QUESTION ONE (40 MARKS)

Question

You are the auditor of Dynamic Clothes Ltd. The company manufactures clothing for the fashion industry. A production manager heads the manufacturing division. He controls the work of 20 foremen and approximately 500 workers. Wages are paid every Friday, based on hours worked during the previous calendar week.

New workers are employed by the foremen. At the start of each working week (Monday), each foreman hands a blank clock card to each of his workers. The workers insert their names and employee numbers on the clock cards and then use the cards for that working week. The clocking device is situated at the entrance to the factory. Workers clock in and out at the entrance to the factory by inserting their clock cards in the clocking device.

The foremen hand the used clock cards to a wage clerk on Monday mornings. The clock cards are divided alphabetically amongst four wage clerks. Each clerk is always allocated the same section of the alphabet for which he/she is fully responsible.

The clerks perform the following work on the clock cards:

Calculate the total number of hours worked per clock card and record this on the relevant clock card.
Enter the hours worked per individual (by employee number) into the weekly wages file on the computer.
After each wage clerk has entered the hours worked into the computer, the computer calculates each worker's gross pay, deductions, and net pay by using the wage rates and deductions in accordance with the personnel information kept on a database. The weekly wages report is then printed by the computer. This report is kept in the wages department.

One of the wage clerks verbally informs the accountant of the amount needed for the week’s net wages. The accountant then prepares a cash cheque for the exact amount of the week’s net wages, after which the cheque is cashed by a wage clerk.

The computer prints pay envelopes for the workers to be paid, bearing the workers' names and employee numbers. Each wage clerk fills the pay envelopes according to the letters of the alphabet for which he/she is responsible. After all the pay envelopes are filled, no money should be left over. If a discrepancy occurs, the pay envelopes are checked and corrected by the wage clerks.

The pay envelopes are then sealed. On Friday afternoons, the pay envelopes are handed to the relevant foremen for the weekly payout. Each foreman pays out the wages to the workers working for him. Unclaimed wages are returned by the various foremen to a wage clerk.



REQUIRED:
Identify the weaknesses in the wage system described above and recommend improvement(s) for each weakness identified. (40 MARKS)
May you kindly include the auditing jargons and the IAS'S

Answer 1

Weaknesses and Recommendations in the Wage System for Dynamic Clothes Ltd.

Weakness 1: Lack of Segregation of Duties

Weakness Identified: The current process lacks adequate segregation of duties. The same personnel (wage clerks) are responsible for calculating wages, entering data into the system, preparing pay envelopes, and physically distributing them. This concentration of responsibilities increases the risk of errors, fraud, and theft.

Recommendation: Implement a proper segregation of duties where:

• One or more clerks are responsible for data entry and calculation.
• A different individual or team is responsible for preparing pay envelopes.
• The distribution of wages should be done by foremen, who should not be involved in the wage calculation or envelope preparation. This would help mitigate the risk of fraud and ensure controls are in place as stated in ISA 265 (Communicating Deficiencies in Internal Control to Those Charged with Governance and Management).

Weakness 2: Manual Handling of Clock Cards

Weakness Identified: The dependency on manual clock cards presents risks including inaccuracies in clocking, loss or damage to cards, and the potential for tampering. The process of entering hours into the system relies heavily on the integrity of these cards.

Recommendation: Advocate for an automated time tracking system, such as biometrics (fingerprints or facial recognition) or electronic time clocing systems. This will enhance the accuracy of time records, reduce the possibility of falsifying time worked, and comply with IAS 38 (Intangible Assets), which may be relevant if the investment in such technological upgrades is capitalized.

Weakness 3: Lack of Independent Review

Weakness Identified: The process allows wage clerks to calculate wages and prepare pay without an independent review. This increases the risk of errors going undetected, such as incorrect wages being processed.

Recommendation: Introduce a procedure for independent review of the wages report before it is finalized. A supervisor or manager should verify the calculations and checks against original time cards. This aligns with ISA 220 (Quality Control for an Audit of Financial Statements) by ensuring the quality and accuracy of the financial information prior to disbursement.

Weakness 4: Inadequate Safeguards for Cash Handling

Weakness Identified: The current system does not have established controls surrounding the handling and distribution of cash. A wage clerk cashes the cheque, thereby holding cash without adequate checks in place. This presents a high risk of misappropriation of funds.

Recommendation: Implement a dual control system for cash handling. The preparation of checks and disbursement of cash should involve two separate individuals. Furthermore, secure cash handling policies should be documented, including regular reconciliation of cash distributions against pay envelopes. This not only minimizes risks but also complies with IAS 1 (Presentation of Financial Statements), which emphasizes the importance of transparency and accountability in financial reporting.

Weakness 5: Absence of Documentation for Unclaimed Wages

Weakness Identified: The return of unclaimed wages between foremen and wage clerks lacks documentation, making it challenging to track discrepancies or potential fraud.

Recommendation: Establish a formal policy governing unclaimed wages that includes proper documentation and communication between foremen and wage clerks. Each unclaimed wage should be documented with the date returned, the employee details, and a sign-off by both parties. This addresses the need for proper record-keeping as per IAS 10 (Events After the Reporting Period) for disclosure of unclaimed wages.

Weakness 6: Limited Training and Awareness

Weakness Identified: Wage clerks may not have adequate training on the importance of controls and errors that can arise from mishandling critical information.

Recommendation: Provide continuous training and professional development for wage clerks regarding best practices in payroll management, integrity in data handling, and internal controls. This aligns with ISA 315 (Identifying and Assessing the Risks of Material Misstatement), as it ensures that personnel are aware of potential risks and encouraged to act accordingly.

Conclusion

The weaknesses identified in the current wage system at Dynamic Clothes Ltd pose significant risks to operational efficiency and financial integrity. By implementing the recommended improvements, the company can bolster its internal controls, promote accountability, and establish a more reliable wage process. Such measures will not only enhance compliance with applicable accounting standards but will also be viewed favorably by auditors during future assessments.