Professional Documents
Culture Documents
Advance Auditing and Assurance PDF
Advance Auditing and Assurance PDF
ICPAP
Institute of Certified Public Accountants of
Pakistan
Advanced Auditing and Assurance ICPAP
Question:-
Answer:
It is apparent from the above that management audit is a systematic fact finding process
that examines, appraises, correlates and reports on the understanding and effectiveness
of various plans and procedures of an organization.
Thus the following emerge as the elements in management function, which need
constant review by the management auditor.
Page | 1
Advanced Auditing and Assurance ICPAP
A proper organizational structure is necessary to translate into action the plans
and policies adopted by the management.
iii. Policies, systems and procedures
For effective management, sound policies and practices are essential.
iv. Means of operation
The means of operation should also be constantly reviewed, analyzed and
appraised for effecting changes, where necessary.
v. Methods of control
In all the areas of business and industry, control measures are adopted. It is
necessary to verify how far the measures of control have been adhered to by the
different persons responsible.
vi. Human and physical facilities
The success of an industrial enterprise depends on proper manning and
optimum utilization or physical facilities.
Techniques
A team of experts should conduct management audit because one individual cannot master the
variety of skills required. This team may consist of the accountant, the operations research
specialist, the industrial engineer and the social scientist.
The members of the management audit team should also be acquainted with salient features of
various functional areas. Experiences of actual work situation would be useful.
To conduct its work properly, the management audit team should have a clearly defined
authority from the management. Management audit cannot be conducted unless it is fully
supported by the top management.
The management auditor is primarily concerned with the appraisal of performances in the
various areas of management. Hence, he does not look for evidence to support definite
accounting figures. Instead, he attempts to evaluate the processes and functions of
management. In doing so, he uses the following techniques effectively:
i. Inquiry
A management auditor collects most of the evidence required by him by asking
relevant questions and obtaining satisfactory answers to these questions.
ii. Examination
In many cases, the management auditor may have to conduct an examination of
documents and records. This may be necessary in case the inquiry process yields
certain information which needs corroboration or which suffers from internal
contradictions.
iii. Confirmation
Page | 2
Advanced Auditing and Assurance ICPAP
A management auditor may also obtain written or oral statements from various
persons in order to confirm the information obtained by him.
iv. Observation of pertinent activities and conditions
In many cases the management auditor may have to rely upon his own
observation of pertinent activities and conditions in the organization. A
management auditor may prepare organizational charts and flow charts as a
result of his observation of pertinent activities and conditions.
v. Correlation of information
The information collected through the various techniques has to be correlated so
that proper conclusions can be arrived at. The management auditor has to
compare the actual performance with the standers laid down or with the
performances in the previous years. A good deal of skill is required in correlating
the relevant information so as to reach meaningful conclusions.
b) The financial audit and operational audit are not mutually exclusive. These are
interconnected. The object of financial audit is to look into the correctness of financial
accounting data and compliance of internal control system. The operational audit on the
other hand through appraisal, review and evaluation of the operating control records
and management information systems, aims at better performance to achieve better
profit. A clear distinction between operational audit and financial audit cannot be drawn
in many cases. However the difference between the two may be stated as under:
iii. To see that the credit control has been To study the credit control system for
strictly followed. suggesting better measure where
considered necessary.
iv. To see that all payments have been To study whether some expenditure of
made with proper authorization and sizeable magnitude could have been
approval. avoided and reduced.
Page | 3
Advanced Auditing and Assurance ICPAP
v. To see that purchases have been made To study whether expenditure has
following the procedure approved by remained within the budgetary provisions.
the management.
To study the reasons for
vi. To see that any abrupt variations as for unfavorable/favorable variances.
example in sales/purchases etc. in
comparison with the immediate
previous year/years are not due to any
manipulation/irregularity.
To study the return on assets employed
vii. To wee that proper records have been along with the question of underutilization
maintained for the fixed assets of the of assets and idle assets.
concern.
viii. To see that the financial statements have To examine whether the operational
been prepared following the established functions are in tune with the management
procedure and that the same display a objectives and to carry out the cost benefit
true and fair view of the business analysis for helping the management in
transactions as also of the position of the taking decisions.
concern as on particular date.
ix. To see whether scrap salvaged and To study whether scrap/loss of material has
surplus materials have been properly remained within the permissible limits etc.
accounted for etc. and the methods of their disposal are
bringing adequate revenue.
c) The operational auditor in an organization has to assess the effectiveness and efficiency
of all the operational aspects of the business. He has to identity with the objectives of the
management, he serves. The operational auditor’s functioning is for management’s
guidance and control of business.
The control is the pivot of an organizational working. It is the brain of an effectively
functioning business. If a business has all the latest tools and techniques of business
functioning but lakes in control, it will not be able to achieve its objectives satisfactorily.
Proper guidance, effective communication, good coordination, timely supervision etc.
can help an organization more than mere use of expertise, theoretical knowledge and
formulation of plans and policies. Therefore, control is a vital management process
which directs all the operational activities towards achievement of objectives and goals
of an organization. It enables the management to compare the performance with the
standards laid down and take appropriate corrective and remedial measures.
An operational auditor has to review and analyze the control measures in operation in
an organization. He has to ascertain and analyze the causes of variations, identify cause
and effects of functioning of various resources employed on the quality and
productivity, point out the ineffective controls and suggest improved means of attaining
Page | 4
Advanced Auditing and Assurance ICPAP
the organizational aim. The operational auditor should review and evaluate the controls,
keeping in mind the outlook of management, nature, size and complexity of operations
and the business environment. He should appraise, as to how various activities like
personnel relations, manufacturing, production, sales, expenditure etc. are controlled,
the weak links therein if any, responsible persons or policies thereof, and suggest
corrective and remedial steps. For this purpose, the operational auditor can verify the
following:
i. Is this control of help to the management of the operation which is being
audited?
ii. Is the cost of maintaining the control justified by the value of the business?
iii. Is there any duplication of work? If so, which is the better place to do it?
iv. Is there any duplication of controls?
v. Are the deviations in performance reported to the management on time?
Therefore, the operational Auditor has to ensure not only the presence of controls but
also their efficacy. Due to this reason, operational audit function is an invaluable
ingredient to ensure a credible and effective service to management, with far reaching
implications.
Question:-
a) The internal auditor of a company with multiple ‘strategic business units (SBUs)’
noticed the following:
i. Same components of material are purchased by different units at different
prices.
ii. Marketing personnel have been offering discounts/price reductions neither
over catalogue/quoted prices beyond the authorized quantum/range without
the prior approval of managing director nor were ratifications obtained
subsequently.
iii. Some of the items of work relating to the manufacture of parts/sub-systems are
sub-contracted to outside parties though there is capability and spare capacity
available in the other sister SBUs within the company on the plea that it is
cheaper to get it done from outside.
Draft the report of the internal auditor covering the above observations. Make
assumptions, if necessary.
Page | 5
Advanced Auditing and Assurance ICPAP
Answer (a) (i)
Date: 28/12/2010
XYZ Limited
Islamabad
Sir
In the course of conducting the internal audit for the last quarter, I have made certain
observations, which relate to major policies and procedures followed by various units of the
company. I submit this Report to highlight these findings and request you to take necessary
steps to lay down suitable procedures and give directive to the different units and departments
to streamline the procedures so as to enable the company to derive overall economies and
benefits for the group.
Page | 6
Advanced Auditing and Assurance ICPAP
The above finding clearly shows that the marketing personnel in this regard are not
following the company’s policies. This is not a healthy practice and should be rectified
immediately lest things will become totally out of control resulting in loss of revenue for
the company and unhealthy and unethical competition among the different marketing
areas/divisions.
How, I summaries below my suggestions to the management in respect of these three matters:
1. Purchase
After making a detailed study of the various items of purchases made by different units,
a common list should be evolved, which should include all items except specific items
with technical specifications to be handled by individual units and the purchases may
be centralized under one department for all units. This will result in large economies
both in expenditure on personnel and purchase efficiency and prices resulting in large
savings in material costs and also ensure that the same material is bought at the same
price across all units of the company. This will enable the company to offer better prices
for their products and be competitive.
Page | 7
Advanced Auditing and Assurance ICPAP
proposed to be outsourced, the Units concerned should give the details to the Purchase
Department of the Company, who in turn, will discuss first with the different units of
the company regarding the possibility of manufacturing the same in house at any unit
and then compare the costs worked out by them with those of outside parties before
taking any decisions. The Unit of the Company which has spare capacity available,
should be given a price, which is more than its marginal cost by may be less than that of
the outside party’s offer.
I shall be glad to discuss these issues in greater detail with you and look forward to meeting
you in person as per your convenience.
Yours faithfully
ABC
Internal Auditors
Encl: As above
Answer (b)
a) Is the size of the inventory adequate or excess compared with the production program?
b) Is the provision most economical?
c) Does it ensure optimum order size?
d) Does it take into account the storage cost on the one hand and carrying cost on the
other?
e) Does it take note of lead-time of the various items or groups of items?
f) Does the receipt and issue system cause any bottleneck in production?
g) Does it involve too many forms and too much paper work?
h) Is there any room for reduction of inventory cost consistent with production needs?
i) Is the inventory as per the priced store ledger and certified by the management as
physically correct?
j) Is the same amount of attention and care given to monies translated into material things
like raw materials, stores and supplies of all kinds as given to liquid cash?
k) Does the issue of raw materials makes the production in accordance with the standard
schedule or otherwise, covered by authorized schedule?
l) Is the expenditure of consumable stores within the standard? If not, why not?
(Note: Illustrative List)
Page | 8
Advanced Auditing and Assurance ICPAP
Question:-
Sales promotion
i. Whether appropriate and suitable techniques have been adopted for market
survey and sales promotion in consonance with short-term and long-term
objectives.
ii. Whether there is a sales promotion budget and if so, how is it determined?
iii. Scrutinizing the policies framed and followed pertaining to promotional policies.
i. Whether credit worthiness of the customers is assessed before selling goods to them.
ii. Is the credit limit reviewed periodically?
iii. Whether the discount given is as per the price list.
iv. Whether any interest is charged for delayed payment.
v. Is the debtors ageing schedule prepared for verifying the outstanding and doubtful
debts?
Liquidity Ratios
These ratios indicate the firm’s liability to discharge its current/short term obligations. Some of
the important ratios under this category are discussed as under.
a) Current Ratio: it is also known as the working capital ratio. It shows the relationship
between current assets and current liabilities of an organization. The change in current
ratio will indicate whether there is accumulation of stock, understatement of liabilities or
manipulation in the value of stocks, debtors etc. A low current ratio indicates that the
Page | 9
Advanced Auditing and Assurance ICPAP
organization is unable to meet its obligations in time. A high current ratio, on the other
hand, indicates that either current liability is understated or there is manipulation in the
value of stocks, cash or creditors.
b) Quick Ratio: It is ascertained by comparing the liquid assets to current liabilities. Liquid
assets are current assets other than stocks. It is a good indicator of the liquidity of the
enterprise or ability of the organization to meet its liabilities quickly/instantly when
called upon.
To ascertain the effectiveness in the use of resources placed at the disposal of the organization
capital turnover ratios needs to be analyzed. Capital turnover ratio is computed by comparing
sales to capital employed. A ratio indicates that the organization is making optimum sales by
utilizing its funds properly. A low ratio may indicate that there is recession in sales or sales
have been suppressed or that the value of any constituents of capital employed (net fixed assets
+ net working capital) might have been inflated. Auditor should critically analyze the ratio and
find out the reasons.
Inventory/Stock Level
Inventory/Stock turnover ratios are to be analyzed. Stock turnover ratio indicates that the sales
are low resulting in an accumulation of stocks or that the levels of stock maintained are
excessive in relation to sales.
Answer (c)
Page | 10
Advanced Auditing and Assurance ICPAP
Question:-
a) Outline the steps for performing the systems audit of ‘preparation of dividend
warrant’ introduced by an organization as part of the programs for the
computerization of company’s secretarial functions.
b) Write notes on any three of the following:
i. Protection of ‘security of networks’.
ii. Effects of computers on auditing
iii. Norms and procedure for computerization
iv. Role of database administrator.
Answer:-
Page | 11
Advanced Auditing and Assurance ICPAP
2. Providing Parameters
The program needs to be provided with certain parameter details like percentage of
dividend being declared, income-tax to be deducted for the various types of
Shareholders, e.g. Corporate Body, Non-Resident individuals, individuals.
a) Shareholding:
b) Names and addresses: and
c) Tax status.
The Systems Auditor should request for the appropriate computer program to be loaded on a
separate computer. He should prepare an exhaustive Test Pack. The Test Pack will consist of a
comprehensive data so that the logic of the program is extensively checked.
The program would now need to be tested. The computer, which has got a copy of the program
loaded, would need to be utilized for loading this Test Data. The loading of Test data is done by
creating a file of shareholders as envisaged in the Test Pack. After loading of the Test Pack, the
necessary commands for commencing the processing should be given (this procedure can easily
be picked up by discussing with the regular users of the Computer). Once the program
commences processing, it would be processing one record at a time, as each of the records
(detail of the shareholders) would need to be verified for its correctness and completeness. It the
first record in the Test Data is processed, the computer should come out with an error message
to say “No Shareholding”.
- For the second record, the message should say “minor but no guardian”.
- The Shareholder has no valid income-tax status.
- The shareholding is negative.
Page | 12
Advanced Auditing and Assurance ICPAP
- Control totals do not tally – Control total.
Note: The contents of the error messages would also require to be fed into the program so that
appropriate message as programmed would be picked up.
If for any reason, the results are not in line with the results as expected if the program were to
function properly, we need to perform the following steps.
1. Ensure the Test Data has been entered into the Machine correctly. (This can be done by
taking out a print out of the test pack and compare it with what was envisaged to be fed
into the computer).
2. Note down the type of malfunctioning of the computer Program, for example, if record
number 1 is processed without giving an error message, the program is not testing for
nil balance of the shareholder, i.e. the Master file contains details of Shareholders who
have ceased to be shareholders as they have sold out all their holdings.
At the end of the testing of the program and after evaluating the results, the Systems Auditor is
able to conclude as to what types of “bugs” are in the program. Bugs, as we know are mistakes
in the program.
The auditor should discuss this with the User Department and then discuss it with the
developers of the program. Till such time as the program bugs are removed, that version of the
program cannot be used, as it is not bug free. The Systems Auditor is required to prepare and
submit a report based on his findings.
The security of Information in transit over the network can be taken care of by encryption,
secure tunnels and tracking.
For this purpose, passwords need to be properly constructed and kept safe.
Page | 13
Advanced Auditing and Assurance ICPAP
Computer systems have affected how auditors carry out their two functions viz.: evidence
collection and evidence evaluation.
Collecting evidence on the reliability of a computer system is often more complex than
collecting evidence on the reliability of a manual system. Auditors confront a diverse and
sometimes complex range of internal control technology that did not exist in manual system.
For example, accurate and complete operation of a disk drive requires a set of hardware
controls not used in a manual system. Similarly, system development controls include
procedures for testing programs that would not be found in the development of manual
systems. Auditors must understand these controls if they are to be able to collect evidence
competently on the reliability of the controls.
First, auditors must understand when a control is acting reliably or malfunctioning. Next, they
must be able to trace the consequences of the control strength or weakness through the system.
In a shared data environment, for example, this task might be difficult. A single input
transaction could update multiple data items that are used by diverse, physically disparate
users. Somehow auditors must be able to trace the consequences of an error in the transaction
input for all users.
Whether developed in-house or bought out from third parties as readymade packages it is an
accepted fact that the user needs would change and so the system would need to be modified. It
is essential that from the point of ensuring that the systems are reliable, well-accepted best
practices should be followed for systems development. This alone would ensure that software is
not only developed properly but also maintained well thereafter. A need for a new system to be
developed may arise under any one of the following conditions:
Page | 14
Advanced Auditing and Assurance ICPAP
iii. A new technology that will enable an organization to take advantage of the
technological developments.
iv. A problem associated with the technology currently in house.
i. Feasibility study.
ii. Requirements definition.
iii. If developed in-house, development, programming, alpha testing.
iv. If readymade package is acquired, acquisition of software and modification thereafter.
v. Beta testing, approval, implementation and post implementation.
The Database Administrator has to ensure the efficient operability of the Database Management
System, including regular backups for safety, and fine-tuning of the database. The Database
Management System (DBMS) may depend upon the Operating System (OS) & the Network
Configuration. The Database Administrator hence has to work with the System Administrator
and Network Administrator to ensure his/her objectives are met. In general, the roles include:
Question
a) “Management audit should be applied to all factors of production and all elements of
costs.” Discuss briefly the points that should be kept in mind by an auditor while
carrying out an appraisal of management methods and performance.
b) Write short notes on the following:
i. Canons of financial propriety
ii. Fixed asset turnover ratio
iii. Current ratio
Answer
a) Management Audit begins when a statutory financial audit ends. The statutory financial
audit has a lot of limitations and therefore there is need for an independent appraisal of
managerial performance at various levels including the top most level. Management
Page | 15
Advanced Auditing and Assurance ICPAP
audit technique can be applied to all factors of production and to all elements of costs. It
can also extend its activities to assess efficiency in planning whether in the preparation
or in the execution stage. An appraisal of management methods and performance is to
conducted with reference to the following:
1. Effectiveness and soundness of Organisational structure.
2. Whether the Organisational structure is in line with the plans and objectives of
the organisation to accomplish its goals.
3. An assessment of management performance as to the extent to which the
management plans, policies, systems and procedures proved a success.
4. What corrective and co-relative steps management should take to surmount the
failures due to bottlenecks, deficiencies, internal friction, shortcomings,
misappropriations and fraud.
5. To what extent management plans, policies and procedures warrant a dynamic
change for future operation and planning of the business.
6. To what extent the available human and physical facilities can be effectively
utilized and to what extent, extensions of facilities are required for organizational
profitability and future growth.
7. Efficiency in financial planning to provide guidance, based on the latest
development in critical assessment of capital budgeting, project analysis and
profitability.
8. Is there an Organisational Manual which is useful and comprehensive?
9. Are the policies and procedures of industrial relations adequate, and effective?
10. Study of problems of co-ordination and co-operation among various levels of
management.
11. Study the extent of an overall congenial climate to exist for better management of
the business.
12. Study motivation and morale and their influence on business decisions.
13. Study the problems of complexity in running the business and the solution
thereto.
14. Effectiveness of methods of control.
15. Effectiveness of management information system, particularly adequacy, clarity
and promptness.
16. Proper climate for continuance and growth of the business.
17. Incentive plans for effective managerial performances.
18. Existence of management development plans for growth potential in executives
to help business in choosing personnel for promoting to higher management as
and when occasion arises.
19. To probe the effectiveness of the proper ‘Span of control’.
20. To probe the balancing between authority and responsibility.
21. Whether a definite procedure is in existence to guide the conduct of every
function.
Page | 16
Advanced Auditing and Assurance ICPAP
22. Whether the policies and practices are operating effectively with regard to
recruitment, selection, placement, promotions, transfer, terminations, job
analysis, job evaluation, labour turnover, staff turnover, absenteeism, and
lateness.
23. Whether there is an adequate policy for security and safety measures.
24. Adequacy of policy regarding salary and wage administration.
25. Whether the duties and responsibility are delegated properly and clearly
defined.
26. In appraising the process of reorganisation to consider functional definition of
authority and responsibility, chain of commands, span of control, division of
jobs/activities, channels of contact, control, perpetuation, effectiveness,
efficiency, and economy.
27. Extent of morale of the employees is existence.
28. Study the organizational personnel’s indifference to organizational needs.
29. To what extent there is existence of ‘resistance to change’ and suggest remedial
measures to overcome such resistance.
30. Existence of executive development training programme to create future
leadership.
31. Whether Ali concerned in the organisation is well aware of the organizational
plans and objectives.
32. Whether the goals are realistic this can be achieved or accomplished.
33. Whether realistic and attainable standards have been fixed to guide the ‘Men at
Work’.
34. Whether there is the existence of sound business judgment.
35. Management of Differences-the auditor may have to report about power and
personality factor, management of difference viz., possible conflict of interest at
the top management and executive management level so that the head of the
organisation will be in a better position to discover and implement more realistic
alternatives for dealing with it.
36. With regard to the human factor, or in other words, the human side of enterprise,
the following factors are to be considered:
- Formulation of personnel policies
- Planning manpower requirement
- Recruitment, training and development
- Group development for executives, managers and trainees
- Salary and Wage administration
- Organisation: Structure
Function
Climate
- Industrial relations
- Collective bargaining
Page | 17
Advanced Auditing and Assurance ICPAP
- Automation and its impact
- Incentives
- Employees active participation
- Suggestion scheme
37. Whether managers have freedom and opportunity to have their own creative
thinking (creativity will provide the basis for business endeavor and activity).
38. Whether there is the existence of in-company meetings of the organizational
personnel representing various departments to discuss problems and to decide
the future course of action through better communication, internal control,
methods, system and procedures.
39. Compliance with statutory and other rules and regulations affecting the
organisation.
40. To what extent the suggestion scheme is effective if there is the existence of such
a scheme.
Management audit technique can be applied to all factors of production and to all
elements of costs. It can also extend its activities to assess efficiency in planning
whether in the preparation or in the execution stage.
b) (i)
Every officer incurring or authorizing expenditure from public funds should be guided by
high standards of financial propriety. Among the principles on which emphasis is generally
laid are the following:
i. Every public officer should exercise the same vigilance in respect of expenditure
incurred from public moneys as a person of ordinary prudence would exercise in
respect of expenditure of his own money.
ii. The expenditure should not be prima facie more than the occasion demands.
iii. No authority should exercise its power of sanctioning expenditure to pass an order
which will be directly or indirectly to its own advantage.
iv. The amount of allowances, such as travelling allowances, granted to meet
expenditure of a particular type, should be so regulated that an allowance is not on
the whole a source of profit to the recipient.
v. Public moneys should not be utilized for the benefit of a particular person or section
of the community unless:
- The amount of expenditure involved is insignificant, or
- A claim for the amount could be enforced in a court of law, or
- The expenditure is in pursuance of a recognised policy or custom.
Page | 18
Advanced Auditing and Assurance ICPAP
The observance of canons of financial propriety is an important aspect looked into in the
Propriety Audit.
b) (ii)
This ratio shows the extent to which the investments in fixed assets contribute towards sales.
The variations in the utilization of capacity are reflected in this ratio:
NetSales
NetAssets
b) (iii)
Current ratio
This shows the relationship between current assets and current liabilities of an organization. It
is computed as:
Currentassets
Currentliabilities
The change in current ratio will indicate whether there is accumulation of stock, understatement
of liabilities or manipulation in the value of stocks, debtors etc. A low current ratio indicates
that the organisation is unable to meet its obligations in time. A high current ratio, on the other
hand, indicates that either current liability is understated or there is manipulation in the value
of stocks, cash or creditors.
Question:-
a) “Internal control refers to the design and utilization of all the means whereby
management is enabled most effectively to safeguard the company’s assets,
administrate the current operations and plan for the future.” In the light of this
statement, state the main components and objectives of an internal control structure
in an organisation.
b) As a cost auditor, what steps would you suggest to the management that would
improve the performance of the labour and that the labour cost is allocated to
different jobs in an equitable manner?
c) “Operational audit is an extension of financial audit.”
Answer:
Page | 19
Advanced Auditing and Assurance ICPAP
structure prevailing in the organisation, management can most effectively safeguard the
company’s assets, administrate the current operations and plan for the future.
Internal control structure has three major components viz.
1. Control environment: The collective effect of various on establishing and
enhancing, the effectiveness of specific policies and procedures.
2. Accounting systems: The methods and records established to identify, assemble,
analyse, classify, record, and report an entity’s transactions and to maintain
accountability for the related assets and liabilities.
3. Control Procedures: Policies and procedures that the management has
established to provide reasonable assurance that specific entity objectives will be
achieved.
Page | 20
Advanced Auditing and Assurance ICPAP
2. Incentive schemes have been introduced for motivation of workers e.g. bonus,
etc. and proper records have been maintained.
3. If wages are paid on piece rate basis he should compare the piecework cards of
workers with stock register and wages sheets.
4. Verify that the wages and salaries being expenditure on additions to plant,
machinery or other assets have been allocated to asset concerned. Wages and
salaries spent on capital heads of expenses are charged to separate head of
account and not to the cost.
5. Salaries of supervisory staff, who are not specifically employed for a particular
center, have been included under factory overheads.
6. System provides for a detailed record of time put in by each workman on each
job and overtime is properly accounted for.
7. Idle time may arise due to productive causes, administrative causes and
economic causes. He should enquire the causes of idle time to ensure that it is
recorded and if the reasons are not satisfactory, mention the fact in his report.
8. Ensure that statements and cost sheets of cost department are reconciled with
financial records.
9. He should check the Attendance Register, Leave Register and the Foreman’s
Register for first-hand information.
10. Ensure that job evaluation has been introduced and workers are put in proper
grades for facilitating performance appraisal.
c) Financial audit and operational audit are not mutually exclusive. These are
interconnected. However, a clear distinction between operational audit and financial
audit cannot be drawn in many cases. The object of financial audit is to look into the
correctness of financial accounting data and compliance of internal control system. The
operational audit on the other hand through appraisal, review and evaluation of the
operational control records and management information systems, aims at better
performance to achieve better profit. The differences between the two may be stated as
under:
Financial Audit Operational Audit
i. To look into the correctness of To see that the financial accounting
financial data and records along records have been properly designed and
with correctness of the accounting maintained to furnish the management
procedure followed. with timely information to help them in
judging the extent to which the
profitability goals have been achieved.
ii. To see that the internal control To see that the internal control system has
system has been working properly. been designed from the point of view of
achieving better efficiency and whether
the same have been functioning
Page | 21
Advanced Auditing and Assurance ICPAP
effectively.
iii. To see that the credit control has To study the credit control system for
been strictly followed. suggesting better measures where
considered necessary.
iv. To see that all payments have been To study whether some expenditure of
made with proper authorization sizeable magnitude could have been
and approval. avoided and reduced.
vi. To see that any abrupt variations as To study the reasons for
for example in sales/purchases etc. unfavorable/favourable variances.
in comparison with the immediate
previous year/years are not due to
any manipulation/irregularity.
vii. To see that proper records have To study the return on assets employed
been maintained for the fixed assets along with the question of
of the concern. underutilization of assets and idle assets.
viii. To see that the financial statements To examine whether the operational
have been prepared following the functions are in tune with the
established procedure and that the management objectives and to carry out
same display a true and fair view of the cost benefits analysis for helping the
the business transactions as also of management is taking decisions.
the position of the concern as on
particular date.
ix. To see whether scrap salvaged and To study whether scrap/loss of material
surplus materials have been has remained within the permissible
properly accounted for etc. limits etc. and the methods of their
disposal are bringing adequate revenue.
Question:-
a) Discuss briefly the basic check points for carrying out information systems audit in
respect of any two of the following.
i. Systems development methodology,
ii. Operational controls,
iii. Internal control in a computerised set-up.
b) Write notes on any three of the following:
Page | 22
Advanced Auditing and Assurance ICPAP
i. Major components in software development
ii. Debugging a programme
iii. Devices/software systems used in network’s security
iv. Encryption, secure tunnels and tracking
v. Construction of a good password.
Answer: - (a)
Every time a change is made, a throughout testing should be done and documented.
The Auditor should get necessary evidence and comment on the lack of proper
adherence to procedure.
Page | 23
Advanced Auditing and Assurance ICPAP
F. Administrator passwords freely floating around and used by developers,
operations staff and administrators.
G. Dirty network cabling with loose cables hanging around, hand crimped cables,
cables not tagged for easy identification.
H. Switches/hugs lying loose on tables/hanging on walls.
I. Data controls not properly checked and filed.
J. Preventive Maintenance of Servers not done.
K. Machines working with covers kept off.
L. Media not properly labeled and recorded in media register.
M. Absence of gate passes culture: machines arbitrarily taken from/into computer
rooms.
N. Unknown and untrusted floppies directly used without checking for virus.
The above scenarios speak of very casual IT setup. Such carelessness can result in
serious downtime. Sensitive data can be pilfered from the servers. The IS auditor
needs to highlight theses flaws as serious lapses.
By applying these principles, management can not only ensure the protection of
hardware and software but the integrity of data can also be maintained before it is
entered into the computer-based components of the information system.
Answer (b)
Page | 24
Advanced Auditing and Assurance ICPAP
computer may not be conveyed properly. In such circumstances, the program would be
defective and technically it is called that the programs has got “bugs” i.e. defects. It is
the responsibility of the programmer to ensure that theses defects or bugs are removed
and the instructions are conveyed properly. This process of removing the bugs is called
debugging. It is the responsibility of the programmer to debug the programs he has
written. He should ensure that the functionality of a program is in order and also that
the built in control function as expected. There are various methods of debugging a
program. By adopting these methods, a programmer would be able to locate the errors
he has committed. He would rectify the error and test the program again and again fill
such time the program function is as expected. The process of debugging a program is
also called the testing of a program. For testing a program, an illustrative but exhaustive
test data would be created i.e. a set of dummy data would be created so that all the
logical paths in the program would be tested. Effectiveness of testing a program is very
much dependent in creating an exhaustive test data. There are various types of testing.
The programmers perform some tests. Some performed by the system analysts, some by
the users.
Page | 25
Advanced Auditing and Assurance ICPAP
information can only be decrypted with the “private” key, which the receiver has, on
his/her machine. Thus even if a cracker traps the information, s/he cannot decrypt it. It
is no use trying to decrypt by permutation because not even the fastest of computers can
crack the encryption in years of continuous working!
Secure tunnels are established by a combination of encryption and authentication by a
special signature. Tracking tools are available to monitor the entire path taken by the
transmitted information. In the event of suspicious activity, the offending machine can
be identified and reported.
Question:-
i. Management audit requires a business doctor to find the symptoms and to diagnose
the company’s ailment at the right time to take corrective action. The approach to
management audit needs to be formulated accordingly.
ii. “Operational audit is a new phase of internal audit technique.” While management
audit is an audit of the management, operational audit is an audit for eh management.
iii. External auditor has no right to comment on the work of the internal auditor, nor
there a need for any interaction between the two.
iv. The application of statistical sampling techniques by an auditor before expressing an
opinion needs careful consideration of certain important factors and exercise of
judgment almost at every stage by the auditor.
v. A plethora of report and returns are generated /received by mangers at different levels
daily, weekly, etc., from the operating and functional department. Hence, there is
hardly any necessity for a separate department/system for ‘management information’.
Page | 26
Advanced Auditing and Assurance ICPAP
Answer:
i. The statement made is correct and apt. Management Audit requires an inter-disciplinary
approach since it involves a review of all aspects of management function. It requires a
change in attitude and aptitude and as such the need for a “business doctor”. The
following steps can be said to cover the entire gamut of management audit to examine
and detect symptoms and diagnose the weaknesses and suggest remedial action.
a) Analytical and objective examination of the organisation of the company,
operation of various plans, policies etc. in all varied functional areas of the
business to ensure optimum utilization of available resources.
b) Objective evaluation of performance.
c) Ascertaining the weakness, identifying potential risks and dangers.
d) Identifying elements of waste, inefficiency, delay etc., which hamper the
efficiency of operations.
e) Reporting the efficiency of operations, plans, Organisational plans and policies
and control systems to the management.
f) Recommending measurers for removing deterrent and disorders, if any present
in the system.
It is apparent from the above that management audit is a systematic fact finding
process that examines, appraises, correlates and reports on the understanding and
effectiveness of various plans and procedures of an organisation.
ii. There are certain similarities between Operational Audit and Internal Audit.
Operational audit is in the form of a scientific tool applied by the auditor to:
a) Given an assurance to the management that the management controls are
efficient and effective:
b) Operational activities are in accordance with the objectives of organisation.
c) Management information Systems in the form of reporting, evaluation and
review are effective to attain organizational goals and objectives.
d) It involves the application of all the basic audit skills of penetrating examination
of relevant evidence, informed analysis of findings and making unbiased
interpretive judgment from an impartial viewpoint.
Internal audit also covers the above areas and provides a service to the management by
evaluating the controls in existence, pointing out weakness and suggesting remedial
action.
Page | 27
Advanced Auditing and Assurance ICPAP
concerned with all operations of business whether financial or non-financial like
production, purchase, sales, personal etc., operational audit is basically
concerned with the operations of a business.
b) Internal Audit is a managerial control, which functions by measuring and
evaluating the effectiveness of other controls. As such Internal Audit is
concerned not only with operations of the business but also with managerial
control. Operational Audit aims at improving future business operations by
concerning the audit with all aspect of management. Hence, it is a new phase of
internal audit technique.
c) Internal audit is concerned first with the financial monitoring systems. However,
many important activities are often better monitored initially in non-financial
monitoring systems lead towards operational auditing. This is the systematic
appraisal of major functional areas of business against corporate and industry
standards with the objective of assuring management that its aims are being
carried out and identifying conditions capable of improvement.
A comparison of the nature of operational Audit vis-à-vis Management Audit
brings out the following distinctions:
Operational Audit is concerned with all operations of a business whether
financial or non-financial and is basically aimed at finding out whether all
operations of the business in the areas of manufacturing, marketing, personnel,
financial services etc. are being carried out properly. It is to point out any lacunae
in the operations of any of its activities. Operational Audit is an audit for the
management.
Management audit covers all aspects or processes of management including
planning, organisation, control etc. of a business. Its aim is to find out the efficacy
of the control systems in operation and in business at any given time. Therefore,
management audit can be considered as audit of the management. Thus the
statements made are correct.
iii. The statement is not correct. The external auditor i.e. the statutory auditor cannot
undertake 100% check of all the transactions of the company due to time and cost
constraints. He conducts test checks and where there is an efficient and effective internal
audit system he can rely on the adequacy and working of the internal control systems,
books and records and plan his own audit work concentrating on important areas.
However, the ultimate responsibility will continue to be that of the external auditor for
expressing an opinion on the Financial Statements and other relevant matters and he
cannot claim immunity for neglect of duty on the plea that he placed reliance on the
work of internal auditor.
Co-ordination and co-operation between the External and Internal Auditors is very
essential and should be based on:
a) Periodic efforts to discuss matters of mutual interest:
Page | 28
Advanced Auditing and Assurance ICPAP
b) Access to each other’s programmes, files and papers:
c) Interchange/exchange of correspondence and reports:
d) Common understanding of audit techniques methods etc.
In order to maximise the use of resources the External Auditor should evaluate the
performance of Internal Auditor prior to determining the workload to be undertaken by
him
a) Internal Audit done by persons with sufficient technical training and proficiency
and appropriates Organisational status is given to the Internal Auditor.
b) Degree of independence of the Internal Audit function and any constraints
imposed by the management on the Internal Auditor.
c) Internal Audit Work is properly planned supervised, reviewed and documented.
d) The scope and extent of coverage.
e) Review of the Internal Auditor’s Working Papers and note books to see that-
- Related audit programmes are adequate for external auditor’s use.
- Appropriate evidence was obtained to have reasonable basis for conclusion.
f) Effectiveness of follow-up of regular internal audit exercises.
Thus, the External Auditor can comment on the work of the Internal Auditor and
Co-ordination and Co-operation between the two is essential.
iv. Statistical sampling is a technique which assists an auditor in his procedural audit by
enabling him to draw conclusions about the characteristics of the items under
consideration/examination (generally referred to as ‘Population’) based on the sample
of items actually examined by him. For these conclusions to be valid, it is necessary to
indicate the margin of error. Sample sizes are determined with the assistance of specially
prepared tables or graphs. Before these may be put to use, a number of factors should be
determined by the auditor, which are as follows:
(i) Population size; (ii) level of confidence required; this must be related to materiality
and represents (conversely) the measure of risk that the sample will be unrepresentative;
(iii) the estimated error rate in the population being examined based on past experience
and initial evaluation of client’s system; (iv) The percentage rate of errors in the sample
examined which is regarded as acceptable by the auditor. Additionally, it is necessary
that actual selection be made on random basis.
The statement made is correct. Application of the technique requires exercise of
judgment by the auditor almost at every stage. It is systematic and requires rigid
compliance of applicable requirements. It enables the Auditor to measure the risk he is
undertaking is expressing a particular opinion and provides a scientific basis for the
same. The following factors should be noted in this regard:
Page | 29
Advanced Auditing and Assurance ICPAP
a) There should be sound internal control in force capable for imparting reliable
accounting data and checking of deviations from the prescribed procedure;
b) The area of operation must be large enough to justify the application of statistical
sampling techniques;
c) There should not be wide variation in the field of data used;
d) The transactions should be of repetitive nature;
e) The result obtained through statistical method should be capable of evolution.
f) Sample size is linked to the precision and confidence level (or vice-versa) the
sample size must be increased.
v. The statement is not correct. As stated there may be in existence a procedure for the
preparation of periodical reports. However, there are several occasions when right type
of information analysis in the required manner is not available at the right time to enable
prompt managerial action. Some of the reports may contain needless information and
the recipient’s ay not even read some. Therefore, there is a need for a Management
Information System using formalized procedures to provide managers at all levels with
adequate and up-to-date information from all relevant sources for the purpose of
planning and controlling the activities for which they are responsible i.e. managerial
decision-making:
MIS refers to a comprehensive and coordinated set of information system – a formal
system providing requisite and meaningful information from various operating
divisions to different levels of management and control. MIS is a systematic procedure
to provide relevant information, at the right time, in right format, to all levels in the
organisation for providing support to decision-making activities. An effective MIS
serves the following purposes:
a) Providing accurate and timely information to assist managers in choosing the
best course of action:
b) Providing planning and control tools.
c) Providing information for controlling organisation activities.
d) Creating a process of communication wherein information is recorded stored
and retrieved for decision –making, planning, operating and control of an
organisation.
e) Providing a system of people, equipment, procedures, documents and
communication that collects, validates operates, stores, retrieves and presents
data for use in planning, budgeting, accounting, controlling and other
management processes.
In view of the above, formalized MIS is a must and preferably a distinct Department
for organizing and operating the MIS is needed.
Page | 30
Advanced Auditing and Assurance ICPAP
Question:-
Answer:-
Page | 31
Advanced Auditing and Assurance ICPAP
were effective. The purpose financial audit is to
of management audit is to determine whether the
assess whether the financial statements
integrated management represent fairly the actual
systems, which are financial position and
required to fulfill the working results of an
contractual and legal organisation.
obligations for the
company to its customers
and community, are being
effectively implemented
and the true and fair
presentation of the results
of such and examination is
attained.
Scope
The management audit The auditor’s certificate Normally covers audit of
concentrates upon the main depends on verification of routine financial
sources of decision-making the Profit and Loss transactions to ensure that
in a firm, which can achieve Account and Ledger no irregularities would
effective and impressive Accounts with reference to occur within the
results for profitability. It original documentary organization in any area
covers mainly management evidence. where finance is involved
areas. and to judge the efficacy of
systems of internal control.
Features
Audit of management Looking into the Covers mainly financial
policies and their correctness of financial transaction, through can be
adequacies to meet data and records along extended to management
corporate objectives. Audit with correctness of the areas in the absence of
of procedures, organization accounting procedures management audit.
and methods to confirm followed. Seeing that
proper implementation of established accounting
policies and rules. systems and procedures
have been complied with.
Page | 32
Advanced Auditing and Assurance ICPAP
date. agencies
e) Requirement under
CARO
f) Ensuring internal
control measures are
followed and are
effective.
Areas
Organisation, methods, All cash transactions- Sales, purchase, receipts,
procedure, controls, receipts and payments, payments, stores and stock,
techniques, systems and wages and salaries, production and
functional areas such as purchase and sales, stocks performance efficiencies,
purchase, production, sales, and work-in-progress, including physical
personnel and inventory physical verification of performance (quantitative
management. assets (current and fixed). and qualitative) and
physical verification of
assets.
Qualifications of Auditor
The statue does not lay The qualifications required It is performed by the
down any qualification for for appointment of employees of the company,
a management auditor, but statutory auditor have drawn from internal audit
he must be a senior person been specified under department. There is no
with enough experience Ordinance 1984 of the statutory qualification.
since management audit Companies Act, 254. Auditor should be a man of
covers all the functional experience and intelligence,
areas of management. The with a logical mind and
qualifications of a analytical approach. His
management auditor are exposure has to be in areas
difficult to be prescribed. of accounts/finance. It is a
Ideally, a candidate with continuing audit which goes
multi-disciplinary on the year round, at
approach is best suited for specified and regular
the job. It could also be a intervals.
team of persons
specializing in different
disciplines.
Periodicity
There is no such defined Statutory financial audit is It is a continuous process.
period. It purely depends conducted every year.
on the management.
Normally it is held once in
2-3 years.
Reporting
Page | 33
Advanced Auditing and Assurance ICPAP
The management audit The financial auditor has to The internal audit report is
report is meant for top make a report to the meant for top management.
management. The report is members of the company A copy of the report
submitted to managing i.e. share-holders. department concerned.
director or executive
director through at times
the report is submitted to
an audit committee of the
board of directors.
Question:-
Answer:-
Page | 34
Advanced Auditing and Assurance ICPAP
A. Monitoring physical assets
B. Ensuring adequate environmental controls such as Air-conditioning
(online UPS functioning all the time with Backups and proper earthling).
3. Organisational Control Comprises of :
A. Defining roles, responsibilities and duties of user-Department and I.T.
Department.
B. Defining roles, responsibilities and duties within the I.T. Department
such as developers, operators and administrators.
4. Application Control Comprises of :
A. Each of the computer systems and sub-systems must have its own set of
controls for input, processing and outputs. Processing controls should
also ensure checks for legal compliance.
B. While performing the audit, each of the controls needs to be studies for
existence and adequacy.
Page | 35
Advanced Auditing and Assurance ICPAP
report information in a way that facilitates decision making by its users, auditors
must know the characteristics of users and the decision-making environment.
Effectiveness auditing often occurs after a system has been running for some
time. Management requests a post audit to determine whether the system is
achieving its stated objectives. The evaluation provides input to the decision on
whether to scrap the system, continue running it, or modify it is some way.
Effectiveness auditing also can be carried out during the design stages of a
system. Users often have difficulty identifying or agreeing on their needs.
Moreover, substantial communication problems often occur between system
designers and users. If a system is complex and costly to implement, the design
is likely to fulfill user needs.
c) There is no change in the fundamental nature of auditing due to computerization and all
pervasive Information Technology. Auditors must still provide a competent,
Page | 36
Advanced Auditing and Assurance ICPAP
independent evaluation as to whether a set of economic activities have been recorded
and reported according to standards or criteria. However, computerization has affected
the basic function of collection and evaluation of evidence as discussed below:
Page | 37
Advanced Auditing and Assurance ICPAP
manual system. Errors in computer system tend to be deterministic i.e. an erroneous
programme will always execute incorrectly. In a manual system errors tend to occur
stochastically e.g. periodically a clerk prices an inventory item incorrectly. Errors are
generated at high speed and the cost to correct and rerun programmes can be very high
while feedback can be given to a clerk committing an error in the manual system, in
computer programmes can involve extensive redesign and reprogramming.
Thus, internal controls that ensure that high quality computer systems are designed,
implemented, operated and maintained are critical. The onus is on the Auditors to
ensure that these controls are sufficient to maintain asset safeguarding, data integrity
systems, effectiveness and efficiency and they are in place and working reliably.
Question:-
Answer:
i. Management Audit assesses whether the integrated management systems which are
required to fulfill the contractual and legal obligations of the company to its customers
and community are being effectively implemented.
Management Audit is concerned with appraisal of total performance of management of
the company. The area and scope of management audit are very wide and
comprehensive. It is a tool in the hands of top management.
Management audit includes cost management functions, and also takes care of economic
environment, social accounting and reporting. Management audit is a technique of
assessing how effectively the executives can plan, organize, direct and control and
ensure effective and efficient use of available resources like men, material, machines,
money and methods for achieving the objectives. Thus it is an audit of various functions
and policies to use economic resources placed at its disposal in an efficient manner.
ii. The main purpose of an independent financial audit is to determine whether the
financial statements represent fairly the actual financial position and working results of
an organisation.
Page | 38
Advanced Auditing and Assurance ICPAP
However, the purpose of management audit is to assess whether the integrated
management systems which are required to fulfill the contractual and legal obligations
for the company to its customers and community are being effectively implemented and
the true and fair presentation of the results of such an examination is attained.
The statutory financial audit has a lot of limitations and therefore there is need for an
independent appraisal of management performance at various levels including the top
most level.
Financial audit takes care of the protective aspect of the business and it does not
normally carry out any constructive appraisal function of business operations. In
financial audit the Auditor’s certificate depends on verification of the Profit and Loss
Account and Ledger Accounts with reference to original documentary evidence.
However, the management audit concentrates upon the main sources of decision
making in a firm, which can achieve effective and impressive results for profitability. In
other words, the report of management auditor contains the auditor’s opinion on the
performance of the management function at all levels.
iii. Operational audit is a scientific tool and technique adopted by the auditor in progressive
business concerns. It is a more of a technical analysis for appraisal and review rather
than a financial cum accounting analysis under financial audit. In operational audit the
audit functioning objectives reach out beyond the financial control aspect into the
operating area of the business. It aims at improving future business operations by
concerning the auditor with all aspects of management. This is a new phase of internal
audit technique.
Operational auditing is auditing the performance for management and this would
embrace the following:
a) Auditing the operational activities to achieve better efficiency and economy.
b) Auditing the organizational objectives to achieve improved profitability.
c) Auditing the management information and control system for achieving better
effectiveness.
iv. An operational auditor has to review and analyze the control measures in operation in
an organisation. In other words, he has to ascertain and analyze the causes of variations
in the functioning of various resources employed on the quality and productivity, point
out the ineffective controls and suggest improved means of attaining the organizational
aim. For this, he has to be familiar with the various types of control measures
functioning in an organization like internal control, management control, executive
control, internal accounting control, management information control etc. the
operational auditor should review and evaluate the controls, keeping in mind the
outlook of management, nature, size and complexity of operations and the business
environment. He has to appraise, as to how various activities like personnel relations,
manufacturing, production etc. are controlled, weak links if any and any remedial
Page | 39
Advanced Auditing and Assurance ICPAP
actions, which can be taken. For this purpose, the operational auditor can verify the
following.
a) Is this control of help to the management of the operation which is being
audited?
b) Is the cost of maintaining the control justified by the value of business?
c) Is there any duplication of work? If so, which is the better way to do it?
d) Is there any duplication of controls?
e) Are the deviations is performance reported to the management on time?
Therefore, the Operational Auditor is vested with a responsibility of ensuring not only
the presence of controls but also their efficacy.
v. Efficiency audit presupposes certain levels of efficiency at which the operations are
being carried on. Efficiency audit establishes relationship between input and output. It
measures the efficiency with which the resources employed are being used. It is the
application of a basic economic principle, namely, resources flow into the most
remunerative channels. Its main purpose is to ensure that all business operations are
being carried on in the most appropriate manner.
Efficiency audit starts with the examination of the plan and extends to the comparison of
actual performance against the plan and investigation with the reasons for variances.
Further, efficiency audit is directed towards the assessment of whether or not corporate
plans have been efficiently and economically executed. Therefore, it is concerned with
every functional or operational area of the organisation to find out whether resources of
the organisation, both physical and economic are being utilized in an effective and
efficient manner to achieve the objectives of the company.
Question:-
a) The chief of an internal audit department has been asked by the managing director of
the company to ensure that no qualifications are made by the statutory auditor in his
report under the Companies (Auditor’s Report) Order, 2003. What are the points that
need to be examined and reported to the managing director by the chief of internal
audit in respect of the following items:
I. Fixed assets:
II. Inventory; and
III. Loans granted or taken?
b) Discuss the advantages and limitations of inter-firm comparison.
Answer:-
a) The points to be examined and reported by the chief of internal audit in respect of the
following are:
I. Fixed Assets
Page | 40
Advanced Auditing and Assurance ICPAP
Check:
A. Whether the company is maintaining proper records showing full
particulars, including quantitative details and situation or fixed assets;
B. Whether these fixed assets have been physically verified by the
management at reasonable intervals. Also is there any material
discrepancies noticed in such verification. If so the same are to properly
dealt with in the books of account;
C. If a substantial part of fixed assets have been disposed of during the year,
whether it has affected the business of the going concern.
II. Inventory
Check:
A. Whether physical verification of inventory has been conducted at
reasonable intervals by the management.
B. Whether the procedures of physical verification of inventory followed is
reasonable and adequate in relation to the size of the company and the
nature of its business. If not what are the inadequacies and what are the
corrections needed.
C. Whether the records of inventory are maintained properly and material
discrepancies noticed on physical verification have been properly dealt
with in the books of accounts.
III. Loans granted or taken
Check:
A. Whether the company has either granted or taken and loans secured or
unsecured to/from companies, firms or other parties covered in the
register maintained under Section 301 of the Companies Act, 1956 and if
so the number of parties and amounts involved in the transactions should
be given.
B. Whether the rate of interest and other terms and conditions of loans given
or taken by the company, secured or unsecured are prima facie
prejudicial to the interests of the company.
C. Whether the payment of the principal amount and interest are also
regular.
D. If overdue amount is more than one lakh, whether reasonable steps have
been taken to recover the dues or pay the amounts owed in respect of
principal and interest.
Apart from the above, it should also be verified whether there is an adequate internal
control procedure commensurate with the size of the company and nature of its
business, for the purchase and sale etc. Also, if there is a continuing failure to correct
major weakness in internal control, the same have to be reported.
Page | 41
Advanced Auditing and Assurance ICPAP
b) Inter-firm comparison is a technique of comparing the performances, efficiencies, costs
and profits of various concerns in an industry for assessing its own performance and
ascertaining the reasons for any difference in performances/efficiencies etc. Inter-firm
comparison has been used on a large scale with the objective of making choice of
investment by potential investors or to assess the stage of performance of a particular
organisation vis-à-vis that of others.
Page | 42
Advanced Auditing and Assurance ICPAP
ix. It stimulates self-criticism and also identifies the various responsibility centres
for various operations and their economic evaluation in terms of corporate
objectives.
In spite of the various advantages, inter-firm comparison is not free from draw backs.
The following limitations of inter-firm comparison may be noted:
i. If information or ratios are not properly collected before they are used,
comparison will be rendered difficult and absurd results will emerge.
ii. Most of the member firms do not disclose the relevant data as they consider
it confidential. Thus, the information supplied may not always be reliable
for comparison or decision making purposes.
iii. The middle management may not be convinced with the utility of inter-firm
comparison or decision making purposes.
iv. Unless there is a uniform costing system among the members, the
information may not be reliable for the purposes of comparison as different
members may imply different things by the usage of same terms.
v. In the normal course, a suitable base for comparison may not be available.
vi. In any comparison, time factor is an important element, any inter-firm
comparison, which ignores this, will lead to misleading results which are
not comparable and as such the very purpose of this exercise will be
frustrated.
vii. The inconsistencies in financial reporting are totally ignored. No
adjustments are made for changes in the prices. No attention is given to the
level of technology and technological developments. Generally, there is a
lack of common valuation method in different units to be compared. All
these aspects adversely affect the reliability of the results obtained by inter-
firm comparison.
Question:-
Page | 43
Advanced Auditing and Assurance ICPAP
communication from the Central Government seeking clarifications was
received by the cost auditor on 16th October, 2004.
iii. The annexure and proforma prescribed was signed by the managing director.
The Company Secretary was on leave. Other directors were not available and
approval of the Board of directors could not be obtained as required under the
Cost Audit (Report) Rules, 2001.
Answer:-
a) Questionnaire on purchase
1. Is the store department’s purchase requisition in parity with receiving reports?
2. Were the competitive bidding procedures followed?
3. Are the receiving reports initialed and signed properly?
4. Is the merchandise reported in supplier’s invoice and receiving report, the same?
5. Are the copies of requisition, purchase order, invoice and receiving report in
order and complete?
6. Whether the principles of buying i.e. right price, quantity, quality etc. are
adhered to or not?
7. Whether the terms in the purchase requisition tally with the materials
specifications, quality required and delivery schedule?
8. Whether a master list of suppliers in maintained with u dations, if any?
9. Whether proper coordination exists between initiating department and purchase
department in the matter of floating enquiries?
10. Whether telephonic/electronically quotations are received and the value
involved is large?
11. Whether any purchase requisition is pending for long?
12. Whether follow up for delivery is done?
13. Whether the operations are in sync are with those in purchase manual?
14. Whether management directives adhered to?
15. How purchase records are maintained?
16. How the stock ledgers and records maintained?
17. Whether the transactions are in parity with purchase budget and cost control
budget?
18. Whether any purchase committee report exists?
19. Whether the purchase department maintains a “purchase value analysis
programme” to ascertain how efficiently and effectively buying is done?
20. Whether statutory laws and rules including Schedule VI to the Companies Act
and are complied with CARO, 2003 etc.
21. Whether the management directives with respect to purchases are properly
adhered to?
(Illustrative)
Page | 44
Advanced Auditing and Assurance ICPAP
i. Pursuant to Rule 5 of the Cost Audit (Report) Rules, 2001, the report of the Cost Auditor
shall be forwarded to the Central Government and to the concerned company within
one hundred and eighty days from the close of the company’s financial year to witch the
report relates. In the present case, the report should have been presented within one
hundred and eighty days from 31st March 2005 i.e. or on before 27th September 2005.
(Rule 5). But it was presented on 25th October 2005. Consequently, the cost auditor
becomes liable (under Rule 8), with fine which may extend to five thousand rupees.
However, the actual default seems to be on the part of the company and every officer
thereof which should have furnished such cost accounting records etc, to the cost
auditor within one hundred and thirty five days from 31st March 2005 (i.e. 13th August
2005) as would have been required for conducting cost audit (Rule 6). Also, the
necessary assistance should have been rendered to the cost auditor so as to enable him
to complete the cost audit and submit his report within the time limit specified in Rule 5.
As the company has contravened the provisions of Rule 6, it shall be liable under Rule 8
or Cost Audit (Report) Rules, 2001.
ii. As per Rule 4(2) of the Cost Audit (Report) Rules, 2001 the Cost Auditor shall give the
clarifications required by the Central Government within 30 days of the receipt of the
communication seeking clarification.
In the present case the communication seeking clarification was received on 16.10.2004.
Therefore, the same were to be furnished by 15.11.2004 i.e. 30 days excluding the date of
receipt.
However, the Cost Auditor furnished the clarifications on 10.12.2004 on the 55th day
excluding the data of receipt of the communication. He is liable for punishment with
fine which may extend to Rs. 5000, (Rule 8).
iii. Rule 7 of the Cost Audit (Report) Rules, 2001 lays down that the Annexure and
Proforma prescribed with the Cost Audit Report shall be approved by the Board of
Directors before submitting the same to the Central Government by the Cost Auditor.
The Annexure and Proforma duly audited by the Cost Auditor shall also be signed by
the Company Secretary and at least one Director. In the absence of the Company
Secretary, the same shall be signed by at least two Directors.
In the present case, there is no approval of the Annexure and Proforma by Board of
Directors and authentication is done by MD only. This contravenes the provisions of
Rule 7 and accordingly penal provisions of Rule 8 shall be attracted.
Question:-
Page | 45
Advanced Auditing and Assurance ICPAP
c) State the technical skills required for conducting systems audit.
d) Indicate the information systems risks associated with internal controls that need
scrutiny by information systems auditor.
Answer:-
a) Most important aspect of Software Life Cycle is change. The change can be given by:
i. Internal Factors
ii. External Factors
There may be a change in Disclosures Format by SEBI. In such case organization has
no choice, but to adopt a changed format.
Change can be driven due to internal factors, because of changes necessitated in internal
control procedures and systems. For instance, there may be changes in tax laws such as
change in Income Tax Law, Central Excise Laws, and Sales Tax etc. This necessitates
making necessary changes in the database and other related programmes in the
computer.
The change control board should consist of functional heads, HOD of internal audit. The
change initiation takes place when detailed written request is raised from the effected
party department. The request is sent to the Co-ordinator of change control board.
Finally after the deliberations the request may be routed to I.T. Department to find out
whether they require extra financial resources for implementation.
The system auditor needs to look into the entire change control process lest the rigor
with which the system was introduced can be diluted. There is high rate of obsolescence
in I.T. the change control board also needs to take care of issues relating to technology
renewal.
Page | 46
Advanced Auditing and Assurance ICPAP
by the management. I.S. auditor has to evaluate their adequacy and appropriateness to
mitigate risk. Weaknesses that exist are to be reported by the I.S. Auditor to understand
the process and procedure of reviewing and evaluating controls.
Threats can be outcome of poor control or no control. A threat is some action or event
that can lead to a loss (a risk). “The potential that a given threat will exploit the
vulnerabilities of an asset or group of assets to cause loss or damage to them” is
considered as risk. The result of threat analysis is vulnerabilities. The risk of a threat
exploiting a vulnerability leads to impact i.e., result of loss of any sort on account of risk.
Exposure is the potential loss on account of the actualizing of the risk. Risk assessment
identifies the elements of risk and combines them to give the overall view of the risk.
For example fire is a threat to a computer center. This is an inherent vulnerability which
cannot be entirely eliminated but can be mitigated by e.g. prohibiting smoking, encasing
all electrical wiring, having fire proof walls or fire proof cabinet for storing all the
software and data, installing smoke detection system or fire extinguishers. These
measures shall mitigate the risk of fire. Further, the company may obtain insurance for
loss of assets/profits. This is called as risk transfer. The remaining risk termed residual
risk has to be accepted by the management.
The loss due to fire is termed exposure. The impact of fire is the loss to the company due
to disruption of business, loss of customers, loss of assets etc. while assessing risk the I.S.
Auditor has to consider the various types of threats, vulnerabilities, risk exposure and
the probability of their occurrence.
A common method used to quantify risk is as follows: calculate the impact against
probability of each treat. e.g. if the loss on account of fire is Rs. 5 lakhs and the
probability of its occurrence is 0.2% then the potential risk exposure would be: 5,00,000
2/100 = Rs. 1,000.
If the expected loss is Rs. 20, 00,000 and the probability of occurrence is 2% then the
exposure would be: 20, 00,000 2/100 = Rs. 40,000
Control assessment: After the risks have been identified, existing controls can be
evaluated or new controls can be designed to ensure that the risk is maintained at the
acceptable level.
At the time of evaluation is should be considered whether controls are preventive or
detective, manual or programmed and formal.
c) The system Auditor is able to assess whether the control objectives are met or not. For
instance Network Security is a major area which is highly technical. It covers Operating
System, Database Management System, Network Detection and Devices such as
Firewalls, Content Inspection and Intrusion Detection. Everyday new attack patterns are
Page | 47
Advanced Auditing and Assurance ICPAP
discovered and remedial measures taken. The I.S. Auditor needs to know about these to
be able to assess the risks for taking steps to overcome the problem. The risks may not
have impact on a given organization, but the functional knowledge of I.S. Auditor will
certainly help in this regard.
d) Nature of Information System Risks related to internal controls
Risks associated with internal control in a computerized environment include:
A. Lack of transaction trails:
B. Uniform processing of transaction:
C. Poor segregation of functions:
D. Potential for errors and irregularities:
E. Initiation or execution of transactions:
F. Dependence of other controls over computer processing:
G. Potential for increased management supervision:
H. Potential for the use of computer assisted audit techniques.
Question:-
You are the manager in-charge on the annual audit of Decimal World Limited (DWL) for the
year ended December 31, 2009. DWL is a leading manufacturer of electrical appliances. 35% of
its shares are held by Binary Pakistan Limited (BPL). However, with the help of some
consenting shareholders, BPL has been able to nominate 5 out of 8 directors on the Board.
During the planning phase of the audit you became aware of the following matters:
a) A foreign investor has made a public offer to purchase 51% shares of DWL at a price of
Rs. 13 per share. The share price has ranged between Rs. 12 to Rs. 14 per share during
the past six months.
b) The company’s statement of financial position includes a deferred tax asset of Rs. 30
million on account of unutilized tax losses which have accumulated during the loss
making period 1999-2004. The management is of the view that future taxable profits
would be sufficient to utilize the available tax losses.
c) DWL has established an e-commerce division to sell its products through internet. This
new division is administered centrally by the head office. This step has been quite
successful as the online sales have risen to 20% of the total sales during the year.
Required:
Identify and explain the audit risks which the auditor should consider while planning the
audit of DWL. Also highlight the key areas on which the auditor should place emphasis
upon, to address the above risks.
Page | 48
Advanced Auditing and Assurance ICPAP
Answer:-
Page | 49
Advanced Auditing and Assurance ICPAP
Question:-
You are a chartered accountant in practice. The following situations have arisen in connection
with two of your clients:
Required:
Explain how you would meet your professional obligations and responsibilities while
carrying out the above assignment.
b) Your firm is the external auditor of a listed company. Recently the management of the
company has requested your firm to provide the following services:
i. Reconciling the creditors’ ledger with the statements submitted by the suppliers.
ii. Estimating the compensation payable to the employees who were seriously injured
while carrying out the trial run of the plant.
Required:
Explain the threats involved in accepting the above assignments and identify the steps the
firm should take to fulfill its professional responsibilities and obligations.
Answer:-
(a) (i) While taking up the assignment, we should keep in mind the following:
A chartered accountant in practice should not assume custody of client’s monies unless
permitted to do so by law.
It creates a self-interest threat to professional behavior and may be a self-interest threat
to objectivity.
To safeguard against such threats, we would:
Keep such monies separately from firm’s assets.
use such money only for the purpose for which they are intended;
at all times, be ready to account for these assets, and any income, dividends or
gains generated, to any persons entitled to such accounting.
Comply with all relevant laws and regulations relevant to the holding of and
accounting for such assets.
Page | 50
Advanced Auditing and Assurance ICPAP
We should be aware of threats to compliance with the fundamental principles through
association of such assets. For example, money derived from illegal activities. In order to
safeguard against these threats, we should:
make appropriate inquires about the source of such assets;
Consider their legal and regulatory obligations.
seek legal advice.
(ii) There is no bar to accepting this business as MNC is not our financial statements audit client.
accounting entries. Therefore, it may create a self-review threat when the financial statements
are subsequently audited by the firm.
While providing such assistance, the auditor should not involve in making management
decision which include:
Determining or changing journal entries, or the classifications for accounts or
transaction or other accounting records.
Authorizing or approving transactions; and
Preparing source documents or originating data or making changes to such
documents or data.
The significance of any threat created should be evaluated and, if the threat is other than
clearly insignificant, safeguards should be considered and applied as necessary to
reduce the threat to an acceptable level. Such safeguards might include:
Making arrangements so such services are not performed by a member of the
assurance team;
Implementing policies and procedures to prohibit the individual providing such
services from assisting in preparation of accounting records and making any
managerial decisions on behalf of the audit client;
provisions in the accounts. Therefore, it may create a self-review threat. The significance of
threat will depend upon the following factors:
Page | 51
Advanced Auditing and Assurance ICPAP
Using professional who are not members of the assurance team to perform the
service;
The involvement of others such as independent experts.
Question:-
You are the manager in charge on the audit of Hexa Garments Limited (HGL). The company is
listed on the Karachi Stock Exchange and has nine directors. It is engaged in the manufacture
and sale of fancy garments through its own retail outlets. You are considering the following
matters in respect of the audit for the year ended December 31, 2009:
a) The diluted earnings per share of Rs. 36.60 has been calculated without taking into
account the share options held by three directors. To justify the above calculations, these
directors have confirmed in writing that they do not intend to exercise the share option.
Had the share options been considered, the diluted earnings per share would have been
Rs. 35.60. The review of subsequent events revealed that four of the remaining directors
had exercised their share options following the balance sheet date.
The share options are available upto December 31, 2010.
b) According to the draft financial statements the total assets of the company are valued at
Rs. 375 million. These include value of ten retail outlets amounting to Rs. 175 million.
The valuation is based on historical cost less accumulated depreciation. During the year
ended December 31, 2009, the management had decided to revalue all the retail outlets.
The value appointed by the management has not been able to complete the assignment
to date. However, he has submitted two interim reports as described below:
Interim Report
First Second
Date of report 31/12/09 20/02/10
Number of shops revalue 3 4
Book value as on 31/12/2009 (Rs. in million 40 60
Revalued amount (Rs. in million 70 100
c) During the year HGL has developed two new brands “Deebal” and “Kalachi” and has
launched an aggressive marketing campaign for their promotion. The company has
recognized the cost incurred on the campaign amounting to Rs. 10 million as an
intangible asset. It is being written off over the estimated useful life of the brands i.e.
four years.
Required:
Discuss the matters that may be of significance to you as an auditor, in respect of the above
issues. Also explain their implications on the audit report.
Page | 52
Advanced Auditing and Assurance ICPAP
Answer:-
Page | 53
Advanced Auditing and Assurance ICPAP
Question:-
You are the quality control partner in a medium size audit firm and have been asked to give
your views on the following situations:
a) Pentagon Limited, an unlisted assurance client, has requested your firm to assist them in
the recruitment of the Chief Financial Officer (CFO) of the company. While short listing
the candidates, it was found that the applicants include CFOs of two of your existing
assurance clients.
b) One of your firm’s large clients, a listed company, has requested that the current year’s
audit should be carried out by the same team which audited the last year’s financial
statements. The request has been justified on the grounds that the accounts department
is extremely busy on a special assignment and a new team would take a lot of their time.
You have also been informed that Mr. Shams has been the manager in charge of that
audit during the last three years.
Required:
Discuss the category of threat involved in each of the above situations. Also explain the
safeguards available with the firm which may eliminate or reduce the threat to an acceptable
level.
Answer:-
(a)
Page | 54
Advanced Auditing and Assurance ICPAP
(b) Client’s request for certain staffs
The audit firm should assess whether the reason given by the client is valid under the
circumstances because if there is any other reason, it may affect the independence of the audit.
Moreover, as a matter of principle, the audit firm should not encourage such requests from the
client.
i. Using the same senior personnel on an assurance engagement over a long period of time
may create a familiarity threat.
ii. The significance of the threat should be evaluated and, if the threat is other than clearly
insignificant, safeguards should be considered and applied to reduce the threat to an
acceptable level.
Such safeguards might include:
Rotating the senior personnel (other than the audit team)
Involving an additional chartered accountant who was not a member of the
assurance team to review the work done by the senior personnel or otherwise
advise as necessary;
Independent internal quality reviews.
Page | 55
Advanced Auditing and Assurance ICPAP
The Role of the Auditor in the Economy
Summary:-
This chapter explored the nature of the attest function, independent audits, and the
auditing profession. To summarize:
Page | 56
Advanced Auditing and Assurance ICPAP
Key Terms
Page | 57
Advanced Auditing and Assurance ICPAP
Questions:-
Select the best answer for each of the following items and give reason for your
choice.
a) Which of the following has primary responsibility for the fairness of the
representations made in financial statements?
1) Client’s management
2) Independent auditor.
3) Audit committee.
4) AICPA.
b) The most important benefit of having an annual audit by a CPA firm is to:
1) Provide assurance to investors and other outsiders that the financial
statements are dependable.
2) Enable officers and directors to avoid personal responsibility for any
misstatements in the financial statements.
3) Meet the requirements of government agencies.
4) Provide assurance that illegal acts, if any exist, will be brought to light.
c) Government auditing, in addition to including audits of financial statements,
often includes audits of efficiency, effectiveness, and:
1) Adequacy.
2) Evaluation
3) Accuracy.
4) Compliance
d) Operational audits often have an objective of determining whether an entity’s:
1) Internal control structure is adequately operating as designed.
2) Operational information is in accordance with generally accepted
governmental auditing standards.
3) Financial statements present fairly the results of operations.
4) Specific operating units are functioning efficiently and effectively.
Professional Standards
This chapter described the nature of the generally accepted auditing standards, the
attestation standards, and quality control standards. To summarize:
Page | 58
Advanced Auditing and Assurance ICPAP
audits must be performed in accordance with generally accepted auditing
standards.
Page | 59
Advanced Auditing and Assurance ICPAP
Questions:-
Select the best answer for each of the following items and give reason for your
choice.
Page | 60
Advanced Auditing and Assurance ICPAP
2) The criteria for audit planning and evidence-gathering.
3) The criteria for the content of the auditors’ report on financial statements.
4) The competence, independence, and professional care to be exerted
while performing the audit.
b) A basic objective of a CPA firm to provide professional services that conform
with professional standards. Reasonable assurance of achieving the basic
objective is provided through:
1) Compliance with generally accepted reporting standards.
2) A system of quality control.
3) A system of peer review.
4) Continuing professional education.
c) Which of the following is not explicitly included in an unqualified standard audit
report?
1) The CPA’s opinion that the financial statements comply with generally
accepted accounting principles.
2) That generally accepted auditing standards were followed during the
audit.
3) That the internal control structure of the client was satisfactory.
4) The subjects of the audit.
d) The general group of the generally accepted auditing standards requires that:
1) The auditors maintain an independent mental attitude.
2) The audit be conducted in conformity with generally accepted
accounting principles.
3) Assistants, if any, be properly supervised.
4) The auditor obtain an understanding of the internal control structure.
e) Which quality control standard would most likely be satisfied when a CPA firm
maintains records indicating which partners or employees of the firm were
previously employed by the records indicating which partners or employees of
the firm were previously employed by the CPA firm’s client?
1) Professional relationship.
2) Supervision.
3) Independence.
4) Advancement.
f) An “external peer review” is most likely to be performed by:
1) Employees and partners of the firm who are not associated with the audits
being reviewed.
2) Audit review staff of the Securities and Exchange Commission.
Page | 61
Advanced Auditing and Assurance ICPAP
3) Audit review staff of the Institute of Certified Public Accountants of
Pakistan
4) Employees and partners of another CPA firm.
Professional Ethics
Page | 62
Advanced Auditing and Assurance ICPAP
Page | 63
Advanced Auditing and Assurance ICPAP
Audit Evidence:-
Page | 64
Advanced Auditing and Assurance ICPAP
Questions:-
Select the best answer for each of the following items and give reason for your
choice.
a) As part of their audit, CPAs obtain a representation letter from their client.
Which of the following is not a valid purpose of such a letter?
1) To increase the efficiency of the audit by eliminating the need for other
audit procedures.
2) To remind the client’s management of its primary responsibility for the
financial statements.
3) To document in the audit working papers the client’s responses to
certain verbal inquires made by the auditors during the engagement.
4) To provide evidence in those areas dependent upon management’s future
intentions.
b) Which of the following statements best describes why auditors investigate
related party transactions?
1) Related party transactions generally are illegal acts.
2) The substance of related party transactions may differ from their form.
3) All related party transaction must be eliminated as a step in preparing
consolidated financial statements.
4) Related party transactions are a form of management fraud.
c) Of the following, which is the least persuasive type of audit evidence?
1) Confirmations mailed by outsiders to the auditors.
2) Correspondence between the auditors and suppliers.
3) Copies of sales invoices inspected by the auditors.
4) Canceled checks returned in the year-end bank statement directly to the
client.
d) Analytical procedures are most likely to detect:
1) Weakness of a material nature in internal control.
2) Unusual transactions.
3) Noncompliance with prescribed control procedures.
4) Improper separation of accounting and other financial duties.
e) If the auditors unknowingly understate control risk, which of the following is
most likely to also be understated?
1) Audit risk.
2) Business risk.
3) Inherent risk
Page | 65
Advanced Auditing and Assurance ICPAP
4) Detection risk.
f) Which of the following is least likely to indicate high inherent risk in an account?
1) The account was misstated in the prior year audit.
2) The company has maintained a 4 – 6 percent increase in profits during
each of the past six years.
3) Valuation of the account is affected by economic factors
4) The company is in poor financial condition and may have a “going
concern problem.”
Chapter summary
This chapter explained the manner in which auditors plan an audit and design audit
programs. To summarize:
Page | 66
Advanced Auditing and Assurance ICPAP
Key terms
Page | 67
Advanced Auditing and Assurance ICPAP
Questions:-
Select the best answer for each of the following items and give reason for your
choice.
Internal control
Chapter summary
Page | 69
Advanced Auditing and Assurance ICPAP
Key Terms
Page | 70
Advanced Auditing and Assurance ICPAP
Page | 71
Advanced Auditing and Assurance ICPAP
Question Requiring Analysis
Required
Internal auditing is a staff function found in virtually every large corporation. The
internal audit function is also performed in many smaller companies as part-time
activity of individuals who may or may not be called internal auditors. The difference
between the audits by independent auditors and to work of internal auditors are more
basic than is generally recognized.
Required:-
Page | 72
Advanced Auditing and Assurance ICPAP
Audit Sampling
Chapter summary
Page | 73
Advanced Auditing and Assurance ICPAP
Key Terms
Page | 74
Advanced Auditing and Assurance ICPAP
Page | 75
Advanced Auditing and Assurance ICPAP
Review questions
Question: In performing a test of controls for sales order approvals, the CPAs stipulate
a tolerable deviation rate of 8 percent with a risk of assessing control risk too low of 5
percent. They anticipate a deviation rate of 2 percent.
Required:
a. What type of sampling plan should the auditors use for this test?
b. Using the appropriate table or formula from this chapter, compute the required
sample size for the test.
c. Assume that the sample indicates four deviations. Man the CPAs conclude with
a 5 percent risk of assessing control risk too low that the population deviation
rate does not exceed the tolerable rate of 8 percent?
Required:
a. Identify and explain four areas in which judgment may be exercised by CPAs in
planning a statistical test of controls.
b. Assume that the auditors’ sample shows an unacceptable deviation rate. Discuss
the various actions that they may take based upon this finding.
c. A nonstratified sample of 80 accounts payable vouchers is to be selected from a
population of 3,200. The vouchers are numbered consecutively from 1 to 3,200
and are listed, 40 to a page, in the voucher register. Describe four different
techniques for selecting a random sample of vouchers for inspection.
Page | 76
Advanced Auditing and Assurance ICPAP
Audit working papers, examination of the general records
Chapter summary
Page | 77
Advanced Auditing and Assurance ICPAP
Key Terms
Page | 78
Advanced Auditing and Assurance ICPAP
Question requiring analysis
Question: The preparation of working papers in an integral part of the CPAs audit of
financial statements. On a recurring engagement the CPAs review the working papers
from their prior audit while planning the current examination to determine the papers’
usefulness for the current engagement.
Required:
a. .
1) What are the purpose or function of audit working papers?
2) What records of the auditors may be included in audit working papers?
b. What factor affect the auditors’ judgement of the type and content of the working
papers for a particular engagement?
c. To comply with generally accepted auditing standards, the auditor include
certain evidence in their working papers, for example. “evidence that the
engagement was planned and work of assistants was supervised and reviewed.”
What other evidence should the auditors include in audit working papers to
comply with generally accepted auditing standards?
Question: “Working papers should contain facts and noting but facts,” said student A.
“Not at all,” replied student B. “The audit working papers may also include expressions
of opinion. Facts are not always available to settle all issues.” “In my opinion,” said
student C, “a mixture of facts and opinions in the audit working papers would be most
confusing if the papers were produced as a means of supporting the auditors’ position
when their report has been challenged.” Evaluate the issues underlying these
arguments.
Chapter summary
Page | 79
Advanced Auditing and Assurance ICPAP
Key Terms
Page | 80
Advanced Auditing and Assurance ICPAP
Question: Among specific procedures that contribute to good internal control over
accounts receivable are.
Page | 81
Advanced Auditing and Assurance ICPAP
Inventories and cost of goods sold
Summary
Key Terms
Page | 82
Advanced Auditing and Assurance ICPAP
Page | 83
Advanced Auditing and Assurance ICPAP
Chapter Summary
Page | 84
Advanced Auditing and Assurance ICPAP
Page | 85
Advanced Auditing and Assurance ICPAP
Key Terms
Page | 86
Advanced Auditing and Assurance ICPAP
Page | 87
Advanced Auditing and Assurance ICPAP
Page | 88
Advanced Auditing and Assurance ICPAP
Page | 89
Advanced Auditing and Assurance ICPAP
Page | 90
Advanced Auditing and Assurance ICPAP
Page | 91
Advanced Auditing and Assurance ICPAP
Page | 92
Advanced Auditing and Assurance ICPAP
Auditors Reports
Chapter Summary
Page | 93
Advanced Auditing and Assurance ICPAP
Page | 94
Advanced Auditing and Assurance ICPAP
Page | 95
Advanced Auditing and Assurance ICPAP
Page | 96
Advanced Auditing and Assurance ICPAP
Page | 97
Advanced Auditing and Assurance ICPAP
Page | 98
Advanced Auditing and Assurance ICPAP
Page | 99
Advanced Auditing and Assurance ICPAP
Page | 100
Advanced Auditing and Assurance ICPAP
Page | 101
Advanced Auditing and Assurance ICPAP
Question:-
a) You are a manager in Farhan & Co, responsible for the audit of SAMSUNG Co, a
company which produces circuit boards which are sold to manufacturers of
electrical equipment such as computers and mobile phones. It is the first time
that you have managed this audit client, taking over from the previous audit
manager, Buland Iqbal, last month.
The audit planning for the year ended 30 November 2012 is about to commence,
and you have just received an email from Munir, the audit engagement partner.
Thank you.
Business overview
Page | 102
Advanced Auditing and Assurance ICPAP
SAMSUNG Co has two production facilities, one of which produces goods for
the export market, and the other produces goods for the domestic market. About
half of its goods are exported, but the export market is suffering due to
competition from cheaper producers overseas. Most domestic sales are made
under contract with approximately 20 customers.
Recent developments
In early November 2012, production was halted for a week at the production
facility which supplies the domestic market. A number of customers had
returned goods, claiming faults in the circuit boards supplied. On inspection, it
was found that the copper used in the circuit boards was corroded and therefore
unsuitable for use. The corrosion is difficult to spot as it cannot be identified by
eye, and relies on electrical testing. All customers were contacted immediately
and, where necessary, products recalled and replaced. The corroded copper
remaining in inventory has been identified and separated from the rest of the
copper.
Work has recently started on a new production line which will ensure that
SAMSUNG Co meets new regulatory requirements prohibiting the use of certain
chemicals, which come into force in March 2013. In July 2012, a loan of Rs.30
million with an interest rate of 4% was negotiated with SAMSUNG Co’s bank,
the main purpose of the loan being to fund the capital expenditure necessary for
the new production line. Rs.2.5 million of the loan represents an overdraft which
was converted into long-term finance.
Other matters
Several of SAMSUNG Co’s executive directors and the financial controller left in
October 2012, to set up a company specialising in the recycling of old electronic
equipment. This new company is not considered to be in competition with
SAMSUNG Co’s operations. The directors left on good terms, and replacements
for the directors have been recruited. One of Farhan & Co’s audit managers,
Buland Iqbal, is being interviewed for the role of financial controller at
SAMSUNG Co. Bob is a good candidate for the position, as he developed good
knowledge of SAMSUNG Co’s business when he was managing the audit.
At SAMSUNG Co’s most recent board meeting, the audit fee was discussed. The
board members expressed concern over the size of the audit fee, given the
Page | 103
Advanced Auditing and Assurance ICPAP
company’s loss for the year. The board members would like to know whether the
audit can be performed on a contingent fee basis.
Extract from draft statement of comprehensive income for the year ended 30
November 2012
The draft statement of financial position has not yet been prepared, but Mo states
that the total assets of SAMSUNG Co at 30 November 2012 are Rs.180 million,
and cash at bank is Rs.130,000. Based on draft figures, the company’s current
ratio is 1.1, and the quick ratio is 0.8.
Required:
Note: The split of the mark allocation is shown within the partner’s email.
Professional marks will be awarded for the presentation, structure, logical flow
and clarity of your answer.
b) You have just received a phone call from Waqar, SAMSUNG Co’s finance
director, in which he made the following comments:
Page | 104
Advanced Auditing and Assurance ICPAP
Required:
Comment on the matters that should be considered, and recommend the audit
procedures to be performed, in respect of the insurance claim.
Answer:-
a) Briefing notes
To: Audit Partner
From: Audit Manager
Regarding: Audit planning and ethical issues in respect of SAMSUNG Co
Introduction
These briefing notes evaluate the business risks facing SAMSUNG Co, and
identify and explain four risks of material misstatement to be considered in
planning the audit of the financial statements for the year ended 30 November
2012. In addition, two ethical issues are discussed and relevant actions
recommended.
i. Business risks
Imported goods – exchange rate fluctuations
SAMSUNG Co relies on a key component of its production process being
imported from overseas. This exposes the company to exchange rate
volatility and consequentially cash flow fluctuations. The company
chooses not to mitigate this risk by using forward exchange contracts,
which may not be a wise strategy for a business so reliant on imports.
Exchange gains and losses can also cause volatility in profits, and as the
company already has a loss for the year, any adverse movements in
exchange rates may quickly increase this loss.
Page | 105
Advanced Auditing and Assurance ICPAP
Reliance on imported goods increases the likelihood of a stock out. Unless
SAMSUNG Co keeps a reasonable level of copper wiring as inventory,
production would have to be halted if supply were interrupted, creating
idle time and inefficiencies, and causing loss of customer goodwill.
Page | 106
Advanced Auditing and Assurance ICPAP
Reliance on key customers
SAMSUNG Co relies on only 20 key customers to generate its domestic
revenue, which accounts for approximately half of its total revenue. In a
competitive market, it may be difficult to retain customers without cutting
prices, which will place further pressure on profit margins. In addition,
the product quality issue in November could mean that some contracts are
cancelled, despite SAMSUNG Co’s swift action to recall defective items,
meaning a potentially significant loss of revenue.
Regulatory issues
New regulations come into force within a few months of the year end. It
would appear that the existing production facilities do not comply with
these regulations, and work has only recently begun on the new and
regulation-compliant production line, so it is very unlikely that the new
regulations can be complied with in time. This creates a significant
compliance risk for SAMSUNG Co, which could lead to investigation by
the regulatory authority, and non-compliance may result in forced
cessation of production, fines, penalties and bad publicity. There may also
be additional on-going costs involved in complying with the new
regulations, for example, monitoring costs, as well as the costs of the
necessary capital expenditure.
Page | 107
Advanced Auditing and Assurance ICPAP
Profitability
The draft statement of comprehensive income indicates that revenue has
fallen by 9.4%, and operating profit fallen by 50%. Overall, the company
has made a loss for the year. In 2012 finance charges are not covered by
operating profit, and it would seem that finance charges may not yet
include the additional interest on the new loan, which would amount to
Rs.500,000 (Rs.30m x 4% x 5/12). The inclusion of this additional cost
would increase the loss for the year to Rs.800,000. This may indicate going
concern problems for the company.
Page | 108
Advanced Auditing and Assurance ICPAP
loss has not been included in profit. Inventory should not be retranslated
at the yearend as it is a non-monetary item, so any retranslation of
inventory would result in over or undervaluation of inventory and profit.
Page | 109
Advanced Auditing and Assurance ICPAP
understate expenses. This could be achieved by treating items of revenue
expenditure as capital expenditure, which would overstate non-current
assets and overstate profit.
Page | 110
Advanced Auditing and Assurance ICPAP
iii. Ethical issues
An audit manager of Farhan & Co is being interviewed for the position of
financial controller at SAMSUNG Co. This creates a potential ethical
threat. According to IFAC’s Code of Ethics for Professional Accountants,
familiarity or intimidation threats may be created by employment with an
audit client.
The familiarity threat is caused by the relationship that Buland Iqbal will
have with the audit team, having worked at the firm. This may cause the
audit team to lose objectivity, fail to challenge him sufficiently and lose
professional skepticism. The more junior members of the audit team may
also feel intimidated by him as his previous position was as audit
manager. He will also be aware of the firm’s audit methodology and
procedures, making it easier for him to circumvent procedures.
IFAC’s Code states that if a former member of the audit team or partner of
the firm has joined the audit client in a position that can influence the
preparation of the financial statements, and a significant connection
remains between the firm and the individual, the threat would be so
significant that no safeguards could reduce the threat to an acceptable
level. Therefore it is crucial that Farhan & Co ensures that no significant
connection between the audit firm and Buland Iqbal remains, for example,
by ensuring that he does not continue to participate or appear to
participate in the firm’s business or professional activities, and by making
sure that he is not owed any material sum of money from the audit firm. If
a significant connection were to remain, then the threat to objectivity
would be unacceptably high, and Farhan & Co would have to consider
resigning as auditors of SAMSUNG Co.
In the event of Buland Iqbal accepting the position and no significant
connection between him and the firm remaining, the existence and
significance of familiarity and intimidation threats would need to be
considered and appropriate safeguards, such as modifying the audit plan
and changing the composition of the audit team, put in place.
Any work that Buland Iqbal may have recently performed on SAMSUNG
Co should be subject to review, as there may have been a self-interest
threat if Bob knew he was going to apply for the role at the same time as
performing work for the client. However, as audit planning has yet to
commence, this may not be an important issue.
Page | 111
Advanced Auditing and Assurance ICPAP
Farhan & Co should have in place policies and procedures which require
members of an audit team to notify the audit firm when entering
employment negotiations with the client, as required by IFAC’s Code. The
firm’s policies and procedures should be reviewed to ensure they are
adequate and they may need to be communicated again to members of
staff.
Note: It is not certain or even implied that Bob has deliberately tried to
hide his intention to join SAMSUNG Co – but credit will be awarded
where candidates assume this to be the case. Equally, credit will be
awarded for comments recognising that it is appropriate that Bob has
been removed from the audit team.
Conclusion
The audit of SAMSUNG Co should be approached as high risk, due to the
number of business risks and risks of material misstatement explained in
these briefing notes. An audit strategy must be developed to minimise the
overall level of audit risk, and strong quality control procedures must be
adhered to throughout the audit. In addition, the ethical issue relating to
Buland Iqbal must be brought to the attention of our firm’s Ethics Partner
as soon as possible.
b) Matters to consider
The amount of Rs.5 million that has been claimed is material to the draft financial
statements, representing 2.7% of total assets. It represents 40% of revenue for the
Page | 112
Advanced Auditing and Assurance ICPAP
year, and if adjusted would turn the loss currently recognised of Rs.300,000 to a
profit of Rs.4.7 million.
The issue here is whether the amount claimed can be considered as virtually
certain or even probable to be received. The business insurance taken out by
SAMSUNG Co might only cover business interruption caused by certain
circumstances or events, such as terrorist acts or natural disasters. And it may
only apply if the whole business operation is curtailed, rather than just activities
in one location.
The amount claimed appears unrealistic. Production was halted for one week at
one location only, so to claim an amount equivalent to 40% of the company’s
total annual revenue seems extreme, making it very unlikely that the claim
would be approved by the insurance provider.
For these reasons, an adjustment to the financial statements would seem
inappropriate, certainly until confirmation has been received from the insurance
provider. If the financial statements are adjusted to include a receivable of Rs.5
million, the audit firm should consider this as a very high risk issue, because of
the potential impact on the auditor’s report of the potentially material and
possibly pervasive misstatement.
Recommended procedures
- Obtain a copy of the insurance claim made and confirm that Rs.5 million is
the amount claimed.
- Enquire as to the basis of the Rs.5 million claimed, and review any supporting
documentation such as extracts of management accounts showing lost income
for the period of halted production.
- Scrutinise the terms of SAMSUNG Co’s insurance policy, to determine
whether production halted in SAMSUNG Co’s circumstances would be
covered.
Page | 113
Advanced Auditing and Assurance ICPAP
- Seek permission to contact the insurance provider to enquire as to the status
of the claim, and attempt to receive written confirmation of the likelihood of
any payment being made.
- Review correspondence between SAMSUNG Co and the insurance provider,
looking for confirmation of any amounts to be paid.
- Contact SAMSUNG Co’s lawyers to enquire if there have been any legal
repercussions arising from the insurance claim, for example, the insurance
company may have disputed the claim and the matter may now be in the
hands of legal experts.
Question:-
a) You are a manager in KPMG, responsible for the audit of the Imran Group (the
Group), which is listed. The Group’s main activity is steel manufacturing and it
comprises a parent company and five subsidiaries. KPMG currently audits all
components of the Group.
You are working on the audit of the Group’s financial statements for the year
ended 30 June 2012. This morning the audit engagement partner left a note for
you:
‘Hello
The audit senior has provided you with the draft consolidated financial
statements and accompanying notes which summarise the key audit findings
and some background information.
Page | 114
Advanced Auditing and Assurance ICPAP
evidence obtained, but you do not need to recommend further specific
procedures.
Thank you’
The Group’s draft consolidated financial statements, with notes referenced to key
audit findings, are shown below:
1. Revenue has been stable for all components of the Group with the exception
of one subsidiary, Copeland Co, which has recognised a 25% decrease in
revenue.
2. Operating expenses for the year to June 2012 is shown net of a profit on a
property disposal of Rs2 million. Our evidence includes agreeing the cash
receipts to bank statement and sale documentation, and we have confirmed
that the property has been removed from the non-current asset register. The
audit junior noted when reviewing the sale document, that there is an option
Page | 115
Advanced Auditing and Assurance ICPAP
to repurchase the property in five years time, but did not discuss the matter
with management.
3. The property revaluation relates to the Group’s head office. The audit team
have not obtained evidence on the revaluation, as the gain was immaterial
based on the initial calculation of materiality.
4. The actuarial loss is attributed to an unexpected stock market crash. The
Group’s pension plan is managed by Alico Co – a firm of independent fund
managers who maintain the necessary accounting records relating to the plan.
Alico Co has supplied written representation as to the value of the defined
benefit plan’s assets and liabilities at 30 June 2012. No other audit work has
been performed other than to agree the figure from the financial statements to
supporting documentation supplied by Alico Co.
Page | 116
Advanced Auditing and Assurance ICPAP
Deferred tax 1,950 1,350
Total non-current liabilities 55,770 45,600
Current liabilities
Trade and other payables 6,200 7,300
Provisions 2,700 2,800
Total current liabilities 8,900 10,100
Total liabilities 64,670 55,700
Total equity and liabilities 118,420 104,100
Required:
Note: The split of the mark allocation is shown within the partner’s note.
b) The audit engagement partner now sends a further note regarding the Imran
Group:
Page | 117
Advanced Auditing and Assurance ICPAP
‘The Group finance director has just informed me that last week the Group
purchased 100% of the share capital of May Co, a company located overseas in
Farland. The Group audit committee has suggested that due to the distant
location of May Co, a joint audit could be performed, starting with the next
financial statements for the year ending 30 June 2013. May Co’s current auditors
are a small local firm called Moore & Co who operate only in Farland.’
Required:
Answer:-
a) .
i. Materiality
Materiality is a matter of judgement, and is commonly determined using a
numerical approach based on percentages calculated on revenue, profit
before tax and total assets. ISA 320 Materiality in Planning and
Performing an Audit requires that the auditor shall revise materiality for
the financial statements as a whole in the event of becoming aware of
information during the audit that would have caused the auditor to
determine a different level of materiality initially.
It may be that during the audit, the auditor becomes aware of a matter
which impacts on the auditor’s understanding of the client’s business and
which leads the auditor to believe that the initial assessment of materiality
was inappropriate and must be revised. For example, the actual results of
the audit client may turn out to be quite different to the forecast results on
which the initial level of materiality was based.
Or, a change in the client’s circumstances may occur during the audit, for
example, a decision to dispose of a major part of the business. This again
would cause the auditor to consider if the previously determined level of
materiality were still appropriate.
Page | 118
Advanced Auditing and Assurance ICPAP
The initial calculation of materiality for the Imran Group was based on the
client’s listed status, and therefore on an assumption of it being high risk.
It is therefore important that any events, such as those explained above,
are taken into account in assessing a new level of materiality for this client
to ensure that sufficient appropriate evidence is obtained to support the
audit opinion.
Revaluation
The revaluation gain recognised of Rs800,000 is below the level of
materiality set initially which was Rs900,000. However, the level of
materiality has now been revised to Rs700,000, meaning that the gain now
needs to be subject to audit procedures to ensure there is no material
misstatement. Further audit work may be needed to ensure that this is the
only property that should be revalued, given that all assets in the same
class should be subject to revaluation.
Actuarial loss
The loss recognised is material to the financial statements, but only limited
procedures have been conducted. Alico Co is a service organisation, and
audit procedures should be carried out according to ISA 402 Audit
Considerations Relating to an Entity Using a Service Organisation.
Auditors are required to gain an understanding of the service
Page | 119
Advanced Auditing and Assurance ICPAP
organization either from the user entity, which in this case is the Imran
Group (the Group), or by obtaining a report on the service organisation.
The procedures that have been conducted so far are not sufficient, as
written confirmation and agreement to Alico Co’s records do not provide
evidence as to the basis of the valuation of the pension plan, which has a
material impact on the Group financial statements. The audit team
themselves should perform procedures to provide evidence as to the
measurement of the plan and the actuarial loss, and not simply rely on the
accounting records of the service organisation.
Goodwill impairment
Goodwill has remained at the same amount in the financial statements,
but the goodwill may be overstated in value. One of the subsidiaries,
Copeland Co, has suffered a 25% reduction in revenue. This is an
indicator of impairment of goodwill, and a written representation and
arithmetical check is not sufficient appropriate evidence for such a
material and subjective matter. Further audit work should be conducted
on management’s assumptions used in the impairment review of goodwill
relating to Copeland Co. As KPMG performs the audit of Copeland Co,
the firm should have sufficient business understanding to challenge
management’s assumptions on the impairment review of goodwill.
Goodwill classification
A trading division relating to one-third of a subsidiary’s net assets is held
for sale at the year end. Any goodwill relating to this trading division
should be reclassified out of goodwill and into the disposal group of
assets held for sale. It may be a subjective and complex process to
determine how much of the subsidiary’s goodwill should be allocated to
the trading division which is held for sale. It may be that no goodwill is
attached to this trading division, but this should be confirmed through
further audit procedures.
The two matters explained above both indicate that the Group’s goodwill
figure could be materially overstated and that further audit procedures
should be performed.
Page | 120
Advanced Auditing and Assurance ICPAP
Associate
The statement of financial position recognises an associate at Rs4.23
million in both the current and prior periods. It is unusual to see no
movement in this figure, especially given that the statement of
comprehensive income recognises a share of profit generated from the
associate, which should normally result in an increase in the value of the
associate recognised as an investment of the Group.
Page | 121
Advanced Auditing and Assurance ICPAP
Finally, the sale of the trading division would seem to meet the definition
of a discontinued operation according to IFRS 5, as its assets were held for
sale at the year end, and it is likely to constitute a separate major line of
business. IFRS 5 requires that the face of the income statement discloses a
single figure in respect of discontinued operations, comprising the post-
tax profit or loss of the discontinued operation and the post-tax gain or
loss recognised on any measurement of its assets to fair value, less cost to
sell. The Group’s income statement does not include any figure in relation
to the trading division which is being sold. Audit procedures should be
performed to determine whether this is necessary.
Non-controlling interest
The statement of financial position correctly discloses the non-controlling
interest as a component of equity, as required by IAS 1 Presentation of
Financial Statements. However, the statement of comprehensive income
does not disclose the profit for the year or total comprehensive income for
the year attributable to the non-controlling interest. Therefore the audit
team must enquire as to whether this disclosure will be made by
management.
Finance cost
A loan of Rs8 million was taken out in October 2011, carrying a 2%
interest charge. This would mean finance costs of Rs120,000 (Rs8 million x
2% x 9/12) should be accrued for. However, the Group’s finance cost has
increased by Rs40,000 only. Therefore the finance cost may not have been
recognised in full, overstating profit and understating liabilities. Work
should be performed to understand the components of the finance charge
recognised, as other finance costs may have ceased during the year. The
notes to the financial statements should also be reviewed to ensure there is
adequate disclosure of the loan taken out.
Page | 122
Advanced Auditing and Assurance ICPAP
b) In a joint audit, two or more audit firms are responsible for conducting the audit
and for issuing the audit opinion. The main advantage of a joint audit of May Co
is that the local audit firm’s understanding and experience of May Co will be
retained, and that will be a valuable input to the audit. At the same time, KPMG
can provide additional skills and resources where necessary.
The country in which May Co is located may have different regulations to the
rest of the Group, for example, there may be a different financial reporting
framework. It makes sense for the local auditors, therefore, to retain some input
to the audit as they will have detailed knowledge of such regulations.
The fact that May Co is located in a distant location means that from a practical
point of view it may be difficult for KPMG to provide staff for performing the
bulk of the audit work. It will be more cost effective for this to be carried out by
local auditors.
Two audit firms can also stand together against aggressive accounting
treatments. In this way, a joint audit works to enhance the quality of the audit.
The benchmarking that takes place between the two firms raises the level of
service quality.
The main disadvantage is that for the Group, having a joint audit is likely to be
more expensive than appointing just one audit firm. However, the costs are
likely to be less than if KPMG took sole responsibility, as having the current
auditors retain an involvement will at least cut down on travel expenses. And the
small local firm will probably offer a cheaper audit service than KPMG.
Question:-
a) You are an audit manager in Kamran & Co, an audit firm which operates as part
of an international network of firms. This morning you received a note from a
partner regarding a potential new audit client:
Page | 123
Advanced Auditing and Assurance ICPAP
‘I have been approached by the audit committee of the Plant Group, which
operates in the mobile telecommunications sector. Our firm has been invited to
tender for the audit of the individual and group financial statements for the year
ending 31 March 2013, and I would like your help in preparing the tender
document. This would be a major new client for our firm’s telecoms audit
department.
The Plant Group comprises a parent company and six subsidiaries, one of which
is located overseas. The audit committee is looking for a cost effective audit, and
hopes that the strength of the Plant Group’s governance and internal control
mean that the audit can be conducted quickly, with a proposed deadline of 31
May 2013. The Plant Group has expanded rapidly in the last few years and
significant finance was raised in July 2012 through a stock exchange listing.’
Required:
Identify and explain the specific matters to be included in the tender
document for the audit of the Plant Group.
b) Kamran & Co is facing competition from other audit firms, and the partners have
been considering how the firm’s revenue could be increased. Two suggestions
have been made:
1. Audit partners and managers can be encouraged to sell non-audit
services to audit clients by including in their remuneration package a
bonus for successful sales.
2. All audit managers should suggest to their audit clients that as well as
providing the external audit service, Kamran & Co can provide the
internal audit service as part of an ‘extended audit’ service.
Required:
Answer:-
Page | 124
Advanced Auditing and Assurance ICPAP
This should provide comfort to the Plant Group’s audit committee that Kamran
& Co has the capability to audit its overseas subsidiary, and that the audit firm
has sufficient resources to conduct the Plant Group audit now and in the future,
given the Plant Group’s rapid expansion.
Audit approach
A description of the proposed audit approach, outlining the stages of the audit
process and the audit methodology used by the firm. Kamran & Co may wish to
emphasise any aspects of the proposed audit methodology which would be
likely to meet the audit committee’s requirement of a cost effective audit. The
proposed audit approach could involve reliance to some extent on the Plant
Group’s controls, which are suggested to be good, and the tender document
Page | 125
Advanced Auditing and Assurance ICPAP
should explain that the audit firm will have to gauge the strength of controls
before deciding whether to place any reliance on them.
Deadlines
The audit firm should clarify the timescale to be used for the audit. This is very
important, given the audit committee’s hope for a quick audit. It would be time
pressured for the audit of all components of the Plant Group and of the
consolidated financial statements to be completed in two months, especially
given the geographical spread of the Plant Group. The audit firm may wish to
propose a later deadline, emphasising that it may be impossible to conduct a
quality audit in such a short timeframe.
Fees
The proposed audit fee should be stated, with a breakdown of the main
components of the fee. The audit firm may wish to explain that the audit fee is
likely to be higher in the first year of auditing the Plant Group, as the firm will
need to spend time obtaining business understanding and ensuring there is
appropriate documentation of systems and controls. The tender document could
explain that the audit is likely to become more cost effective in subsequent years,
when the audit firm has gone through a learning curve.
Note: Credit will also be awarded for alternative comments regarding fees, for
example, candidates may suggest that the audit fee will be relatively constant
year on year (the reason being that initial costs are not passed on to the client in
the first year of providing the audit service).
Page | 126
Advanced Auditing and Assurance ICPAP
given the rapid expansion of the Plant Group. The provision of such services
would have to be considered carefully by the audit firm due to the threat to
objectivity that may be created, so the tender document should outline any
safeguards that may be used to reduce risks to an acceptable level. This is
particularly important, given the listed status of the Plant Group. This part of the
tender document may remind the audit committee members that corporate
governance requirements may prohibit the audit firm from offering certain non-
audit services.
Note: Credit will be awarded for discussion of other matters that may be
included in the tender document, if made relevant to the Plant Group.
b) Ethical issues
Kamran & Co must ensure that any efforts to increase the firm’s revenue do not
create any threats to objectivity and independence.
In this case, the fact that the remuneration will be paid to the partner creates a
significant threat to objectivity due to their influential position in the audit team.
IFAC’s Code states that a key audit partner shall not be evaluated on or
compensated (remunerated) based on that partner’s success in selling non-
assurance services to the partner’s audit client. Therefore the bonus scheme
should not be offered to partners as it creates an unacceptable threat to
objectivity.
Page | 127
Advanced Auditing and Assurance ICPAP
IFAC’s Code does not specifically state that managers should not be evaluated or
remunerated for selling services to audit clients. It may be possible in the case of
an audit manager having been remunerated for such a sale for safeguards to be
put in place to reduce the threat to objectivity to an acceptable level, for example
by having a review of the work of the manager in relation to the client. However,
it would be more prudent for Kamran & Co not to offer the remuneration scheme
at all.
IFAC’s Code also states that performing a significant part of the client’s internal
audit activities increases the possibility that firm personnel providing internal
audit services will assume a management responsibility. This threat cannot be
reduced to an acceptable level, and IFAC’s Code requires that audit personnel
shall not assume a management responsibility when providing internal audit
services to an audit client. Management responsibility may include, for example,
performing procedures that are part of the internal control and taking
responsibility for designing, implementing and maintaining internal control.
Accordingly, an audit firm may only provide internal audit services to an audit
client where:
Page | 128
Advanced Auditing and Assurance ICPAP
- The client’s management evaluates the adequacy of the internal audit
services and the findings resulting from their performance;
- The client’s management evaluates and determines which
recommendations resulting from internal audit services to implement and
manages the implementation process; and
- The client’s management reports to those charged with governance detail
the significant findings and recommendations resulting from the internal
audit services.
In the case of an audit client that is a public interest entity, an audit firm shall not
provide internal audit services that relate to:
Where internal audit services are supplied to an audit client, they should be the
subject of a separate engagement letter and billing arrangement, and should also
be pre-approved by those charged with governance of the audited entity.
Question:-
Page | 129
Advanced Auditing and Assurance ICPAP
the Furniture, and that the vendor is required to return any unsold Furniture
after a period of nine months. When the vendor sells an item of Furniture to a
customer, legal title passes from Kashmir Co to the customer.
Required:
Comment on the matters that should be considered, and explain the audit
evidence you should expect to find in your file review in respect of the
consignment stock arrangement.
c) Your firm also performs the audit of Javed Co, a company which installs
windows. Javed Co uses sales representatives to make direct sales to customers.
The sales representatives earn a small salary, and also earn a sales commission of
20% of the sales they generate.
Javed Co’s sales manager has discovered that one of the sales representatives has
been operating a fraud, in which he was submitting false claims for sales
commission based on non-existent sales. The sales representative started to work
at Javed Co in January 2012. The forensic investigation department of your firm
has been engaged to quantify the amount of the fraud.
Required:
Recommend the procedures that should be used in the forensic investigation
to quantify the amount of the fraud.
Answer:-
a) Revenue recognition
A high risk area of the audit is one where a risk of material misstatement is
considered likely to occur. A factor giving rise to a risk of material misstatement
is subjectivity, and in many companies revenue recognition is a subjective
matter. For example, a company which provides services to customers over a
long period of time will need to gauge the proportion of a service that has been
provided during the financial year in order to determine the amount of revenue
Page | 130
Advanced Auditing and Assurance ICPAP
that may be recognised, possibly on a percentage basis. This determination
involves judgement, therefore increasing the risk of material misstatement.
Revenue recognition can also be a complex issue. For example, companies that
engage in multiple-element sales transactions need to carefully consider when
revenue can be recognised, for instance if selling a tangible item such as a
computer, and selling as part of the transaction a two-year warranty, the
company needs to separate the sale of the goods and the sale of the services and
recognise the revenue on each element of the transaction separately.
Note: Credit will be awarded for any relevant examples of situations where
revenue recognition is subjective or complex, for example, when accounting for
long-term contracts, linked transactions, sale and leaseback or bill and hold
arrangements.
The method of sale and the absence of appropriate internal controls can also
mean that revenue has a high risk of material misstatement. For example, when
sales are made over a company’s website, there is a risk that the website is not
fully integrated into the accounting system, creating a risk that sales go
unrecorded.
A further issue relevant to revenue recognition is that of fraud. ISA 240 The
Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements
states that the auditor should use a presumption that there are risks of fraud in
revenue recognition. Revenue recognition is regarded as an accounting area at
risk of fraudulent financial reporting, as it is susceptible to management bias and
earnings management techniques. Revenue can be overstated through premature
revenue recognition or recording fictitious revenues, or revenue can be
understated by improperly shifting revenues to a later period.
There may be issues particular to the company, which mean that deliberate
manipulation of revenue is more likely, for example, in a listed company where
performance is measured in terms of year-on-year revenue or profit growth.
Page | 131
Advanced Auditing and Assurance ICPAP
However, it is not the case that all companies’ revenue recognition is complex,
subjective or at particular risk of fraud. Smaller companies with a single source
of revenue based on simple transactions do not have a particularly high risk of
material misstatement in relation to revenue. ISA 240 requires that where the
presumption of a risk of material misstatement due to fraud relating to revenue
is not applicable in the circumstances of an audit, the reasons must be fully
documented.
b) Matters
The accounting treatment of the revenue and inventory in respect of the
consignment stock arrangement with vendors must be carefully considered, as
there is a risk that Kashmir Co is recognising revenue too early. According to IAS
18 Revenue, the sale of goods criteria should be applied to a transaction to
determine whether the company has the right to recognise revenue. Crucially,
revenue may only be recognised when the entity has transferred to the buyer the
significant risks and rewards of ownership of the goods and where the entity
does not retain managerial involvement or control over the goods.
Therefore revenue is being recognised too early, and is overstated by Rs4 million.
Profit is overstated by Rs1 million; this is material to profit at 6.7% of profit
before tax. Inventory is understated by Rs3 million as it should remain
recognised in the statement of financial position, until such time as risk and
reward have passed. The inventory held at external vendors is material to the
statement of financial position at 5.5% of assets.
Page | 132
Advanced Auditing and Assurance ICPAP
There may also be adjustments necessary to the opening balances, which were
not audited by Tanoli & Co. Any correction to opening balances should be
accounted for retrospectively according to IAS 8 Accounting Policies, Changes in
Accounting Estimates and Errors.
Evidence
- Copies of sales contracts with key external vendors and confirmation of
the terms of the contract.
- A review of the terms of the contract and conclusion whether the terms
indicate that Kashmir Co retains risk exposure and managerial
involvement with the goods.
- Results of a direct circularisation to selected external vendors for
inventory balances at the year end to ensure the accuracy of the records.
- Enquiries as to the proportion of goods which are usually returned from
the external vendors to form an understanding of potential levels of
obsolete goods.
- Results of auditor’s test counts of inventory at a selection of vendors’
premises to ensure the existence of goods held on consignment.
- Client’s working papers from the previous year end, such as analysis of
receivables and external vendors’ inventory reports at 31 July 2011,
reviewed to determine the potential adjustment required to opening
balances.
Page | 133
Advanced Auditing and Assurance ICPAP
Question:-
a) You are the manager responsible for the audit of Dawlance, a listed company,
and you are reviewing the working papers of the audit file for the year ended 30
September 2012. The audit senior has left a note for your attention:
‘Dawlance outsources its entire payroll, invoicing and credit control functions to
Haroon Co. In August 2012, Haroon Co suffered a computer virus attack on its
operating system, resulting in the destruction of its accounting records, including
those relating to Dawlance. We have therefore been unable to perform the
planned audit procedures on payroll, revenue and receivables, all of which are
material to the financial statements. Haroon Co has manually reconstructed the
relevant figures as far as possible, and has supplied a written statement to
confirm that they are as accurate as possible, given the loss of accounting
records.’
Required:
i. Comment on the actions that should be taken by the auditor, and the
implications for the auditor’s report; and
ii. Discuss the quality control procedures that should be carried out by the
audit firm prior to the audit report being issued.
b) You are also responsible for the audit of Suzuki, a listed company, and you are
completing the review of its interim financial statements for the six months
ended 31 October 2012. Suzuki is a car manufacturer, and historically has offered
a three-year warranty on cars sold. The financial statements for the year ended 30
April 2012 included a warranty provision of Rs1.5 million and recognised total
assets of Rs27.5 million. You are aware that on 1 July 2012, due to cost cutting
measures, Suzuki stopped offering warranties on cars sold. The interim financial
statements for the six months ended 31 October 2012 do not recognise any
warranty provision. Total assets are Rs30 million at 31 October 2012.
Required:
Assess the matters that should be considered in forming a conclusion on
Suzuki’s interim financial statements, and the implications for the review
report.
Page | 134
Advanced Auditing and Assurance ICPAP
Answer:-
a)
i. There is a clear lack of audit evidence in respect of payroll, receivables and
revenue. The written statement from Haroon Co is not sufficient
appropriate evidence on which to reach a conclusion regarding these
balances and transactions which are material to the financial statements of
Dawlance.
The audit firm could request an extension to the agreed deadline for the
completion of the audit to perform such additional work. This may be
seen as a favourable option to the client, who presumably would want to
avoid a modified audit opinion in the event that insufficient audit
evidence was obtained.
Given that Haroon Co’s accounting systems were affected in August, only
one month before the financial year end, it may be possible to obtain
sufficient appropriate evidence for the majority of transactions that
occurred during the year, and that it is only a small proportion of
transactions that cannot be confirmed, which may be immaterial to the
financial statements. In this case, an unmodified opinion would be issued.
Page | 135
Advanced Auditing and Assurance ICPAP
this opinion, the auditor states that except for the possible effects of the
potential misstatements of payroll, receivables and revenue, the financial
statements give a true and fair view.
The auditor may conclude that the possible effects on the financial
statements of undetected misstatements, if any, could be both material
and pervasive, in which case the auditor should disclaim an opinion. In
this case, the auditor states that sufficient appropriate evidence has not
been obtained to provide a basis for an audit opinion, and accordingly the
auditor does not express an opinion on the financial statements.
Page | 136
Advanced Auditing and Assurance ICPAP
likely to consider whether there are any alternative means of confirming
the balances and transactions.
The auditor’s report may not be signed and dated until the completion of
the engagement quality control review.
It would appear correct that a warranty provision is not recognised for cars sold
since 1 July 2012, as Suzuki has no obligation relating to those sales. However,
cars sold previous to that date are subject to a three-year warranty, so a warranty
provision should continue to be recognised for the obligation arising in respect of
Page | 137
Advanced Auditing and Assurance ICPAP
those sales. Therefore Suzuki’s interim financial statements understate liabilities
and overstate profits.
ISRE 2410 requires that when a matter comes to the auditor’s attention that leads
the auditor to question whether a material adjustment should be made to the
interim financial information, additional inquiries should be made, or other
procedures performed. In this case, the auditor may wish to inspect sales
documentation to ensure that warranties are no longer offered on sales after 1
July. The auditor should also review customer correspondence to ensure that
warranties on sales prior to 1 July are still in place.
If the amount remains unadjusted, meaning that in the auditor’s opinion the
interim financial statements contain a material departure from the applicable
financial reporting framework, the report on the review of interim financial
information should contain a qualified or adverse conclusion. This is a
modification of the report, and the auditor must describe the reason for the
modification, which is provided in a paragraph entitled ‘Basis for Qualified
Conclusion’, presented immediately before the qualified conclusion.
Page | 138
Advanced Auditing and Assurance ICPAP
Finally, the audit firm should consider whether it is possible to withdraw from
the review engagement and resigning from the audit appointment.
Question:-
Qureshi Steels Limited (QSL) is a manufacturer of steel and iron products. During the
year the company has incurred a net loss of Rs. 306 million. The following information
is also available:
i. At the year end, the company’s accumulated losses amounted to Rs. 17 million
whereas its net equity was Rs. 283 million.
ii. During the year, QSL has defaulted in repayment of a loan. The management is
however quite hopeful that the lender would agree to a rescheduling.
iii. The management believes that the company’s profitability has been hampered on
account of soaring electricity prices along with a fall in demand for steel which
have had a negative impact on the prices of its finished products. Moreover, its
production has also suffered on account of the prevailing energy crisis.
Consequently, the management has decided to discontinue its operations
temporarily.
iv. To counter the impact of high electricity prices, the company intends to convert
its plant to run on gas as well.
v. The management has informed you that it would need to install a gas converting
unit which would be imported at a cost of Rs. 30 million. However, as the
process of installing the gas conversion unit and completing the necessary
formalities would take at least a year, therefore the management is negotiating to
lease the plant to Nadeem Enterprises for a period of one year.
Required:
a) Evaluate the above situation and state the procedures which you would perform
as an auditor in the above situation.
b) Describe the implications of the above issues on the audit report.
Answer:-
a) Although QSL’s accumulated losses are only Rs. 17 million i.e. about 5% of the
share capital yet the following circumstances indicate that QSL is facing going
concern issues:
QSL has incurred huge loss during the past year which is almost equal to
its share capital.
Page | 139
Advanced Auditing and Assurance ICPAP
QSL has defaulted on its loan repayments.
The management has certain plans to revive the business however these
are subject to major uncertainties as discussed below:
- The company plans to convert the plant to make it possible to run it
on gas. However, it would require significant costs whereas QSL is
in financial crisis.
- It is not certain whether the company’s banker would agree on the
restructuring of loan.
- The above conversion would require a year’s time and the
company may be required to bear the fixed costs for that period.
- Due to current energy crisis prevailing in the country it seems
doubtful that the company would be able to secure a gas
connection in the first place and whether sufficient gas would be
available to it or not.
- The company is negotiating to lease its plant temporarily to reduce
losses during the period of its planned inactivity. However this
plan does not seem very convincing as the prospective lessee
would also be subject to the same circumstances.
The auditor would need to evaluate the company’s detailed plan by carrying
out the following procedures:
i. Review the cash flow projections provided by QSL and assess their
reasonableness
ii. Discuss with the management about the uncertainties described above
and assess whether the management would be in a position to
overcome them.
iii. Consider subsequent events and discuss the impact thereof, with the
management, if necessary.
iv. Seek written representation from management regarding its plans for
future actions.
v. After performing the above procedures, if there is a doubt about the
appropriateness of the going concern assumption, auditor will need to
carryout additional audit procedures depending upon the
circumstances.
Besides the going concern issues, the discontinuance of operations of
company and reduction in production of steel may result in impairment of
plant and machinery, as the company may not be able to recover the
Page | 140
Advanced Auditing and Assurance ICPAP
carrying amount of the plant. The auditor needs to review the value in use
of the plant and machinery provided by the client.
Page | 141
Advanced Auditing and Assurance ICPAP
Question:-
You are the manager responsible for the audit of Dulux Paints Limited (DPL). The draft
financial statements for the year ended 31 March 2013 show revenue of Rs. 1,250 million
(2012: Rs. 1,175 million), profit before taxation of Rs. 100 million and total assets of Rs.
1.2 billion.
The audit incharge has noted the following points for your consideration:
i. In May 2012 a chemical leakage from one of the tanks in the factory caused a fire
which damaged the plant and machinery and the premises. DPL has incurred Rs.
3 million in cleanup costs, Rs. 10 million for modernisation of tanks to prevent
future leakages and a fine of Rs. 500,000 to a regulatory agency. The fine has been
expensed whereas the remaining costs have been capitalised.
ii. While the tanks in the factory were undergoing modernisation, DPL had made
arrangements with a nearby factory for storage of its chemicals. At the time of
stock check you were informed that it is not possible to segregate DPL’s stock
from that of the other factory. According to DPL’s record, the value of its stock of
chemicals as at 31 March 2013 which is lying in the nearby factory is Rs. 200
million. The value of stock of chemicals as at 31 March 2012 was Rs. 120 million.
Required:
Discuss the matters that you would consider and how would you obtain the necessary
audit evidence.
Answer:-
Page | 142
Advanced Auditing and Assurance ICPAP
material to the financial statements. The Company has rightly capitalized
the said cost.
The substantial cost of modernization of tanks when included in the
present carrying value, may result in carrying value being in excess of the
recoverable amount. In this case auditor would need to carryout
impairment testing of the storage tanks and if said testing concludes any
impairment loss, the auditor would need to check whether such losses
have been recognized appropriately.
The management would be asked as to whether any other fine has been
levied by any regulatory agency, due to this leakage; and the matter
would be documented.
Review legal confirmations obtained by you and see whether they contain
any information in this regard.
Physical verification of storage tanks should be carried out.
Major payments should be vouched.
Obtain management representation that the matter is now closed and no
further proceeding are in progress against the company.
ii. Outsourced storage facility- Evaluation of the situation:
Matters to be considered
Inventory at the end of the reporting period (31 March 2013) represents
16.67% of the total asset value and is therefore a material item in the
statement of financial position.
The inability of the auditor to carry out a stock check may result in a
limitation of scope.
It can be seen that inventory has increased by 67%, although the revenue
has increased by 6.4% only. Moreover, there is a decline in the inventory
turnover from 9.79 times in 2012 to 6.25 times in 2013. This situation when
viewed in the light of auditor’s inability to carry out a stock check may
indicate the possibility of material misstatement.
Page | 143
Advanced Auditing and Assurance ICPAP
Test of control established by the management in respect of quantity,
quality and access to the inventory stored at nearby factory.
Confirmation from the nearby factory needs to be obtained, relating to the
quantity of the stock held by them.
Monthly returns / stock details submitted by neighboring factory should
be analysed and significant movements in inventory should be traced to
the material consumption reports and purchase invoices.
The auditor may refer to the inventory aging analysis to determine the
possibility of obsolescence of stock.
Subsequent transfers of chemicals from the neighboring factory to DPL’s
premises should be reviewed.
Question:-
The following matters relating to different clients are under the consideration of Mr.
Naeem, who is the engagement partner:
a) The management of Imran Limited had been illegally dumping its chemical
waste in the neighbouring plot of land. When confronted, the chief financial
officer, instead of providing an assurance to address the issue, informed the
audit senior that the management is least bothered about the minor fines that
may be levied by the regulatory agencies.
b) Abdullah was the audit senior assigned to the audit of Mansha (Private) Limited.
During the course of the audit, Abdullah had resigned from the firm. While
reviewing the audit files Mr. Naeem has noticed that the audit fieldwork was
completed in almost half the time than is usually required.
Required:
Evaluate each of the above situations and briefly describe what course of action the
engagement partner would be expected to adopt.
Answer:-
a) Dumping of waste
The fines levied by the regulatory authority maybe immaterial but the
same could have significant implications on ML as any mishap may lead
to severe legal action specially in case a mishap occurs.
Page | 144
Advanced Auditing and Assurance ICPAP
The engagement partner should discuss the matter with those charged
with Governance and advise them to take necessary steps to avoid future
non compliances.
The engagement partner should consult the legal advisor about the laws
and regulations and the possible impact of the non-compliance on the
client. If engagement partner is not satisfied with the opinion of ML’s legal
advisor it should consult with its own lawyer, relating to possible legal
consequences.
If those charged with governance agree to rectify the situation, the auditor
need to consider the cost of cleaning up the site and ask the client to make
necessary provision. If necessary, the partner may ask ML to obtain
opinion from the relevant expert as regards the present condition of the
plot and the cost of the measures necessary to clean-up the site in
accordance with the requirements of law.
The partner should consider the possibility of similar non-compliance in
other areas.
In case no action is taken by those charged with governance, the partner
must consider:
- The impact on the audit report.
- Withdrawing from the engagement now or not accepting the
assignment for the next year, as may be appropriate.
The engagement partner should consider the legal responsibilities to
report to the authorities.
b) Engagement performance
Quality control issues:
- Mr. Naeem should have the audit files reviewed by another
chartered accountant who had not been involved in the said
engagement.
- If the working papers reflect anything done improperly or not done
in accordance with the auditing standards Mr. Naeem should
discuss the matter with the concerned manager.
- If the audit manager fails to provide a satisfactory reply, it would
be indicative of a quality control issue.
- In such a situation Mr. Naeem would need to take the following
steps:
Address the issues which have remained unattended during the audit.
Page | 145
Advanced Auditing and Assurance ICPAP
Assess the reasons for the manager’s failure to detect the situation and
take corrective measures which may include all or any of the following:
Reviewing the firms systems, procedures and policies etc., and taking
corrective actions
Emphasis on due training of staff at all levels.
Question:-
You are the quality control partner of Nishat and Company, Chartered Accountants
(NCC) and presently following matters are under your consideration:
b) While appreciating the services rendered by your firm, the managing director of
a client has informed the engagement partner that an audit trainee has helped
him in the purchase of a plot of land. On investigation, the engagement partner
was able to establish that the trainee works part-time in an estate agency and
receives 0.5% commission on all deals.
c) Javed Limited (JL), an unlisted audit client of your firm has approached your
firm to recruit a chartered accountant for the position of finance director in JL. In
response to an advertisement published in the newspaper, NCC received various
applications which include individuals working at some of your clients and some
of your ex-employees.
Required:
Identify and evaluate the threats involved and explain what actions you would take in
the above circumstances including the steps required, if any, to reduce the risks to an
acceptable level.
Answer:-
Page | 146
Advanced Auditing and Assurance ICPAP
- The financial statements are materially misstated.
- The tax return is misstated.
- The tax official’s suspicions are unjustified.
The quality control partner may engage another chartered accountant to
review the financial statements as well as the tax return to investigate the
allegations leveled against the client.
If Financial Statements are Misstated:
- Quality control partner may ask the engagement partner to review
the situation and establish whether the financial statements need to
be revised.
- Quality Control Partner may like to know whether the mistake
could have been avoided if the Quality control policies of the firm
had been followed.
- If there is a lapse on the part of the firm’s employees, appropriate
action would be taken and the capacity of the reviewer would also
be questioned.
- If the mistake was such that it could not have been detected using
the standard audit procedures of the firm, the firms policies and
procedures may be reviewed to ensure that weaknesses if any are
properly addressed.
If Tax Return are Misstated:
- If it is established that tax returns filed by NCC on behalf of the
client are materially misstated then NCC should ensure that proper
remedial actions (such as revision of tax returns etc) are followed
subsequent to the discovery of misstatement.
- If the above actions are not taken by the client, the auditor should
consider the firm’s legal responsibilities.
In the case of error in the financial statement or the tax return, quality
control partner would need to assess whether the error was made
intentionally by the management.
- If it is established that the misstatement was made intentionally the
auditor would need to review whether it would be appropriate to
discontinue its relationship with the client.
b) A close business relationship between a member of assurance team and the
management of the client will involve a common financial interest and may
create self-interest threat.
Page | 147
Advanced Auditing and Assurance ICPAP
The materiality and significance of the financial interest, needs to be evaluated. If
the financial interest is immaterial or relationship is clearly insignificant then the
audit trainee may be allowed to work on that client, otherwise only safeguard
available is to not to allocate that audit trainee on the client.
If the conduct of the trainee is not in accordance with the firm’s policies,
appropriate action may be taken.
Use of separate engagement teams for the audit and recruitment procedure.
Clear guidelines for members of the engagement team and recruitment teams on
issues of objectivity, confidentiality.
Question:-
Zeeshan & Shabir Limited is a distributor of personal care products. Its sales manager
had committed a fraud by making sales to fictitious customers. Cheques received from
various genuine customers were credited to these fictitious accounts to keep their
balances within reasonable limits. The sales manager had the outstanding amounts,
appearing against fictitious and genuine customers, written off by convincing the sales
director that those customers were unable to pay their remaining balances. A total of 38
Page | 148
Advanced Auditing and Assurance ICPAP
invoices amounting to Rs. 7.2 million were issued over a period of seven months. The
fraud was detected when the sales manager had left the company’s employment.
Required:
Identify the usual controls which may have been lacking in the aforementioned
situation.
Answer:-
Question:-
You are the job incharge on the audit of Gulfam Petroleum Limited (GPL) for the year
ending 30 June 2013. GPL is engaged in the exploration and production of crude oil. The
last year’s audit file contains the following information:
Page | 149
Advanced Auditing and Assurance ICPAP
In 2005, GPL had entered into an agreement with the Government for
exploration and production of oil for fifteen years. The licence for exploration
was granted at a fee of Rs. 600 million.
Under a separate agreement Muslim Petroleum Limited (MPL), a 100%
government owned entity, had guaranteed the purchase of all crude oil to be
produced by GPL for a period of ten years from the start of commercial
production i.e. 2008.
The plant and equipment was imported in 2006 at a total cost of Rs. 6 billion
which includes a decommissioning provision of Rs. 500 million. The cost of the
plant was financed by GPL’s parent company by way of a long-term foreign
currency loan.
During the current year’s planning stage, you have observed the following conditions:
i. The problem of circular debts has become severe and as a result GPL as well as
MPL have accumulated huge receivables and payables.
ii. An environmental control agency has filed a suit alleging that at the time of
abandoning one of its oil wells, GPL has failed to restore the site in accordance
with the prescribed standards. The company believes that it has met all its
obligations and plans to contest the case strongly.
iii. Due to law and order situation the Government has not been able to provide
infrastructure facilities as were agreed in the exploration agreement.
iv. The management had budgeted a profit of Rs. 200 million for the current year
but latest estimates suggest that the profit would be somewhere between Rs. 100
to Rs. 120 million.
Required:
Identify and evaluate the audit risks in the above situation and specify the audit
procedures that you would perform to address those risks.
Answer:-
Audit risks:
i. Impairment of assets:
Values of license granted by the Government and the value of plant and
machinery for exploration purposes may be impaired due to the
following:
Page | 150
Advanced Auditing and Assurance ICPAP
- Government has not been able to provide the required
infrastructure facilities due to which the exploration work might be
affected and GPL might not be able to obtain the expected benefits
from the use of plant and machinery.
- Due to the problem of circular debt, MPL may not be able to
purchase oil as agreed in the contract.
- Due to circular debt problem there is a possibility that amount of
receivable from MPL may be impaired.
Page | 151
Advanced Auditing and Assurance ICPAP
Where the entity has prepared a cash flow forecast, the auditor shall:
- Evaluate the reliability of the underlying data used in preparation
of the forecast.
- Determining whether there is adequate support for the
assumptions used in preparation of the forecast.
Request written representations from management and where
appropriate, those charged with governance, regarding their plans for
future action and feasibility of these plans.
Page | 152
Advanced Auditing and Assurance ICPAP
Question:-
a) Habib Limited has a policy to carry its buildings at revalued amounts. At the
balance sheet date i.e. 31 December 2012, the valuer had finalised the valuation
reports of only 3 out of a total of 8 properties. According to these reports these
properties were assigned a valuation of Rs. 50 million as against the carrying
amount of Rs. 62 million.
Required:
Evaluate the above condition and discuss the impact on the audit report in each
of the following situations:
Page | 153
Advanced Auditing and Assurance ICPAP
i. The impairment of Rs. 12 million is recorded in the financial
statements.
ii. The impairment is not recorded.
b) During the year ended 31 December 2012 Chiragh Limited has changed its policy
for valuation of investment in a subsidiary from the ‘fair value’ to ‘cost’. Had the
company continued with its previous policy for valuation of investment at ‘fair
value’, the subject value would have been reduced by Rs. 50 million.
Required:
Discuss the matters which you should consider in respect of the above situation
and the possible impact thereof on the audit report.
Answer:-
a) As per IAS 16, if an item of property, plant and equipment is revalued, the entire
class of property, plant and equipment to which that asset belongs shall be
revalued.
It is not appropriate to incorporate the revised value of only three properties out
of eight as the effect of revaluation of entire class of properties has not been
incorporated in the financial statements.
Page | 154
Advanced Auditing and Assurance ICPAP
b) Auditor will ask the management for justification for change in accounting
policy from fair value to cost method.
The auditor shall mention the exception to the consistent application of
accounting policy and a statement that whether they concur with the change in
accounting policy or not.
Moreover, the auditor would need to evaluate whether all the accounting
treatment/disclosures related to the change have been appropriately recorded in
accordance with IAS -8.
If the management is unable to provide reasonable justification for change in
accounting policy than the auditor will issue a qualified or adverse opinion,
depending upon the materiality and pervasiveness of the matter.
Question:-
You are the audit manager of Rizwan Pharmaceuticals Limited (RPL) for the year ended
30 September 2013. The draft financial statements disclose a profit before tax of Rs. 200
million (2012: Rs. 150 million) and total assets of Rs. 5 billion (2012: Rs. 4.8 billion).
The following matters arose during the course of audit and are under your
consideration:
a) RPL has been awarded a 20 year patent right for a new drug with a brand name
of Dengcol. The drug has been developed at a cost of Rs. 400 million.
b) As part of the Dengue Control Programme, the Government had provided a
conditional grant of Rs. 150 million to RPL for development of Dengcol. Under
the terms of the grant, RPL was required to sell 40% of the total production to the
Government Hospitals subject to a minimum of 1,000,000 vaccines per annum,
for the next five years.
Answer:-
a) Matters to consider:
Development cost is approximately 8% of total assets and 200% of profit
before tax and is therefore material.
Whether the development costs incurred on Dengcol meet the
capitalization criteria as specified in IAS 38.
Carrying value of the patent and possibility of impairment thereof.
Audit Evidence:
Details of development costs to ensure that all the costs meet the criteria
specified in IAS 38 for capitalization as intangible asset.
Page | 155
Advanced Auditing and Assurance ICPAP
Assessment and conclusion whether all the costs are related to the
development of Dengcol.
Supports/ vouching related to major payments
Details of market research performed to ensure that the project is
commercially viable.
Projections prepared by management, assessment of reasonableness of
assumptions, recalculation of projections, conclusion whether or not
economic benefits to be generated from the use of asset exceed the cost.
Documents related to registration of patent.
Written representations from management as to the commercial viability,
technical feasibility and adequacy of findings.
b) Matters to consider:
The Government grant represents 75% of profit before tax and is therefore
material to the financial statements.
Accounting treatment of the Government Grant.
Company’s ability to meet the conditions associated with the grant.
Audit Evidence
Receipt of the government grant of Rs. 150 million, to confirm that the
amount has been granted.
Agreement with the government, to confirm that it is a grant.
Assessment of whether the company is complying with or in a position to
comply with the terms and conditions contained in the agreement.
Management representation confirming that it is in compliance and would
be able to comply with all the conditions attached to the Government
Grant.
Question:-
On reviewing the cash flow projections, you have noted the following:
i. .
Cash sales constitute 80% of the total sales of the new business.
Page | 156
Advanced Auditing and Assurance ICPAP
Debtors turnover days related to current business are projected to be
reduced from 75 days to 30 days.
ii. In the forecast, 24% of the income is under the head “Income from an associate”,
which is the management’s estimate of the company’s share of the associate
income. The associated company has confirmed the amounts which are
incorporated in the forecast; however no other details are available with FL to
support this assumption.
Required:
a) Comment on the above situations and briefly discuss the steps that you would
take in the given circumstances.
b) Assuming that your firm decides to modify the report on prospective financial
information, draft the basis for modification paragraph and opinion paragraph to
be included in the report. (You may assume necessary details and choose to base
the modification either on para (i) or para (ii) above)
Answer:-
a) .
I. It is a best estimate assumption and the auditor is required to obtain
sufficient appropriate evidence from internal and external sources that
best estimate assumptions on which prospective financial information is
based are not unreasonable. The following steps may be carried out in this
regard:
Discuss and evaluate how the management plans to reduce the
credit period from 75 days to 30 days.
Consider the market norms and practices, related to credit period
prevailing in personal care to assess the reasonableness of
assumptions.
Consider whether food packaging business can expect to achieve
80% cash sales. For this purpose, the general practice prevailing in
companies which are in the same line of business may be
considered.
The auditor will need to ask the management to explain basis on
which they have made the assumptions specially as regards the
assumptions which appear to be un-reasonable in comparison with
market practices and norms.
Page | 157
Advanced Auditing and Assurance ICPAP
If the management is unable to provide the basis on which any of
the assumption is based or the basis provided by the management
are not appropriate to conclude that the assumptions are
reasonable, then the auditor will conclude that the assumption
relating to debtors turnover days or cash sales does not provide a
reasonable basis for the prospective financial information and will
either express an adverse opinion or withdraw from engagement.
II. It is a best estimate assumption and the auditor is required to obtain
sufficient appropriate evidence from internal and external sources that
best estimate assumptions on which prospective financial information is
based are not unreasonable. The following steps may be carried out in this
regard:
The confirmation provided by the associate company cannot be
taken as sufficient appropriate audit evidence in support of
company’s income from the associated company.
The auditor should check the dividend history of the associate to
ascertain the reasonableness of the forecasted receipts.
The auditor should communicate with management to prepare an
investee company income forecast to support the assumptions.
If the forecast is prepared, the auditor would need to assess the
assumptions on which it is based and to evaluate the overall
reasonableness of the forecast.
If the forecast is not provided or the auditor is unable to obtain
evidence in relation to reasonableness of assumption then it will
constitute a scope limitation.
If the investee company do not provide forecast then the auditor
should either withdraw from the engagement or disclaim the
opinion and describe the scope limitation in the report on the
prospective financial information.
b) As discussed under the caption “Debtors” in the summary of significant forecast
assumptions, the debtor’s turnover days are forecasted to be 30 days as
compared to present debtors turnover days of 75 days. The debtors turnover
days forecasted are not consistent with the prevailing market practices. Further,
the company has not committed any resources or taken any steps to reduce the
debtors turnover days that provide the basis for reducing debtors’ turnover days.
The accompanying forecast is not presented fairly in accordance with the
International Standard on Assurance Engagements applicable to the examination
Page | 158
Advanced Auditing and Assurance ICPAP
of prospective financial information because management assumption, as
discussed in the preceding paragraph, do not provide a reasonable basis for
management’s forecast.
Question:-
You are the manager responsible for the annual audit of Tanveer Limited (TL) for the
year ending 31 December 2013. TL is a listed company and is engaged in the business of
construction, renting and selling of apartments and office buildings to individuals,
businesses and government departments.
Extracts from TL’s draft Profit and Loss Account are as follows:
2013 2012
(Upton Nov)
-----Rs. in million-----
Revenue 1,520 1,883
Operating expenses (1,165) (1,470)
Operating profit 355 413
Financial charges (190) (225)
Profit before tax 165 188
During the planning stage, the audit team has presented the following points for your
consideration:
Page | 159
Advanced Auditing and Assurance ICPAP
and accordingly this amount has been provided in the accounts. The residents
have rejected the offer and filed a suit against the company.
iii. During the year, construction equipment costing Rs. 300 million was acquired on
lease. The lease rentals were allocated to the contracts on the basis of time
utilized. Lease rentals pertaining to idle time were charged to financial expenses.
iv. During the year TL sold a two storey office building to Ali Limited. According to
the contract of sale, TL is entitled to construct further offices on the third and
fourth floors.
Required:
Identify the audit risks that exist in the above scenarios and describe the manner in
which you would address those risks.
Answer:-
Audit Risks:
The audit risks that exists in the given scenarios and the manner in which the auditor
would have to deal with them are discussed hereinafter:
Page | 160
Advanced Auditing and Assurance ICPAP
- The claim for damages against the company is indicative of contingent
liabilities that may require provision or disclosure in the financial statements
and there is a risk that liabilities related to the alleged claim may not be
recognized appropriately in the financial statements.
The petition filed by the residents and the basis of their claim would be
reviewed.
The information provided to the prospective buyers during the marketing
campaign would be reviewed to assess whether any claim was made by
the company e.g. claim regarding the building being earthquake proof
etc.
Legal opinion would be obtained from the company’s lawyers.
A valuer may be consulted to assess the loss.
If loss is probable and can be determined with reasonable accuracy
management would be asked to make a provision, otherwise a disclosure
would be appropriate.
iii. Construction equipment
- The accounting treatment of allocation of lease rentals to financial expenses is
not appropriate.
- There is a risk of wrong classification of lease that may affect the operating
results and financial position of the company.
Page | 161
Advanced Auditing and Assurance ICPAP
Manner in which the risk is to be addressed:
The auditor would need to assess how this right has been valued in TL’s
financial statements.
The auditor would need to review the terms of the sale agreement relating
to the first two floors and assess the extent of rights available with the TL
relating to the use of building i.e. construction of third and fourth floor. If
required a legal opinion may be obtained.
If appropriate, the auditor may obtain a valuation report to assess the
value of the rights available with the client regarding the rights presently
attached with the building.
Based on the above information, the auditor would assess whether the
accounting treatment (carrying value of land) is appropriate.
Question:-
Salahuddin had set up a private limited company Neelum (Private) Limited (NPL) in
which his brother and wife are directors. NPL supplies spare parts to JMPL. The fraud
was committed with the help of Karamat, a production supervisor and Farhan, the store
keeper. The supplies delivered by NPL contained a large proportion of damaged spare
parts. However, full payments were made to NPL as Farhan never raised any objections
on the quality of goods received. On the other hand, Karamat issued inflated
consumption reports to cover significant part of the damaged spare parts.
The fraud was discovered when Farhan went on leave due to illness. A review of
inventory sheets indicates that large quantities of spare parts are still lying in inventory.
Required:
Identify the control weaknesses in the above situation which may have enabled the
perpetration of fraud.
Answer:-
Page | 162
Advanced Auditing and Assurance ICPAP
There is a lack of segregation of duties as the functions of obtaining and
evaluation of bids, approval of supplier and placement of orders are performed
by Salahuddin.
Controls over authorization and approval of supplier, as purchase manager was
able to get the approval of NPL, without any detailed background checking.
There appears no system of stock inspection by an independent person when it is
received in the store.
There appears to be no system of physical verification of stock to identify any
damage stock, so that it can be identified on timely basis.
It appears that there are no benchmarks/standards or other controls over stock
consumption i.e. identification of over consumption/under consumption as no
concern is raised when production supervisor charges extra costs as to the
consumption reports.
It appears that there are no benchmarks/standards regarding the quantities of
inventory that are to be maintained.
Question:-
a) Dynamic (Private) Limited (DPL) is a client of your firm. At the finalization stage
of annual audit, it was discovered that a senior member of the assurance team is
the co-owner of a property, for the possession of which DPL has filed a legal
case. On investigation, the member informed that the said case is pending for the
last three years and he did not consider necessary to disclose it at the time of
commencement of audit.
Required:
Discuss the matters that should be considered and the course of action which
may be followed in the above situation.
b) Murree Limited (ML) and Bhurban Limited (BL) are listed assurance clients of
your firm. BL has filed a claim of Rs. 50 million in the court in respect of low
quality of goods delivered by ML. Upto last year ML had not acknowledged the
claim of BL. However, in the planning phase, you were informed by ML’s
management that in order to avoid bad reputation in the market and to continue
its business relationship with BL, ML intends to settle the dispute by making a
payment of Rs. 20 million to BL. The debt of Rs. 50 million is fully provided in
the books of BL.
Required:
Page | 163
Advanced Auditing and Assurance ICPAP
Being the auditor of both the companies, identify and evaluate the threats for the
firm and explain how these can be reduced to an acceptable level.
Answer:-
a) When litigation takes place, or appears likely, between the firm or a member of
the assurance team and the assurance client, a self-interest or intimidation threat
may be created. The significance of the threat created will depend upon
materiality of the litigation. In this regard, the following steps may be
undertaken:
Disclosing to the audit committee or others charged with governance, the
extent and nature of litigation.
Involving an additional chartered accountant in the firm who was not a
member of the assurance team to review the work done or otherwise
advise as necessary.
If the assurance team member knew about the suit filed and he does not disclose
the fact to the firm then, it raises questions related to independence and integrity
of the assurance team member, and possible course of action, in additions to the
steps taken above may include:
If the employee avoided declaring his interest by making an incorrect
declaration, appropriate action should be taken against him as per the
firm’s policies.
If no such declaration is required under the firms policies then the QCR
policies of the firm need to be reviewed and revised appropriately.
Assurance member’s argument that he did not consider it necessary to
disclose the matter is indicative of deficiency in the training program of
the firm and needs improvement.
Page | 164
Advanced Auditing and Assurance ICPAP
Notifying all known relevant parties that the chartered accountant in
practice is acting for two parties in respect of a matter where their
respective interests are in conflict, and obtaining their consent to do so; or
Notifying the client that the chartered accountant in practice does not act
exclusively for any one client in the provision of proposed services and
obtaining their consent to so act.
The use of separate engagement teams; and
Procedures to prevent access to information (e.g., strict physical
separation of such teams, confidential and secure data filing); and
Clear guidelines for members of the engagement team on issues of
security and confidentiality.
The use of confidentiality agreements signed by employees and partners
of the firm; and
Regular review of the application of safeguards by a senior individual not
involved with relevant client engagement.
Where a conflict of interest poses a threat to one or more of the
fundamental principles, including objectivity, confidentiality or
professional behavior, that cannot be eliminated or reduced to an
acceptable level through the application of safeguards, the chartered
accountant may resign from the engagement.
Question:-
Kabul (Private) Limited (KPL) has advanced Rs. 100 million to Qandhar Limited (QL),
one of its suppliers of raw material. KPL and QL have recently signed an agreement
whereby the above advance has been converted into a loan and QL has agreed to pay
mark-up on the outstanding balance at prevailing market rates. QL has confirmed the
amount of loan and the interest accrued thereon. However, you have acquired some
information which suggests that QL is facing financial difficulties.
Required:
Discuss how you would deal with the above situation and possible implications thereof
on the audit report.
Answer:-
Page | 165
Advanced Auditing and Assurance ICPAP
As QL is facing financial difficulties, there is an indication that the recovery of
advance is doubtful.
In order to address the issue the auditor should:
- Review latest audited financial statements of QL to determine QL’s ability to
pay back the loan in future.
- Review the audited financial statements to determine whether QL has
defaulted in repayment of any loans and advances etc.
- Review agreements between KL and QL to check what remedy is available in
case of non-payment by QL.
- Inquire as to the steps taken by QL in order to overcome the financial
difficulties.
Discuss the issue with management and consider their assessment about the
recoverability of the amount and assess the reasonability of the assumptions on
which such assessment is based.
If the above procedures, suggest impairment in the value of advance, the auditor
should ask the management to make appropriate provision in the financial
statements.
If in the auditor’s opinion the recovery of the loan or mark-up accrued thereon is
doubtful and the client fails to make appropriate provision in the financial statements,
the auditor will issue a qualified opinion or an adverse opinion depending upon
materiality and pervasiveness of the matter.
If the management fails to assess the issue objectively or the auditor is unable to obtain
relevant and appropriate audit evidence, then it would represent a scope limitation ,
and the auditor will issue a qualified or disclaimer of opinion depending upon
materiality and pervasiveness of the matter.
Question:-
a) ABC and Company, Chartered Accountants, have been requested to give their
consent for appointment as the auditor of Sindh Limited (SL), in place of XYZ
and Company, Chartered Accountants. The matter of appointment of ABC and
Company is to be placed in the annual general meeting of SL.
Required:
Page | 166
Advanced Auditing and Assurance ICPAP
i. Explain the responsibility of ABC and Company and the steps that it
needs to take before acceptance of the audit.
ii. What would be the retiring auditor’s responsibilities with respect to the
above and the responsibility of ABC and Company, in case the retiring
auditor does not fulfil its responsibility?
b) Assume that in (a) above XYZ and Company had qualified the previous year’s
audit report because it was unable to physically verify the factory building and
to observe physical inventory count, due to law and order situation. However,
during the course of current year’s audit, ABC and Company was able to observe
the physical inventory count and also carry out physical verification of the
factory building as the law and order situation has improved.
Required:
Discuss the matters which you would consider in the above situation and the
possible impact thereof on the audit report.
Answer:-
a) .
i. New Auditor’s (ABC and Company) responsibility before acceptance of
audit:
ABC and Company should consider whether the acceptance of new
client would create any threats to compliance with fundamental
principles.
Evaluate significance of threats before accepting the audit
engagement. If the threats are other than clearly insignificant,
safeguards should be considered and applied as necessary, to
eliminate them or reduce them to an acceptable level.
Communicate with the retiring auditor to establish the facts and
circumstances behind the proposed change, however, before
communicating it shall seek permission of the client for such
communication.
Comply with relevant legal and other regulations in
communicating with retiring auditor.
Page | 167
Advanced Auditing and Assurance ICPAP
Retiring auditor is responsible to respond to any communication by the
incoming auditor. However, before giving any information about the
client, he should seek client’s permission.
While communicating with the auditor, the retiring auditor need to meet
the legal and ethical requirements related to such communication and
disclosure.
The retiring auditor should promptly transfer to the new auditor all books
and papers related to SL, which may be held after the appointment has
been effected and should also advise SL accordingly.
b) The matters that would be considered in the above situation are as follows:
Whether auditors are in a position to obtain sufficient appropriate audit
evidence with respect to quantities of inventory at the beginning of the
year by means of other operating procedures.
If auditors are unable to obtain sufficient appropriate audit evidence with
respect to quantities of last year through other audit procedures, it will
imply that the matter giving rise to modification is still unresolved, and
the auditor shall modify the auditor’s opinion on the current period’s
financial statements.
Page | 168
Advanced Auditing and Assurance ICPAP
Even if the above matters are resolved auditor shall be required to include
in the audit report, an other matter paragraph stating that:
o The financial statements of the prior period were audited by the
predecessor auditor, who has issued a qualified opinion due to non-
observance of inventory count and date of prior year’s audit report.
The qualification related to non-verification of building of last year is not
relevant as the auditor is able to physically verify the building.
Question:-
You are the manager responsible for the audit of Health and Beauty Brands Limited
(HBBL) for the year ended 31 March 2014. HBBL has been selling its products through
its own retail outlets only. However, during the year under review, HBBL had entered
into an agreement for sale of its products at JDS, a chain of departmental stores.
According to the agreement, JDS would make payments within 30 days of the
sale to customers. Any unsold/expired products would be returned to HBBL.
The stock sheets provided by JDS to HBBL revealed differences as compared to
the balances appearing in the HBBL’s inventory system. According to JDS these
were due to posting errors in the system of JDS, and have been subsequently
corrected. HBBL’s management is of the view that such differences are not
material as compared to sales made through JDS.
There is a significant improvement in the operating results of HBBL. The
management considers that the agreement with JDS has played a major role in
such improvement.
The confirmation sent to JDS was not received. Alternatively, the audit team had
examined partial payment amounting to 65% of the outstanding balance upto 31
May 2014.
Required:
Discuss with reasons, what course of action you would adopt in the above situation and
the possible impact thereof on the audit report.
Solution:-
Significant improvements in profits reflects the risk that the revenue and profit in the
2014 financial statements may be significantly overstated.
The following point are needed to be considered in relation to the given situation:
Page | 169
Advanced Auditing and Assurance ICPAP
HBBL’s arrangement with JDS is such that JDS facilitated sales to customers but
does not purchase the inventory itself and HBBL retains title to the product until
it is sold to the final customer.
HBBL may have knowingly or erroneously, recognize the Sales Revenue on
dispatch of goods to JDS.
Subsequent recovery of 65% upto 31 May 2014, is also not sufficient appropriate
audit evidence of receivable balance from JDS, because as per the agreement JDS
is required to make the payments within 30 days of sale to customers.
It is also indicative of the risk that sales/receivable balance is overstated.
Although, the differences between stock sheets and balances were corrected
subsequently, but it is indicative of a risk that during the year there is a
possibility of wrong posting in the system of JDS, which consequently will result
in overstatement/ understatement of sales and stock in trade
After performing the above procedures if the auditor finds any error in the
recording of sales or receivables, he should ask the client to make appropriate
adjustments, failing which the report may be modified i.e. qualified or adverse
depending upon the materiality of the amounts involved.
If we are unable to obtain sufficient appropriate audit evidence, as regards the
recording of sales or in relation to receivable from JDS, it will be scope limitation
and based on the materiality and pervasiveness of the matter, the auditor may
issue a qualified or disclaimer of opinion.
Question:-
You are the quality control partner in a firm of chartered accountants. The following
independent situations are under your consideration.
a) Nawaz, a manager in the firm is assigned on deputation for training of the newly
hired staff in the accounts department of a brokerage house. The brokerage
house is also an audit client of your firm.
Page | 170
Advanced Auditing and Assurance ICPAP
b) Your firm has received a proposal from an audit client for implementation of a
new IT system which the company has acquired.
c) The client has written a letter of appreciation showing their gratitude for the
involvement and guidance provided by an audit manager on various issues
regarding application of accounting standards.
Required:
Identify and evaluate the threats involved and explain what actions should be taken in
the above circumstances including the steps required, if any, to reduce the risks to an
acceptable level.
Solution:-
The significance of threats should be evaluated and if the threat is other than
clearly insignificant, safeguards should be considered and applied as necessary
to eliminate the threat or reduce to an acceptable level. Such safeguards might
include:
Making arrangement so that personnel providing such services do not
participate in the assurance engagement;
Involving an additional chartered accountant to advise on the potential
impact of the activities on the independence of the firm and the assurance
team;
b) The listing regulations clearly stipulate that prohibited services by the auditors
include financial information technology system design and implementation,
significant to overall financial statements.
However, if the auditor concludes that it is not significant to overall financial
statements and is therefore permissible under the listing regulations, the
situation would need to be assessed from the point of view of Code of Ethics,
which states that:
The provision of services involving design and implementation of information
systems that are used to generate information forming part of financial
statements may create a self review threat.
Page | 171
Advanced Auditing and Assurance ICPAP
The self-review threat is likely to be too significant to allow the provision of such
services to a financial statement audit client unless appropriate safeguards are
put in place ensuring that;
- The audit client acknowledges its responsibility for establishing and
monitoring the system of internal controls;
- The audit client designates a competent employee preferably in the senior
management cadre, with the responsibility to make all management decisions
with respect to the design and implementation of the hardware or software
system;
- The audit client evaluates the adequacy and result of the design and
implementation of the system; and
- The audit client is responsible for the operation of the system (hardware or
software) and the data used or generated by the system.
Page | 172
Advanced Auditing and Assurance ICPAP
Abit Businesses Limited is a listed company engaged in the business of manufacturing
paints, pharma and chemicals. During the planning stage of an audit, the auditor has
found that:
a) The company has advanced a significant amount of Rs. 2.5 billion to a related
party, for construction of an office tower. In the notes to the financial statements,
it has been stated that transactions with related parties were carried out on arms
length basis.
b) The audit committee meetings were not held during the year, because all audit
committee members remained out of country. Consequently, the interim
financial statements were issued by the company without being reviewed by the
audit committee.
Required:
Evaluate and discuss how the auditor should deal with the above situations.
Answer:-
i. The auditor need to ascertain whether transactions with the related party have
been appropriately accounted for and disclosed in accordance with the IFRS and
Companies Ordinance, 1984.
Management’s assertion that the transactions were conducted on terms
equivalent to those prevailing in an arm’s length transaction may be materially
misstated due to practical difficulties that limit the auditor’s ability to obtain
audit evidence that all aspects of the audit evidence are equivalent to those of the
arm’s length transaction.
In order to address the above factors, the auditor shall:
- Inspect the underlying contracts or agreement.
- Determine the business rationale behind the transaction.
- Determine whether the terms of the transactions are consistent with
management’s explanations.
- Obtain audit evidence that the transactions have been
appropriately authorized and approved.
The auditor will evaluate management’s support for the assertion of arms
length transaction, which may involve one or more of the following:
- Considering the appropriateness of management’s process for
supporting the assertion.
Page | 173
Advanced Auditing and Assurance ICPAP
- Verifying the source of the internal or external data supporting the
assertion, and testing the data to determine their accuracy,
completeness and relevance.
- Evaluating the reasonableness of any significant assumptions on
which the assertion is based.
In addition to the above, we shall seek representation that management
has disclosed all the facts and documents related to the above transaction.
ii. .
It is a case of non compliance with the Code of Corporate Governance and
the auditor would also need to re-assess the risk of material misstatement
and consider its impact on other areas of audit.
Question:-
You are the audit manager responsible for audit of consolidated as well as separate
accounts of Haier Limited (HL) and its subsidiaries. In the initial meeting, the financial
controller has informed you that during the year:
a) the group has changed its policy for valuation of plant and machinery from cost
to revalued amount. The revaluation has been carried out by a global firm of
professional valuers, who have been advising HL for the last several years.
b) one of HL’s subsidiary has incurred substantial losses. Deferred tax has been
recognized on these losses. The financial projections prepared by the CFO show
that as a result of planned re-structuring, the subsidiary would be able to recoup
the losses during the next three years.
Required:
Describe the steps that you would take in each of the above situations.
Page | 174
Advanced Auditing and Assurance ICPAP
Answer:-
Review change in accounting policy for biases and evaluate whether the
circumstances producing the bias, if any, represent a risk of material
misstatement due to fraud.
Whether the change in accounting policy will result in reliable and more
relevant information about entity’s financial position, its performance and
cashflows.
Whether the requirements of IAS 16 in relation to change in accounting
policy, has been complied with.
Evaluate the competence, capabilities and objectivity of the professional
valuers;
Obtain an understanding of the work of that valuer; and
Evaluate the appropriateness of that valuer’s work as audit evidence for
the relevant assertion
Consider the need for appointment of an auditor’s expert.
Ensure that all the assets in the entire class of plant and machinery has
been revalued.
Checking appropriateness of disclosures related to the requirements of
Companies Ordinance, 1984 and IAS 16.
ii. Deferred tax asset:
Steps needs to be taken by the auditor:
Whether the recognition criteria for deferred tax asset as specified in IFRS
has been met.
Whether the methods estimating the amount of deferred tax are
appropriate and have been applied consistently, and whether changes, if
any, in accounting estimates are appropriate in the circumstances.
Determining whether events occurring up to the date of the auditor’s
report provide evidence regarding the deferred tax asset.
Review the company’s restructuring plan (assumptions) to assess its
reasonableness and viability.
Review the future projections provided by the client and their viability vis
a vis restructuring plan.
Checking appropriateness of disclosures related to the requirements of
IAS 12.
Written representations from the management.
Page | 175
Advanced Auditing and Assurance ICPAP
Question:-
a) You are a partner in a firm of chartered accountants, looking after the audit and
advisory services department. One of your clients has approached you for
services in relation to certification of compliance with a specific control
framework, with regard to their production process.
Required:
What are the different types of reports that you can offer to the client, clearly
specifying the key characteristics of each form of report.
b) Your manager has identified that the client should prepare a statement of
compliance with the said control framework and your firm can only issue a
report on that statement.
Required:
Identify the type of assurance engagement to which the manager is referring to
and the key characteristics of such engagement.
Answer:-
Page | 176
Advanced Auditing and Assurance ICPAP
Question:-
Required:
Briefly describe the key controls which you as an auditor expect to find in respect of
receipts and payments.
Answer:-
Overall controls – statement showing donations, fee and income and payments are
reviewed by senior management personnel on a monthly basis (i.e. business
performance review covering all assertions)
i. Cash
For cash received at counters, the cashier counts the cash and prepares a
receipt voucher (Completeness, Accuracy, Rights/Obligation, Cut off)
For donation boxes – donation boxes are unlocked / opened in the
presence of two / three persons and then a cash count is performed
following which a receipt voucher is prepared showing details about the
date, time, place of box and the total cash collected. (Completeness,
Accuracy)
Cash count is performed on regular basis by a person independent of the
custodian of cash and results are matched with the daily receipt record
maintained in the system (Existence)
Cash is kept in safe custody and at day end the cash is deposited with
bank. (Existence)
Surprise cash counts are also conducted by the persons independent of the
custodian of cash (Existence)
Appropriate segregation of duties exist, i.e. person receiving the cash,
maintaining its custody and recording the transactions is not the same
Bank accounts
Page | 177
Advanced Auditing and Assurance ICPAP
Bank reconciliation statements are prepared and reviewed on a regular
basis and unadjusted / reconciling items are investigated and recorded on
timely basis. (Completeness, Accuracy, Rights / Obligations, Cut off)
The cashier counts the cash and prepares a receipt voucher showing
details about the date, time, name of student and the cash collected.
(Completeness, Accuracy, Rights / Obligations, Cut off)
A student wise fee outstanding report is prepared and reviewed on a
monthly basis and the schedule of overdue fee is presented to the
management for appropriate action as per policy.
i. Teachers
Payroll process is initiated by the payroll department based on the
master data maintained by HR department.
The attendance record reviewed by the Head of the Department before
the processing of payroll.
A month-to-month payroll reconciliation is prepared before the
distribution of payroll.
Changes to master data is made by the HR department only after due
authorization.
ii. Petty cash
Pre-numbered / sequentially controlled petty cash vouchers are
maintained.
Cash on the basis of IOUs is not disbursed.
Surprise cash counts are conducted by the persons independent of the
custodian of cash (Existence)
Payments are recorded in general ledgers after the details are reviewed by
the Finance Manager.
Question:-
Angro Foods Limited (AFL) manufactures a variety of food products. The incharge of
the audit team at AFL has requested you to advise on the following issues:
Page | 178
Advanced Auditing and Assurance ICPAP
legal advisor in his confirmation. On being confronted, the management has
informed that they are in the negotiation phase with the competitor and intend to
settle the dispute through payment of Rs. 150 million.
b) Stock in trade valuing Rs. 65 million is placed in a warehouse owned by Hameed
Limited (HL). According to news reports, FIA has recently initiated an enquiry
against HL for evading import duties and taxes. HL has confirmed the quantities
of stock at year end.
Required:
Discuss how the auditor should deal with the above situations.
Answer:-
a) .
i. The failure to include all the cases in the confirmation depicts that the legal
advisor has not replied appropriately to the general enquiry letter. In this
case:
The auditor may directly communicate with the legal advisor (after
client permission) through a letter of specific enquiry, which shall
include the following:
- Details of litigation for which the auditor needs to obtain
information.
- Management’s assessment of the outcome of the identified
litigation and its financial implications.
- A request for confirming the reasonableness of management’s
assessment and providing further information if the details of case
or management’s assessment is incorrect.
ii. The auditor’s course of action would depend upon the reply to the specific
enquiry, and the auditor will proceed in the matter, as follows:
Legal Advisor confirms the view point of management but does not agree
with the amount provided in the financial statements:
Page | 179
Advanced Auditing and Assurance ICPAP
If the legal advisor confirms the viewpoint of management , but disagrees
with the management relating to the amount of settlement, then the auditor
will ask the management to resolve the matter.
b) .
i. Discuss the news report with the client to assess the authenticity of your
information and what action is the client taking in this regard.
Page | 180
Advanced Auditing and Assurance ICPAP
ii. Ask the client for physical verification of stock held by the HL in the presence
of an audit team member.
iii. Review the reconciliation between yearend stock and the quantities verified
at the auditor’s request.
iv. Update your information about the status of FIA’a action so far.
v. In case the severe action against HL is imminent, then consider its impact on
the financial statements.
vi. If the expected impact is significant ask the client to resolve the issue (shifting
of stock, guarantee from HL etc)
vii. If HL fails to take reasonable action consider its impact on the financial
statements and audit report.
******************************************************************
Page | 181