development Travel to Vancouver Business lunch expenses ADV_AMT $2,500.00 $1,000.00 $8,000.00 $3,000.00 APPROVER 5104 5104 5019 5104 EXR_ID 1016 1026 1026 1026 1026 1034 1034 1058 1058 1069 1069 1088 1088 1088 ITEM_DATE 3/2/2013 3/1/2013 3/9/2013 3/9/2013 3/8/2013 1/2/2013 2/4/2013 3/15/2013 3/16/2013 3/2/2013 3/19/2013 12/24/2012 12/24/2012 2/15/2013 ITEM_DESC AAA Steak House: Anderson, Deeb, Cole, Gio Airfare Hotel XYZ Per diem Dinner with client Plants for conference room Cleaning supplies for kitchen Train ticket Lunch with potential donor Lunch with 2 potential donors Flowers for a donor in the hospital Two-way train ticket to Montreal Computer store colour printer for office Conference registration ITEM_AMT $1,050.00 $4,223.25 $2,326.12 $400.00 $300.00 $84.23 $34.25 $150.00 $125.00 $96.50 $52.13 $188.29 $499.25 $500.00

A unique number for each purchased item claimed in the expense report A unique number for each expense report filed The date when a particular item is purchased A description of the nature of the item purchased The amount of the item purchased

ADV_ID: ADV_DATE: REQUESTOR: ADV_DESC: ADV_AMT: APPROVER:

A unique number for each cash advance request The date when cash advance request is approved The EMP_ID of the claimant A description of the cash advance request The amount of cash advance requested The EMP_ID of the person who approves the cash advance request

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Question 4 DS Auto is a nation-wide used car retailer. Its strategy of leveraging buying power and re-distributing vehicles within its national network of retail outlets to match demand has been extremely successful and has led to profitable growth over the years. To increase its presence in regional areas, the company has chosen to undertake a buyout program. Instead of competing with local dealers, DS Auto will evaluate the competition and, if identified as a value-added company, it will make an offer to purchase the used car operation. The evaluation involves identification of potential buyout target companies. If the conditions are favourable then the owners are contacted. DS Auto will usually offer 10-15% over the estimated market value of the company as an incentive to persuade the target companys owners. This premium is usually insignificant compared to the construction and other associated costs DS Auto would have to incur to build a new outlet and compete with established used car retailers in the area. The estimated market value is determined by DS Autos in-house analysts, who review the buyout targets financial statements. The last step in the evaluation process is outsourced, usually to an accounting firm in the area. Once the target companys owners have agreed to the possibility of a buyout, DS Auto will send in an internal auditor to review its operations and system of controls. If the company receives a positive report from the auditor, then DS Auto will usually make an offer (as described above). An additional condition of sale is that the companys management stay on as salaried employees for the first year. Once acquired, DS Auto usually does not make any significant changes to operations for the first year. Management has found this beneficial as sometimes they are able to identify value-added practices that they can use at other outlets throughout the country. DS Auto has identified a target company, Tracer Cars Inc., a used car dealership with three locations in the Montreal area. Tracer Cars has already passed the first step of the evaluation process and now your firm has been hired to conduct an audit. Peter is the DS Auto analyst responsible for identifying Tracer Cars as well as hiring your firm. Peter is a CGA and close friend of your boss, Sheila. Their friendship is one of the main reasons why your firm was selected to conduct the audit. Sheila has assigned you, a CGA, to review the operations of Tracer Cars. As a preliminary step you meet with Peter to understand Tracer Cars as well as the needs and expectations of DS Auto. In the meeting, Peter explains DS Autos strategy and how important the evaluation process is to the companys success. According to Peter, DS Autos growth in the past few years has come exclusively from acquisitions of profitable local companies. Tracer Cars sells vehicles not only to the retail market, but also to the commercial market, specifically other used car dealerships. This has allowed for much greater sales volume with only slightly reduced profit margins. Tracer Cars has a $3 million line of credit that is backed by the used vehicles in its inventory. After about 45 minutes, Peter begins to joke around with you and it is apparent that he feels comfortable. He mentions that he and Sheila are old friends and that she was extremely appreciative of this contract. He also shared with you that there are many future work opportunities as DS Auto is looking into several other target companies in Eastern Canada, and if all goes well he sees no reason why the contracts should not go to your firm. In closing, he emphasized how important it was that the review of Tracer Cars results in a positive recommendation from your firm. He mentioned that his annual bonus is calculated as a percentage of the value of the target companies successfully acquired. The offer to purchase depends on the outcome of your firms internal audit. With a much better understanding of the process, you thank Peter for his time and proceed to your scheduled meeting at one of Tracer Cars three locations to meet Franois, the president of Tracer Cars.

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Franois explains that he is considering selling his operation as he is near retirement and this opportunity has come along at the perfect time. He has met with Peter, who explained the evaluation process, and he therefore realizes its importance in finalizing the sale. You immediately question Franois about the purchases and the inventory. Franois explains that he has a conditional line of credit to use exclusively for the purchase of automobiles. The bank loans Tracer Cars 100% of the cost of a car to make a purchase, pending receipt of all relevant documentation. After one month, Tracer is required to pay back 5% of the cost of the car, after two months 20%, and after three months the remaining balance. Franois explained that it usually takes longer than three months to sell most vehicles. When a car is sold, Tracer Cars is required by the terms of the line of credit to submit supporting documentation to the bank confirming the car is sold. At that point, Tracer Cars has five business days to repay the amount loaned. This guarantees the bank that the money lent is to pay for the purchase of vehicles and not for salary and administrative expenses. Franois has made his staff and some relevant documentation available to you, including monthly statements for the line of credit that list the make, model, and current value of the automobiles used as collateral to justify the balance outstanding. As you are leaving, you notice that there are very few cars on the lot. Curious, you visit the other two locations and again are surprised at the seemingly low number of vehicles on each lot. The inventory number reported on the financial statements is much higher than the number of cars you see. The year-end line of credit statement confirms that the number indicated is the same as the figure for inventory on the financial statements. Confused, you phone Franois to ask for an explanation. He asks to meet in person at Chez Pierre, an expensive local restaurant, and offers to discuss your concerns over supper. Franois orders expensive wine and advises you to order whatever you would like, as he will pay the bill. After some discussion and a few glasses of wine, Franois confirms that the amount of cars in actual inventory is less than what is reported to the bank, but credits the discrepancy to a cut-off problem. He admits that on occasion his company does not submit the documentation of sale in a timely manner, but he insists that the delay is never much longer than a month. However, he firmly denies that this is a common practice and does not see it as a problem as the company is still paying interest on the money borrowed. He quickly points out that he has been running his company in this manner for the past five years and has never not been able to pay back the bank. The sales justify the means! he says. Franois, trying to downplay the situation, advises that he does not want to make this a big deal and jeopardize the sale of his company. He pays the bill, and before leaving, he states: I hope that I have satisfactorily answered all your questions and trust that some information will remain confidential. If there is anything I can do for you, please do not hesitate to ask. In addition, I want to extend an offer to youif you should be interested in purchasing a new vehicle, I am more than happy to offer you a very generous discount. You advise him you would consider his offer and thank him for the supper. The next day you meet with Sheila to discuss your concerns regarding this contract. You are particularly concerned about the failure to report to the bank and what it implies, as well as the effect on the financial statements of overstating the inventory. She is rather disappointed by what she hears and is careful to point out how this will impact the work her friend Peter has performed. She asks you to prepare an audit plan outlining what would be your objectives, criteria, procedures, and so on for this mandate. In addition, she asks that if you were to consider advising to proceed with the acquisition, to describe the areas for DS Auto to monitor to mitigate its risk and for your firm to cover its exposure. Required 18 a. Write the memo to Sheila outlining your audit plan and explaining the importance and considerations for the monitoring phase of this audit. Note:
4 marks for clarity, logic, and persuasiveness.

8 100
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b. Define independence and objectivity. Additionally, describe any potential impact(s) on independence and objectivity as a result of this audit. Also identify and describe the impact of any two ethical issues. END OF EXAMINATION
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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). 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. 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. Explain

Compare

Contrast

Criticize

Define

Describe Design

Determine

Diagram

Discuss

Evaluate

CGA-CANADA INTERNAL AUDITING & CONTROLS [MU1] EXAMINATION June 2013 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. 3) Topic 8.4 (Level 2)

b. 1) Topic 8.5 (Level 1) c. 3) Topic 2.1 (Level 1)

d. 3) Topic 7.1 (Level 2) e. f. 1) Topic 7.1 (Level 2) 2) Topic 8.1 (Level 2)

g. 4) Topic 8.2 (Level 1) h. 4) Topic 10.3 (Level 2) i. j. 2) Topic 10.4 (Level 1) 2) Topic 10.4 (Level 2)

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Question 2 a. Source: Topics 3.1 and 9.2 (Level 1) MEMORANDUM Date: To: From: Re: May 1, 2013 Fred Sherman, President Joan Song, CGA Analysis of Sherman Shoes Human Resources Function

Per your request, I have spent the last week analyzing the human resources function at Sherman Shoes. I have interviewed employees from the manufacturing, shipping, and sales and marketing departments and believe that I have collected a sufficient amount of information to identify the business risks related to human resources, as well as provide you with recommendations on how to mitigate the risks to an acceptable level. The role of a human resources department is to manage the acquisition, training, motivation, and compensation of its employees, as well as ensure that the organizations structure, key processes, and procedures are well communicated to all its employees. Based on the information that I was able to gather, there are several risks that need to be addressed. There are currently no processes in place to monitor the short- and long-term staffing needs of Sherman Shoes. This should be a major concern since not being able to predict your staffing needs can seriously affect your bottom line. For instance, the manufacturing department has a very large portion of its employees that will be retiring over the next couple of years, and it appears difficult to find and train suitable replacements. With the increased demand on production, Sherman Shoes cannot afford to lose a large portion of its specialized workforce nor can the company wait one year for the staff to be proficient in the use of the machinery. Another staffing issue is the outlet stores, which are seriously overstaffed. According to the sales supervisor, currently there are no plans to reduce the sales staff size as they wish to transfer employees to a proposed new outlet store set to open in the next year. If the new outlet stores opening is delayed for any reason, this will inevitably delay the repositioning of the sales staff and result in higher overhead costs. As a result, I recommend that the human resources manager regularly create reports to monitor the long-term staffing needs of each department and determine a strategy to fill these positions with skilled employees. At the same time, the manager will have to ensure that the departments are not unnecessarily overstaffed. If this is the case, then Sherman Shoes should implement a plan to reduce staff size or reposition or retrain employees to make the workforce distribution more efficient and reduce overhead cost. It is extremely important to have a good training program for each department. For each of the departments that I studied, there was no formal training program. In the shipping department there were no standard procedures. In the manufacturing department new employees were trained on the machines; however, there is no process to ensure that they learn all the machines in a timely fashion. Not training employees will affect their efficiency and productivity, which will cost the company more money over the long run. I recommend that the human resources (HR) department work with each department to ensure that there is a standard training program in place. In addition, HR should monitor the progress of each employee throughout this process as well as ensure the continual development of the existing employees. A development session may be organized by Sherman Shoes to give employees a chance to perfect or learn new skills.

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Furthermore, the human resources department should effectively communicate the structure of the organization as well as all the opportunities available to its employees. Sherman Shoes may have some very talented employees that are looking to change career paths or wanting to further develop their skills. If these employees are not nurtured and made aware of opportunities to advance they may look elsewhere. It would be advantageous to have all job postings and development sessions notifications posted in a common area accessible and visible to all staff, perhaps on a company intranet website with an option to apply online. For Sherman Shoes to continue to succeed and grow in the industry, it is of upmost importance that the human resources department mitigate these business risks. In order to do so, they will have to monitor key statistics (age, skills, turnover, demand) for each department, which will allow them to foresee the short- and long-term staffing needs. They will also need to develop and standardize procedures to hire, terminate, evaluate, and promote employees. Once this is done, the human resources department should ensure that the companys procedures are properly communicated to all employees and that the information is readily available. Implementation of these recommendations will greatly enhance the efficiency of the human resources department and its functions. If successfully completed, I believe that Sherman Shoes will have a solid foundation to continue to prosper in the future. Please let me know if you have any questions concerning these recommendations. Note:
2 marks for each risk identified to a maximum of 8 marks 2 marks for each recommendation to a maximum of 8 marks 2 marks for the conclusion 4 marks for clarity, logic, and persuasiveness

b. Source: Topic 6.1 (Level 2) In order to conduct an effective interview, the internal auditor must plan thoroughly for the interview, which requires a review of background information and decisions about what areas to cover. The interviewer should ask open-ended questions as these will generally elicit useful details and anecdotal information in the response. A key point is to listen effectively, which implies taking notes, and clarifying/confirming information gathered in the interview. The conclusion of the interview is equally important and is accomplished by advising the interviewee that their cooperation is appreciated. This will end the interview on a positive note and facilitate any future interaction as required. In the case of Sherman Shoes, the internal auditor was not prepared at all for the interviews. In addition, there was no evidence of the interviews being planned efficiently. In this case the interviewees dictated the time, duration, and location of the interviews. Furthermore, the internal auditor did not ask open-ended questions. He asked specific questions, which could have lead the interviewees in a specific direction and not allowed them to share other information. Fortunately, he was still able to obtain some important anecdotal information regarding operations and practices. It was not directly stated in the case whether the auditor was listening effectively; however, it is important to ensure that the auditor understands the information being provided. One way to do this would be by taking notes and repeating paraphrased information back to the interviewee to help confirm the main points of the conversation. On the other hand, the internal auditor did tell the interviewee that their cooperation is appreciated, which concluded the interview on a positive note as is recommended. Note:
2 marks for defining the guidelines for conducting interviews 2 marks for identifying each deviation to a maximum of 4 marks

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

Join the tables EXR and EXR_DETAIL by matching their common fields EXR_ID and join the resulting table to the table EMPLOYEE by matching REQUESTOR to EMP_ID. Join the resulting table again to table EMPLOYEE by matching APPROVER to EMP_ID. Sort by REQUESTOR and then by EXR_ID. Summarize the table EXR_DETAIL by EXR_ID with the summation of ITEM_AMT; that is, sum (ITEM_AMT). Join the resulting table to table EXR by matching their common fields EXR_ID. Join the resulting table to ADV by matching their common fields ADV_ID.

Conclusions

A business lunch was claimed in expense report 1016, approved by development supervisor Cathy Cole, who is a participant in the lunch. Cathy Cole is the supervisor of the claimant, employee 5106 Ellen Elm. Therefore, Cathy Cole essentially approved an entertainment expense that she partially incurred. Employee 5106, Ellen Elm, filed three expense reports to clear three cash advances. One of the advances had been kept by her for a long period of time (nine months). In addition, the amount of cash eventually spent was a fraction of the original sum advanced in each case. The employee seems to have intentionally overstated the cash required and kept large amounts of excess cash from the company for prolonged period of time. Expense report 1026 seems to be an unreasonably large claim for a trip to Vancouver for four days. In addition, the cost for an extra dinner was claimed on top of four days of per diem allowed ($100/day four days, according to the reimbursement policy). Expense report 1088 includes purchases related to a trip to Montreal as well as the purchase of a colour printer for office use. This constitutes non-compliance in accordance to the reimbursement policy, which stipulates that an expense report filed for a trip should only include the expenses incurred for that trip.

Note:
2 mark for each procedure for a maximum of 4 marks 3 marks for each conclusion for a maximum of 12 marks

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b. Source: Topic 5.7 (Level 1)

Weakness: System allows additional cash advances to be given to employees before previous advances are accounted for by expense report filing. Impact: Opportunity for employees to acquire additional cash without accounting for what has already been received. This encourages fraud and ties up capital of the organization. Recommendation: Application controls should be implemented to forbid cash advances to employees who have outstanding advances.

Weakness: Cash advances can be held by employees for a prolonged period of time. Moreover, the amount finally spent can be much smaller than the sum advanced. Impact: Opportunity for employees to use advances as an interest-free loan. The organization loses in the return on capital and risks further losses if the employee cannot pay back the cash. It also encourages fraud. Recommendation: Accounting should review periodically outstanding advances and the subsequent amounts accounted for in expense reports. Claimants with unreasonable use of advances should be forbidden from getting future approval for advances.

Weakness: Supervisors can approve expenses he or she incurred, by asking a subordinate to file the claim to circumvent the policy. Impact: Reduces accountability on expense claims and encourages unreasonable spending. Recommendation: Policy should require that any expense report with spending involving a supervisor have the approval from an employee one level above the supervisor.

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

c.

Source: Topic 7.6 (Level 1) Programmed controls involve the use of automated processing within the application to perform control-related functions. They can be either:

Computer-assisted control procedures, where computer-produced data are used together with manual user procedures Fully-automated control procedures, where the complete control procedure is executed by computer

A fully-automated control procedure could be for the system to check if an outstanding advance exists for an employee requesting a cash advance, and deny the request if the employee does.

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Question 4 a. Source: Topics 4.7 and 6.6 (Level 1) MEMORANDUM

Date: To: From: Re:

May 1, 2013 Sheila Jacobs, CGA John Smith, CGA Acquisition of DS Auto

As mandated by DS Auto, our firm has been selected to conduct an internal audit of the operations of Tracer Cars. The result of our work is to be a decisive factor in determining whether our client will proceed with the acquisition. To date, I have met with staff at both DS Auto and Tracer Cars. I have conducted some preliminary interviews as well as analysis, and based on the results I would propose the following audit plan. The scope of the audit will be to review the operations and system of controls surrounding the purchasing function for automobiles. The audit objective will be to determine if the controls in place are effective and the daily operations are carried out with due regard for economy. This includes compliance with all policies and procedures as required by the company or any other third party stakeholder, such as a financial institution. The audit criteria should reflect the risks identified and therefore is as follows:

Physical inventory counts should be performed on a regular basis, in particular at year end, to verify the value to be reported on financial statements. Any discrepancies should be investigated, adjusted, and documented. A draw from the line of credit is backed by the purchase of an automobile and is supported by documentation. Upon sale of an automobile, all supporting documentation is submitted to the bank without delay. Once sales have been reported to the bank, payments are made within five business days.

The audit procedures are:

Review documentation of inventory counts and review adjustments based on identified inventory discrepancies. Select a sample of withdrawals from the line of credit and verify if the supporting documentation is available. Select a sample of sales and compare the date of submission of the supporting documentation to the actual date of sale and deposit of funds from the sale. Select a sample of sales and validate that the repayment to the bank was made within five business days of the reported sale.

The execution of this audit plan should serve to identify if there are any material issues with regard to the reporting of inventory and compliance with bank requirements. It is DS Autos policy to not alter the operations of companies it has acquired for the first year. This is done in order to determine if there are best practices that can be leveraged throughout the company. Additionally this is a perfect opportunity to implement corrective action or at least monitor the operations of the acquired company to ascertain if any of the risks identified by the audit will materialize.

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The purpose of the monitoring phase is to verify that management has taken sufficient corrective action to address the recommendations in the audit report. This phase represents the last step in the audit cycle and the output is the follow-up audit report. This report certifies that the issues and risks identified in the audit report have been mitigated to an acceptable level. In review of Tracer Cars, there are two important issues. The first issue is the non-compliance with the conditions governing the line of credit. The current practice, yet to be determined as to its prevalence, is to delay reporting to the bank and using the proceeds of sale to pay salaries and other administrative expenses. Despite the fact that interest is still being paid, this represents a breach in the agreement with the bank, as the bank believes that all money borrowed is backed by an automobile. Additionally, according to the bank, the line of credit is exclusively for the use of purchasing automobiles and not to fund daily operations. The second issue has to do with the inventory, which is overstated and falsely reduces the cost of goods sold, resulting in higher profit margins on the financial statements. This issue is really a consequence of the first as the inventory figure is taken from the banks statement for the line of credit at year end. This statement is assumed to be correct and representative of the true value of the inventory of automobiles. As a stakeholder in Tracer Cars, the bank would have the right to know about this practice as it may be a material misstatement affecting the financial statements. DS Auto should closely monitor the management practices at Tracer Cars. If it is a viable operation, the resolution of the issues will not adversely affect its profitability. At this juncture I would recommend proceeding with the audit as outlined above to determine the potential impact of these issues. Once completed, our firm will be in a better position to assess the extent of the risk and the potential impact for not only Tracer Cars but ultimately DS Auto. If you have any questions please feel free to contact me. Note:
2 marks for an audit objective 1 mark for each audit criteria to a maximum of 3 marks 1 mark for each audit procedure to a maximum of 3 marks 2 marks for explaining the importance of the monitoring phase 4 marks for identifying the issues for follow up 4 marks for clarity, logic, and persuasiveness

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b. Source: Topics 1.9 and 2.3 (Level 1) 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. Controls can be implemented to help ensure the protection of the auditors independence, such as segregation of duties, reporting relationships, and so on. Objectivity is an unbiased mental attitude that allows internal auditors to perform engagements with no quality compromises. Objectivity is something for which the individual auditor has ultimate accountability. In this case, there are many contributing factors to the potential impairment of independence and objectivity. At the consulting firm, Sheila is good friends with the analyst from DS Auto. It has already been explained that the contract is the direct result of that friendship. There may be an expectation or a bias on Sheilas part to meet her friends expectations regarding a positive outcome for this internal audit. Even though this may not be the case, the perception still exists nonetheless. As the supervisor, Sheila may feel persuaded to alter or influence the audit findings. Indirectly she has already explored the possibility by asking for a memo that would outline mitigating action for DS Auto to follow should it proceed with the acquisition despite signs of the existence of material issues. Sheila should distance herself from any involvement in this file and assign supervisory responsibility to another partner. Peter, the analyst at DS Auto, appears to be in a conflict of interest as his compensation is directly related to the successful acquisition of Tracer Cars. Once acquired, he would receive a percentage based bonus regardless of how the company performs subsequently. Again, this is a perception issue and Peter appears to be motivated by this factor as by his own admission it is important to him as it would affect his compensation. To avoid this problem, DS Auto should base incentives not only on acquisitions, but also on the successful financial performance of those companies for at least one year. In consideration of the ethical issues in this case there are many. As a stakeholder, the bank has the right to know about the non-compliant practices of Tracer Cars, as this may influence its decision to provide financing, especially considering the impact this has on the financial statements. The bank has granted credit with the understanding that this is to fund the purchase of automobiles, which are then used as collateral. This is currently not the case and as a CGA you have a duty to inform all stakeholders of the implications and impact of these issues. Furthermore, Franoiss action to extend a generous offer of a significant discount on the purchase of an automobile in exchange for a favourable opinion on the audit is questionable. As a CGA, you may already be perceived as being in a conflict as you accepted an invitation to a very expensive supper and when faced with the offer regarding the discount you did not refuse but instead advised that you would take it into consideration. Franois has a vested interest in the outcome of the audit as this would influence DS Autos decision to purchase. He has already expressed to you his desire to retire and see this deal go through as it would be very lucrative for him. It is obvious by both his companys practices and his own actions that he has a disregard for ethics and has drawn into question your judgment as well. This should be reported immediately to your firm, at which time a decision can be made by the partners on how to best proceed and avoid any conflicts of interest, whether in fact or in perception. Note:
2 marks for each ethical issue identified and explained to a maximum of 4 marks 2 marks for defining independence and objectivity 2 marks for describing the impairment of independence and objectivity

END OF SOLUTIONS 100

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CGA-CANADA INTERNAL AUDITING & CONTROLS [MU1] EXAMINATION June 2013 EXAMINERS COMMENTS

General Comments
Overall performance was satisfactory. This is in line with previous examination results. Candidates performance on Question 1 remains unsatisfactory. The questions require candidates to study all recommended course material, including the readings. 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 outlined a good audit program for the purchasing function and described the importance of the monitoring phase. Areas for improvement include defining interview procedures, demonstrating knowledge of purchasing and marketing functions, reporting lines for public sector audits, and controls surrounding IT systems.

Specific Comments
Question 1 Multiple choice (Levels 1 and 2) Overall, performance was unsatisfactory. Candidates had difficulty with questions relating the purchasing and marketing functions, and with public sector auditing. Question 2 Risk assessment process human resources context (Levels 1 and 2) Performance was satisfactory. The majority of candidates could identify the risks facing the company in question and provide reasonable recommendations. However, in part (b), many had difficulty describing the interview process and identifying deviations from the normal set of procedures relative to the case. Question 3 Analysis of data (output from audit software) and computer-assisted audit techniques (Levels 1 and 2) Performance was satisfactory. The level of understanding of 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. In addition, candidates had difficulty describing IT process controls (both partial and fully automated), which is required in order to effectively evaluate controls. Question 4 Internal audit planning process and monitoring phase (Levels 1 and 2) Performance on this question was satisfactory. Candidates did very well in presenting an audit program for the purchasing function. However, some improvement is required in demonstrating the application of theory to the case facts to develop a customized audit program. Description of the monitoring phase and its importance was performed satisfactorily by the majority of candidates.

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