Auditing-1, George brown college, canada

Question-1

Describe the fraud of lapping. Who commits the fraud and against whom?

Question:2

After the testing of internal controls, the audit partner for XYZ Engineering and Design determined that controls relating to revenue recognition in this audit engagement were quite weak and could not be relied upon.

XYZ provides engineering and design services under contract to a number of clients. It primarily bills based on timesheets completed by engineers but also bills extra hours for engineers who are travelling out of town for client work. As well, any travel expenses are billed with an administrative charge of 10% in addition to the actual expense. The audit partner wants increased substantive testing for completeness since expenses are often recognized a month before being billed. With a lot of out of town work scheduled for December, she is concerned about matching expenses and revenues.

Analytical procedures performed at the planning stage had indicated increased sales with no associated increase in expenses, though discussion with the client's VP Finance revealed that this was due to finishing several long term contracts many of which had holdbacks on progress billings. Under IFRS 15, these holdbacks could not be recognized until the holdback period had expired.

1. With respect to the key assertions related to sales, identify two of the major challenges in this audit. Be as precise as possible.
2. The original plan called for dual direction testing starting with the sales invoice. With the identified weakness in internal control, and thinking about the audit trail for sales and receivables, will this still generate sufficient evidence over completeness? If not, briefly describe how you would modify the test program.

a. The partner identified a completeness issue due to billings done after services are delivered. The expenses are primarily time based payroll expenses. For contracts that are delivered over time, the typical method is to create work in process accounts and use progress billings. The progress billings must match percentage of completion estimates. These estimates may require a specialist to determine if progress billings are in line with work completed.

The analytical procedures revealed changes in the margins on sales. The VP Finance said they were do to the release of holdbacks. Accounting for holdbacks is a complex area and prone to both error and manipulation. This will require extra audit work to offset the greater risk of error.

b. Dual direction means tracing an invoice back towards the customer order for validity purposes and forward to the general ledger for completeness purposes. However, this is not where the risk of completeness comes from. The risk in this case is that the invoice has not yet been produced or does nor include everything such as travel expenses that should be included. If there is no invoice, then we cannot select it for dual purposes testing. The test is not sufficient. It may be better to start at the delivery stage by testing from timesheets and engineer expense reports.