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Question : cherry has an internal audit department which has provided you with details of internal controls around the NCA cycle. One such control is that upon receipt of a new asset, each asset is assigned a unique serial number and this is recorded on the asset and in the NCA register.
This is the question : you now turn your attention to cherry NCA cycle.
Which of the following statement is correct regarding audit procedure concerning the NCA cycle?
A – If the same ordering documentation is used in the NCA cycle as in the purchase cycle, it will not be necessary to produce additional system documentation.
B- Because there are likely to be fewer capital purchases than standard purchase in the year, it may not be cost efficient to undertake test of controls.
C- because the control risk around the NCA cycle is likely to be high it is important to perform tests of controls.
D- The NCA cycle is likely to have a lower risk of material misstatement than purchase cycle.
The answer is B. Why is it B??Can you tell me what it is about the published answer that you don’t understand?
“It is likely that the number of capital purchases in the year will be less than the number of standard purchases in the year. If the invoices are not segregated, it may not be cost-efficient to test the controls over this area, in which case substantive testing would have to be undertaken. Although controls around the non-current assets cycle will probably resemble those around the purchases cycle, the auditor should still understand how the company’s system records capital invoices. The risk of material misstatement in relation to the non-current assets cycle is high, because orders are likely to be of a less routine nature, larger amounts may be involved, and there may be an incentive to account creatively for tax or other purposes.”By a process of elimination it can’t be any of the others:
Not A because, as illustrated in the Q (“On receipt, each asset is assigned a unique serial number and this is recorded on the asset and in the non-current assets register”), NCAs require additional documentation.
Not C because the importance of controls is not the reason for testing them – the auditor must expect controls to be EFFECTIVE before choosing to test them (see the diagram on page 49 of the notes).
Not D because that should be clearly wrong – purchases will be made up of 000s of small transactions none of which would be individually material – a single item of NCA could be material.This last point underlies why B is correct. Read the explanation of the two audit approaches on page 50:
1. TOC + reduced substantive procedures
2. substantive procedures onlyThere is no avoiding substantive procedures so where there is a huge volume of the same transaction, 1 is the most cost effective audit approach (as long as the controls are expected to be effective). But where the population of a class of transactions is relatively small but the individual $ amounts are relatively high, there is no efficiency in testing controls if you’re going to have to test the additions substantively in any case. I think this is true even if documentation for purchases of capital items are separable from other purchases.
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