QUESTION ONE

You are the newly appointed financial director of KQ Shoes Ltd., which operated a chain of 50 retail stores, selling on a cash only basis. The stores are administered and monitored from a central head office and all stock is issued to the stores from a central warehouse at retail selling price. One of your key functions is to review the quarterly branch accounts.

A detailed analysis of the branch accounts for the last quarter revealed that the average gross profit margin for the 50 stores was 46% whilst five stores reported margins below20%.

Being most concerned about this finding, you asked your internal auditor to recount the stock of the five stores and prepare their branch accounts to the date of the second stock take. Following this second stock take similar gross profit margins were reported, thus confirming your suspicion of theft in the five stores.

You approached the managers of the stores in question and they all ascribed the stock/cash losses to week branch internal control systems. You conceded that the company has grown rapidly and that no formal branch systems or controls exist.

You reported your findings to the managing director who asked you to design branch systems and controls which would highlight theft from stores and result in a constant gross profit margin at all outlets.

As a result of the number and distribution of the stores, it is not possible to computerize branch activities although all processing at head office is computerized.

Required

Design branch systems and controls which will highlight theft from the stores and result in a constant gross profit margin at all outlets.

Your systems and controls should be detailed under the following headings:

(a) Dispatch from warehouse to stores (5 Marks)

(b) Receiving of goods by stores (5 Marks)

(c) Physical store and stock controls (6 marks)

(d) Mark down of stock (5 Marks)

(e) Cash controls (4 marks)

(Total: 25 marks)

QUESTION THREE

The published annual report of a public limited company, may include financial and a statistical information within the directors’ report and the chairman’s statements well as the audited financial statements.

Required

(a) State the responsibilities of the auditor for the financial statements covered by his

audit report (6 marks)

(b) State the responsibilities of the auditor for the financial and statistical information

included within the directors’ report and chairman’s statement (4 Marks)

(c) Discuss the various actions which could be taken by the auditor if he considers and such financial or statistical information refereed to in (b) contains a material misstatement or inconsistency with the financial statements covered by his audit report (5 Marks)

(Total: 15 marks)

QUESTION FOUR

You are the auditor of Kenya drinks Ltd., a company which imports and distributes whisky to a wide range of customers in the country. In recent years company has experienced low profitability as the popularity of whisky has declined. The draft accounts as at 30 April 1996 show net liabilities of Sh.16,000,000. The company’s major source of finance is a bank loan of Sh.40,000,000 which is due for repayment in full on 30 September 1996. The company is negotiating with its bankers for a replacement long term loan of Sh.80,000,000 and intended to use these additional funds to finance an expansion of its activities into the potentially more profitable business of importing and distributing wines.

The directors are optimistic that the bank will agree to make the loan available in view of the profit forecast for the year to 30 April 1997 which they submitted with their loan application. However, they do not expect negotiations to be completed before the Annual General Meeting on 23 August 1996.

The detailed audit work has been completed with the exception of obtaining the necessary confirmation from the bank and no other audit problems have been noted. The directors have asked you not to approach the bank because of the negotiations.

Required

(a) State the enquiries you would make and the procedures you would perform with

regard to establishing the status of Kenya Drinks Ltd. as a going concern (8 marks)

(b) Discuss the alternative audit opinions which may be relevant to the accounts of

Kenya Drinks ltd. together with the circumstances in which each would be appropriate

(7 marks)

(Total: 15 marks)

 QUESTION FIVE

(a) Discuss whether it is practical and desirable within the limits of procedures and costs, for the auditor to accept a general responsibility to detect fraud and other irregularities

(12 marks)

(b) With reference to decided cases briefly explain the extent and limits of an auditor’s obligation to detect error and fraud

(8 marks)

(Total: 20 marks)