Carmel Harrison runs Emerald Spa, a business providing women-only hairdressing, beauty, relaxation massage, and counselling services in a small tourist town. Ninety percent of the clients using the beauty and massage services at Emerald Spa are weekend visitors to the town, but 80 percent of the hairdressing and counselling clients are locals. The massage therapist and counsellor have formal qualifications and are registered with the medical authorities, allowing clients to claim the cost of the service with their private health insurer if an appropriate receipt is provided when the client pays.

Emerald Spa has just opened another branch of the business in a town 100 kilometres away, and there are plans for a third branch to be opened next year. Carmel has been very busy establishing the new branches and relies on staff in each office to run the day-to-day operations, including ordering supplies and banking receipts. In addition, the branch manager organizes the staff and authorizes their time sheets. Carmel makes the payments for rent, power, salaries, and large items of expenditure, such as furniture purchases.

Required

a. Give examples of transactions that would occur at Emerald Spa.

b. Explain what could go wrong with these transactions if the system of internal controls could not meet any of the seven generally accepted objectives of internal controls.

Basic Moderate Challenging 7.4 Explain the purpose of

(a) preventive controls and

(b) detective controls. Why would it be important for an entity to have both types of controls?

7.5 What does ITGCs stand for? Explain their purpose.

7.6 What are the four types of tests of controls? Explain them and comment on the reliability of the evidence obtained from each.

7.7 What factors do auditors consider when deciding how much control testing to do?

7.8 Discuss the concepts of nature, timing, and extent as they relate to control testing.

7.9 Four approaches to internal control documentation are discussed in the chapter. Assess the advantages and disadvantages of each. How would documentation assist the auditor to identify strengths and weaknesses of an entity’s system of internal controls?

7.10 Why do auditors prepare management letters