Question 3:

Rock Limited, a transportation subcontractor company with sales of $7 million and profits of $1 million for the financial year ended January 31, 2020, recently dismissed its chief financial officer for misappropriating company funds. Following his dismissal, the remaining directors of Rock Limited asked your firm to carry out a full review of the company's internal control system with a view to recommending improvements as appropriate to guarantee the effectiveness of the controls.

An audit partner at your firm has written to the directors of Rock Limited confirming that the firm will review the various components of the company's internal controls, including control activities employed. He has explained however that any system of internal control can only provide reasonable assurance that the company's financial reporting objectives will be achieved.

The company has over 1,600 customers to whom it sells on credit terms and it employs a manager and five clerks in its sales accounting function. The circumstances of the CFO's dismissal were that in the six month period up to October 31, 2019, he colluded with another senior manager of the company, to misappropriate individual sums totalling $9,682 received from the company's customers. The directors discovered the fraud following a meeting between one of the customers and the managing director of Rock Limited in April 2020, and have subsequently asserted that the auditors of Rock Limited were negligent in not having discovered the fraud while auditing the company's financial statements for the year ended January 31, 2020.

The auditors have stated that the directors are being unreasonable in making this assertion and are confident that an independent review of their audit working papers will confirm that they have not been negligent in their audit work.

Required:

(a) Explain why it is important that the directors of Rock Limited should ensure that the company has an effective system of internal control.

(b) State FOUR types of control activity and briefly describe each type of control activity management should implement in a strong internal control system.

(c) any system of internal control can provide an entity with only reasonable assurance that the entity's financial reporting objectives will be achieved

(d) Briefly comment as to whether the directors of Rock Limited would appear to be justified in asserting that the company's auditors were negligent in not detecting the fraud perpetrated by the company's CFO and another senior manager during the year ended January 31, 2020.