After a period of expansion into several overseas markets and some structural decentralisa

tion, Loho Company was considering its internal audit and internal control needs. Although privately owned and therefore not subject to listing rules, Loho’s auditors had often suggested that a formal internal audit function would be beneficial.

The launch of several new products and a rapid increase in exports had raised a number of problems at Loho. These included problems in meeting order deadlines, whilst a number of operational constraints had meant that some orders had been delivered to customers late. The increase in overseas business had also, according to Sonja Tan, the financial director, increased the overall risk profile of the business. Credit risk had risen substantially as had a range of risks associated with exporting and overseas investment. In addition to a growth from 150 to 600 employees in its home country, Loho also had recruited a further 200 people overseas in order to facilitate business in those countries.

As part of her continuing professional development (CPD), Sonja Tan, the finance director who was also a professional accountant, had been to a seminar on improving internal controls (IC). She believed that at this point in its growth, Loho could benefit from tighter internal controls. Speaking about this to the board on her return from the seminar, she reminded her colleagues that sound internal controls could only provide ‘reasonable assurance’ and that any IC system had inherent limitations and could never be totally effective whatever changes were made to improve them. This came as a surprise to some board members who assumed, because internal controls were often very expensive, that they should be guaranteed to be fully effective.

Required:

(a) Construct the case for establishing an internal audit function at Loho Company. (10 marks)

(b) Explain the reasons why many internal controls can never be guaranteed to be fully effective and discuss why ICs being ‘very expensive’ are no guarantee of their effectiveness. (9 marks)

(c) The finance director Sonja Tan learned about improved internal controls as part of her continuing professional development (CPD).

Required:

Explain the advantages of continuing professional development (CPD) for professional accountants such as finance director Sonja Tan. (6 marks)