Question 2 (32 marks)

Healthy Blessing Medical Manufacturing Limited (HB) was established in Hong Kong. It is a manufacturer for disposable wound-care and surgical products. Its products include tapes and bandage, cotton balls, cotton pads, alcohol wipes, surgical gowns, surgical masks, medical gloves, etc. Its production plant is in Vietnam. Its products are exported to more than 50 countries around the world.

Staff costs are one of the largest cost components of HB. The company has three types of employees: direct labour (i.e. factory workers), selling and administrative staff and the management. The factory workers generally work on full-time basis, work 8 hours per shift. In case of any sudden increase in products demand, HB would recruit part-time labour and request full-time labour to work on additional hours (i.e. over-time work). Factory full-time workers, part-time labour and additional hours are charged on hourly rate.

Every day, a production supervisor records the names and the working hours of each worker in an attendance register. The production supervisor is also responsible for the daily physical head counts. On 23rd every month, the production supervisor submits the attendance register to the account clerk for calculating the wages. Wages for factory workers are paid by cash through cash withdrawal by the account clerk. The payment is made during the period on the 25th of each month to 7 th of next month. The exact day of cash payment depends on the calculation of account clerk, if he can complete the calculation earlier, wages would be paid earlier (i.e. on 25th of that month). In case there is a delay in his calculation, wages would be paid later. Due to the employment related regulations, wages must be paid on or before 7 th of next month. To simplify the process, the account clerk records the monthly wages of these factory workers on cash basis.

Selling and administrative staff and management receive fixed monthly salaries, which are also paid on the 25th of each month via bank transfer. The account clerk records the fixed monthly salaries for selling and administrative staff and management every month.

A destructive earthquake and tsunami occurred in late November 2019 caused a huge demand on HBs products. The company employed part-time labour and over-time work from full-time factory workers. The production plant operated on 24-hour basis in December 2019 and January 2020.

You are the auditor of HB and have been engaged to perform the audit of its financial statements for the year ended 31 December 2019. Shortly before the commencement of the audit, the account clerk resigned and left HB. The management discovered that the actual bank balances were significantly lower than that stated in the accounting record because the account clerk misappropriated the companys funds by creating fake workers and falsifying payroll payments to these non-existent workers.

Required:

(a) Identify and explain the internal control weaknesses in HBs payroll process. (8 marks)

(b) Suggest measures that can improve HBs internal controls in the payroll process. (8 marks)

(c) Analyse and assess the risks of material misstatements at cut-off assertion in relation to the payroll process. (8 marks)

(d) Suggest audit procedures to respond to the assessed risks of material misstatements at cut-off assertion in relation to the payroll process identified in Question 2(c). (8 marks)

[Total for Question 2: 32 marks]