Dalston Limited was incorporated on 1 November 2018 as a limited liability company.

but commenced business on 1 January 2019. It carries out general merchandise business.

On 5 February 2020, your firm was appointed as the external auditors to audit the

companys accounts for the year ended 31 December 2019. The signed copy of the

engagement letter has been received from the Managing Director. The audit team has gone

to commence the audit assignment at the company.

The job schedules have been assigned by the Audit Manager to the audit team members

based on the Audit Planning Memorandum. The accounting system and internal controls

were reviewed, and the audit completed within the time frame of two weeks.

At the commencement of the audit the following accounting systems were recorded.

(a). Income Recognition

Income is recognised by the client based on the amount in the sales invoices issued for the

goods supplied. The amounts of the sales orders are recognised as income for all the

pending suppliers as at 31 December of each year. Commissions are paid to the sales

executives in the first week of January following the year end. This is based on the turnover

figure in the management accounts prepared by the chief accountant before the year-end

audit is done by the external auditors.

(b) Salary Payment

Staff salaries are prepared in a register maintained by the accountant from where the salary

summary sheet is prepared and submitted to the chief accountant for approval. The cashier

subsequently withdraws cash needed for the salary payment and pays the staff members

Staff members are not required to sign for the payment. This is because Management

believes that the payment process is witnessed by another staff from the sales department

At the end of the payment , the cashier stamps the salary summary sheets with Paid

Stamp as evidence of the salary payment.

(c). Directors Drawings

The Chief Accountant gives approval for personal drawings requested by the Directors

based on the telephone discussion with the Director. No drawings account is maintained for

each of the directors in the general ledger. The accountant only has the consolidated

outstanding balance in the Directors Drawings account without showing the amount drawn

by each of the Directors.

The engagement partner discovered during his review of the audit file that the following

adjustments were passed by the audit manager which made some of the figures in the

drafts accounts to be different from those of the management accounts prepared by

the client.

(i). The turnover figure was adjusted by 250,000 which made the figure of 1million in the

management accounts drop to 750,000 in the draft copy of the audited financial

statements.

(ii). Part of the staff salaries, 24,000 included in the cost of sales in the management

accounts was reclassified to increase staff salary figure to 108,000 in the draft copy of

the audited financial statements

.

(iii). The Directors personal drawings totalling 50,000 included in the cost of sales in the

management accounts was adjusted and taken to directors current account which

consequently reduced the costs of sales in the management accounts to 600,000.

(d). The managing director disagreed with the firm on the above audit journals passed and

gave the following reasons to support his argument.

(i). The turnover of 250,000 that was adjusted represented the sales orders received on

30 December 2019 for new supplies to be made in the following year. He said that their

decision to recognise the amount as income in the year 2019 was to help the company

reach a turnover benchmark of 1million required to completely bid for government

contacts. He also said that commission on sales has been paid to the sales executives on

the basis of the turnover of 1million disclosed in the management accounts .

(ii). Staff salaries of 24,000 was included in the cost of sales so as to reduce the

PAYE tax to be paid by the company.

(iii). The Directors personal drawing of 50,000 was included in the cost of sales so that

the amount could be hidden from the companys shareholders.

The Board of Directors refused to sign the audited financial statements because of the

disagreement that occurred on the above audit adjustments.

QUESTION

As the audit senior in charge, you are required to:

(a). Explain FIVE major items to be included in the engagement letter.

(b). Identify TEN weaknesses in the internal control system of Dalston Limited.