You are the Audit Manager in charge of the audit of Adepaye Ltd (Adepaye) for the year ended 30 April 2016 and you are currently planning the year-end audit. Adepaye specialises in the sale of provisions at its head office. The company has opened branches in Ofankor Barrier, Makola, Nanakrom, Kasoa and Kanda within ten years of incorporation. During the interim audit you noted that due to the present economic challenges in Ghana, the company has suffered increases in cost. Also, the presence of competitors are driving the sales prices of the company downward affecting the profitability of the company.
Furthermore, the company has not recorded profit for over five years thus threatening the going concern of the company. Due to the consistent cash flow challenges, the company has financed its operations with bank overdraft and huge long term loans as part of its capital structure.
In a discussion with management and those charged with governance during the interim audit, you were informed that the company plans to improve the customer relationship management of its operations to maintain its market share. The company has asked its bank for a loan to finance its working capital. This they believe would improve the liquidity of the company.
The company has prepared a cash flow forecast for five years from the end of the reporting year 30 April 2016 to support its bank loan request. The internal audit department has reported on the forecast to the board of directors. However, the bank has said it would like a report from the external auditors to confirm the reasonability of the forecast amidst the current challenges in Ghana after their final audit.
The company has approached your firm to examine the cash flow forecast and then to report to the bank.
Required:
Explain FIVE (5) factors you will consider before placing reliance on the work of the internal auditors of Adepaye Ltd. (10 marks)
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Factors to consider before placing reliance on the work of internal auditors
The external auditors would normally be able to use the work of the internal auditors of Adepaye Ltd provided that:
- They are independent (in this case, of the accounting department and finance director to whom the accounting department reports). It appears that they have reported to the whole board, which would be a factor increasing their independence. It would be even better if they had strong links with the audit committee (if applicable).
- They are competent. Your firm would have formed a view in past years of their reliability by considering the background (including qualifications and experience, particularly as regards forecasting) of the internal audit staff and by examining their reports and working papers. You may also have reviewed some aspects of their work in the current year to the same end.
- Effective communication, whether there is likely to be effective communication between the internal auditors and the external auditor.
- Whether there are established policies for hiring, training and assigning internal auditors to internal audit engagements.
- The internal audit function does not have managerial or operational duties that are outside of the internal audit function.
- They have exercised due professional care, the work would need to have been properly planned including detailed work programmes, supervised, documented and reviewed. The company is experiencing difficulties due to the economic down turn and it requires the loan in order to expand. Management might place pressure upon the internal auditors to present the cash flow forecast in a more favourable light.
This would impact the independence of the internal auditors.
You would still take full responsibility for any report that you issue.