Professional Documents
Culture Documents
F8 AA QB September 2020-June 2021 As at 11 May 2020 FINAL
F8 AA QB September 2020-June 2021 As at 11 May 2020 FINAL
F8 AA QB September 2020-June 2021 As at 11 May 2020 FINAL
ACCA
AUDIT AND ASSURANCE
www.iaww.com/publishing
ISBN 978-1-78480-790-0
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Contents
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AUDIT AND ASSURANCE
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AA
Getting Started on Audit
and Assurance
AUDIT AND ASSURANCE
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GETTING STARTED ON AUDIT AND ASSURANCE
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AA
Questions
AUDIT AND ASSURANCE
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QUESTIONS
2. In respect of the conflict between your existing client Bugby Ltd and the potential
new client Fusball Ltd, what is the best course of action for your firm?
A. Politely decline the offer from Fusball Ltd, and keep being the auditor of Bugby Ltd
B. Accept the offer from Fusball Ltd, but only if Fusball Ltd and Bugby Ltd are both
happy with your firm auditing both companies
C. Accept the offer from Fusball Ltd, and resign as auditor of Bugby Ltd, using last
year’s audit team from the Bugby Ltd assignment to audit Fusball Ltd
D. Politely decline the offer from Fusball Ltd, and also resign as auditor of Bugby Ltd
3. If a partner from Kricket and Co attend a meeting with Fusball Ltd and its bankers,
which type of threat to objectivity will be created?
A. Self-review
B. Advocacy
C. Intimidation
D. Self-interest
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AUDIT AND ASSURANCE
12
QUESTIONS
8. Ensuring the existence of the lorries is difficult as most of the time they are being
used to deliver goods to customers. Very few lorries are therefore actually at the
client premises so be seen (which is the normal method of proving existence). Which
of following is the best way of obtaining sufficient evidence to confirm the existence
of a sample of lorries?
A. Obtaining the approximate geographical location of the lorries and then
driving around the country to try and find them
B. Waiting until the lorries are driven back to the client’s premises and
then seeing them
C. Obtaining evidence such as insurance documentation and repair invoices
showing the registration number of the lorries
D. Ignoring the sample and only verifying those lorries at the client’s premises on
a particular day.
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AUDIT AND ASSURANCE
9. As part of the trade receivables audit, you are undertaking a direct confirmation by
sending requests for confirmation of year-end balances to a sample of the client’s
customers. After selecting a sample for this purpose, the Finance Director has asked
you not to send the confirmation to one of the customers on the list you selected.
Which of the following should you now do?
(1) Inform the client that you are required to send the confirmation request to all
customers sampled, irrespective of whether the client is agreeable
(2) Ask the client for reasons why they do not want you to communicate with this
customer, and seek evidence to support whatever reasons are given
(3) Perform alternative audit procedures to obtain sufficient appropriate evidence
as to the existence and valuation of this customer balance
(4) Select a different customer to replace the one that the client does not want
you to communicate with
10. Work on valuation of trade receivables included ensuring debts were paid after the
end of the year. During your audit of after date cash receipts you noticed a number
of old receivables balances which were over 6 months old. The total amount was
immaterial. Apart from informing the client of the possible bad debts, what action
should the auditor take regarding these balances?
A. Insist that the financial statements include appropriate provision for non-payment
B. Add the amount to the schedule of unadjusted errors found during the audit
C. Include the matter in the significant matters section of the audit report as a
material internal control weakness found during the audit
D. Adjust the financial statements for the client
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QUESTIONS
12. Which of the following controls will help to ensure that no sales summary sheets are
mislaid or lost in each store?
A. Manual numbering of completed sheets with number sequence being checked
prior to banking
B. Pre-numbering of all sheets with the number sequence being checked
prior to banking
C. Signing of all sheets by a member of the finance department to confirm receipt
of each sheet
D. Copying all completed sheets with copies being filed in a different location
away from the finance department (where the originals are stored)
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AUDIT AND ASSURANCE
13. The directors of Boneneeoo are concerned that staff are not recording all sales made
in tills. This means that cash will be understated on the till record of sales and staff
can steal cash as it will not have been recorded. Which of the following controls will
be most effective in ensuring staff do not steal cash?
A. Requiring all till staff to sign a copy of the Boneneeoo’s code of ethics which
states that cash is not to be stolen
B. CCTV monitoring of all tills with footage being reviewed on a regular basis
ensuring cash for all goods sold is placed in the tills.
C. Agreeing actual cash in the till to the cash record maintained in the till by a
member of the finance department in each shop
D. Comparing cash receipts each day and asking staff to explaining changes
in sales made
14. Which of the following is the most accurate statement regarding the auditor’s
responsibilities in respect of fraud at a client?
A. The auditor’s responsibility is to identify the risks of fraud taking place and to
design audit tests in response to these assessed risks
B. The auditor’s responsibility is to detect all fraud that gives rise to material
misstatement in the financial statements
C. The auditor’s responsibility is to prevent fraud happening at clients
D. The auditor’s responsibility is to identify the risks of material misstatement in
the financial statements caused by fraud, and to design audit tests in response
to these assessed risks
15. Having noticed weaknesses in the control systems for cash, you decide to
communicate these to the client. Which of the following statements is correct
regarding communication of significant control weaknesses?
A. Communication will be in writing to the finance director.
B. Communication will be in writing to those charged with governance
C. Communication can be either verbal or in writing to the finance director
D. Communication is only necessary where weaknesses are significant and
material errors are known to occur in the financial statements
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QUESTIONS
17. During the finalisation stage of the audit, which of the following statements are
correct in respect of the misstatements discovered during the audit process?
(1) The auditor must correct those misstatements which the auditor deems
to be material
(2) The auditor must provide all recorded misstatements to the client and request
that the misstatements are corrected
(3) The auditor must provide only material misstatements to the client and request
that they are corrected
(4) The auditor must request a representation from the client explaining why any of
the misstatements reported to the client have not been corrected
A. (2) and (4)
B. (3) and (4)
C. (1) and (3)
D. (1) and (2)
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AUDIT AND ASSURANCE
18. The audit partner disagrees with the senior’s recommendation for the auditor’s
opinion. On the assumption that the errors are corrected by RealEats, what form of
audit report will be issued?
A. Unmodified
B. Modified report with an emphasis of matter paragraph drawing the attention
of users of the financial statements to the errors that had to be corrected
C. Modified report with a modified opinion “except for” as the errors identified
were material in total but not fundamental
D. Modified report with an other matters paragraph explaining how the auditor
managed to amend the financial statements after discussion with the client
19. The audit senior has been asked to draft the Key Audit Matters section of the audit
report. What is the purpose of this section of the report?
A. To explain the purpose of the audit and how the auditor follows the ISAs when
carrying out an audit
B. To clarify the key areas where the auditor had to rely on internal controls as a
form of audit evidence
C. To explain key matters identified during the audit, such as internal control
weaknesses or major problems with obtaining audit evidence
D. To explain all the adjustments that the auditor had to recommended to the
audit client as the audit progressed
20. Given that the management of RealEats do not want to sign the management
representation letter, what is the most appropriate action for the audit
partner to take now?
A. Modify the auditor’s report with an “except for” qualification due to the
material but not fundamental nature of this lack of evidence
B. Attempt to obtain alternative audit evidence
C. Discuss the matter with those charged with governance and offer, where
necessary, to draft the management representation letter for RealEats
D. Do nothing as the management representation letter is only persuasive evidence
(it is generated by the client and therefore not a reliable source of evidence)
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QUESTIONS
22. With respect to the shares being held by the audit partner, what action must the
partner now take?
A. Transfer the shares to his spouse
B. Sell the shares
C. Declare an interest in the shares and ensure that he is not involved in the audit
D. Not vote at any meeting of the AnyCarSold
23. A standard engagement letter will have been sent to the directors of AnyCarSold.
Which of the following will NOT normally be included in this letter?
A. Initial assessment of internal control weaknesses identified at the client
B. Basis on which fees are calculated
C. The format of any reports that will be issued
D. Responsibilities of directors and auditors
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AUDIT AND ASSURANCE
24. As this is a new audit client, Katzoo will need to ensure that the preconditions for an
audit are in place prior to the audit commencing.
Select by ticking the appropriate option whether the following statements are true
or false regarding preconditions for an audit.
25. AnyCarSold is a listed company. How will this affect the audit (compared to an audit
of an unlisted company)?
A. Materiality will be set to be higher.
B. No audit staff below the grade of senior will be allowed on the audit due to the
increased risk of misstatement of balances.
C. The audit report must be signed within 3 months of the year end.
D. The audit report must include a Key Audit Matters section.
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QUESTIONS
Age Total
0 to 1 month 453,092
1 to 2 months 250,028
2 to 4 months 74,092
4 to 6 months 24,881
Over 6 months 17,008
Total $819,101
Audit work on these balances, along with other statement of financial position balances, is
just starting.
26. Tyecotton maintains a provision for bad debts at 45% against balances over 6 months
old and 1% of the remaining balances. The directors have informed the audit team
that last year’s provision of $15,000 is considered adequate for this year’s financial
statements. Based on this information, which of the following statements is correct?
A. Profit is overstated by $675
B. Profit is understated by $675
C. Profit is overstated by $15,675
D. Profit is understated by $15,675
27. The audit team propose to send out receivables circularisation letters to confirm
the receivables balances. Which of the following assertions is NOT tested using this
audit procedure?
(1) Existence
(2) Completeness
(3) Rights and obligations
(4) Presentation
A. (2) and (3)
B. (1) and (4)
C. (2) and (4)
D. (1) and (3)
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AUDIT AND ASSURANCE
28. Members of the audit team attended the TyeCotton’s inventory count at the end
of the client’s financial year. Clothes to the inventory value of £175,000 were not
included in the count as despatch notes had already been raised; however, these
clothes were not despatched until the following day as the courier did not arrive to
collect them. Sales invoices for these clothes were therefore included in the sales
day book on the first day of the new accounting period. Which additional activities
must now take place to remove any error from the financial statements?
A. Nothing as despatch of clothes and sales have been recorded in the
books of TyeCotton
B. Add the clothes back into inventory at the year-end at the sales price as they
have been sold
C. Include the sales invoices in this year’s sales day book
D. Add the clothes back into inventory at the year-end and include the sales in
this year’s sales day book
29. A new audit junior is unclear why a receivables circularisation is being carried out.
“Why waste all this time preparing letters when customers may not even bother to
write back” was the comment made. Which of the following is the best reason for
carrying out a receivables circularisation?
A. It saves the auditor time because a response from the customer agreeing
the balance means no other audit procedures are necessary on that
receivable balance
B. A receivables circularisation has to be carried out to comply with the ISAs
C. TyeCotton (and any other client) prefer auditors to carry out the circularisation
as the confirms the accuracy of their receivables ledger
D. Responses to the circularisation provide a reliable source of audit evidence
30. The audit team noticed that a significant number of receivables had exceeded their
credit limit on the receivables ledger at the period-end. Which of the following
controls should be in place to prevent this happening?
A. Maintaining a list of authorised credit limits by the credit controller
B. Review of outstanding balances before new orders are authorised
C. Ensuring that receivables balance is no more than 2 months old before
authorising new orders
D. Ensuring cash received is allocated to the correct receivable account in the
receivables ledger
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QUESTIONS
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AUDIT AND ASSURANCE
32. Regarding the potential going concern situation in Adigeon, the directors propose
to place a note in the financial statements explaining the situation to the company’s
members. The audit partner has reviewed a draft of this note and considers it does
explain the going concern situation correctly. In this situation, what will be the effect
on the audit report for Adigeon?
A. No effect as the matter is adequately disclosed in the financial statements
B. Modification of the report with a Material Uncertainty Relating to Going Concern
paragraph to draw the reader’s attention to the ongoing going concern issue
C. Modification of the report with a qualified opinion “except for” due to the
uncertainty of the ability of Adigeon to continue as a going concern
D. Modification of the report with an adverse opinion as it appears that Adigeon
cannot continue as a going concern
33. Towards the end of 2019, the directors of Adigeon received a letter from a small
farming claiming that a manufacturing defect in some farm machinery manufactured
by Adigeon had caused an accident on the farm, injuring the farmer. As the farmer
can no longer work, there is a claim against Adigeon for hospital expenses and loss
of profits from the farm. The amount of the claim at $450,000 is material to the
financial statements. Adigeon’s legal advisors are of the opinion that the success
of the claim is only possible. What action should the directors of Adigeon take
regarding this claim in the financial statements of the company?
A. Nothing as the claim is unlikely to succeed
B. Disclosure of the claim in a note, stating the circumstances but not the
financial effect
C. Disclosure of the claim in a note, stating the circumstances and the possible
financial effect on the company
D. Make a provision of $450,000 in case the claim is successful
34. The audit partner has received a request from the directors of Adigeon to attend the
meeting with the bank with them in April. The reason for this is so the auditor can
support the directors in their loan application. The directors are of the opinion that
the bank is more likely to grant a loan if the company’s auditor is present. What is
the main threat to independence in this situation?
A. Advocacy
B. Self-interest
C. Intimidation
D. Self-review
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QUESTIONS
35. The auditor of Adigeon has produced a list of misstatements identified during the
audit. What actions must the auditor now take regarding these misstatements?
Note that the total of the misstatements is immaterial.
A. No action at all as the misstatements are immaterial
B. Provide all recorded misstatements to the client and request that the
misstatements are corrected
C. Request that the client acknowledges receipt of the list of misstatements and
gives reasons for any misstatements not corrected
D. Inform those charged with governance that if the misstatements are not
corrected then the audit report will be modified with an “except for”
qualification
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AUDIT AND ASSURANCE
37. During payments testing, the audit senior discovered $5,500 of payments made to a
director for which there were no receipts. Initial discussion with the Finance Director
indicated that these payments were short term loans to a director but the relatively
small amounts meant no documentation had been maintained. What action is most
appropriate for the audit senior to take now?
A. Immediate reporting to the police (or appropriate government agency) as a
possible money laundering transaction
B. Recommend to the Finance Director that disclosure of the loan is required in the
financial statements
C. No action as the amount is immaterial and the Finance Director can be trusted to
ensure the loans are repaid
D. Raise an audit file note and inform the audit partner of the situation for
subsequent investigation
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QUESTIONS
38. During the audit of the purchase day book, various items of capital expenditure were
found to be incorrectly categorised as repairs expenditure. What is the effect on the
financial statements of this error?
A. Repairs expenditure understated and non-current assets overstated
B. Repairs expenditure understated and non-current assets understated
C. Repairs expenditure overstated and non-current assets overstated
D. Repairs expenditure overstated and non-current assets understated
39. A review of the control systems on purchase invoices identified that a number of
invoices were not signed to confirm that invoice details had been agreed to the
original purchase order. Apart from this, the invoices were correctly processed
through the purchases system. What is the main effect of this control weakness?
A. Purchase invoices may not represent valid company expenditure as items may
not have been ordered
B. Payables will be over-stated because the invoice will not be paid
C. The purchases expense will contain a material error as the control system has
not worked correctly
D. Inventory will be understated because the invoice was not recorded correctly
40. During audit work on the purchase ledger, a purchase invoice was found to be posted
to the wrong supplier account. Which of the following audit procedures should
identify this error?
A. Agreeing cash payments to the purchase ledger account ensuring payments
relate to invoices posted to each account
B. Casting of the individual purchase ledger accounts and agreeing the total of
those accounts to the Payables Ledger Control Account
C. Analytical review of purchases for the year
D. Supplier statement reconciliations
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AUDIT AND ASSURANCE
42. The wages clerk updates the wage rates for individual workers and adds and removes
workers from the computer as those employees join or leave the company. What is
the most likely effect of this control weakness?
A. Workers as paid for work not done as the hours worked are incorrectly calculated
B. The clerk can set up “ghost employees” in the computer system
C. Workers will be removed from the computer who are still employees
D. Incorrect amounts of wages tax will be paid to the government
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QUESTIONS
43. Regarding access to the computer systems, which of the following controls is most
effective at preventing unauthorised personnel seeing the wages information?
A. Encryption of data on the computer
B. Password controls over the wages system
C. Computer logs monitoring and recording all accesses to the computer system
D. Maintaining duplicate files on a secure server in another location
44. The clerk manually rechecks 10% of the wages calculations each week. Why might
this be considered an excessive amount of re-checking?
A. Computers don’t make mistakes so there is no need for re-checking at all
B. The clerk, being human, makes many mistakes so many calculations must
be checked to ensure that the computer is correct to overcome errors
made by the clerk
C. Wages calculations are standard (time * rate etc.) so each calculation is based
on the same programme. Checking just a few calculations will identify any
programme error; there is no need to re-check 10% of the calculations.
D. The computer programme may be only partly updated for changes in payroll
tax rat which apply to all employees, so many calculations need to be tested to
confirm the accuracy of any update
45. The auditor needs to confirm the accuracy of the wages calculations on the computer
(that is calculation of gross pay, payroll deductions and calculation of net pay).
Which audit procedure is likely to be used to perform this test?
A. Observing employees clocking in and out from their shifts
B. Tracing wages payments from the wages system to the bank statements
C. Tracing wages paid on the bank statements to the net wages due on
the wages system
D. Using audit software to re-perform the processing carried out by the
wages software
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AUDIT AND ASSURANCE
47. Which of the following may be included in the Key Matters section of the audit report?
A. List of all control weaknesses identified during the audit
B. Areas with a high risk of material misstatement
C. Matters in the chairman’s statement that conflict with the information in the
financial statements
D. Areas involving significant judgement
48. With respect to the fall in value of the inventory notified to the audit manager by the
Finance Director, what action is it appropriate for the manager to take.
A. No action is necessary as the audit work at Deneva is complete
B. Modify the audit opinion if the Finance Director does not decrease the value of
inventory in the financial statements
C. Include the inventory issue in the Key Matters section of the audit report but not
modify the opinion as the defect was found after the period-end
D. Include the matter in the planning notes for next year’s audit as inventory will be
revalued in the next accounting year
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QUESTIONS
49. Regarding the work carried out by the internal audit department of Deneva for the
external auditors, which of the follow should NOT have been delegated to internal audit.
A. Internal auditor observation of client’s inventory counts
B. Internal auditor’s work on assessing whether the company’s provisions have
been accounted for appropriately
C. Internal audit testing of the operational effectiveness of your client’s
internal controls
D. Internal audit testing of transactions through the information system for
financial reporting purposes
50. The manager needs to assess whether or not Deneva is a going concern. Tick
whether the following statements are true or false. (The situations represent two
possible outcomes for the client.)
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AUDIT AND ASSURANCE
52. The actual inventory count took a lot longer than expected due to inadequate
labelling of some inventory by Endicor’s staff. A few hours before the count was due
to be completed, Endicor’s warehouse manager said he would allow his staff and
the audit team members to purchase any games system at cost price (a saving of up
to $150). This was a “thank you” for their hard work and to provide an incentive to
finish the count quickly. 3 of the 5 of the audit team accepted this offer after carrying
out their work correctly. Which of the fundamental ethical principles have the team
members broken?
A. Confidentiality
B. Professional competence and due care
C. Objectivity
D. Professional behavior
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QUESTIONS
53. When audit staff are inspecting inventory during count attendance, which of the
following assertions can evidence be collected for?
(1) Cut-off
(2) Rights and obligations
(3) Existence
(4) Accuracy
A. (2) and (4)
B. (1) and (2)
C. (1) and (3)
D. (3) and (4)
54. During attendance at the inventory count, it was noted that inventory sheets were
not pre-numbered (even though the count instructions specifically stated sheets
would be pre-numbered).
A. Inventory may be counted and recorded twice
B. If sheets are lost, then this will not be identified
C. The auditor will not be able to re-count easily as it will not be clear which
sheets inventory is recorded on
D. The inventory count may be incorrect as inventory is difficult to locate
55. Regarding the manager’s requirement to count petty cash, what is the main reason
auditors do not normally audit petty cash at all?
A. There are unlikely to be errors as petty cash is always well-controlled
B. Petty cash is only used to reimburse individuals for small items of expenditure,
such as tea and coffee
C. Petty cash is normally immaterial to the financial statements
D. Petty cash is normally controlled by the Finance Director who can
always be trusted
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AUDIT AND ASSURANCE
57. If internal audit is outsourced, are the following statements true or false?
58. If the external auditors decide to tender for the internal audit work at Farius, which
safeguard is needed to maintain the independence of the internal and external auditor?
A. As long as the fee is less than 10% of the total fee income for the audit firm in
which case no other safeguards are required
B. The internal audit and external audit teams will be comprised of different
members of the audit firm
C. The internal audit team must all be qualified auditors
D. The external auditor must report to the Finance Director and internal audit to
the audit committee
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QUESTIONS
59. If the external auditors start to provide internal audit services and the external
audit partner joins Farius as head of systems development and to monitor the
internal audit services provided by the external auditor, what is the main threat to
independence for the external audit firm?
A. Self-review as system development work produced by the partner will be
reviewed by this previous audit firm
B. Self-interest as the external audit firm will receive an increased fee from carrying
out both internal and external audit
C. Advocacy as they will be seen to be supporting the system development work at
their audit client due to the partner working at the client
D. Intimidation as members of the external audit team may not wish to query a
previous partner of their audit firm
60. If the internal audit department is outsourced, which person or group should make
the appointment for this service?
A. The Finance Director
B. The main board of Farius
C. The audit committee
D. The shareholders in general meeting
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AUDIT AND ASSURANCE
62. The assurance firm is preparing the financial statements of its client Galorndon (using
the business services section of the firm). To ensure independence is maintained in
the audit firm, which of the following procedures must be in place?
A. Staff in the business services section of the assurance firm must never work in
the assurance department; similarly, staff in the assurance department must
never work in the business services section
B. Staff in business services may work in the assurance department, but not on
the audit of any client they have prepared the financial statements for
C. Staff in assurance may work in the business services section, including work
on their assurance clients, because the business services section is never
involved in audits
D. Staff from both assurances and business services section of the firm can work
in either department without any restriction
36
QUESTIONS
63. The directors of Galorndon have been informed that the invoice for $35,000 in
respect of repair and redecoration work must be included in the financial statements.
The directors are still unsure whether they want to adjust. Which of the following
summarises the effect of this invoice on the financial statements of Galorndon?
64. The directors of Galorndon have notified the audit firm of the existence of the
repairs and redecoration invoice for $35,000. Apart from obtaining a copy of the
invoice, what action must the assurance firm now take?
A. No action; it is up to the directors to decide whether to include in the invoice
in the financial statements
B. The business services section will amend the financial statements as it is their
responsibility to ensure the financial statements are accurate
C. Ask the directors what the invoice was for
D. Ensure that the management representation letter includes a point where the
directors confirm that the financial statements are complete and all evidence
required for the audit has been given to the assurance firm
65. The directors of Galorndon are interested to know what happens to an audit report
if the financial statements are not amended for a material error. If there is a material
error, which of the following shows the correct modification to the auditor’s report?
A. Inclusion of emphasis of matter paragraph, normally at the end of the report
B. Qualification of the auditor’s opinion “except for” and an additional paragraph
added below the opinion paragraph to explain the modification
C. Qualification of the auditor’s opinion “except for” with a Key Matters point
added to explain the modification
D. Qualification of the auditor’s opinion to make this adverse with an additional
paragraph added below the opinion paragraph to explain the modification
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AUDIT AND ASSURANCE
38
QUESTIONS
67. Which two of the following statements regarding the use of analytical review at the
completion stage of the audit are correct?
A. Analytical procedures help the auditor identify risk areas for further
investigation
B. Analytical procedures help the auditor in ensuring that the overall
conclusion on the financial statements is consistent with the auditor’s
understanding of the company
C. Analytical procedures provide substantive evidence regarding the balances in
the financial statements
D. Analytical procedures are optional on completion of the audit but they do save
the auditor time if they are used
68. Regarding the disclosure of the uncertainty of ongoing financing from the company’s
bankers in the financial statements (effectively a going concern note) what effect will
this have on the audit report?
A. No effect as the matter is fully disclosed in the financial statements
B. A mention in the Key Matters section of the report to ensure the readers of the
financial statements are aware of the situation
C. Modification of the report with a “Material Uncertainty Relating to Going
Concern” paragraph drawing attention to the disclosure
D. Modification of the report with a qualified opinion regarding the uncertainty
of the going concern assumption for the company
69. Given the lack of finance staff at Hekaras, the FD may have asked the auditor to
prepare the financial statements. Which of the following statements is correct
regarding this request?
A. Auditors can produce the financial statements for a listed company
B. Auditors can produce the financial statements for listed company if requested
to do so by the Board of that company
C. Auditors can produce the financial statements for a listed company during its
first year of listing only
D. Auditors may only assist in the production of financial statements for a listed
company in an emergency situation
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AUDIT AND ASSURANCE
72. If the auditor had identified material errors in the sales system which have been
clearly quantified, what would be the effect on the audit report?
A. Modified report with an emphasis of matter paragraph drawing attention to
the problem of lack of completeness of sales
B. Modified report with a qualified opinion “except for” as the auditor can
determine the extent of the error
C. Modified report with a qualified opinion “except for” because Ilecom has
failed to maintain proper accounting records
D. Modified report which disclaims any opinion as the matter is both material and
fundamental to the understanding of the financial statements
73. Regarding the advice required by the directors on good corporate governance,
the Finance Director has produced a list of the changes that he believes are
necessary. Which of the following governance changes is NOT required by corporate
governance codes?
A. The remuneration committee will decide on the remuneration of all directors
B. The audit committee will recommend external auditors to the board and the
extent of their remuneration
C. The board will have a mix of executive and non-executive directors with
the chairman having the casting vote. The chairman will also therefore be
non-executive
D. Directors (executive and non-executive) will received training on their role and
an explanation of the activities of Ilecom when they join the board
40
QUESTIONS
74. The FD of Ilecom has asked the external auditor to report on the prospectus being
produced for the listing of the company next year, and to attend listing events to
explain the prospectus to potential buyers of the company’s shares. Which of the
following ethical threats is most likely to apply in this situation?
A. Advocacy
B. Intimidation
C. Self-interest
D. Self-review
75. The FD of Ilecom knows that he needs to appoint more non-executive directors to
the board. To try and obtain good candidates for the post, he wants to offer various
incentives. Which of the following is NOT allowed in respect of non-executive directors?
A. Service contracts of up to three years
B. Holding of shares in Ilecom
C. Access to independent advice on their role at Ilecom’s expense
D. Inclusion of bonuses based on good company results in the remuneration package
41
AUDIT AND ASSURANCE
77. Regarding the query about principles based governance systems, which of the
following is the best definition of principles based systems?
A. Governance is a system of principles or codes which only have to be followed if
the company chooses to do so
B. Governance is a system of rules which must be followed at all times, or the
company directors may be liable to legal proceedings
C. The principles of good governance should be followed, with the annual report
explaining situations where those principles were not followed
D. Corporate governance is a code; companies must apply the code unless their
members in general meeting allow non-compliance
42
QUESTIONS
78. The chairman’s statement does not agree with the financial statements; the
chairman stating turnover increased by 11% when this was really 5%. The financial
statements are accurate in this respect. What action should the auditor now take?
A. No action is necessary as the chairman’s statement is not audited
B. Statement in the Key Matters section of the audit report that the chairman’s
statement cannot be relied on
C. Inclusion of an other matters paragraph in the audit report to draw attention
to the incorrect figure in the chairman’s statement
D. Inclusion of an emphasis of matter paragraph in the audit report to draw
attention to the incorrect figure in the chairman’s statement
79. Jerido purchased a new machine for $400,000 during the financial year under audit.
Historically, machines of this type have been depreciated over 5 years on a straight-
line basis. The finance director believes that improvements in technology mean that
the machine can be depreciated over 10 years. The auditor believes that 5 years’
depreciation is appropriate and has raised an audit adjustment on this basis. What
is the effect of this adjustment on the financial statements? Tick the appropriate
answer for each of the statements.
Correct Incorrect
Profit will be overstated?
The amount will be material?
80. As a maximum, under corporate governance codes, how many years can the senior
independent director remain in office and still be deemed to be independent?
A. 3
B. 6
C. 9
D. 12
43
AUDIT AND ASSURANCE
82. Sufficiency of audit evidence is affected by several things. Which of the following is
the least relevant factor in assessing the sufficiency of audit evidence?
A. Reliability of the evidence
B. Relevance of the evidence
C. Risk of the balance being materially misstated
D. Time taken to collect additional evidence
83. Regarding your analytical review to understand changes in sales for the year, which
of the following sources of evidence will be the LEAST use to you?
A. Breakdown of sales by month
B. Forecast sales of Kesat for the next year
C. Financial statements of similar companies to Kesat
D. Industry report on sales in the plastics industry by product type for the
previous 5 years
44
QUESTIONS
84. Audit testing on sales returns has encountered significant problems; many of the
credit notes in the audit sample being tested were not signed to indicate that details
had been agreed back to the goods returned notes. There are various options
available to the auditor at this stage. Place the options below in the order that the
auditor is most likely to use.
(1) Modify the audit report
(2) Extend the sample size for test of control testing
(3) Include the matter in the letter of weakness to management
(4) Extend substantive testing for sales returns
A. 1, 4, 2, 3
B. 2, 4, 1, 3
C. 3, 2, 4, 1
D. 2, ,4, 3, 1
85. Regarding the controls testing approach being taken for the audit, which of the
following statements is FALSE regarding that testing?
A. Any error found can be expressed in monetary terms
B. Substantive testing is never eliminated completely when tests of controls are used
C. The auditor will assess the effectiveness of controls using walkthrough testing
prior to placing reliance on controls
D. The sample testing in controls testing is indicative not conclusive evidence that
the control worked for the whole population
45
AUDIT AND ASSURANCE
87. With respect to the cash flow forecast, which of the following statements is correct?
A. Janit’s auditors cannot assist with the preparation of the forecast as this will
cause a self-review threat as the forecast cannot be independently reviewed
B. Janit’s auditors can assist with the preparation of the forecast as long as the
audit partner is involved
C. Janit’s auditors can assist with the preparation of the forecast as long as the fee
income is not more than 15% of the audit fee being charged to the client
D. Janit’s auditors cannot assist with the preparation of the forecast because as an
assurance firm they will not have the necessary preparation skills
46
QUESTIONS
88. Regarding the inventory at Janit, which of the following audit procedures will
normally be carried out to confirm the existence of inventory?
A. Analytical review of the balance compared to previous years’ inventory balance
and movement in sales
B. Test counting of random samples at 10% of the stores
C. Test counting at all stores
D. Agreeing quantities to recent purchase invoices
90. As part of the expansion plans for Janit Co, the board are keen to appoint new
non-executive directors to the board. Janit Co trades in a jurisdiction which has a
principles based system of corporate governance. The Finance Director has asked
the audit partner to be a non-executive director. Which of the following statements
are correct regarding this potential appointment?
A. The audit partner cannot accept appointment in any circumstances
B. The audit partner can accept appointment but must resign from being the audit
partner and being a partner in the audit firm
C. The audit partner can accept appointment in two years but must resign from
being audit partner now
D. The audit partner can accept appointment in two years but must resign from
being audit partner now and the audit firm must resign as auditors when the
appointment is made.
47
AUDIT AND ASSURANCE
92. The audit team are agreeing the individual payables balances on the payables ledger
accounts to supplier statements. Which of the following assertions is NOT tested
using this audit procedure?
A. Existence
B. Completeness
C. Rights and obligations
D. Presentation
93. A number of supplier statements could not be obtained leaving a material amount
of the payables balance initially untested. Which of the following audit procedures
must the audit team now perform to try and obtain sufficient and appropriate
evidence regarding completeness of the payables balance?
A. A written management representation that the payables balances are complete
B. Review invoices received after the end of the year-end to see if they relate to
goods received before the year-end
C. Review invoices received before the year-end and ensure they are correctly
recorded in the appropriate payables individual ledger account
D. Perform analytical review on the payables balances in comparison to last year
and ask management to explain any changes
48
QUESTIONS
94. A new audit junior is unclear why so much time is spent auditing payables and has
asked for clarification on this matter. Which of the following statements are reasons
for carrying out a payables audit?
(1) The directors have prepared the financial statements of the company correctly
(2) The auditor has a legal duty to audit payables in all companies
(3) To ensure management have not manipulated profit to obtain a higher bonus
(4) To ensure that all related party transactions are identified and correctly disclosed
in the financial statements
A. 1 and 4
B. 2 and 4
C. 1 and 3
D. 2 and 3
95. A review of the ageing of balances on the payables ledger has identified a balance
over 6 months old. Which of the following is the most likely reason for this balance
remaining unpaid?
A. A lack of cash to pay the supplier
B. An accounting error with the supplier invoice being posted to the wrong
payables account in the payables ledger
C. A dispute with the supplier regarding the quality or quantity of goods supplied
D. The supplier is in liquidation and so cannot chase Luria Co for payment of the debt
49
AUDIT AND ASSURANCE
97. Which of the following correctly summarises the effect of not providing depreciation
on the new building in Malcor?
A. Profit before tax is materially overstated and total assets are materially overstated
B. Profit before tax is not materially overstated and total assets are
materially overstated
C. Profit before tax is materially overstated and total assets are not
materially overstated
D. Profit before tax is not materially overstated and total assets are not
materially overstated
98. The auditor will produce a schedule or proposed adjustments to the financial
statements at the end of the audit based on the results of audit procedures carried
out. What will be included in this schedule?
A. All errors found during the audit
B. Only material errors found during the audit
C. Material and immaterial errors found during the audit
D. Only immaterial errors found during the audit (material errors being
automatically adjusted by the client)
50
QUESTIONS
99. The schedule of proposed adjustments shows a list of errors that are immaterially
individual but material in total. If the FD of Malcor refuses to amend the financial
statements for these errors, what will be response of the auditor in the audit report?
A. Unmodified and unqualified report
B. Modified report with a “Material Uncertainty Relating to Going Concern” paragraph
C. Modified report with a qualified opinion “except for” as the misstatement is
material but not pervasive
D. Modified report with a qualified opinion “adverse” as the misstatements are
material and pervasive as there is more than one adjustment to make
100. The auditor of Malcor has identified the following points when completing the audit of
the company. Which of these points individually will result in a modified audit opinion?
(1) A number of immaterial transactions with a director have not been disclosed in
the financial statements
(2) Inventory has been valued on a FIFO basis but inventory overall is immaterial to
the financial statements
(3) The company relies completely on cash sales although audit procedures did not
identify any errors in the control systems
(4) Lack of depreciation on the new building turns the company’s profit for the year
into a small loss
A. (1) and (4)
B. (3) and (4)
C. (2) and (3)
D. (1) and (2)
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AUDIT AND ASSURANCE
Carnation Co
The difference in the balance is due to an invoice which is under dispute due to faulty
goods which were returned on 29 June 2020.
Lily Co
The difference in the balance is due to the supplier statement showing an invoice
dated 28 June 2020 for $70,000 which was not recorded in the financial statements
until after the year end. The payables clerk has advised the audit team that the
invoice was not received until 2 July 2020.
101. The audit manager has asked you to review the full list of trade payables and select
balances on which supplier statement reconciliations will be performed.
Which of the following items should you select for testing?
1. Suppliers with material balances at the year end
2. Suppliers which have a high volume of business with Poppy Co
3. Major suppliers with nil balances at the year end
4. Major suppliers where the statement agrees to the ledger
A. 1 only
B. 1, 2 and 3 only
C. 2 and 4 only
D. 1, 2, 3 and 4
52
QUESTIONS
102. Which of the following audit procedures should be performed in relation to the
balance with Lily Co to determine if the payables balance is understated?
A. Inspect the goods received note to determine when the goods were received
B. Inspect the purchase order to confirm it is dated before the year end
C. Review the post year-end cashbook for evidence of payment of the invoice
D. Send a confirmation request to Lily Co to confirm the outstanding balance
103. Which of the following audit procedures should be carried out to confirm the
balance owing to Carnation Co?
1. Review post year-end credit notes for evidence of acceptance of return
2. Inspect pre year-end goods returned note in respect of the items sent back
to the supplier
3. Inspect post year-end cash book for evidence that the amount has been settled
A. 1, 2 and 3
B. 1 and 3 only
C. 1 and 2 only
D. 2 and 3 only
104. The audit manager has asked you to review the results of some statistical sampling
testing, which resulted in 20% of the payables balance being tested.
The testing results indicate that there is a $45,000 error in the sample: $20,000 which is
due to invoices not being recorded in the correct period as a result of weak controls and
additionally there is a one-off error of $25,000 which was made by a temporary clerk.
What would be an appropriate course of action on the basis of these results?
A. The error is immaterial and therefore no further work is required
B. The effect of the control error should be projected across the whole population
C. Poppy Co should be asked to adjust the payables figure by $45,000
D. A different sample should be selected as these results are not reflective of
the population
105. To help improve audit efficiency, Viola & Co is considering introducing the use of
computer assisted audit techniques (CAATs) for some audits. You have been asked to
consider how CAATs could be used during the audit of Poppy Co.
Which of the following is an example of using test data for trade payables testing?
A. Selecting a sample of supplier balances for testing using monetary unit sampling
B. Recalculating the ageing of trade payables to identify balances which may
be in dispute
C. Calculation of trade payables days to use in analytical procedures
D. Inputting dummy purchase invoices into the client system to see if
processed correctly
53
AUDIT AND ASSURANCE
107. If, after the financial statements have been issued, Blenkin & Co becomes aware of
a fact which may have caused its report to be amended, the firm should consider
several possible actions.
Which of the following are appropriate actions for Blenkin & Co to take?
1. Discuss the matter with management and, where appropriate, those charged
with governance
2. Obtain a written representation from management
3. Consider whether the firm should resign from the engagement
4. Enquire how management intends to address the matter in the financial
statements where appropriate
A. 1 and 2
B. 1 and 4
C. 2 and 3
D. 3 and 4
54
QUESTIONS
108. Which of the following audit procedures should be performed to form a conclusion
as to whether the financial statements require amendment in relation to the unfair
dismissal claim?
1. Inspect relevant correspondence with Sampson Co’s lawyers
2. Write to the finance director to confirm the claim and level of damages
3. Review the post year-end cash book for evidence of payments to the finance director
4. Request that management confirm their views in a written representation
A. 1, 2 and 3
B. 1, 2 and 4
C. 1, 3 and 4
D. 2, 3 and 4
109. You are drafting the auditor’s report for Sampson Co and the audit engagement
partner has reminded you that the report will need to reflect the requirements of ISA
701 Communicating Key Audit Matters in the Independent Auditor’s Report.
According to ISA 701, which of the following should be included in the ‘Key Audit
Matters’ paragraph in the auditor’s report?
A. Matters which required significant auditor attention
B. Matters which result in a modification to the audit opinion
C. All matters which were communicated to those charged with governance
D. All matters which are considered to be material to the financial statements
110. Which of the following audit opinions will be issued if the unfair dismissal case is
NOT adjusted for or disclosed within the financial statements?
A. A qualified audit opinion as the financial statements are materially misstated
B. A qualified audit opinion as the auditor is unable to obtain sufficient
appropriate evidence
C. An unmodified opinion with an emphasis of matter paragraph
D. An unmodified audit opinion
55
AUDIT AND ASSURANCE
Sycamore & Co has identified that the current year fees to be received from Fir Co for
audit and other services will represent 16% of the firm’s total fee income and totalled
15·5% in the prior year. The audit engagement partner has asked you to consider
what can be done in relation to this self-interest threat.
111. In relation to the composition of the current audit team, which of the following
correctly identifies the fundamental principle which is at risk and provides an
appropriate safeguard?
112. Which of the following identifies the threat which could arise as a result of the
finance director’s previous employment at Sycamore & Co and recommends an
appropriate safeguard?
A. A self-review threat; review the work performed by the previous audit manager
B. A familiarity threat; a different audit manager should be appointed
C. A self-review threat; change the existing audit plan
D. A familiarity threat; the firm should resign from the engagement
56
QUESTIONS
113. Ignoring the potential effect on total fee levels, which of the following options
correctly identifies the threats to independence from providing the above non-
audit services?
114. Which of the following safeguards would NOT be relevant in mitigating the threat
identified in relation to fees?
A. Disclosure to those charged with governance that fees from Fir Co represent
more than 15% of Sycamore & Co’s total fee income
B. A pre-issuance review to be conducted by an external accountant
C. The use of separate teams to provide the audit and non-audit services
D. A post-issuance review to be conducted by an external accountant or
regulatory body
115. During the course of the audit of Fir Co, a suspicious cash transfer has been
identified. The audit team has reported this to the relevant firm representative as a
potential money-laundering transaction.
Which of the following statements is true regarding the confidentiality of
this information?
A. Details of the transaction can only be disclosed with the permission of Fir Co
B. If there is a legal requirement to report money-laundering, this overrides the
principle of confidentiality
C. Sycamore & Co is not permitted to disclose details of the suspicious transaction
as the information has been obtained during the course of the audit
D. In order to maintain confidentiality, Sycamore & Co should report their
concerns anonymously
(30 marks)
57
AUDIT AND ASSURANCE
58
QUESTIONS
2. Brampton Co
(a) Explain the difference between the interim audit and the final audit. (4 marks)
59
AUDIT AND ASSURANCE
Note: The total marks will be split equally between each part. (6 marks)
(20 marks)
60
QUESTIONS
Note: The total marks will be split equally between each part.
(10 marks)
5. Confidentiality and independence (June 2006)
(a) Explain the situations where an auditor may disclose confidential information
about a client. (8 marks)
(b) Assume the date is 3rd June 2020.
You are an audit manager in McKay & Co, a firm of Chartered Certified
Accountants. You are preparing the engagement letter for the audit of Ancients,
a public limited liability company, for the year-ending 30 June 2020.
Ancients has grown rapidly over the past few years, and is now one of your
firm’s most important clients. Ancients has been an audit client for eight years
and McKay & Co has provided audit, taxation and management consultancy
advice during this time. The client has been satisfied with the services provided,
although the taxation fee for the period to 31 December 2019 remains unpaid.
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AUDIT AND ASSURANCE
Audit personnel available for this year’s audit are most of the staff from last year,
including Mr Grace, an audit partner and Mr Jones, an audit senior. Mr Grace
has been the audit partner since Ancients became an audit client. You are aware
that Allyson Grace, the daughter of Mr Grace, has recently been appointed the
financial director at Ancients.
To celebrate her new appointment, Allyson has suggested taking all of the audit
staff out to an expensive restaurant prior to the start of the audit work for this year.
Required:
Identify and explain the risks to independence arising in carrying out your audit
of Ancients for the year-ending 30 June 2020, and suggest ways of mitigating
each of the risks you identify. (12 marks)
(20 marks)
6. LV Fones Co
(a) State the FIVE threats contained within ACCA’s Code of Ethics and Conduct and for
each threat list ONE example of a circumstance that may create the threat. (5 marks)
62
QUESTIONS
Required:
(b) Explain the ethical threats which may affect the independence of Jones & Co’s
audit of LV Fones Co; and (5 marks)
(c) For each threat explain how it might be avoided. (5 marks)
(d) Describe the steps an audit firm should perform prior to accepting a new audit
engagement. (5 marks)
(20 marks)
7. NAB & Co (June 2011)
You are an audit manager in NAB & Co, a large audit firm which specialises in the
audit of retailers. The firm currently audits Goofy Co, a food retailer, but Goofy Co’s
main competitor, Mickey Co, has approached the audit firm to act as auditors. Both
companies are highly competitive and Goofy Co is concerned that if NAB & Co audits
both companies then confidential information could pass across to Mickey Co.
Required:
(a) Explain the safeguards that your firm should implement to ensure that this
conflict of interest is properly managed. (4 marks)
Goofy Co’s year end is 31 December, which is traditionally a busy time for NAB & Co.
Goofy Co currently has an internal audit department of five employees but they have
struggled to undertake the variety and extent of work required by the company,
hence Goofy Co is considering whether to recruit to expand the department or to
outsource the internal audit department. If outsourced, Goofy Co would require a
team to undertake monthly visits to test controls at the various shops across the
country, and to perform ad hoc operational reviews at shops and head office.
Goofy Co is considering using NAB & Co to provide the internal audit services as well
as remain as external auditors.
Required:
(b) Discuss the advantages and disadvantages to both Goofy Co and NAB & Co of
outsourcing their internal audit department. (10 marks)
(c) The audit engagement partner for Goofy Co has been in place for approximately
six years and her son has just accepted a job offer from Goofy Co as a sales
manager; this role would entitle him to shares in Goofy Co as part of his
remuneration package. If NAB & Co is appointed as internal as well as external
auditors, then Goofy Co has suggested that the external audit fee should be
renegotiated with at least 20% of the fee being based on the profit after tax of the
company as they feel that this will align the interests of NAB & Co and Goofy Co.
Required:
From the information in (c) explain the ethical threats which may affect the
63
AUDIT AND ASSURANCE
independence of NAB & Co in respect of the audit of Goofy Co, and for each
threat explain how it may be reduced. (6 marks)
(20 marks)
8. Serena VDW Co (December 2011)
(a) Explain what is meant by ‘corporate governance’ and why it is important.
(3 marks)
(b) Serena VDW Co has been trading for over 20 years and obtained a listing on a stock
exchange five years ago. It provides specialist training in accounting and finance.
The listing rules of the stock exchange require compliance with corporate
governance principles, and the directors are fairly confident that they are
following best practice in relation to this. However, they have recently received
an email from a significant shareholder, who is concerned that Serena VDW Co
does not comply with corporate governance principles.
Serena VDW Co’s board is comprised of six directors; there are four executives who
originally set up the company and two non-executive directors who joined Serena
VDW Co just prior to the listing. Each director has a specific area of responsibility
and only the finance director reviews the financial statements and budgets.
The chief executive officer, Daniel Brown, set up the audit committee and he sits
on this sub-committee along with the finance director and the non-executive
directors. As the board is relatively small, and to save costs, Daniel Brown has
recently taken on the role of chairman of the board. It is the finance director and
the chairman who make decisions on the appointment and remuneration of the
external auditors. Again, to save costs, no internal audit function has been set up
to monitor internal controls.
Since the company listed, the directors have remained unchanged and none have
been subject to re-election by shareholders.
Required:
Describe SIX corporate governance weaknesses faced by Serena VDW Co and
provide recommendations to address each weakness, to ensure compliance with
corporate governance principles. (12 marks)
(c) Explain the auditor’s ethical responsibilities with regard to client confidentiality
and when they have an:
(i) obligatory responsibility; and
(ii) voluntary responsibility to disclose client information. (5 marks)
(20 marks)
64
QUESTIONS
You are the audit manager of Currant & Co and you are planning the audit of Orange
Financials Co (Orange), who specialise in the provision of loans and financial advice to
individuals and companies. Currant & Co has audited Orange for many years.
The directors are planning to list Orange on a stock exchange within the next few
months and have asked if the engagement partner can attend the meetings with
potential investors. In addition, as the finance director of Orange is likely to be
quite busy with the listing, he has asked if Currant & Co can produce the financial
statements for the current year.
During the year, the assistant finance director of Orange left and joined Currant & Co
as a partner. It has been suggested that due to his familiarity with Orange, he should
be appointed to provide an independent partner review for the audit.
Once Orange obtains its stock exchange listing it will require several assignments
to be undertaken, for example, obtaining advice about corporate governance best
practice. Currant & Co is very keen to be appointed to these engagements, however,
Orange has implied that in order to gain this work Currant & Co needs to complete
the external audit quickly and with minimal questions/issues.
The finance director has informed you that once the stock exchange listing has been
completed, he would like the engagement team to attend a weekend away at a
luxury hotel with his team, as a thank you for all their hard work. In addition, he has
offered a senior member of the engagement team a short-term loan at a significantly
reduced interest rate.
Required:
(b)
(i) Explain SIX ethical threats which may affect the independence of Currant &
Co’s audit of Orange Financials Co; and
(ii) For each threat explain how it might be reduced to an acceptable level.
(12 marks)
(c) Orange is aware that subsequent to the stock exchange listing it will need to
establish an audit committee and has asked for some advice in relation to this.
Required:
Explain the benefits to Orange of establishing an audit committee. (4 marks)
(20 marks)
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AUDIT AND ASSURANCE
(b) State FOUR matters that should be included within an audit engagement
letter. (2 marks)
(c)
(i) Identify and explain FIVE ethical risks which arise from the above actions of
Salt & Pepper & Co; and
(ii) For each ethical risk explain the steps which Salt & Pepper & Co should
adopt to reduce the risks arising.
Note: The total marks will be split equally between each part. (10 marks)
(20 marks)
66
QUESTIONS
67
AUDIT AND ASSURANCE
Required:
(a) Identify and explain TWO factors which would indicate that an engagement
letter for an existing audit client should be revised. (2 marks)
(b) List SIX matters which should be included within an audit engagement
letter. (3 marks)
(c) Your audit firm has just won a new audit client, Milky Way Technologies Co
(Milky Way), and you have been asked by the audit engagement partner to gain
an understanding about the new client as part of the planning process.
Required:
68
QUESTIONS
Required:
Explain FIVE audit risks, and the auditor’s response to each risk, in planning the audit
of Eagle Heating Co.
(10 marks)
14. Sunflower Stores Co (December 2012)
Sunflower Stores Co (Sunflower) operates 25 food supermarkets. The company’s year-
end is 31 December 2020. The audit manager and partner recently attended a planning
meeting with the finance director and have provided you with the planning notes below.
You are the audit senior, and this is your first year on this audit. In order to familiarise
yourself with Sunflower, the audit manager has asked you to undertake some
research in order to gain an understanding of Sunflower, so that you are able to assist
in the planning process. He has then asked that you identify relevant audit risks from
the notes below and also consider how the team should respond to these risks.
Sunflower has spent $1·6 million in refurbishing all of its supermarkets; as part of this
refurbishment programme their central warehouse has been extended and a smaller
warehouse, which was only occasionally used, has been disposed of at a profit. In
order to finance this refurbishment, a sum of $1·5 million was borrowed from the
bank. This is due to be repaid over five years.
The company will be performing a year-end inventory count at the central
warehouse as well as at all 25 supermarkets on 31 December. Inventory is valued at
selling price less an average profit margin as the finance director believes that this is
a close approximation to cost.
Prior to 2020, each of the supermarkets maintained their own financial records
and submitted returns monthly to head office. During 2020 all accounting records
have been centralised within head office. Therefore at the beginning of the
year, each supermarket’s opening balances were transferred into head office’s
accounting records. The increased workload at head office has led to some changes
in the finance department and in November 2020 the financial controller left. His
replacement will start in late December.
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AUDIT AND ASSURANCE
Required:
(a) List FIVE sources of information that would be of use in gaining an understanding
of Sunflower Stores Co, and for each source describe what you would expect to
obtain. (5 marks)
(b) Using the information provided, describe FIVE audit risks and explain the
auditor’s response to each risk in planning the audit of Sunflower Stores Co.
(10 marks)
(c) The finance director of Sunflower Stores Co is considering establishing an
internal audit department.
Required:
Describe the factors the finance director should consider before establishing an
internal audit department. (5 marks)
(20 marks)
15. Kangaroo Construction Co (June 2013)
(a) Explain the concepts of materiality and performance materiality in accordance
with ISA 320 Materiality in Planning and Performing an Audit. (5 marks)
You are the audit senior of Rhino & Co and you are planning the audit of Kangaroo
Construction Co (Kangaroo) for the year ended 31 March 2020. Kangaroo specialises
in building houses and provides a five-year building warranty to its customers. Your
audit manager has held a planning meeting with the finance director. He has provided
you with the following notes of his meeting and financial statement extracts:
Kangaroo has had a difficult year; house prices have fallen and, as a result, revenue
has dropped. In order to address this, management has offered significantly
extended credit terms to their customers. However, demand has fallen such that
there are still some completed houses in inventory where the selling price may be
below cost. During the year, whilst calculating depreciation, the directors extended
the useful lives of plant and machinery from three years to five years. This reduced
the annual depreciation charge.
The directors need to meet a target profit before interest and taxation of $0·5
million in order to be paid their annual bonus. In addition, to try and improve profits,
Kangaroo changed their main material supplier to a cheaper alternative. This has
resulted in some customers claiming on their building warranties for extensive
repairs. To help with operating cash flow, the directors borrowed $1 million from the
bank during the year. This is due for repayment at the end of 2020.
70
QUESTIONS
Draft Actual
2020 2019
$m $m
Revenue 12·5 15·0
Cost of sales (7·0) (8·0)
Gross profit 5·5 7·0
Operating expenses (5·0) (5·1)
Profit before interest and taxation 0·5 1·9
Inventory 1·9 1·4
Receivables 3·1 2·0
Cash 0.8 1·9
Trade payables 1·6 1·2
Loan 1·0 –
Required:
(b) Using the information above, calculate FIVE ratios, for BOTH years, which would
assist the audit senior in planning the audit.
(5 marks)
(c) Using the information provided and the ratios calculated, identify and describe
FIVE audit risks and explain the auditor’s response to each risk in planning the
audit of Kangaroo Construction Co.
(10 marks)
(20 marks)
16. Amethyst & Co (March/June 2016)
(a) Define audit risk and the components of audit risk. (5 marks)
You are an audit supervisor of Amethyst & Co and are currently planning the audit of
your client, Aquamarine Co (Aquamarine) which manufactures elevators. Its year end
is 31 July 2020 and the forecast profit before tax is $15·2 million.
The company undertakes continuous production in its factory, therefore at the year
end it is anticipated that work in progress will be approximately $950,000. In order to
improve the manufacturing process, Aquamarine placed an order in April for $720,000
of new plant and machinery; one third of this order was received in May with the
remainder expected to be delivered by the supplier in late July or early August.
At the beginning of the year, Aquamarine purchased a patent for $1·3 million which
gives them the exclusive right to manufacture specialised elevator equipment for five
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years. In order to finance this purchase, Aquamarine borrowed $1·2 million from the
bank which is repayable over five years.
In January 2020 Aquamarine outsourced its payroll processing to an external service
organisation, Coral Payrolls Co (Coral). Coral handles all elements of the payroll cycle
and sends monthly reports to Aquamarine detailing the payroll costs. Aquamarine
ran its own payroll until 31 December 2019, at which point the records were
transferred over to Coral.
The company has a policy of revaluing land and buildings and the finance director
has announced that all land and buildings will be revalued at the year end. During a
review of the management accounts for the month of May 2020, you have noticed that
receivables have increased significantly on the previous year end and against May 2019.
The finance director has informed you that the company is planning to make
approximately 65 employees redundant after the year end. No decision has been
made as to when this will be announced, but it is likely to be prior to the year end.
Required:
(b) Describe SIX audit risks, and explain the auditor’s response to each risk, in
planning the audit of Aquamarine Co. (12 marks)
(c) Explain the additional factors Amethyst & Co should consider during the audit in
relation to Aquamarine Co’s use of the payroll service organisation. (3 marks)
(20 marks)
17. Sitia Sparkle Co (September 2016)
(a) ISA 300 Planning an Audit of Financial Statements provides guidance to assist
auditors in planning an audit.
Required:
Explain the benefits of audit planning. (4 marks)
You are an audit supervisor of Chania & Co and are planning the audit of your client,
Sitia Sparkle Co which manufactures cleaning products. Its year end was 31 July 20X0
and the draft profit before tax is $33·6 million. You are supervising a large audit team
for the first time and will have specific responsibility for supervising and reviewing
the work of the audit assistants in your team.
Sitia Sparkle Co purchases most of its raw materials from suppliers in Africa and
these goods are shipped directly to the company’s warehouse and the goods are
usually in transit for up to three weeks. The company has incurred $1·3 million of
expenditure on developing a new range of cleaning products which are due to be
launched into the market place in November 20X0. In September 20X9, Sitia Sparkle
Co also invested $0·9 million in a complex piece of plant and machinery as part of the
development process. The full amount has been capitalised and this cost includes the
purchase price, installation costs and training costs.
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QUESTIONS
This year, the bonus scheme for senior management and directors has been changed
so that rather than focusing on profits, it is instead based on the value of year-end
total assets. In previous years an allowance for receivables, made up of specific
balances, which equalled almost 1% of trade receivables was maintained. However,
the finance director feels that this is excessive and unnecessary and has therefore not
included it for 20X0 and has credited the opening balance to the profit or loss account.
A new general ledger system was introduced in May 20X0; the finance director
has stated that the data was transferred and the old and new systems were run in
parallel until the end of August 20X0. As a result of the additional workload on the
finance team, a number of control account reconciliations were not completed as at
31 July 20X0, including the bank reconciliation. The finance director is comfortable
with this as these reconciliations were completed successfully for both June and
August 20X0. In addition, the year-end close down of the purchase ledger was
undertaken on 8 August 20X0.
Required:
(b) Describe SIX audit risks, and explain the auditor’s response to each risk, in
planning the audit of Sitia Sparkle Co.
Note: Prepare your answer using two columns headed Audit risk and Auditor’s
response respectively. (12 marks)
(c) In line with ISA 220 Quality Control for an Audit of Financial Statements, describe
the audit supervisor’s responsibilities in relation to supervising and reviewing the
audit assistants’ work during the audit of Sitia Sparkle Co. (4 marks)
(20 marks)
18. Hurling Co (March/June 2017)
(a) Define audit risk and the components of audit risk. (4 marks)
You are an audit supervisor of Caving & Co and you are planning the audit of
Hurling Co, a listed company, for the year ending 31 March 20X0. The company
manufactures computer components and forecast profit before tax is $33·6m and
total assets are $79·3m.
Hurling Co distributes its products through wholesalers as well as via its own
website. The website was upgraded during the year at a cost of $1·1m. Additionally,
the company entered into a transaction in February to purchase a new warehouse
which will cost $3·2m. Hurling Co’s legal advisers are working to ensure that the legal
process will be completed by the year end. The company issued $5m of irredeemable
preference shares to finance the warehouse purchase.
During the year the finance director has increased the useful economic lives of
fixtures and fittings from three to four years as he felt this was a more appropriate
period. The finance director has informed the engagement partner that a revised
credit period has been agreed with one of its wholesale customers, as they have
been experiencing difficulties with repaying the balance of $1·2m owing to Hurling
Co. In January 20X0, Hurling Co introduced a new bonus based on sales targets for
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its sales staff. This has resulted in a significant number of new wholesale customer
accounts being opened by sales staff. The new customers have been given favourable
credit terms as an introductory offer, provided goods are purchased within a two-
month period. As a result, revenue has increased by 5% on the prior year.
The company has launched several new products this year and all but one of these new
launches have been successful. Feedback on product Luge, launched four months ago,
has been mixed, and the company has just received notice from one of their customers,
Petanque Co, of intended legal action. They are alleging the product sold to them was
faulty, resulting in a significant loss of information and an ongoing detrimental impact
on profits. As a precaution, sales of the Luge product have been halted and a product
recall has been initiated for any Luge products sold in the last four months.
The finance director is keen to announce the company’s financial results to the stock
market earlier than last year and in order to facilitate this, he has asked if the audit
could be completed in a shorter timescale. In addition, the company is intending to
propose a final dividend once the financial statements are finalised.
Hurling Co’s finance director has informed the audit engagement partner that one
of the company’s non-executive directors (NEDs) has just resigned, and he has
enquired if the partners at Caving & Co can help Hurling Co in recruiting a new NED.
Specifically he has requested the engagement quality control reviewer, who was
until last year the audit engagement partner on Hurling Co, assist the company in this
recruitment. Caving & Co also provides taxation services for Hurling Co in the form of
tax return preparation along with some tax planning advice. The finance director has
recommended to the audit committee of Hurling Co that this year’s audit fee should
be based on the company’s profit before tax. At today’s date, 20% of last year’s audit
fee is still outstanding and was due to be paid three months ago.
Required:
(a) Describe EIGHT audit risks, and explain the auditor’s response to each risk, in
planning the audit of Hurling Co.
Note: Prepare your answer using two columns headed Audit risk and Auditor’s
response respectively. (16 marks)
(b)
(i) Identify and explain FIVE ethical threats which may affect the
independence of Caving & Co’s audit of Hurling Co; and
(ii) For each threat, suggest a safeguard to reduce the risk to an acceptable level.
Note: The total marks will be split equally between each part. Prepare your
answer using two columns headed Ethical threat and Possible Safeguard
respectively. (10 marks)
(30 marks)
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Required:
(a) Describe the process Cupid & Co should have undertaken to assess whether
the PRECONDITIONS for an audit were present when accepting the audit of
Prancer Construction Co. (3 marks)
(b) Identify THREE main areas, other than audit risks, which should be included
within the audit strategy document for Prancer Construction Co, and for each
area provide an example relevant to the audit.
(3 marks)
(c) Using all the information provided describe SEVEN audit risks, and explain the
auditor’s response to each risk, in planning the audit of Prancer Construction Co.
Note: Prepare your answer using two columns headed Audit risk and Auditor’s
response respectively.
(14 marks)
(20 marks)
20. Loganberry & Co (March/June 2018)
You are an audit senior of Loganberry & Co and are planning the audit of Blackberry
Co for the year ending 31 March 20X8. The company is a manufacturer of portable
music players and your audit manager has already had a planning meeting with the
finance director. Forecast revenue is $68·6m and profit before tax is $4·2m.
She has provided you with the following notes of the meeting:
Planning meeting notes
Inventory is valued at the lower of cost and net realisable value. Cost is made up
of the purchase price of raw materials and costs of conversion, including labour,
production and general overheads. Inventory is held in three warehouses across the
country. The company plans to conduct full inventory counts at the warehouses on
2, 3 and 4 April, and any necessary adjustments will be made to reflect post year-end
movements of inventory. The internal audit team will attend the counts.
During the year, Blackberry Co paid $1·1m to purchase a patent which allows the
company the exclusive right for three years to customise their portable music players
to gain a competitive advantage in their industry. The $1·1m has been expensed
in the current year statement of profit or loss. In order to finance this purchase,
Blackberry Co raised $1·2m through issuing shares at a premium.
In November 20X7, it was discovered that a significant teeming and lading fraud
had been carried out by four members of the sales ledger department who had
colluded. They had stolen funds from wholesale customer receipts and then to cover
this, they allocated later customer receipts against the older receivables. These
employees were all reported to the police and subsequently dismissed. As a result of
the vacancies in the sales ledger department, Blackberry Co decided to outsource its
sales ledger processing to an external service organisation. This service organisation
handles all elements of the sales ledger cycle, including sales invoicing and chasing
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QUESTIONS
Note: Prepare your answer using two columns headed Audit risk and Auditor’s
response respectively. (16 marks)
(20 marks)
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(10 marks)
22. SouthLea (Pilot Paper 2006)
SouthLea Co is a construction company (building houses, offices and hotels) employing
a large number of workers on various construction sites. The internal audit department
of SouthLea Co is currently reviewing cash wages systems within the company.
The following information is available concerning the wages systems:
• Hours worked are recorded using a clocking in/out system. On arriving for work
and at the end of each day’s work, each worker enters their unique employee
number on a keypad.
• Workers on each site are controlled by a foreman. The foreman has a record of
all employee numbers and can issue temporary numbers for new employees.
• Any overtime is calculated by the computerised wages system and added to the
standard pay.
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QUESTIONS
• The two staff in the wages department make amendments to the computerised
wages system in respect of employee holidays, illness, as well as setting up and
maintaining all employee records.
• The computerised wages system calculates deductions from gross pay, such
as employee taxes, and net pay. Finally a list of net cash payments for each
employee is produced.
• Cash is delivered to the wages office by secure courier.
• The two staff place cash into wages packets for each employee along with a
handwritten note of gross pay, deductions and net pay. The packets are given to
the foreman for distribution to the individual employees.
Required:
(a) Identify and explain FIVE weaknesses in SouthLea Co’s system of internal
control over the wages system that could lead to mis-statements in the financial
statements; (5 marks)
(b) For each weakness, suggest an internal control to overcome that weakness. (5 marks)
(10 marks)
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(20 marks)
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QUESTIONS
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AUDIT AND ASSURANCE
You are the audit senior responsible for the audit of Have A Bite Co, a company that
runs a chain of fast food restaurants. You are aware that a major risk of their sector is
that poor food quality might result in damage claims by customers.
You had satisfied yourself at the interim audit that the company’s control risk as
regards purchases of food and its preparation in the kitchen was low. However,
during your final audit it comes to your attention that one month before the year-
end, a customer has sued the company for personal injury caused by food poisoning,
claiming an amount of $200,000 in compensation. This amount is material to the
stated profit of the company, but management believes that it has good defences
against the claim.
Required:
(b) In respect of the potential claim state THREE items of evidence you should obtain
and explain how they might enable you to form a conclusion on the likelihood of
the claim being successful. (6 marks)
(c)
(i) State TWO controls that the company should have in place to reduce the risk
associated with purchases of food and its preparation in the kitchen; and
(ii) State TWO audit procedures you should carry out during controls testing to
satisfy yourself that control risk in this area is low.
(4 marks)
Following your audit you have concluded that there is a possibility, but not
a probability, that the claim will be successful. However, management have
decided not to make a provision or disclosure in the financial statements in
respect of this matter.
Required:
(d) Describe how the matter should be reported in the financial statements and
explain the effect on your audit report. (4 marks)
(20 marks)
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QUESTIONS
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Required:
(b) Identify SIX STRENGTHS in Letham’s control environment in respect of non-
current assets and explain why they may reduce control risk. (12 marks)
(c) As part of your work as external auditor you are reviewing the non-current
assets audit programme of the internal auditors and notice that the basis of their
testing is a representative sample of purchase invoices. They use this to test
entries in the non-current assets register and the updating movements on the
annual budget.
Required:
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QUESTIONS
It is not possible to order goods from other branches of stores as all ordering must
be undertaken through the purchasing manager. If a customer requests an item of
clothing, which is unavailable in a particular store, then the customer is provided
with other branch telephone numbers or recommended to try the company website.
Goods received and invoicing
To speed up the ordering to receipt of goods cycle, the goods are delivered directly
from the suppliers to the individual stores. On receipt of goods the quantities
received are checked by a sales assistant against the supplier’s delivery note, and
then the assistant produces a goods received note (GRN). This is done at quiet times
of the day so as to maximise sales. The checked GRNs are sent to head office for
matching with purchase invoices.
As purchase invoices are received they are manually matched to GRNs from the
stores, this can be a very time consuming process as some suppliers may have
delivered to over 500 stores. Once the invoice has been agreed then it is sent to the
purchasing director for authorisation. It is at this stage that the invoice is entered
onto the purchase ledger.
Required:
(a) As the external auditors of Greystone Co, write a report to management in
respect of the purchasing system which:
(i) Identifies and explains FOUR deficiencies in that system;
(ii) Explains the possible implication of each deficiency;
(iii) Provides a recommendation to address each deficiency. A covering
letter is required.
Note: Up to two marks will be awarded within this requirement for presentation.
(14 marks)
(b) Describe substantive procedures the auditor should perform on the year-end
trade payables of Greystone Co. (6 marks)
(20 marks)
28. Tinkerbell Toys Co (June 2011)
Tinkerbell Toys Co (Tinkerbell) is a manufacturer of children’s building block toys; they
have been trading for over 35 years and they sell to a wide variety of customers including
large and small toy retailers across the country. The company’s year-end is 31 May 2020.
The company has a large manufacturing plant, four large warehouses and a head
office. Upon manufacture, the toys are stored in one of the warehouses until they are
despatched to customers. The company does not have an internal audit department.
Sales ordering, goods despatched and invoicing
Each customer has a unique customer account number and this is used to enter sales
orders when they are received in writing from customers. The orders are entered by
an order clerk and the system automatically checks that the goods are available and
that the order will not take the customer over their credit limit. For new customers, a
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sales manager completes a credit application; this is checked through a credit agency
and a credit limit entered into the system by the credit controller. The company has a
price list, which is updated twice a year. Larger customers are entitled to a discount;
this is agreed by the sales director and set up within the customer master file.
Once the order is entered an acceptance is automatically sent to the customer by
mail/email confirming the goods ordered and a likely despatch date. The order is
then sorted by address of customer. The warehouse closest to the customer receives
the order electronically and a despatch list and sequentially numbered goods
despatch notes (GDNs) are automatically generated. The warehouse team pack the
goods from the despatch list and, before they are sent out, a second member of the
team double checks the despatch list to the GDN, which accompanies the goods.
Once despatched, a copy of the GDN is sent to the accounts team at head office and
a sequentially numbered sales invoice is raised and checked to the GDN. Periodically
a computer sequence check is performed for any missing sales invoice numbers.
Required:
(a) Recommend SIX tests of controls the auditor would normally carry out on the
sales system of Tinkerbell, and explain the objective for each test. (12 marks)
(b) Describe substantive procedures the auditor should perform to confirm
Tinkerbell’s year-end receivables balance. (8 marks)
(20 marks)
29. Oregano Co (December 2013)
You are a member of the recently formed internal audit department of Oregano
Co (Oregano). The company manufactures tinned fruit and vegetables which are
supplied to large and small food retailers. Management and those charged with
governance of Oregano have concerns about the effectiveness of their sales and
despatch system and have asked internal audit to document and review the system.
Sales and despatch system
Sales orders are mainly placed through Oregano’s website but some are made
via telephone. Online orders are automatically checked against inventory records
for availability; telephone orders, however, are checked manually by order clerks
after the call. A follow-up call is usually made to customers if there is insufficient
inventory. When taking telephone orders, clerks note down the details on plain
paper and afterwards they complete a three part pre-printed order form. These
order forms are not sequentially numbered and are sent manually to both despatch
and the accounts department.
As the company is expanding, customers are able to place online orders which will
exceed their agreed credit limit by 10%. Online orders are automatically forwarded
to the despatch and accounts department.
A daily pick list is printed by the despatch department and this is used by the
warehouse team to despatch goods. The goods are accompanied by a despatch note
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QUESTIONS
and all customers are required to sign a copy of this. On return, the signed despatch
notes are given to the warehouse team to file.
The sales quantities are entered from the despatch notes and the authorised sales
prices are generated by the invoicing system. If a discount has been given, this has to
be manually entered by the sales clerk onto the invoice. Due to the expansion of the
company, and as there is a large number of sale invoices, extra accounts staff have
been asked to help out temporarily with producing the sales invoices. Normally it is
only two sales clerks who produce the sales invoices.
Required:
(a) Describe TWO methods for documenting the sales and despatch system; and for
each explain an advantage and a disadvantage of using this method. (6 marks)
(b) List TWO control objectives of Oregano Co’s sales and despatch system. (2 marks)
(c) Identify and explain SIX deficiencies in Oregano Co’s sales and despatch system
and provide a recommendation to address each of these deficiencies. (12 marks)
(20 marks)
30. Scarlet & Co (September/December 2015)
You are an audit senior of Scarlet & Co and are in the process of reviewing the
systems testing completed on the payroll cycle of Bronze Industries Co (Bronze), as
well as preparing the audit programmes for the final audit.
Bronze operate several chemical processing factories across the country, it
manufactures 24 hours a day, seven days a week and employees work a standard
shift of eight hours and are paid for hours worked at an hourly rate. Factory
employees are paid weekly, with approximately 80% being paid by bank transfer and
20% in cash; the different payment methods are due to employee preferences and
Bronze has no plans to change these methods. The administration and sales teams
are paid monthly by bank transfer.
Factory staff are each issued a sequentially numbered clock card which details their
employee number and name. Employees swipe their cards at the beginning and end
of the eight-hour shift and this process is not supervised. During the shift employees
are entitled to a 30-minute paid break and employees do not need to clock out
to access the dining area. Clock card data links into the payroll system, which
automatically calculates gross and net pay along with any statutory deductions. The
payroll supervisor for each payment run checks on a sample basis some of these
calculations to ensure the system is operating effectively.
Bronze has a human resources department which is responsible for setting up new
permanent employees and leavers. Appointments of temporary staff are made
by factory production supervisors. Occasionally overtime is required of factory
staff, usually to fill gaps caused by staff holidays. Overtime reports which detail the
amount of overtime worked are sent out quarterly by the payroll department to
production supervisors for their review.
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To encourage staff to attend work on time for all shifts Bronze pays a discretionary
bonus every six months to factory staff; the production supervisors determine the
amounts to be paid. This is communicated in writing by the production supervisors
to the payroll department and the bonus is input by a clerk into the system.
For employees paid by bank transfer, the payroll manager reviews the list of the
payments and agrees to the payroll records prior to authorising the bank payment. If
any changes are required, the payroll manager amends the records. For employees
paid in cash, the pay packets are prepared in the payroll department and a clerk
distributes them to employees; as she knows most of these individuals she does not
require proof of identity.
Required:
(a) Identify and explain FIVE internal control STRENGTHS in Bronze Industries Co's
payroll system. (5 marks)
(b) Identify and explain SIX internal control DEFICIENCIES in Bronze Industries Co's
payroll system and provide a RECOMMENDATION to address each of these
deficiencies. (12 marks)
(c) Describe substantive ANALYTICAL PROCEDURES you should perform to confirm
Bronze Industries Co's payroll expense. (3 marks)
(20 marks)
31. Hessonite & Co (March/June 2016)
You are an audit senior of Hessonite & Co and are in the process of reviewing the
inventory system documentation for your audit client, Lemon Quartz Co (Quartz)
which manufactures computer equipment. The company’s factory and warehouse
are based on one large site, and their year end is 30 June 2020. Quartz is planning to
undertake a full inventory count at the year end of its raw materials, work in progress
and finished goods and you will be attending this count. In preparation you have been
reviewing the inventory count instructions for finished goods provided by Quartz.
The count will be undertaken by 15 teams of two counters from the warehouse
department with Quartz’s financial controller providing overall supervision. Each
team of two is allocated a number of bays within the warehouse to count and they
are provided with sequentially numbered inventory sheets which contain product
codes and quantities extracted from the inventory records. The counters move
through each allocated bay counting the inventory and confirming that it agrees with
the inventory sheets. Where a discrepancy is found, they note this on the sheet.
The warehouse is large and approximately 10% of the bays have been rented out to
third parties with similar operations; these are scattered throughout the warehouse.
For completeness, the counters have been asked to count the inventory for all
bays noting the third party inventories on separate blank inventory sheets, and the
finance department will make any necessary adjustments.
Some of Quartz’s finished goods are high in value and are stored in a locked area of
the warehouse and all the counting teams will be given the code to access this area.
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QUESTIONS
There will be no despatches of inventory during the count and it is not anticipated
that there will be any deliveries from suppliers.
Each area is counted once by the allocated team; the sheets are completed in ink,
signed by the team and returned after each bay is counted. As no two teams are
allocated the same bays, there will be no need to flag that an area has been counted.
On completion of the count, the financial controller will confirm with each team that
they have returned their inventory sheets.
Required:
(a) In respect of the inventory count procedures for Lemon Quartz Co:
(i) Identify and explain FIVE deficiencies;
(ii) Recommend a control to address each of these deficiencies; and
(iii) Describe a TEST OF CONTROL the external auditors would perform to
assess if each of these controls, if implemented, is operating effectively.
Note: The total marks will be split equally between each part.
(15 marks)
(b) Quartz’s finance director has asked your firm to undertake a non-audit
assurance engagement later in the year. The audit junior has not been involved
in such an assignment before and has asked you to explain what an assurance
engagement involves.
Required:
Explain the five elements of an assurance engagement. (5 marks)
(20 marks)
32. Heraklion Co (September 2016)
Heraklion Co is a manufacturer of footballs and is a new audit client for your
firm. You are an audit supervisor of Spinalonga & Co and are currently preparing
for the forthcoming interim and final audit for the year ending 31 October 20X0.
You are required to document and assess the sales system, recommend control
improvements to deal with a specific fraud issue as well as undertake substantive
testing of revenue.
Sales ordering, goods despatched and invoicing
Heraklion Co sells footballs to a range of large and small sports equipment retailers
in several countries. Sales are made through a network of sales staff employed by
Heraklion Co, but new customer leads are generated through a third party company.
Sales staff are responsible for assessing new customers’ creditworthiness and
proposing a credit limit which is then authorised by the sales director. The sales
staff have monthly sales targets and are able to use their discretion in granting sales
discounts up to a maximum of 10%. They then record any discount granted in the
customer master data file.
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The sales staff visit customer sites personally and orders are completed using a two-
part pre-printed order form. One copy is left with the customer and the other copy is
retained by the sales person. The sales order number is based on the sales person’s
own identification (ID) number.
The company markets itself on being able to despatch all orders within three working
days. Once the order is taken, the sales person emails the finance department and
warehouse despatch team with the customer ID and the sales order details and from
this a pick list is generated. Sequentially numbered goods despatched notes are
completed and filed in the warehouse.
Sequentially numbered invoices are generated using the pick lists for quantities and
the customer master data file for prices. Standard credit terms for customers are 30
days and on a monthly basis sales invoices which are over 90 days outstanding are
notified to the relevant sales person to chase payment directly with the customer.
Payroll fraud
The finance director, Montse Mirabelle, has informed you that a significant fraud
took place during the year in the payroll department. A number of fictitious
employees were set up on the payroll and wages were paid into one bank account.
This bank account belonged to two supervisors, who were married, and were
employed by Heraklion Co. One had sole responsibility for setting up new joiners in
the payroll system and the other processed and authorised bank transfer requests
for wages and supplier payments. These employees no longer work for the company
and Montse has asked the audit firm for recommendations on how to improve
controls in this area to prevent this type of fraud occurring again. Heraklion Co
operates a Human Resources department.
Required:
(a) Describe TWO methods for documenting the sales system, and for each explain
ONE advantage and ONE disadvantage of using this method. (6 marks)
(b) Identify and explain SEVEN deficiencies in the sales system of Heraklion Co and
provide a recommendation to address each of these deficiencies.
Note: Prepare your answer using two columns headed Control deficiency and Control
recommendation respectively. (14 marks)
(c) In relation to the payroll fraud, identify and explain THREE controls Heraklion Co
should implement to reduce the risk of this type of fraud occurring again and, for
each control, describe how it would mitigate the risk. (6 marks)
(d) Describe substantive procedures the auditor should perform to obtain sufficient
and appropriate audit evidence in relation to Heraklion Co’s revenue. (4 marks)
(30 marks)
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QUESTIONS
Control activities are the policies and procedures which help ensure that
management directives are carried out.
Required:
Describe FOUR different types of control activities and, for each type, provide an
example control a company may implement. (4 marks)
Equestrian Co manufactures smartphones and tablets. Its main customers are retailers
who then sell to the general public. The company’s manufacturing is spread across
five sites and goods are stored in its nine warehouses located across the country. You
are an audit supervisor of Baseball & Co and in preparation for the forthcoming audit
for the year ending 30 June 20X0, you are reviewing the following notes your audit
manager has provided you with in relation to the company’s internal controls.
Equestrian Co has a small internal audit (IA) department. During the year, IA started
a programme of physically verifying the company’s assets and comparing the results
to the non-current assets register, as this type of reconciliation had not occurred for
some time. To date only 15% of assets have had their existence confirmed as IA has
experienced significant staff shortages and several members of the current IA team
are new to Equestrian Co.
During the year, Equestrian Co conducted an extensive reorganisation of its
manufacturing process to improve efficiency. Due to the significant number of
employee changes required, the human resources department (HR) has been very
busy and to ease their workload during this period, the payroll department has
assisted by setting up any new employees who have joined the company. In January
20X0, the wage rate paid to employees was increased by the HR director and he
notified payroll by emailing the payroll supervisor.
A new sales ledger system was introduced in May 20X0 and will continue to be run
in parallel with the old system until IA has completed its checks between the two
systems. New customers obtained by the sales team are required to undergo a full
credit check; on the basis of this, a credit limit is proposed by sales staff and approved
by the sales director and these credit limits remain static in the sales system.
Monthly perpetual inventory counts are undertaken at each of the nine warehouses,
as a full year-end inventory count is too disruptive for the company. High value items
are stored in a secure area in each warehouse. Access is via a four digit code, which
for convenience is the same across all sites. Due to the company’s reorganisation
programme, some of the monthly inventory counts were not performed.
Bank reconciliations are undertaken monthly by an accounts clerk and details of all
reconciling items are included. Where the sum of the reconciling items is significant,
the reconciliation is sent to the financial controller for review. In order to maximise
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cash balances, the finance director approves all purchase invoices for payment 75
days after receipt of the invoice.
Required:
(b) Identify and explain EIGHT deficiencies in Equestrian Co’s internal controls and
provide a recommendation to address each of these deficiencies.
Note: Prepare your answer using two columns headed Control deficiency and
Control recommendation respectively. (16 marks)
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QUESTIONS
Note: Prepare your answer using three columns headed Control deficiency, Control
recommendation, and Test of control respectively. The total marks will be split
equally between each part. (15 marks)
(d) Describe substantive procedures the auditor should perform to obtain
sufficient and appropriate evidence in relation to Comet Publishing Co’s
purchases and other expenses. (5 marks)
(30 marks)
35. Raspberry Co (March/June 2018)
Raspberry Co operates an electric power station, which produces electricity 24 hours
a day, seven days a week. The company’s year end is 30 June 20X8. You are an audit
manager of Grapefruit & Co, the auditor of Raspberry Co. The interim audit has been
completed and you are reviewing the documentation describing Raspberry Co’s
payroll system.
Systems notes – payroll
Raspberry Co employs over 250 people and approximately 70% of the employees
work in production at the power station. There are three shifts every day with
employees working eight hours each. The production employees are paid weekly in
cash. The remaining 30% of employees work at the head office in non-production
roles and are paid monthly by bank transfer.
The company has a human resources (HR) department, responsible for setting up
all new joiners. Pre-printed forms are completed by HR for all new employees and,
once verified, a copy is sent to the payroll department for the employee to be set up
for payment. This form includes the staff member’s employee number and payroll
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cannot set up new joiners without this information. To encourage staff to attend
work on time for all shifts, Raspberry Co introduced a discretionary bonus, paid
every three months, for production staff. The production supervisors determine
the amounts to be paid and notify the payroll department. This quarterly bonus is
entered into the system by a clerk and each entry is checked by a senior clerk for
input errors prior to processing. The senior clerk signs the bonus listing as evidence
of undertaking this review.
Production employees are issued with clock cards and are required to swipe their
cards at the beginning and end of their shift. This process is supervised by security
staff 24 hours a day. Each card identifies the employee number and links into the hours
worked report produced by the payroll system, which automatically calculates the
gross and net pay along with relevant deductions. These calculations are not checked.
In addition to tax deductions from pay, some employees’ wages are reduced for
such items as repayments of student loans owed to the central government. All
employers have a statutory obligation to remit funds on a timely basis and to
maintain accounting records which reconcile with annual loan statements sent
by the government to employers. At Raspberry Co student loan deduction forms
are completed by the relevant employee and payments are made directly to the
government until the employee notifies HR that the loan has been repaid in full.
On a quarterly basis, exception reports relating to changes to the payroll standing
data are produced and reviewed by the payroll director. No overtime is worked by
employees. Employees are entitled to take 28 holiday days annually. Holiday request
forms are required to be completed and authorised by relevant line managers,
however, this does not always occur.
On a monthly basis, for employees paid by bank transfer, the senior payroll manager
reviews the list of bank payments and agrees this to the payroll records prior
to authorising the payment. If any errors are noted, the payroll senior manager
amends the records.
For production employees paid in cash, the necessary amount of cash is delivered
weekly from the bank by a security company. Two members of the payroll
department produce the pay packets, one is responsible for preparing them and the
other checks the finished pay packets. Both members of staff are required to sign the
weekly payroll listing on completion of this task. The pay packets are then delivered
to the production supervisors, who distribute them to employees at the end of the
employees’ shift, as they know each member of their production team.
Monthly management accounts are produced which detail variances between
budgeted amounts and actual. Revenue and key production costs are detailed,
however, as there are no overtime costs, wages and salaries are not analysed.
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QUESTIONS
Required:
(a) In respect of the payroll system for Raspberry Co:
(i) Identify and explain FIVE KEY CONTROLS which the auditor may seek to place
reliance on; and
(ii) Describe a TEST OF CONTROL the auditor should perform to assess if each of
these key controls is operating effectively.
Note: Prepare your answer using two columns headed Key control and Test of control
respectively. The total marks will be split equally between each part. (10 marks)
(b) Identify and explain FIVE DEFICIENCIES in Raspberry Co’s payroll system and
provide a recommendation to address each of these deficiencies.
Note: Prepare your answer using two columns headed Control deficiency and Control
recommendation respectively. (10 marks)
The finance director is interested in establishing an internal audit department (IAD).
In the company she previously worked for the IAD carried out inventory counts,
however, as this is not relevant for Raspberry Co, she has asked for guidance on what
other assignments an IAD could be asked to perform.
Required:
(c) Describe assignments the internal audit department of Raspberry Co could carry
out. (5 marks)
(30 marks)
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QUESTIONS
Required:
Identify and briefly explain the FIVE components of an entity's internal control.
(5 marks)
(b) Bonsai Trading Co (Bonsai) manufactures electrical equipment, and its year
end is 30 September 2020. You are the audit supervisor of Poplar & Co and
are developing the audit programmes for the forthcoming interim audit. The
company's internal audit department has provided you with documentation
relating to the non-current assets cycle including the related controls listed below.
‒ Bonsai has a capital expenditure committee and all purchase orders for
capital items are required to be authorised by this committee.
‒ On receipt, each asset is assigned a unique serial number and this is
recorded on the asset and in the non-current assets register.
‒ When the asset arrives, a goods received note (GRN) is completed which
details the nature of the expenditure (i.e. whether it is capital or revenue),
and the GRN classification is reviewed and initialled by a responsible official.
Copies of the GRNs relating to capital expenditure are then submitted to the
finance department for updating of the non-current assets register.
‒ Periodically, internal audit undertakes a review of assets in the register
and compares them to assets on site, using the serial number to confirm
existence of the asset.
‒ Access to the non-current assets register is restricted through passwords to
a small number of staff in the finance department.
Required:
Describe a test of control which the auditor of Bonsai Trading Co would perform
to assess whether or not each of the non-current asset controls listed above is
operating effectively.
(5 marks)
(10 marks)
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Rose’s finance director has notified you that an error occurred in the closing
of the purchase ledger at the year-end. Rather than closing on 1 November,
it accidentally closed one week earlier on 25 October. All purchase invoices
received between 25 October and the year-end have been posted to the 2020
year-end purchase ledger. (5 marks)
(b) Receivables
Rose’s trade receivables have historically been low as most members pay
monthly in advance. However, during the year a number of companies have
taken up group memberships at Rose and hence the receivables balance is now
material. The audit senior has undertaken a receivables circularisation for the
balances at the year-end; however, there are a number who have not responded
and a number of responses with differences. (5 marks)
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QUESTIONS
Required:
Describe substantive procedures you would perform to obtain sufficient and
appropriate audit evidence in relation to the above matters.
Note: The mark allocation is shown against each of the two matters above.
(10 marks)
41. Newthorpe
Assume that the date is 6th June 2020.
You are auditing the financial statements of Newthorpe Engineering Co, a listed
company, for the year-ended 30 April 2020.
In March 2020 the Board decided to close one of the company’s factories on 30 April
20209. The plant and equipment and inventories will be sold. The employees will
either be transferred to another factory or made redundant.
At the time of your audit in June 2020, you are aware that:
(i) Some of the plant and equipment has been sold
(ii) Most of the inventories have been sold
(iii) All the employees have either been made redundant or transferred to
another factory
The company has provided you with a schedule of the closure costs, the realisable
values of the assets in (i) and (ii) above and the redundancy cost.
Details of the plant and machinery are maintained in a non-current asset register.
A full inventory count was carried out at 30 April 2020. Audit tests have confirmed that
the inventory counts are accurate and there are no purchases or sales cut-off errors.
You are aware the redundancy payments are based on the number of years of
service of the employee and their annual salary (or wage). Most employees were
given redundancy of one week’s pay for each year’s service. A few employees have a
service contract with the company and were paid the amount stated in their service
contract which will be more than the redundancy pay offered to other employees.
Employees who are transferred to another factory were not paid any redundancy.
Required:
For the factory being closed, describe the audit procedures you will carry out to
verify the company’s estimates of:
(a) The net realisable value of plant and equipment, and inventories (6 marks)
(b) The redundancy cost (4 marks)
(10 marks)
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2020 2019
$ $
Trade payables 884,824 816,817
Accruals 56,903 51,551
Provision for legal action 60,000 –
1,001,727 868,368
The provision for legal action relates to a claim from a customer who suffered
an injury while assembling a chair supplied by Metcalf Co. The directors of
Metcalf Co dispute the claim, although they are recommending an out of court
settlement to avoid damaging publicity against Metcalf Co.
Required:
List the substantive audit procedures that you should undertake in the audit
of current liabilities of Metcalf Co for the year-ended 31 March 2020. For each
procedure, explain the purpose of that procedure.
(20 marks)
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QUESTIONS
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the loan becomes immediately repayable. The company has a policy of revaluing land
and buildings, and the finance director has announced that all land and buildings will
be revalued as at the year-end.
The reporting timetable for audit completion of Abrahams Co is quite short, and the
finance director would like to report results even earlier this year.
Required:
(c) Using the information provided, identify and describe FIVE audit risks and explain
the auditor’s response to each risk in planning the audit of Abrahams Co.
(10 marks)
(20 marks)
44. Substantive procedures
Shiny Happy Windows Co (SHW) is a window cleaning company. Customers’ windows
are cleaned monthly, the window cleaner then posts a stamped addressed envelope
for payment through the customer’s front door.
SHW has a large number of receivable balances and these customers pay by cheque
or cash, which is received in the stamped addressed envelopes in the post.
The following procedures are applied to the cash received cycle:
• A junior clerk from the accounts department opens the post and if any cheques
or cash have been sent, she records the receipts in the cash received log and
then places all the monies into the locked small cash box.
• The contents of the cash box are counted each day and every few days these
sums are banked by which ever member of the finance team is available.
• The cashier records the details of the cash received log into the cash receipts day
book and also updates the sales ledger.
• Usually on a monthly basis the cashier performs a bank reconciliation, which he
then files, if he misses a month then he catches this up in the following month’s
reconciliation.
Required:
For the cash cycle of SHW:
(a) Identify and explain THREE deficiencies in the system; (3 marks)
(b) Suggest controls to address each of these deficiencies; and (3 marks)
(c) List tests of controls the auditor of SHW would perform to assess if the controls
are operating effectively. (4 marks)
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QUESTIONS
(20 marks)
45. Donald Co (June 2011)
The auditor has a responsibility to design audit procedures to obtain sufficient and
appropriate evidence. There are various audit procedures for obtaining evidence,
such as external confirmation.
Required:
Apart from external confirmation:
(a) State and explain FIVE procedures for obtaining evidence and; (5 marks)
(b) For each procedure, describe an example relevant to the audit of purchases and
other expenses. (5 marks)
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Required:
(c) Using the information provided, describe FIVE audit risks. (5 marks)
(d) Explain the auditor’s response to each risk in planning the audit of Donald
Co. (5 marks)
(20 marks)
46. Audit evidence and internal audit (June 2013)
(a)
(i) Describe FIVE types of procedures for obtaining audit evidence; and
(ii) For each procedure, describe an example relevant to the audit of property,
plant and equipment.
Note: The total marks will be split equally between each part.
(10 marks)
Bush-Baby Hotels Co operates a chain of 18 hotels located across the country. Each
hotel has bedrooms, a restaurant and leisure club facilities. Most visitors to the
restaurant and leisure club are hotel guests; however, these facilities are open to
the public as well. Hotel guests generally charge any costs to their room but other
visitors must make payment directly to the hotel staff.
During the year, senior management noticed an increased level of cash discrepancies
and inventory discrepancies, and they suspect that some employees have been
stealing cash and goods from the hotels. They are keen to prevent this from
reoccurring and are considering establishing an internal audit department to
undertake a fraud investigation.
Required:
(b) Explain how the new internal audit department of Bush-Baby Hotels Co could
assist the directors in preventing and detecting fraud and error. (3 marks)
(c) Describe the limitations of Bush-Baby Hotels Co establishing and maintaining an
internal audit department.
(2 marks)
The directors would like the internal audit department to have as broad a role as
possible, as this will make the decision to recruit an internal audit department more
cost effective.
Required:
(d) Describe additional functions, other than fraud investigations, the directors of Bush-
Baby Hotels Co could ask the internal audit department to undertake. (5 marks)
(20 marks)
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QUESTIONS
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AUDIT AND ASSURANCE
Note: Up to two marks will be awarded within this requirement for presentation
and the remaining marks will be split equally between each part. (16 marks)
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QUESTIONS
(b) Describe audit procedures you would perform during the audit of Andromeda
Industries Co:
(c) During the audit, the team discovers that one of the five development projects,
valued at $980,000 and included within intangible assets, does not meet the
criteria for capitalisation. The finance director does not intend to change the
accounting treatment adopted as she considers this an immaterial amount.
Required:
Discuss the issue and describe the impact on the audit report, if any, if the issue
remains unresolved. (4 marks)
(20 marks)
49. Elounda Co (September 2016)
Elounda Co manufactures chemical compounds using a continuous production
process. Its year end was 31 July 20X0 and the draft profit before tax is $13·6 million.
You are the audit supervisor and the year-end audit is due to commence shortly. The
following matters have been brought to your attention.
Revaluation of property, plant and equipment (PPE)
At the beginning of the year, management undertook an extensive review of Elounda
Co’s non-current asset valuations and as a result decided to update the carrying
value of all PPE. The finance director, Peter Dullman, contacted his brother, Martin,
who is a valuer and requested that Martin’s firm undertake the valuation, which took
place in August 20X9. (5 marks)
Inventory valuation
Your firm attended the year-end inventory count for Elounda Co and ascertained that
the process for recording work in progress (WIP) and finished goods was acceptable.
Both WIP and finished goods are material to the financial statements and the
quantity and stage of completion of all ongoing production was recorded accurately
during the count.
During the inventory count, the count supervisor noted that a consignment of
finished goods, compound E243, with a value of $720,000, was defective in that the
chemical mix was incorrect. The finance director believes that compound E243 can
still be sold at a discounted sum of $400,000.
(6 marks)
Bank loan
Elounda Co secured a bank loan of $2·6 million on 1 October 20X8. Repayments of
$200,000 are due quarterly, with a lump sum of $800,000 due for repayment in
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AUDIT AND ASSURANCE
January 20X1. The company met all loan payments in 20X9 on time, but was late in
paying the April and July 20X0 repayments.
(4 marks)
Required:
(a) Describe substantive procedures you should perform to obtain sufficient,
appropriate audit evidence in relation to the above three matters.
Note: The mark allocation is shown against each of the three matters above.
(b) Describe the procedures which the auditor of Elounda Co should perform in
assessing whether or not the company is a going concern. (5 marks)
(20 marks)
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QUESTIONS
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AUDIT AND ASSURANCE
(b) Describe audit software procedures which could be carried out during the audit
of Airsoft Co’s trade payables and accruals. (3 marks)
(c) Describe substantive procedures the auditor should perform to obtain sufficient
and appropriate audit evidence in relation to Airsoft Co’s year-end bank
balances. (5 marks)
(c) Describe substantive procedures the auditor should perform to confirm the
directors’ remuneration included in the financial statements at the year
end. (3 marks)
A member of your audit team has asked for information on ISA 701
Communicating Key Audit Matters in the Independent Auditor’s Report as she has
heard this standard is applicable to listed clients such as Airsoft Co.
Required:
(d) Identify what a key audit matter (KAM) is and explain how the auditor
determines and communicates KAM. (5 marks)
(20 marks)
51. Dashing Co (September/December 2017)
Dashing Co manufactures women’s clothing and its year end was 31 July 20X7. You
are an audit supervisor of Jaunty & Co and the year-end audit for Dashing Co is due
to commence shortly.
The draft financial statements recognise profit before tax of $2·6m and total assets of
$18m. You have been given responsibility for auditing receivables, which is a material
balance, and as part of the audit approach, a positive receivables circularisation is to
be undertaken.
At the planning meeting, the finance director of Dashing Co informed the audit
engagement partner that the company was closing one of its smaller production sites
and as a result, a number of employees would be made redundant. A redundancy
provision of $110,000 is included in the draft financial statements.
Required:
(a) Describe the steps the auditor should perform in undertaking a positive
receivables circularisation for Dashing Co. (4 marks)
(b) Describe substantive procedures, other than a receivables circularisation, the
auditor should perform to verify EACH of the following assertions in relation to
Dashing Co’s receivables:
(i) Accuracy, valuation and allocation;
(ii) Completeness; and
(iii) Rights and obligations.
Note: The total marks will be split equally between each part. (6 marks)
(c) Describe substantive procedures the auditor should perform to confirm the
redundancy provision at the year end. (5 marks)
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QUESTIONS
A few months have now passed and the audit team is performing the audit fieldwork
including the audit procedures which you recommended over the redundancy
provision. The team has calculated that the necessary provision should amount to
$305,000. The finance director is not willing to adjust the draft financial statements.
Required:
(d) Discuss the issue and describe the impact on the auditor’s report, if any,
should this issue remain unresolved.
(5 marks)
(20 marks)
52. Cranberry & Co (March/June 2018)
You are an audit manager of Cranberry & Co and you are currently responsible for
the audit of Gooseberry Co, a company which develops and manufactures health and
beauty products and distributes these to wholesale customers. Its draft profit before
tax is $6·4m and total assets are $37·2m for the financial year ended 31 January 20X8.
The final audit is due to commence shortly and the following matters have been
brought to your attention:
Research and development
Gooseberry Co spent $1·9m in the current year developing nine new health and
beauty products, all of which are at different stages of development. Once they
meet the recognition criteria under IAS® 38 Intangible Assets for development
expenditure, Gooseberry Co includes the costs incurred within intangible assets.
Once production commences, the intangible assets are amortised on a straight
line basis over three years. Management believes that this amortisation policy is
a reasonable approximation of the assets’ useful lives, as in this industry there is
constant demand for innovative new products.
Depreciation
Gooseberry Co has a large portfolio of property, plant and equipment (PPE). In March
20X7, the company carried out a full review of all its PPE and updated the useful
lives, residual values, depreciation rates and methods for many categories of asset.
The finance director felt the changes were necessary to better reflect the use of the
assets. This resulted in the depreciation charge of some assets changing significantly
for this year.
Bonus
The company’s board is comprised of seven directors. They are each entitled to a
bonus based on the draft year-end net assets, excluding intangible assets. Details of the
bonus entitlement are included in the directors’ service contracts. The bonus, which
related to the 20X8 year end, was paid to each director in February 20X8 and the costs
were accrued and recognised within wages and salaries for the year ended 31 January
20X8. Separate disclosure of the bonus, by director, is required by local legislation.
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Required:
(a) Describe substantive procedures the auditor should perform to obtain sufficient
and appropriate audit evidence in relation to Gooseberry Co’s research and
development expenditure. (5 marks)
(b) Describe substantive procedures the auditor should perform to obtain sufficient
and appropriate audit evidence in relation to the matters identified regarding
depreciation of property, plant and equipment. (5 marks)
(c) Describe substantive procedures the auditor should perform to obtain sufficient
and appropriate audit evidence in relation to the directors’ bonuses. (5 marks)
During the audit, the team discovers that the intangible assets balance includes
$440,000 related to one of the nine new health and beauty products development
projects, which does not meet the criteria for capitalisation. As this project is
ongoing, the finance director has suggested that no adjustment is made in the 20X8
financial statements. She is confident that the project will meet the criteria for
capitalisation in 20X9.
Required:
(d) Discuss the issue and describe the impact on the auditor’s report, if any, should
this issue remain unresolved. (5 marks)
(20 marks)
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QUESTIONS
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AUDIT AND ASSURANCE
Note: The total marks will be split equally between each event.
(10 marks)
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QUESTIONS
(10 marks)
55. Chestnut & Co (June 2015)
You are the audit manager of Chestnut & Co and are reviewing the key issues
identified in the files of two audit clients.
(a) Palm Industries Co (Palm)
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The finance director is confident the issue will be resolved and no allowance for
receivables was made with regards to this balance.
(b) Ash Trading Co (Ash)
Ash is a new client of Chestnut & Co, its year end was 31 January 2020 and the firm
was only appointed auditors in February 2020, as the previous auditors were suddenly
unable to undertake the audit. The fieldwork stage for this audit is currently ongoing.
The inventory count at Ash's warehouse was undertaken on 31 January 2020 and was
overseen by the company's internal audit department. Neither Chestnut & Co nor the
previous auditors attended the count. Detailed inventory records were maintained but it
was not possible to undertake another full inventory count subsequent to the year end.
The draft financial statements show a profit before tax of $2·4 million, revenue of
$10·1 million and inventory of $510,000.
Required:
For each of the two issues:
(i) Discuss the issue, including an assessment of whether it is material;
(ii) Recommend ONE procedure the audit team should undertake to try to
resolve the issue; and
(iii) Describe the impact on the audit report if the issue remains UNRESOLVED.
Notes:
1. The total marks will be split equally between each of the two issues
2. Audit report extracts are NOT required.
(10 marks)
56. Violet & Co (December 2012)
You are the audit manager of Violet & Co and you are currently reviewing the audit
files for several of your clients for which the audit fieldwork is complete. The audit
seniors have raised the following issues:
(a) Daisy Designs Co (Daisy)
Daisy’s year end is 30 September, however, subsequent to the year end the
company’s sales ledger has been corrupted by a computer virus. Daisy’s finance
director was able to produce the financial statements prior to this occurring;
however, the audit team has been unable to access the sales ledger to undertake
detailed testing of revenue or year-end receivables. All other accounting records
are unaffected and there are no backups available for the sales ledger. Daisy’s
revenue is $15.6m, its receivables are $3.4m and profit before tax is $2m.
Fuchsia has experienced difficult trading conditions and as a result it has lost
significant market share. The cash flow forecast has been reviewed during
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QUESTIONS
the audit fieldwork and it shows a significant net cash outflow. Management
are confident that further funding can be obtained and so have prepared the
financial statements on a going concern basis with no additional disclosures; the
audit senior is highly sceptical about this. The prior year financial statements
showed a profit before tax of $1.2m; however, the current year loss before tax is
$4.4m and the forecast net cash outflow for the next 12 months is $3.2m.
Required:
For each of the two issues:
(i) Discuss the issue, including an assessment of whether it is material;
(ii) Recommend procedures the audit team should undertake at the completion
stage to try to resolve the issue; and
(iii) Describe the impact on the audit report if the issue remains unresolved.
Notes:
1. The total marks will be split equally between each issue.
2. Audit report extracts are NOT required.
(10 marks)
57. Humphries Ltd
Assume the date is 5th December 2020.
The audit of two of your clients is nearing completion. The outstanding situations are
explained below.
Client 1: Humphries Co.
Humphries Co operates a chain of food wholesalers across the country and its year-
end was 30 September 2020. The final audit is nearly complete and it is proposed
that the financial statements and audit report will be signed on 13 December.
Revenue for the year is $78 million and profit before taxation is $7·5 million. The
following events have occurred subsequent to the year-end.
(a) Receivable
(b) Lawsuit
A key supplier of Humphries Co is suing them for breach of contract. The lawsuit
was filed prior to the year-end, and the sum claimed by them is $1 million.
This has been disclosed as a contingent liability in the notes to the financial
statements; however correspondence has just arrived from the supplier
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AUDIT AND ASSURANCE
indicating that they are willing to settle the case for a payment by Humphries Co
of $0·6 million. It is likely that the company will agree to this.
Required:
For each of the two events above:
(i) discuss whether the financial statements require amendment;
(ii) describe audit procedures that should be performed in order to form a
conclusion on the amendment; and
(iii) explain the impact on the audit report should the issue remain unresolved.
(10 marks)
Note: The total marks will be split equally between each event.
Client 2: Vega
On 1 November 2020, Vega was notified that an administrator had been appointed
at Sirius Ltd. Sirius Ltd is a regular customer of Vega with annual sales to Sirius
amounting to around 0.15% of revenue. The balance due from Sirius at 20 September
2020 was $30,000.
The pre-tax profit of Ash for the year-ended 30 September 2020 is $4.5m and total
assets at that date are $12.5m.
Vega’s year-end is 30 September 2020
Required:
(c) Explain the auditors’ responsibility and the audit procedures and actions that
should be carried out according to ISA 560 (Redrafted) Subsequent Events.
(6 marks)
(d) Discuss the implications for the audit report on the financial statements of Vega
for the year-ended 30 September 2020. (4 marks)
(20 marks)
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QUESTIONS
Chapter 8 Reporting
58. Ethical threats, going concern (June 2013)
(a) Compliance with the fundamental principles in ACCA’s Code of Ethics and
Conduct can be threatened in a number of ways.
Required:
List the FIVE ethical threats to independence and objectivity and for EACH threat
identify ONE example of a circumstance that may create the threat.
(5 marks)
(b) In accordance with ISA 570 Going Concern, explain the responsibilities of auditors
and management regarding going concern. (3 marks)
(c) Describe the content of a “Material Uncertainty Relating to Going Concern”
paragraph. (2 marks)
(10 marks)
59. EastVale (Pilot Paper 2006)
Assume the date is 3rd December 2020.
EastVale Co manufactures a range of dairy products (for example, milk, yoghurt and
cheese) in one factory. Products are stored in a nearby warehouse (which is rented
by EastVale) before being sold to 350 supermarkets located within 200 kilometres
of EastVale’s factory. The products are perishable with an average shelf life of eight
days. EastVale’s financial statements year-end is 31 July 2020.
It is four months since the year-end at your audit client of EastVale and the annual
audit of EastVale is almost complete, but the auditor’s report has not been signed.
The following events occurred in late November 2020.
Event 1: A fire in the warehouse rented by the company has destroyed 60% of the
inventory held for resale.
Event 2: A batch of cheese produced by EastVale was found to contain some
chemical impurities. Over 300 consumers have complained about food poisoning
after eating the cheese. 115 supermarkets have stopped purchasing EastVale
products and another 85 are considering whether to stop purchasing from EastVale.
Lawyers acting on behalf of the consumers are now presenting a substantial claim for
damages against EastVale.
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Required
In respect of each of the events at EastVale Co mentioned above:
(a) Describe the additional audit procedures you will carry out; (8 marks)
(b) State, with reasons, whether or not the financial statements for the year-end
require amendment; and (6 marks)
(c) Discuss whether or not the audit report should be modified. (6 marks)
(20 marks)
60. Elements of an audit report and accounting adjustment (December 2014)
(a) ISA 700 Forming an Opinion and Reporting on Financial Statements requires auditors
to produce an audit report. This report should contain a number of consistent
elements so that users are able to understand what the audit report means.
Required:
Describe FOUR elements of an unmodified auditor’s report and for each explain why
they are included.
(4 marks)
(b) Bullfinch.com is a website design company whose year-end was 31 October
2020. The audit is almost complete and the financial statements are due to be
signed shortly. Revenue for the year is $11·2 million and profit before tax is $3·8
million. A key customer, with a receivables balance at the year-end of $283,000,
has just notified Bullfinch.com that they are experiencing cash flow difficulties
and so are unable to make any payments for the foreseeable future. The
finance director has notified the auditor that he will write this balance off as an
irrecoverable debt in the 2021 financial statements.
Note: The total marks will be split equally between each part. (6 marks)
Bullfinch’s finance director has expressed an interest in Tangerine & Co performing
other review engagements in addition to the external audit; however, he is unsure
how much assurance would be gained via these engagements and how this differs to
the assurance provided by an external audit.
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QUESTIONS
Required:
(c) Identify and explain the level of assurance provided by an external audit and
other review engagements. (2 marks)
(20 marks)
61. Assurance engagements and financial statement amendments (June 2013) - amended
(a) Explain the five elements of an assurance engagement. (5 marks)
(b) Panda Co manufactures chemicals and has a factory and four offsite storage
locations for finished goods. Panda Co’s year end was 30 April 2020. The final
audit is almost complete and the financial statements and audit report are due
to be signed next week. Revenue for the year is $55 million and profit before
taxation is $5·6 million.
The following two events have occurred subsequent to the year end. No
amendments or disclosures have been made in the financial statements.
Event 1 – Defective chemicals
Panda Co undertakes extensive quality control checks prior to despatch of any
chemicals. Testing on 3 May 2020 found that a batch of chemicals produced
in April was defective. The cost of this batch was $0·85 million. In its current
condition it can be sold at a scrap value of $0·1 million. The costs of correcting
the defect are too significant for Panda Co’s management to consider this an
alternative option.
Event 2 – Explosion
An explosion occurred at the smallest of the four offsite storage locations on
20 May 2020. This resulted in some damage to inventory and property, plant
and equipment. Panda Co’s management have investigated the cause of the
explosion and believe that they are unlikely to be able to claim on their insurance.
Management of Panda Co has estimated that the value of damaged inventory and
property, plant and equipment was $0·9 million and it now has no scrap value.
Required:
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AUDIT AND ASSURANCE
Note: The total marks will be split equally between each event.
(12 marks)
(c) The directors do not wish to make any amendments or disclosures to the
financial statements for the explosion (event 2).
Required:
Explain the impact on the audit report should this issue remain unresolved.
(3 marks)
(20 marks)
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QUESTIONS
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AUDIT AND ASSURANCE
Thirty-mark questions
62. Minty Cola Co (December 2013)
Minty Cola Co (Minty) manufactures fizzy drinks such as cola and lemonade as well
as other soft drinks and its year end is 31 December 2020. You are the audit manager
of Parsley & Co and are currently planning the audit of Minty. You attended the
planning meeting with the engagement partner and finance director last week and
recorded the minutes from the meeting shown below. You are reviewing these as
part of the process of preparing the audit strategy.
Minutes of planning meeting for Minty
Minty’s trading results have been strong this year and the company is forecasting
revenue of $85 million, which is an increase from the previous year. The company has
invested significantly in the cola and fizzy drinks production process at the factory.
This resulted in expenditure of $5 million on updating, repairing and replacing a
significant amount of the machinery used in the production process.
As the level of production has increased, the company has expanded the number
of warehouses it uses to store inventory. It now utilises 15 warehouses; some are
owned by Minty and some are rented from third parties. There will be inventory
counts taking place at all 15 of these sites at the year end.
A new accounting general ledger has been introduced at the beginning of the year,
with the old and new systems being run in parallel for a period of two months.
As a result of the increase in revenue, Minty has recently recruited a new credit
controller to chase outstanding receivables. The finance director thinks it is not
necessary to continue to maintain an allowance for receivables and so has released
the opening allowance of $1·5 million.
In addition, Minty has incurred expenditure of $4·5 million on developing a new
brand of fizzy soft drinks. The company started this process in January 2019 and is
close to launching their new product into the market place.
The finance director stated that there was a problem in November in the mixing
of raw materials within the production process which resulted in a large batch of
cola products tasting different. A number of these products were sold; however,
due to complaints by customers about the flavour, no further sales of these goods
have been made. No adjustment has been made to the valuation of the damaged
inventory, which will still be held at cost of $1 million at the year end.
As in previous years, the management of Minty is due to be paid a significant annual
bonus based on the value of year-end total assets.
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QUESTIONS
Required:
(a) Explain audit risk and the components of audit risk. (5 marks)
(b) Using the minutes provided, identify and describe SIX audit risks, and explain the
auditor’s response to each risk, in planning the audit of Minty Cola Co. (12 marks)
(c) Describe substantive procedures the audit team should perform to obtain sufficient
and appropriate audit evidence in relation to the treatment of the $5 million
expenditure incurred on improving the factory production process. (5 marks)
(d) Describe substantive procedures the audit team should perform to obtain
sufficient and appropriate audit evidence in relation to the following three matters:
(i) The release of the $1·5 million allowance for receivables; and
(ii) The damaged inventory.
Note: The total marks will be split equally between each part. (8 marks)
(30 marks)
63. Blake Co (December 2008)
Assume the date is 3rd December 2020.
Introduction
Blake Co assembles specialist motor vehicles such as lorries, buses and trucks. The
company owns four assembly plants to which parts are delivered and assembled into
the motor vehicles. The company’s year-end is 30 September 2020.
The motor vehicles are assembled using a mix of robot and manual production
lines. The ‘human’ workers normally work a standard eight hour day, although this
is supplemented by overtime on a regular basis as Blake has a full order book. There
is one shift per day; mass production and around the clock working are not possible
due to the specialist nature of the motor vehicles being assembled.
Wages system–shift workers
Shift-workers arrive for work at about 7.00 am and ‘clock in’ using an electronic
identification card. The card is scanned by the time recording system and each
production shift-worker’s identification number is read from their card by the
scanner. The worker is then logged in as being at work. Shift-workers are paid from
the time of logging in. The logging in process is not monitored as it is assumed that
shift-workers would not work without first logging in on the time recording system.
Shift-workers are split into groups of about 25 employees, with each group under
the supervision of a shift foreman. Each day, each group of shift-workers is allocated
a specific vehicle to manufacture. At least 400 vehicles have to be manufactured
each day by each work group. If necessary, overtime is worked to complete the
day’s quota of vehicles. The shift foreman is not required to monitor the extent of
any overtime working although the foreman does ensure workers are not taking
unnecessary or prolonged breaks which would automatically increase the amount
of overtime worked. Shift-workers log off at the end of each shift by rescanning their
identification card.
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Payment of wages
Details of hours worked each week are sent electronically to the payroll department,
where hours worked are allocated by the computerised wages system to each
employee’s wages records. Staff in the payroll department compare hours worked
from the time recording system to the computerised wages system, and enter a code
word to confirm the accuracy of transfer. The code word also acts as authorisation to
calculate net wages. The code word is the name of a domestic cat belonging to the
department head and is therefore generally known around the department.
Each week the computerised wages system calculates:
• gross wages, using the standard rate and overtime rates per hour for each employee,
• statutory deductions from wages, and
• net pay.
The list of net pay for each employee is sent over Blake’s internal network to the
accounts department. In the accounts department, an accounts clerk ensures that
employee bank details are on file. The clerk then authorises and makes payment to
those employees using Blake’s online banking systems. Every few weeks the financial
accountant reviews the total amount of wages made to ensure that the management
accounts are accurate.
Termination of employees
Occasionally, employees leave Blake. When this happens, the personnel department
sends an e-mail to the payroll department detailing the employee’s termination date
and any unclaimed holiday pay. The receipt of the e-mail by the payroll department
is not monitored by the personnel department.
Salaries system – shift managers
All shift managers are paid an annual salary; there are no overtime payments.
Salaries were increased in July by 3% and an annual bonus of 5% of salary was
paid in November.
126
QUESTIONS
Required:
(a) List FOUR control objectives of a wages system.
(2 marks)
(b) As the external auditors of Blake Co, write a management letter to the directors
in respect of the shift workers’ wages recording and payment systems which:
(i) Identifies and explains FOUR weaknesses in that system;
(ii) Explains the possible effect of each weakness;
(iii) Provides a recommendation to alleviate each weakness.
Note: up to two marks will be awarded within this requirement for presentation.
(14 marks)
(c) List THREE substantive analytical procedures you should perform on the shift
managers’ salary system. For each procedure, state your expectation of the
result of that procedure. (6 marks)
(d) Audit evidence can be obtained using various audit procedures, such as inspection.
Apart from this procedure, in respect of testing the accuracy of the time recording
system at Blake Co, explain FOUR procedures used in collecting audit evidence
and discuss whether the auditor will benefit from using each procedure (8 marks)
(30 marks)
64. Lily Window Glass Co (December 2012)
Lily Window Glass Co (Lily) is a glass manufacturer, which operates from a large
production facility, where it undertakes continuous production 24 hours a day,
seven days a week. Also on this site are two warehouses, where the company’s raw
materials and finished goods are stored. Lily’s year end is 31 December.
Lily is finalising the arrangements for the year-end inventory count, which is to be
undertaken on 31 December 2020. The finished windows are stored within 20 aisles
of the first warehouse. The second warehouse is for large piles of raw materials, such
as sand, used in the manufacture of glass. The following arrangements have been
made for the inventory count.
The warehouse manager will supervise the count as he is most familiar with
the inventory. There will be ten teams of counters and each team will contain
two members of staff, one from the finance and one from the manufacturing
department. None of the warehouse staff, other than the manager, will be involved
in the count.
Each team will count an aisle of finished goods by counting up and then down each
aisle. As this process is systematic, it is not felt that the team will need to flag areas
once counted. Once the team has finished counting an aisle, they will hand in their
sheets and be given a set for another aisle of the warehouse. In addition to the
above, to assist with the inventory counting, there will be two teams of counters
from the internal audit department and they will perform inventory counts.
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The count sheets are sequentially numbered, and the product codes and descriptions
are printed on them but no quantities. If the counters identify any inventory which is
not on their sheets, then they are to enter the item on a separate sheet, which is not
numbered. Once all counting is complete, the sequence of the sheets is checked and
any additional sheets are also handed in at this stage. All sheets are completed in ink.
Any damaged goods identified by the counters will be too heavy to move to a central
location, hence they are to be left where they are but the counter is to make a note
on the inventory sheets detailing the level of damage.
As Lily undertakes continuous production, there will continue to be movements
of raw materials and finished goods in and out of the warehouse during the count.
These will be kept to a minimum where possible.
The level of work-in-progress in the manufacturing plant is to be assessed by the
warehouse manager. It is likely that this will be an immaterial balance. In addition, the
raw materials quantities are to be approximated by measuring the height and width
of the raw material piles. In the past this task has been undertaken by a specialist;
however, the warehouse manager feels confident that he can perform this task.
Required:
(a) For the inventory count arrangements of Lily Window Glass Co:
(i) Identify and explain SIX deficiencies; and
(ii) Provide a recommendation to address each deficiency
128
QUESTIONS
Required:
Describe the process the auditor should undertake to assess whether the
PRECONDITIONS for an audit are present.
(3 marks)
You are an audit senior of White & Co and are required to advise on the following
two situations.
Assume that the date is 5th June 2020.
Situation 1
The directors of Maximus Ltd have asked your firm to accept appointment as its
external auditor for the year-ended 30 September 2020. Maximus is a manufacturer
of training shoes and other sports equipment, operating from three factories around
the UK. The company’s managing director, Mr Commodus, has requested that your
firm also perform the following services:
• Preparation of the company’s tax return
• Assistance with the selection of a new computerised accounting package
for the company
The company’s current auditors have notified Mr Commodus that they will not
be seeking re-appointment at the company’s forthcoming AGM. They have not
given a specific reason for this, but Mr Commodus believes it is because they have
recently taken on a new client which operated in the same sector as Maximus, and is
approximately three times the size of Maximus. Mr Commodus is unsure as to why this
is such a big issue for the outgoing auditors and has asked you to provide an explanation.
Required:
(b) Identify the treats to objectivity that would arise by the provision of audit and
non-audit services requested by the company, and describe the safeguards that
could be put in place to mitigate the threats. (6 marks)
(c) Draft a response to the query raised by Mr Commodus concerning the outgoing
auditors and describe the measures that could have been taken to enable them
to act as auditors for both companies. (6 marks)
Situation 2
You are planning the audit of Redsmith Co for the year ended 30 September 2020.
The company produces printers and has been a client of your firm for two years; your
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audit manager has already had a planning meeting with the finance director. He has
provided you with the following notes of his meeting and financial statement extracts.
Redsmith’s management were disappointed with the 2019 results and so in 2020
undertook a number of strategies to improve the trading results. This included the
introduction of a generous sales-related bonus scheme for their salesmen and a high
profile advertising campaign. In addition, as market conditions are difficult for their
customers, they have extended the credit period given to them.
The finance director of Redsmith has reviewed the inventory valuation policy and
has included additional overheads incurred this year as he considers them to be
production related. He is happy with the 2020 results and feels that they are a good
reflection of the improved trading levels.
130
QUESTIONS
Required:
(d) Using the information above:
(i) Calculate FIVE ratios, for BOTH years, which would assist the audit senior in
planning the audit; and (5 marks)
(ii) From a review of the above information and the ratios calculated, explain
the audit risks that arise and describe the appropriate response to these
risks. (10 marks)
(30 marks)
66. Maple & Co (June 2015) - amended
You are the audit supervisor of Maple & Co and are currently planning the audit of
two existing clients.
Client 1
Willow Wands Co (Willow), is a listed company which has been an audit client for
eight years and specialises in manufacturing musical instruments.
Bethan Oak was the audit engagement partner for Willow and as she had completed
seven years as the audit engagement partner, she has recently been rotated off the
audit engagement. The current audit partner, Sandeep Pine, has suggested that in
order to maintain a close relationship with Willow, Bethan should undertake the
role of independent review partner this year. In addition Willow has requested that
Bethan assist them by attending their audit committee meetings, as a non-executive
director has recently left the company.
Willow has also asked Sandeep and the other partners at Beech & Co to help them in
recruiting a new non-executive director.
The total fees received by Beech & Co for last year equated to 16% of the firm's total
fee income. The current year's audit fee has not yet been confirmed, but along with
taxation and other possible non-audit fees the total income from Willow this year
could be greater than for last year. Last year's audit fee was being paid monthly by
Willow but no payments have been made for the last three months.
The audit manager for Willow has just announced that he is leaving Beech & Co to
join Willow as the financial controller.
Required:
(a) Using the information above:
(i) Identify and explain FIVE ethical threats which may affect the independence
of Beech & Co's audit of Willow Wands Co; and
(ii) For each threat explain how it might be reduced to an acceptable level.
(10 marks)
Note: The total marks will be split equally between each part.
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Client 2
Sycamore Science Co (Sycamore), whose year-end was 30 April 2020. Sycamore is a
pharmaceutical company, which manufactures and supplies a wide range of medical
supplies. The draft financial statements show revenue of $35·6 million and profit
before tax of $5·9 million.
Sycamore's previous finance director left the company in December 2019 after it was
discovered that he had been claiming fraudulent expenses from the company for a
significant period of time. A new finance director was appointed in January 2020 who
was previously a financial controller of a bank, and she has expressed surprise that
Maple & Co had not uncovered the fraud during last year's audit.
During the year Sycamore has spent $1·8 million on developing several new products.
These projects are at different stages of development and the draft financial
statements show the full amount of $1·8 million within intangible assets. In order
to fund this development, $2·0 million was borrowed from the bank and is due for
repayment over a ten-year period. The bank has attached minimum profit targets as
part of the loan covenants.
The new finance director has informed the audit partner that since the year end
there has been an increased number of sales returns and that in the month of May
over $0·5 million of goods sold in April were returned.
Maple & Co attended the year-end inventory count at Sycamore's warehouse. The
auditor present raised concerns that during the count there were movements of
goods in and out the warehouse and this process did not seem well controlled.
During the year, a review of plant and equipment in the factory was undertaken and
surplus plant was sold, resulting in a profit on disposal of $210,000.
Required:
(b) State Maples & Co's responsibilities in relation to the prevention and detection
of fraud and error.
(4 marks)
(c) Describe SIX audit risks, and explain the auditor's response to each risk, in
planning the audit of Sycamore Science Co.
(12 marks)
(d) Sycamore's new finance director has read about review engagements and is
interested in the possibility of Maple & Co undertaking these in the future.
However, she is unsure how these engagements differ from an external audit and
how much assurance would be gained from this type of engagement.
132
QUESTIONS
Required:
(i) Explain the purpose of review engagements and how these differ from
external audits; and
(2 marks)
(ii) Describe the level of assurance provided by external audits and
review engagements.
(2 marks)
(30 marks)
67. Blair & Co (December 2011) – amended
(a) ISA 300 Planning an Audit of Financial Statements provides guidance to auditors.
Planning an audit involves establishing the overall audit strategy for the
engagement and developing an audit plan. Adequate planning benefits the audit
of financial statements in several ways.
Required:
Explain the importance of audit planning.
(5 marks)
(b) You are the audit senior in charge of the audit of Swandive Co (Swandive), and
have been informed by your audit manager that during the year a fraud occurred
at the client. A payroll clerk set up fictitious employees and the wages were paid
into the clerk’s own bank account. This clerk has subsequently left the company,
but the audit manager is concerned that additional frauds have taken place in
the wages department.
Required:
(5 marks)
You are the audit senior of Blair & Co and your team has just completed the interim
audit of Chuck Industries Co, whose year-end is 31 January 2021. You are in the
process of reviewing the systems testing completed on the payroll cycle, as well as
preparing the audit programmes for the final audit.
Chuck Industries Co manufactures lights and the manufacturing process is
predominantly automated; however there is a workforce of 85 employees, who
monitor the machines, as well as approximately 50 employees who work in sales and
administration. The company manufactures 24 hours a day seven days a week.
Below is a description of the payroll system along with deficiencies identified by
the audit team:
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AUDIT AND ASSURANCE
Factory workforce
The company operates three shifts every day with employees working eight hours each.
They are required to clock in and out using an employee swipe card, which identifies the
employee number and links into the hours worked report produced by the computerised
payroll system. Employees are paid on an hourly basis for each hour worked. There is no
monitoring/supervision of the clocking in/out process and an employee was witnessed
clocking in several employees using their employee swipe cards.
The payroll department calculates on a weekly basis the cash wages to be paid to
the workforce, based on the hours worked report multiplied by the hourly wage
rate, with appropriate tax deductions. These calculations are not checked by anyone
as they are generated by the payroll system. During the year the hourly wage was
increased by the Human Resources (HR) department and this was notified to the
payroll department verbally.
Each Friday, the payroll department prepares the pay packets and physically hands
these out to the workforce, who operate the morning and late afternoon shifts, upon
production of identification. However, for the night shift workers, the pay packets are
given to the factory supervisor to distribute. If any night shift employees are absent
on pay day then the factory supervisor keeps these wages and returns them to the
payroll department on Monday.
Sales and administration staff
The sales and administration staff are paid monthly by bank transfer. Employee
numbers do fluctuate and during July two administration staff joined; however,
due to staff holidays in the HR department, they delayed informing the payroll
department, resulting in incorrect salaries being paid out.
Required:
(c) For the deficiencies already identified in the payroll system of Chuck Industries Co:
(d) Describe substantive procedures you should now perform to confirm the
accuracy and completeness of Chuck Industries’ payroll charge. (5 marks)
(e) Chuck Industries has decided to outsource its sales ledger department and as
a result it is making 14 employees redundant. A redundancy provision, which is
material, will be included in the draft accounts.
Required:
Describe substantive procedures you should perform to confirm the redundancy
provision at the year-end. (3 marks)
(30 marks)
134
QUESTIONS
Required:
Explain why it is important that auditors communicate throughout the audit with
those charged with governance
(2 marks)
Client 1 – Fox industries
Introduction
Fox Industries Co (Fox) manufactures engineering parts. It has one operating site and
a customer base spread across Europe. The company’s year-end was 30 April 2020.
Below is a description of the purchasing and payments system.
Purchasing system
Whenever production materials are required, the relevant department sends a
requisition form to the ordering department. An order clerk raises a purchase order
and contacts a number of suppliers to see which can despatch the goods first. This
supplier is then chosen. The order clerk sends out the purchase order. This is not
sequentially numbered and only orders above $5,000 require authorisation.
Purchase invoices are input daily by the purchase ledger clerk, who has been in
the role for many years and, as an experienced team member, he does not apply
any application controls over the input process. Every week the purchase day book
automatically updates the purchase ledger, the purchase ledger is then posted
manually to the general ledger by the purchase ledger clerk.
Payments system
Fox maintains a current account and a number of saving (deposit) accounts. The
current account is reconciled weekly but the saving (deposit) accounts are only
reconciled every two months.
In order to maximise their cash and bank balance, Fox has a policy of delaying
payments to all suppliers for as long as possible. Suppliers are paid by a bank
transfer. The finance director is given the total amount of the payments list, which he
authorises and then processes the bank payments.
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AUDIT AND ASSURANCE
Required:
(b) As the external auditors of Fox Industries Co, write a report to management in
respect of the purchasing and payments system described above which:
(i) Identifies and explains FOUR deficiencies in the system; and
(ii) Explains the possible implication of each deficiency; and
(iii) Provides a recommendation to address each deficiency.
Note: Up to two marks will be awarded within this requirement for presentation
and the remaining marks will be split equally between each part. (14 marks)
(16 marks)
Client 2 – Greenfields
Greenfields Co specialises in manufacturing equipment which can help to reduce
toxic emissions in the production of chemicals. The company has grown rapidly over
the past eight years and this is due partly to the warranties that the company gives
to its customers. It guarantees its products for five years and if problems arise in this
period it undertakes to fix them, or provide a replacement product.
You are the manager responsible for the audit of Greenfields and you are performing
the final review stage of the audit and have come across the following two issues.
Receivable balance owing from Yellowmix Co
Greenfields has a material receivable balance owing from its customer, Yellowmix
Co. During the year-end audit, your team reviewed the ageing of this balance and
found that no payments had been received from Yellowmix for over six months, and
Greenfields would not allow this balance to be circularised. Instead management has
assured your team that they will provide a written representation confirming that the
balance is recoverable.
Warranty provision
The warranty provision included within the statement of financial position
is material. The audit team has performed testing over the calculations and
assumptions which are consistent with prior years. The team has requested a written
representation from management confirming the basis and amount of the provision
are reasonable. Management has yet to confirm acceptance of this representation.
Required:
(c) Discuss the appropriateness of written representations as a form of audit
evidence; and (4 marks)
(d) Describe additional procedures the auditor should now perform in order to
reach a conclusion on the balance to be included in the financial statements.
(8 marks)
Note: The total marks will be split equally between each issue.
(30 marks)
136
QUESTIONS
Note: The mark allocation is shown against each of the three matters above.
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AUDIT AND ASSURANCE
(30 marks)
70. Jackdaw Motor Cars Co (December 2014) - amended
Jackdaw Motor Cars Co (Jackdaw) manufactures a range of motor cars and its year
end is 31 January 2021. You are the audit supervisor of Puffin & Co and are currently
preparing the audit programmes for the year-end audit of Jackdaw. You have had
a meeting with your audit manager and he has notified you of a number of issues
identified during the audit risk assessment process.
Land and buildings
Jackdaw have a policy of revaluing land and buildings, this is undertaken on a rolling
basis over a five-year period. During the year Jackdaw requested an external valuer
to revalue a number of properties, including a warehouse purchased in May 2020.
Depreciation is charged on a pro rata basis.
Work in progress
Jackdaw undertakes continuous production of cars, 24 hours a day, seven days a
week. An inventory count is to be undertaken at the year end and Puffin & Co will
attend. You are responsible for the audit of work in progress (WIP) and will be part
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QUESTIONS
of the team attending the count as well as the final audit. WIP constitutes the partly
assembled cars at the year end and this balance is likely to be material. Jackdaw
values WIP according to percentage of completion, and standard costs are then
applied to these percentages.
Required:
(a) Explain the factors Puffin & Co should consider when placing reliance on the
work of the independent valuer.
(5 marks)
(b) Describe the substantive procedures the auditor should perform to obtain
sufficient and appropriate audit evidence in relation to:
(i) The revaluation of land and buildings and the recently purchased warehouse;
and (6 marks)
(ii) The valuation of work in progress. (4 marks)
During the audit, your team has identified an error in the valuation of work in progress,
as a number of the assumptions contain out of date information. The directors of
Jackdaw have indicated that they do not wish to amend the financial statements.
Required:
(c) Explain the steps Puffin & Co should now take and the impact on the audit report
in relation to the directors’ refusal to amend the financial statements. (5 marks)
Your firm has suggested Jackdaw should establish an internal audit department
to help ensure that the accounting systems in the company are effective. The
management of Jackdaw are uncertain on whether to accept this recommendation.
Required:
(d) Explain the need for internal audit as required by different corporate governance
systems. (4 marks)
(e) Contrast the role of internal and external auditors. (6 marks)
(30 marks)
71. Kiwi & Co (June 2012)
(a) Compare the responsibilities of the directors and auditors regarding the
published financial statements limited companies. (6 marks)
(b) Explain the three stages of an audit when analytical procedures can be used by
the auditor. (3 marks)
You are the audit manager of Kiwi & Co and you have been provided with financial
statements extracts and the following information about your client, Strawberry
Kitchen Designs Co (Strawberry), who is a kitchen manufacturer. The company’s year-
end is 30 April 2020.
Strawberry has recently been experiencing trading difficulties, as its major customer
who owes $0·6m to Strawberry has ceased trading, and it is unlikely any of this will
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AUDIT AND ASSURANCE
be received. However the balance is included within the financial statements extracts
below. The sales director has recently left Strawberry and has yet to be replaced.
The monthly cash flow has shown a net cash outflow for the last two months of
the financial year and is forecast as negative for the forthcoming financial year. As
a result of this, the company has been slow in paying its suppliers and some are
threatening legal action to recover the sums owing.
Due to its financial difficulties, Strawberry missed a loan repayment and, as a result
of this breach in the loan covenants, the bank has asked that the loan of $4·8m be
repaid in full within six months. The directors have decided that in order to conserve
cash, no final dividend will be paid in 2020.
Financial statements extracts for year ended 30 April:
DRAFT ACTUAL
2020 2019
$m $m
Current Assets
Inventory 3.4 1.6
Receivables 1.4 2.2
Cash 1.2
Current Liabilities
Trade payables 1.9 0.9
Overdraft 0.8
Loans 4.8 0.2
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QUESTIONS
(c) Explain the potential indicators that Strawberry Kitchen Designs Co is not a going
concern. (6 marks)
(d) Describe the audit procedures that you should perform in assessing whether or
not the company is a going concern. (6 marks)
(e) Having performed the going concern audit procedures, you have serious
concerns in relation to the going concern status of Strawberry. The finance
director has informed you that as the cash flow issues are short term he does not
propose to make any amendments to the financial statements.
Required:
(i) State Kiwi & Co’s responsibility for reporting on going concern to the
directors of Strawberry Kitchen Designs Co; and (2 marks)
(ii) If the directors refuse to amend the financial statements, describe the
impact on the audit report. (3 marks)
Assume that the directors of Hood Enterprises have prepared a cash flow
forecast for submission to the bank. They have asked you as the auditor to
provide a negative assurance report on this forecast.
Required:
(f) Briefly explain the difference between positive and negative assurance, outlining
the advantages to the directors of providing negative assurance on their cash
flow forecast. (4 marks)
(30 marks)
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AA
Answers
AUDIT AND ASSURANCE
144
ANSWERS
5. A
Non-executive directors normally comprise the majority if not all of the board sub-
committees, sitting on multiple committees, so A is acceptable. The CEO cannot
chair the remuneration committee (and will not normally be on that committee)
otherwise the CEO is determining his/her own wages. The FD is not allowed on the
audit committee due to the conflict of preparing the financial statements as FD and
then reviewing them as an audit committee member. Finally, the board must have
a balance of executive and non-executive directors – the chairman having a casting
vote - hence a majority of executives is not allowed.
6. Options 2 and 3
Option (1) is by definition obtaining evidence by recalculation and so is not an
analytical procedure. Option (4) is obtaining documentary evidence by inquiry
of management and again is not an analytical procedure. Options (2) and (3) are
analytical procedures as they relate to the analysis of the depreciation charge, either
by comparison or prediction. .
7. Option 1
Recalculation of the depreciation charge helps confirm the value on the statement
of financial position and so is the correct answer. Option 2 is a test of existence that
the property literally exists. Option 3 confirms the completeness of the asset register.
Option 4 is a test of rights and obligations – that the company does own the property.
8. Option 3
Option (1) is possible but not particularly time efficient and so will not be used.
Option (2) is also possible although there is no guarantee when the lorries will appear
and so again this will not be efficient. While option 4 is also possible, the sample
will be biased and no statistical results can be drawn. Using alternative evidence in
option 3 is also possible; and because the lorries are insured or have repairs carried
out is persuasive evidence of existence.
9. Options 2 and 3
The auditor will normally try and understand why the company does not want the
confirmation sent and obtain evidence for this (so option 2 is correct). The balance
will then be verified by alternative procedures such as auditing cash received after
the end of the year (so option 3 is correct). Option 1 is not correct as the auditor has
to obtain sufficient appropriate evidence and there are various methods of doing this
(see option 3). Similarly option 4 is not correct as this will affect the statistical validity
of the conclusions drawn from the audit procedure.
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AUDIT AND ASSURANCE
10. Option 2
Informing the client is the appropriate initial action. However, insisting that the
financial statements are amended option 1 is inappropriate as there is no material
error in receivables. Similarly, the auditor does not amend the financial statements
(option 4), this is always the responsibility of the client. The matter is also not a
material control weakness as bad debts are a normal business expense and the
amount is, as already noted, not material, so option 3 is incorrect. The amount will
simply be added to the schedule of possible adjustments; if a material error is found
from all adjustments, only then will an amendment to the financial statements be
requested. Option 2 is correct.
11. C
Signing of the cash receipt sheet does not confirm completeness; cash could be
stolen prior to recording on the sheet (so A is incorrect). Agreeing amounts on the
bank statements back to the paying in slips only confirms what has been banked
in on the paying in slips; again cash could be stolen before being banked so B is
incorrect. Banking of cash receipts on the same day may decrease the risk of
cash being stolen but is does not mean all cash was recorded (so D is incorrect).
Therefore, C is the right answer as agreeing cash recorded in the till to the cash
summary sheets does confirm that cash is correctly recorded on those sheets.
12. B
Pre-numbering of sheets is the only effective control as gaps in the sequence can be
investigated later (so B is correct). Manual numbering is ineffective as sheets may
be lost prior to being numbered, signing the sheet does not identify missing sheets
while copying sheets does not stop sheets being lost being before copies (so options
A, C and D are incorrect).
13. B
Signing a code of ethics does not stop fraud (so A is incorrect), it is only a deterrent
against being caught. While agreeing cash in the till to the cash record in the till is a
good control (especially when carried out by an independent person) it does not stop
cash being stolen prior to recording, so C does not necessarily work. Asking staff to
explain differences in daily sales is also ineffective as staff do not control the level of
sales (so D is incorrect). Having CCTV monitoring does work as this shows staff actually
recording sales and placing cash in the tills (so B is correct). (On a practice note, look
up when you are next in a supermarket – and try and spot the CCTV cameras!).
14. D
B and C are both incorrect as the auditor does not have to detect all fraud and has
no responsibility to prevent fraud – that is management’s responsibility. Regarding A
and D, the comments are similar but D uses the term “material misstatement”. As the
auditor has to identify material misstatements rather than simply “the risks of fraud”
which could be any value, then D is the correct answer.
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ANSWERS
15. A
Communication will be in writing (hence C is incorrect) to those charged with
governance (that is the audit committee in most large companies) not the board,
so A is incorrect. A control weakness does not have to result in material errors to
be communicated (so D is incorrect) as auditors will normally provide explanation
of material and immaterial weaknesses to assist the client in maintain good control
systems. B is therefore correct as communication to those charged with governance
will hopefully ensure that action is taken to overcome those weaknesses (the audit
committee comprising non-executive directors).
16. D
Those charged with governance (normally the audit committee) communicate with
the auditor on a regular basis during the audit, it is therefore this group that will
initially be informed of the errors so independent action can be taken to remove
the errors as necessary. The board will be informed later during the process (so
A is incorrect initially). The senior independent director normally chairs the audit
committee so all committee members (not just the senior independent director) will
be aware of the errors (so C is incorrect) while the shareholders are not involved in
the audit (so B is incorrect).
17. A
Regarding option 1, the client corrects the financial statements, not the auditor, so
this option is incorrect. Options 2 and 3 concern whether the auditor communicates
to the client all misstatements or just material ones. ISA 450 paragraph 8 confirms
it is all misstatements that are communicated so option 2 is correct and 3 incorrect.
Finally, the auditor has to understand management’s reasons for not correcting
misstatement, but this does not have to be in writing.
18. A
As the financial statements do not contain a material error then an unmodified
report and opinion can be given (so option A is correct). The emphasis of matter is
only used to draw attention to matters correctly disclosed in the financial statements
which are fundamental to understanding the financial statements, which is not the
case here (so B is incorrect). No modification of the opinion is required as there is
no material error (so C is incorrect). The other matter paragraph draws attention to
discrepancies within the annual report which the auditor has not audited. There is
no mention of the matters outside of the audited report needing disclosure so D is
also incorrect.
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AUDIT AND ASSURANCE
19. C
The section literally explains the Key Matters from the audit that the auditor
wants to bring to the attention of the users of the financial statements, hence C is
correct. The auditor will explain in the basis of opinion paragraph how the audit was
conducted (so A is incorrect) including reliance on internal controls (so B is incorrect).
Finally, adjustments will only be mentioned where material error occurs in the
financial statements – not as a commentary on how the audit progressed - so D is
also incorrect.
20. C
The partner will need to find out in more detail why management will not provide
the letter. There is nothing to stop the audit partner writing the letter – as long as
the management of RealEats actually sign it. Option C is correct. Doing nothing is
not an option as management representations are required on key areas such as
completeness of the financial statements (so B and D are incorrect). A modification
will only be proposed where material errors remain after discussion with management
– so proposing a modified report straight away is inappropriate (so A is incorrect).
21. C
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ANSWERS
22. Option 2
As a partner in Katzoo Co, no shares can be held in any client company. The shares
must be sold as soon as possible so option 2 is correct. Transferring shares to his
spouse does not remove the self-interest threat as presumably the manager has
benefit in the company via his spouse, so option 1 is ineffective. Option 3 is not
allowed as the shares will still be held in the client. Similarly, option 4 is not allowed
as the shares will still be held, even though the voting rights are not used.
23. Option 1
Internal control weaknesses will be communicated during and at the end of the audit
in a management letter, so option 1 is the correct answer. Options 2, 3 and 4 are
standard contents of an engagement letter.
24.
ISA210 requires the company’s management to ensure that the pre-conditions for an
audit are met (para 5). If the pre-conditions are not in place, then the auditor needs
to discuss this with management but if the matter cannot be resolved then the audit
cannot be accepted (para 8).
25. Option 4
The main change is that the audit report must include a Key Audit Matters section
(this is optional for unlisted companies). All other options are incorrect. In option
1, materiality may be set to be lower, not higher, due to increased risk of material
misstatement. There is no other bar on staff working for unlisted companies so
option 2 is incorrect. There is also no time limit for signing the audit report so option
3 is also incorrect.
26. A
The provision for bad debts is (45% * $17,008) + 1% * ($819,101 – $17,008) = $15,675.
Last year’s provision was $15,000 so the provision this year is understated by $675.
The increase in the provision represents an additional charge to the profit and loss
account, so profit is overstated by $675.
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AUDIT AND ASSURANCE
27. C
Existence is proved because the receivable writes back to the audit firm.
Completeness is not proved as the client may not have sent invoices for all
goods despatched.
Rights and obligations is proved as the receivable acknowledges there is a debt to pay.
Presentation is not proved as the accounts disclosure and presentation is not testing
using this procedure.
The correct answer is therefore C.
28. C
There is a mis-match between the clothes being removed from inventory and the
sale being recorded in the financial statements. Removal of clothes from inventory
and sale must be recorded in the same accounting period. Doing nothing is
therefore not an option so A is incorrect. B starts to match the removal of clothes
from inventory and the sale to the next accounting period; however, the valuation
is incorrect. D incorrectly includes the sale in this year’s financial statements with
the inventory, so D is incorrect. The only correct option is C; the sale of clothes and
removal from inventory are both recorded in the same accounting period at the
correct value.
29. D
A receivables circularisation does not confirm the completeness of the receivables
balance (or valuation in that the receivable may not pay the amount due) so
more audit work is necessary (so A is incorrect). The ISAs simply state sufficient
appropriate evidence has to be obtained but rarely state which audit procedures to
use, so B is incorrect. The circularisation is used by the auditor not the client (and the
accuracy of the receivables ledger is not proven as invoices may still be omitted) so C
is incorrect. However, as external written evidence, responses to a circularisation are
a reliable source of evidence so D is the correct answer.
30. B
Authorisation of a credit limit does not mean that limit will be maintained, so A is
actually ineffective. Just because a receivable pays (option C) does not mean that
a credit limit will not be exceeded. Similarly confirmed correct posting of cash only
helps to confirm the balance on the receivables ledger, not the amount of credit
given. However, reviewing the outstanding balance (manually or by computer) will
help ensure credit limits are not exceeded, so the correct answer is B.
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ANSWERS
31. C
Event (i) requires disclosure so the potential impact on the company of the flood can
be understood. The event is not adjusting as it does not affect the condition of the
company at the year-end. Event (ii) requires adjustment as it provides more evidence
on the valuation of the receivable at the year-end (assuming that the sale was made
pre-year-end).
32. Option 2
As the going concern situation of Adigeon is fully disclosed in the notes to the
financial statements, no qualification of the audit report is necessary. This
means answers 3 and 4 are incorrect. However, as the matter is important to the
understanding of the financial statements then the auditor will draw attention to
this in a “Material Uncertainty Relating to Going Concern” paragraph, meaning that
answer 2 is correct. Taking no action is therefore incorrect (answer 1) as the matter
must be bought to the attention of the members.
33. Option 3
There is no need to make a provision as the outcome of the legal case is only possible
(not probable) and the amount is an estimate (and probably unreliable at the
moment). Option 4 is incorrect. However, there is a need to at least make disclosure
as success is still probable (hence option 1 is incorrect). IAS 37 requires disclosure of
probably claims along with the amount. So although the directors may want option
2 to hide the actual amount, following the standard actually gives option 3 as the
correct answer.
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AUDIT AND ASSURANCE
34. Option 1
This is an advocacy threat as the audit partner will be seen to be supporting the client
in the loan application, literally advocating the client’s position. The correct answer
is therefore option 1. While there may be some additional fee for attending the
meeting, this is likely to be small compared to the audit so there is a very limited self-
interest threat (option 2 is incorrect). The client has not threatened the audit partner
with reprisals if the meeting is not attended hence there is no intimidation threat
(option 3 is therefore incorrect). Finally, there is no self-review as the auditor is not
be asked to review any work produced by the audit firm and so option 4 is incorrect.
35. Options 2 and 3
Taking no actions is not appropriate as there are misstatements and the client must
be informed about them, even if they are immaterial in total; so option 1 is incorrect.
There is no need to modify the audit report as the misstatements are immaterial so
4 is incorrect. 2 and 3 are the appropriate actions; the list must be given to the client
and reasons for non-adjustment obtained.
36. B
Tracing orders to invoices is ensuring all orders have been invoiced hence this is a
procedure for completeness.
Tracing GRN’s to purchase invoice is ensuring all goods received have been invoiced
so this is also a procedure for completeness. The same procedure can also be used
at the period-end to confirm that goods received and associated invoice have been
recorded in the same accounting period, as so this is also a procedure for cut-off.
Tracing PBD entries back to invoices ensures that the PBD book entry represents a
real invoice and so is a procedure for occurrence.
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ANSWERS
Tracing payments made back to invoices ensures that the payment is for a valid
company expense and so is a procedure for occurrence.
37. Option 4
The situation may not be money laundering – and anyway the audit senior’s
responsibility is to report to the audit partner or anti-money laundering officer, so
option 1 is incorrect. The loan must be disclosed but simply telling the FD this does
not ensure disclosure, so option 2 is not the most effective option. While the matter
is immaterial, all transactions with directors require disclosure so the loans cannot
be ignored; option 3 is incorrect. Therefore, raising a file note and asking the partner
to investigate further is appropriate – a senior member of the audit firm needs to
discuss the matter with the FD.
38. Option 4
Too much expenditure has been included in repairs hence this expense is over-
stated. However, too little expenditure has been added to non-current assets hence
this balance is under-stated. The correct answer is therefore option 4.
39. Option 1
Lack of agreement to the purchase order could indicate that the order is missing
and so the invoice may not be a valid company expense, so option 1 actually is the
correct answer. There is no indication that the invoice will not be paid (invoices
were processed) so option 2 is incorrect. The extent of the error is unclear so it is
impossible to conclude at the moment that there is a material error (so option 3 is
incorrect). The inventory system is not affected by invoice receipt (the GRN updated
inventory) so option 4 is also incorrect.
40. D
Ensuring payments are made for invoices in the ledger account does not confirm the
accuracy of the posting of those invoices, so A is not correct. Casting of the accounts
will not identify any error as the accounts will still add up (the lack of one invoice
in one account being balanced by the addition of that invoice in another account).
B is incorrect. Analytical review will not be affected as overall purchases are still
accurate so C is not correct. A supplier statement reconciliation will show the error
as the statement from the supplier will not show the invoice (in the account where
the invoice was incorrectly posted to) so D is right.
41. B
Tracing hours worked from the clocking in/out system to gross wages is ensuring the
completeness and accuracy of wages in that calculation, not occurrence.
Observing employees clocking in and out may confirm that employee should be paid
– which again relates to the completeness of the wages calculation.
Tracing hours worked from gross pay back to the hours worked does confirm that the
wages payment should be made (it is for actual hours worked) and therefore relates
to the occurrence assertion.
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AUDIT AND ASSURANCE
Tracing employee details to the HR records confirms that those employees are valid
and should be paid – which again confirms occurrence.
The correct answer is therefore options 3 and 4 – answer B.
42. B
The computer calculates wages from the clocking in and out system so it is unlikely
hours worked are incorrect – option A is incorrect. If workers are removed from the
computer system incorrectly, then presumably they will complain that they have not
been paid, so this error will be detected quickly (so C is incorrect). The clerk does not
calculate wages tax (and the tax will be calculated for all employees) so D is incorrect.
However, as the clerk adds new employees to the computer system and sets the
wages rates, ghost or dummy employees can be set up.
43. B
Encryption of data means it cannot be read without the appropriate software,
although this control by itself will not prevent access. So option A is not the best
control. Recording access to the computer has not prevented access so option C
is weak. Maintaining duplicate files is a backup control and there is no mention of
access to the original files, so D is also weak. Use of passwords will prevent access
so option B is the best answer particularly if those passwords relate to the wages
system only and not the computer systems overall.
44. C
Computers can make mistakes if the programmes have errors in them, or standing
data such as payroll tax deductions are wrong; so option A is not correct. Option B is
only correct in saying that humans do make mistakes. Extending testing to eliminate
any human error does not make sense as the clerk will re-check a calculation if an
apparent error is found to see whether that mistake was human or computer based.
So option B is not correct. An update of a computer programme will apply to all
calculations, so testing only one or two calculations will show the accuracy of the
update. A partial update of standard data is extremely unlikely making D incorrect.
C however is correct because wages calculations are standard; hence testing one or
two calculations will show whether all calculations are accurate.
45. D
Observing employees clocking in and out only ensures that the employees do clock
in an out and has no effect on the calculation of wages, so option A is not correct.
Options B and C take the net wages (after calculation of wages) and so are not
actually testing the calculation of wages, so these are also incorrect. Audit software
means that the data from the wages systems is used to re-calculate wages and so
option D is the correct answer.
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ANSWERS
46. Option 2
Where sales records are missing for two months, this represents a lack of audit
evidence. Management stating that sales are correct is not sufficient to show this is
case. If additional alternative evidence cannot be found, then the audit report will
be modified and qualified. Option 2 is therefore correct. Options 1, 3 and 4 are all
standard points that will be included in a representation letter per ISA 580.
47. Options 2 and 4
Control weaknesses will be reported to those charged with governance – and
significant weaknesses may be mentioned in the Key Matters section of the
report – but not all weaknesses, so option 1 is incorrect. Areas with a high risk of
misstatement and areas involving significant judgement are specifically mentioned
in ISA701 for inclusion in the Key Matters section so options 2 and 4 are correct.
Differences between information in the chairman’s statement and the financial
statements are reported in an ‘other matter’ paragraph in the audit report, so option
3 is incorrect.
48. Option 2
Taking no action is inappropriate as this matter does affect the financial statements
under audit (it is an adjusting event). Option 1 is incorrect. So if the inventory is not
revalued, the auditor will need to modify the opinion as this is a material amount and
inventory will be overstated (so option 2 is correct). The Key Matters section of the
audit report cannot be used as a reason for not modifying the opinion so option 3 is
incorrect. Finally, simply noting the matter for next year’s audit is also wrong as it the
financial statements being audited now that are affected – so option 4 is also incorrect.
49. Option 2
Options 1, 3 and 4 are all part of the normal functions of internal audit (as mentioned
in ISA 610 paragraph A3). The external auditor will always want to assess provisions
have been accounted for appropriately as these are one-off end of year items with a
significant amount of judgment involved. Audit work on this area will therefore not
be delegated to internal audit.
50.
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AUDIT AND ASSURANCE
If management do not make a going concern assessment for their company, then this
will result in a modified opinion as the audit has not obtained sufficient appropriate
evidence. Management must carry out a going concern assessment. If the going
concern assumption is not appropriate, then an adverse opinion is required as the
matter is material and pervasive to the financial statements. This means that both
statements are false.
51. A
(1) reviewing the inventory count instructions is a test of control; the auditor is
ensuring that there are no deficiencies in those instructions that will affect the count.
(2) obtaining GRN details is a substantive procedure as the auditor will be
re-performing the work of Endicor’s staff
(3) observing client staff is a test of control – the auditor is ensuring that staff are
following the inventory count instructions
(4) is a substantive procedure as the auditor is in effect re-performing the valuation
carried out by the client
As (1) and (3) are tests of control then the correct answer is A.
52. C
As the audit team members knew that they could obtain a games system at reduced
price, this may have affected their objectivity. The team members would not want
to find any inventory counting errors in case this reflected badly on them and the
offer was withdrawn. C is the correct answer. Audit staff were not asked to disclose
client information to third parties, so there was no confidentiality issue (option A is
incorrect). Hopefully they did no discredit the profession
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ANSWERS
53. D
The auditor confirms that the inventory exists by seeing it (option 3) and may gain
evidence about accuracy (that is the valuation of inventory) where the inventory
appears old or damaged (option 4). The answer therefore is D. Unless inventory is
counted at the period-end then no evidence can be obtained regarding cut-off (and
the question states the inventory is being inspected, not the counting system where
inventory would not be moved during the count), so option 1 is not correct. The fact
that inventory is on the client’s premises does not prove the client has a right to that
inventory; it could belong to another company. So option 2 is also not correct.
54. B
Lack of pre-numbering of inventory sheets means that sheets can be lost. In other
words, the numeric sequence of the sheets cannot be determined. B is therefore the
correct answer. Lack of numbering has no effect on recording or locating inventory
as inventory will be marked as counted and a map of the warehouse will still be
available showing where inventory is. Answers A and D are therefore incorrect.
Finally, as long as the auditor has inventory sheets then recounting can take place, so
answer C is also incorrect.
55. C
In most companies the petty cash balance is very small, so it is immaterial. Even
large errors in petty cash will not affect the true and fair of the financial statements
so C is the correct answer. Petty cash does not always have a good internal control
system (in fact controls may be poor due to the relative smallness of the amount), so
option A is incorrect. While FD’s can normally be trusted, “trust” is not classified as
audit evidence so other appropriate evidence will be sought by the auditor, meaning
D is incorrect. Finally, the fact that petty cash is used for reimburse small items of
expenditure does not mean errors cannot occur, so B is incorrect.
56. Options 2 and 4
(1) Reporting to the Finance Director is not independent as the FD is responsible
overall for the accounting systems in the company and may choose to ignore
recommendations from internal audit.
(2) Basing work on ISAs is indicative of independence as the work standard is set by
external sources not by staff, including the FD, within the company
(3) While monitoring controls is normally the work of internal audit, implementing new
systems is not independent as these will then have to be audited – a self-review threat
(4) Reporting to the audit committee is independent as the committee itself is made
up from non-executive directors who are also independent.
Both options (2) and (4) show independence.
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AUDIT AND ASSURANCE
57.
The external auditors will report to the audit committee in the first instance to
discuss the findings of their audit. However, the final report will still be to the
shareholders. Internal audit cannot be as independent as external audit as they are
appointed by the company; the external auditors are appointed by the shareholders
who are independent to the running of the company, providing independence on
external auditor appointment.
58. Option 2
It is correct that fees must be less than 10% of the external auditor’s income,
however, other safeguards are needed, hence option 1 is incorrect. The internal
and external audit teams must have different members (to avoid self-review threats)
so option 2 is correct. There is no requirement for internal audit to have qualified
auditors only (the same as the external audit team) so option 3 is incorrect. Finally,
the different teams reporting to different people (FD and audit committee) appears
to give independence, however, this is not the case as external audit must still report
to the audit committee to give independence from the FD. Option 4 is also incorrect.
59. Option 4
The main threat is intimidation as the external audit team may not wish to query
their old audit partner. The answer is therefore option 4. The threat may be implied
but real. In practice the audit firm may have to resign given the significance of this
threat. There is no self-review (option 1) as different teams produce and review
the systems work. There is an automatic self-interest threat but this results from
receiving a fee as internal auditor, not from the audit partner working at the client
(so 2 is incorrect). Finally, the external auditor will be auditing the system not
supporting them as such so there is no advocacy threat and 3 is incorrect.
60. Option 3
As the audit committee comprises non-executive directors, they are the group to
make the appointment as they will give an independent decision (so the answer is
option 3). The FD and the board are not independent being an executive director
or including executive directors (so options 1 and 2 are incorrect) while the
shareholders will not have sufficient knowledge to make an effective appointment
(so option 4 is incorrect). Note in company law the shareholders do normally
appoint the external auditor, but this is a recommendation from the board or audit
committee which the shareholders normally accept.
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ANSWERS
61. C
The address in the audit report shows the town that the auditor practices from, so
C is the correct answer. This town may be the head office of the audit firm, but that
is not the point of the address itself, so A is not correct. The address is also not that
of the audit partner – partly to maintain some confidentiality of that information but
also because the partner may live in a different town – so B is incorrect. Finally, there
is no requirement for the audit firm to be located in the same town as their client, in
fact the audit firm may be in a completely different town, so D is also incorrect.
62. B
The assurance firm needs to avoid the self-review threat of the preparation and
audit of the financial statements of Galorndon by the same staff members. The
only way to do this is to ensure staff only work on Galorndon in either the assurance
or the business services departments. Answer B provides this control recognising
that business services staff can work in assurance but not on their business services
client. Answer A is possible but this is very restrictive and will not allow staff to use
their expertise in either department. Answers C and D do not provide the necessary
independence as assurance staff could still be producing the financial statements of
Galorndon which they then also audit.
63. C
The repairs and redecoration invoice of $35,000 is only 4% of net profit (35/857,000)
and 0.4% of turnover (35,000/8,500,000) and so is not material. As profit will be
overstated (as the expense has been omitted from the income statement), then the
correct answer is C.
64. D
The main issue with the invoice is ensuring that there is no other information
that the auditor is unaware of. Obtaining the management representation letter
point is therefore essential for the audit and the answer is D. Doing nothing is not
appropriate as the auditors know an invoice is omitted from the financial statements
– at the very least the directors must be asked what they want to do – so option
A is incorrect. B is incorrect as it not the responsibility of the business services
department to amend the financial statement; this is up to the directors. The auditor
already knows the answer to C so this option is also incorrect.
65. B
The emphasis of matter paragraph is used to draw attention to significant items
in the financial statements; it cannot be used to avoid qualifying the opinion, so
A is incorrect. While the audit opinion will be qualified, this does not mean that
the modification is explained as a Key Matter, so C is incorrect. The modification
is explained in a separate paragraph below the opinion paragraph so B is correct.
Finally, the matter is only material, not material and pervasive, hence an adverse
opinion is inappropriate and D is incorrect.
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66. C
1 is a self-review threat as the senior appears to have produced and checked the tax
computation. Another member of the audit firm must review this to identify any errors.
2 is a familiarity threat; although the manager is not yet married to the member
of the accounts staff, there is a risk that the manager will not want to upset the
engagement and so not question audit evidence sufficiently.
3 is an advocacy threat. Even though the partner did not speak at the meeting, the
presence of the partner still supports the client.
4 is a familiarity threat – not just regarding the cash flow but because golf is a weekly
event meaning the partner and FD are good friends.
In summary:
Self-review 1
Familiarity 2 and 4
Advocacy 3
So the correct answer is C.
67. B
Analytical procedures help the auditor identify risk areas as part of audit planning,
so A is incorrect. The use of analytical procedures at the end of the audit is not
to collect substantive evidence, this is during the audit so option C is incorrect.
Analytical procedures are compulsory at completion so D is incorrect. Therefore, B is
the correct answer as analytical procedures help the audit to ensure that the financial
statements are consistent with knowledge of the client accumulated during the audit.
68. C
As the going concern issue is fully disclosed, there is no need to modify the audit
opinion, so D is incorrect. However, disclosure in the Key Matters section is
insufficient (so B is incorrect) and the auditor must mention the issue somewhere in
the report (so A is inappropriate). Use of the material uncertainty regarding going
concern paragraph is standard to bring the matter to the attention of the readers of
the report, so option C is correct.
69. D
The normal rule is that auditors cannot assist in producing the financial statements
for a listed company, so options A, B and C are incorrect. The only time the auditor
can assist is in exceptional circumstances, hence an emergency situation perhaps
where the FD has left and there are no qualified accounts staff MAY apply. The
correct answer is D.
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ANSWERS
70. B
Each ISA has an objective which the auditor must follow, so statement (1) is not
correct. However, where legislation in a country is different from the ISA, then
that legislation must be followed; ISAs are guidance only whereas legislation is by
definition legally enforceable. This means B is correct as only statement 2 is correct.
71. B
Confirming the completeness and accuracy of sales means tracing documents
forward through the sales system from customer order, goods despatch note and
sales invoice. Only option B does this and so this is the correct answer. Answer A
confirms that the invoice is valid (occurrence assertion) and so is incorrect. Numeric
sequence of sales invoices does not confirm that despatches have been invoiced
(so C is incorrect) while reviewing payments for possible bad debts and/or disputed
invoices simply means that a customer is disputing goods that have been received,
not missing invoices. D is also incorrect.
72. B
As there is a material error then the audit opinion must be modified, so A is
incorrect. Given that the auditor can quantify the error then answer B is most likely.
Answer C by itself is incorrect; the auditor may mention that proper accounting
records have not been maintained but the audit opinion will still be qualified on
the material error in sales. D is incorrect as there is no indication that the matter is
material and fundamental.
73. A
The remuneration committee only sets the remuneration of the executive directors;
the board (executives only) decide the remuneration of the non-executive directors
to avoid any conflict of interest. So A is the correct answer. All the other points are
normal requirements of good corporate governance.
74. A
While the audit firm may be able to report on the prospectus, attending meetings
with potential shareholders will be seen to be closely supporting Ilecom and is
therefore an advocacy threat. A is the correct answer. There is no evidence that
the client is forcing the external auditors to attend (hence no intimidation) so B
is incorrect. There will be some self-interest as the auditors will want to be paid,
although there is no indication any fee thresholds are broken, hence C is incorrect.
As the FD will be producing the prospectus there is no self-review threat and so D is
also incorrect.
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75. D
Service contracts can run for up to 3 years for non-executives; executives are
normally re-appointed annually, so A is incorrect. Non-executive directors can
hold shares in the company, (note the question does not state the shares were
provided by the company which would be incorrect) and so B is wrong. Non-
executive directors can obtain advice in respect of the discharge of their duties so C
is incorrect. Non-executive directors are only paid a salary for attending meetings,
so D is the correct answer – any other form of incentive scheme is against corporate
governance codes.
76. Options 1 and 3
Threats to objectivity must be communication per ISA 260 and so option (1) is
correct. ISA 260 para 16 also requires difficulties experienced during an audit to be
communicated to those charged with governance, hence (3) is correct. Regarding
option (2), ISA 260 only requires an auditor communicate to those charged with
governance the auditor’s responsibility regarding the financial statements, not the
responsibilities of those charged with governance to those financial statements (para
14(b)), while option (4) is a breach of confidentiality and therefore not allowed.
77. Option 3
Option 1 is partly correct in that corporate governance codes have no legal backing.
However, an explanation of non-compliance is normally expected, meaning option 3
is more correct than 1. Option 2 is an explanation of the Sarbanes Oxley system or a
rules based regime and therefore incorrect. Option 4 is incorrect as it is the directors
that decide on non-compliance; members do not authorise this.
78. Option 3
Taking no action is not appropriate as the chairman’s statement can be seen as
casting doubt on the correct figures in the financial statements, hence option
1 is incorrect. The Key Matters section draws attention to key risks and issues
encountered during the audit, but as the chairman’s statement is not audited this
cannot be used to state the problem (so option 2 is incorrect). Similarly, as the
chairman’s statement is outside the audited financial statements, option 4 cannot
be used. Emphasis of matter only draws attention to matters within the audited
financial statements. So option 3 is the correct answer; the other matters paragraph
draws attention to differences between the audited sections of the annual report
and the unaudited sections (in this case the chairman’s statement).
79.
Correct Incorrect
Profit overstated? √
Material? √
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ANSWERS
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AUDIT AND ASSURANCE
86. C
Statement 1 is an advocacy threat. Even though the audit partner will not speak at the
meeting, the presence of the partner will appear to support the client’s loan application.
Statement 2 is possibly a self-interest threat. However, as long as the manager
pays for the cleaning on normal commercial terms then there is no threat. There is
nothing in the scenario to suggest this is not the case.
Statement 3 is a self-review threat. There is no check on the tax computation and
the audit partner will sign the audit report, effectively reviewing his own work
Statement 4 may appear to be a self-review threat as the audit firm is reviewing
its own work. However, a quality control review is being carried out by a second
partner, hence there is no self-review.
There are no self-interest threats.
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ANSWERS
87. Option 2
The assurance firm can certainly assist in preparing the forecast and will have the
skills to do this – the assurance firm is used to preparing and reviewing financial
information, so option 4 is incorrect. Option 1 is also incorrect as other staff within
the same firm can still review the forecast; there is no self-review threat. The
audit partner can be involved, and it may be preferable to do so, to provide client
continuity and so his experience of the client can be used to prepare an accurate
forecast. Option 2 is therefore correct. Option 3 is not correct as the fee limits
relate to the total fee from the client as a percentage of the firm’s total fee, not the
amount of other services compared to the audit fee.
88. Option 1
The inventory balance is immaterial so detailed audit testing is not required. An
analytical review of the balance as suggested in option 1 may be carried out; the
comparison to key cutting income provides basic assurance that inventory is correct
(roughly the same percentage change over the year). There is no need to attend the
inventory count, so options 2 and 3 are incorrect. Agreeing quantities to purchase
invoices is a valuation test (not completeness) so option 4 is also incorrect.
89.
There is nothing to indicate that Janit Co is not a going concern so normal audit
procedures will be carried out in this area. Even if the bank loan is not obtained,
Janit’s existing stores are profitable hence there is no going concern risk.
The Key Audit Matters section of the audit report is for matters affecting the audit
this year, not factors affecting the client in the future.
Neither statement is correct.
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90. Option 3
Being a non-executive director can be seen as being involved in the management of
Janit Co as this is a board position. Rules of professional conduct state that an audit
partner can only take a management role in an audit client after two years have
elapsed with no audit involvement with that client. This means the audit partner
must resign now and wait two years before accepting appointment (so option 3 is
correct). There is no requirement for the audit firm to resign when appointment is
accepted so option 4 is not correct. If the partner accepted appointment straight
away then the audit firm may well have to resign due to the lack of independence,
but this is not given as an option here.
91. A
The omission of the invoice means that the purchases balance is understated – hence
gross profit will be overstated as cost of sales will be understated.
As the invoice was not recorded then both purchases (see above) and payables will
be understated, the amount not being paid at the year end.
So gross profit is overstated and payables understated. The correct answer is A.
92. D
The supplier statement is literally from the supplier confirming the existence of the
supplier (so option A is not correct). If the audit client omits a purchase invoice from
the records (and so understates a payable) this invoice will still be shown on the supplier
statement (as the supplier wants to be paid). The statement therefore confirms the
completeness of the supplier balance and option B is incorrect. The statement also
confirms an amount is to be paid to the supplier (hence option C is incorrect as this is
the rights and obligations assertion). D is the correct answer as presentation of the
payables balance on the financial statements (hopefully under current liabilities) is not
proved – the auditor must review the financial statements to do this.
93. B
Obtaining a management representation will not be sufficient as management may be
biased to omit purchases (and other more relevant audit evidence will be available)
so option A is not correct. Reviewing invoices prior to the year-end does not identify
missing invoices (because the invoices are not there!) so option C is not correct.
Performing an analytical review only provides a general indication of the completeness
of the balance; invoices may still be missing, so option D is inappropriate. B is the
correct answer as reviewing invoices after the end of the year may indicate liabilities
that need accruing for (such as goods receive prior to the year-end).
94. C
Statement 1 is correct. The directors must produce financial statements that comply
with appropriate company legislation. The auditor obtains evidence on payables
(normally a material figure in the financial statements) to ensure this is accurate and
the directors have met their obligations in this area.
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ANSWERS
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AUDIT AND ASSURANCE
99. C
An unmodified opinion is not possible as the financial statements contain overall
material errors. This means options A and B are not correct. An emphasis of matter
is only used to draw reader’s attention to specific items of disclosure in the financial
statements, not as a reason for not qualifying the opinion. As there is a material
error, the option C is the most likely report. Option D is possible where there are
many errors of a material nature which do affect the whole financial statements; this
is not the case here where all errors are immaterial individually.
100. A
Directors’ loans must be disclosed even if there are immaterial. Lack of disclosure by
Malcor means that the auditor will disclose the information in the audit report.
Although Malcor has not followed IAS 2 regarding inventory valuation, the amount is
immaterial and so no amendment to the audit report is needed
Although cash sales are inherently risky, no weaknesses were found in the control
systems so no modification is needed to the audit report. Just because a company
has cash as its main form of sales does not mean an audit report modification is
automatically needed
Changing a profit to a loss changes the view given by the financial statements (and
the economic decisions of the users of those financial statements), therefore this will
result in an audit report modification.
As (1) and (4) are correct the answer is A.
101. B
There is a risk of understatement of trade payables and to ensure completeness,
it makes sense to include in the sample balances which have a chance of being
recorded at a lower value in Poppy’s accounts, in addition to the material balances
and those of suppliers who do a lot of business with the company.
102. A
The discrepancy is due to an invoice received by Poppy after year end, but the purchase
should have been recognised when the goods, and not the invoice, were received.
103. C
Poppy should not be liable for the disputed invoice if the company has returned the
faulty goods before year end and if that return has been accepted by the supplier
104. B
The error is below the materiality threshold of $50,000 but only relates to 20% of
payables. If the rest is examined it is possible for more errors to be found, so it has
to be extrapolated in order to see what effect this mistake could have on the whole
population. The $25,000 error, being one-off and also made by a temporary clerk, is
unlikely to have occurred in the rest of the population, but the $20,000 cut-off error
due to weak controls should be projected across.
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ANSWERS
105. D
Using test data means the auditor puts a fake transaction through the client’s system
to see if it could break it. Inputting dummy invoices is testing Poppy’s controls
using a computer, the rest of the options represent using audit software (computer
substantive testing)
106. C
The auditor has an active duty to test events after the reporting period until the date
he signs the audit report. After that date until the AGM he has only a passive duty
(i.e. no need to test any further events)
107. B
The first steps the auditor should take are discuss the matter with management/
those charged with governance, in order to understand the nature and effect of the
event, and then find out what management is planning to do with the accounts in
relation to this matter. Resigning is too extreme, and just obtaining a management
representation would not do much.
108. C
The amount is not material (less than 5% of profit and less than 0.5% of revenue). All
the procedures except for asking the ex-director for confirmation would make sense
in relation to the accounting treatment of the claim.
109. A
The ‘Key Audit Matters’ paragraph is required for listed companies only. It should
include all the issues requiring significant auditor attention that were discussed with
those charged with governance
110. D
The opinion should be unmodified as the amount is below the materiality threshold
(see answer 108) therefore the misstatement will be immaterial. No emphasis of matter
paragraph can be included given the issue is not in the financial statements at all.
111. D
The client makes very specialist products and the potential risk is that the new audit
team members are not competent enough to understand the client and audit the
accounts. To overcome this a specialist training should be provided for the team
members, and not reinstate a partner who has already done the audit for 7 years, as
this would lead to a familiarity threat.
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AUDIT AND ASSURANCE
112. B
Self-review threat arises when the auditor checks his own work. This is not relevant
to the question as the previous partner now being the finance director of the client
will not be auditing his own work. However the new audit partner could trust him too
much and not check his work enough or deliberately ignore some errors, because of
their friendship (familiarity threat). Resigning from the engagement is too extreme as
a measure, appointing another audit partner should be a more appropriate solution.
113. C
The most obvious threat is advocacy, which would arise in situation 3, because the
auditor representing the client to the tax authority could create the impression
the auditor is on the client’s side. Therefore you can eliminate answers B and D.
Maintaining the payroll records and later auditing them is also obviously a self-review
threat in situation 1 which means the correct answer must be C.
114. C
The risk here is that because Fir Co provides so much of the auditor’s fees mistakes
could be ignored in order not to upset the client and lose the large income. Using
two different teams for the different types of work will not help resolve this problem.
115. B
Sycamore will be in breach of the law if it does not report the suspicious cash
transfer. This is one of the situations where confidentiality overrides applies.
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ANSWERS
Tutor's Tips
This is a very typical question on corporate governance. It does not get examined as
often as some other topics but if it does then you are expected to do well in it as it is
fairly standard.
To score full marks take into account what the examiner report said:
Candidates were awarded ½ mark for each weakness identified and a further ½ mark
if the candidate explained why this was a weakness. One mark was available for
each recommendation, however candidates often worded their recommendation as
either a “statement’ or an ‘objective’ rather than an “action” and so were often not
awarded the recommendation mark.
You should be careful not to go over the top, suggesting more than the required
number of weaknesses though as this could compromise your time management and
not give you any extra marks.
Marking guidance
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AUDIT AND ASSURANCE
Weaknesses Recommendations
Board Balance
The company’s board has more than half of For the board to be balanced at least half
the directors being executives and as such is of the board should consist of independent
not balanced. This means independence is non-executive directors (NEDs) The company
threatened as the executive directors could should appoint at least 2 more NEDs to
have too much power. achieve this proportion.
Independence of NEDs
Given the chairman and one of the other Those two directors should be replaced by
NEDs are ex-executive directors, their two new independent NEDs, in order to
independence is questionable. maintain board balance.
Audit Committee
This should consist of a minimum of three One of the newly recruited independent NEDs
independent NEDs, and at least one of them should be a person with recent experience in
with recent relevant financial (and audit) finance and audit, and the company should
experience. Currently this is not the case as ensure that all remaining committee members
none of the NEDs has the required experience are independent.
and they are not all independent.
Board of Directors
All directors have been on the board for at Regular performance review of the board and
least 4 years and there is no mention that each of its members should be carried out
their performance has been reviewed, with (ideally annually). Directors should be subject
directors being reappointed or dismissed. It is to retirement every couple of years with the
possible that the current board members are option for shareholders to reappoint them, if
not the best option for the shareholders, and satisfied with their performance.
no steps are taken to change this.
Internal Audit
Currently there is no internal audit function, The Audit committee should regularly review
therefore only the Audit committee is the need for Internal audit function in
responsible for overseeing of the company’s Tangerine, and also suggest how this should
risk management and internal controls. be resourced, if it is required.
These might be ineffective and need more
monitoring and some improvement.
2. Brampton Co
Tutor's Tips
Part (a) – try and make two comments about both interim and final audit to gain the
four marks on offer. The answer here provides plenty of ideas; note only 4 sentences
are needed for a clear pass standard.
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ANSWERS
Part (b) is slightly generous – for 2 marks a procedure. Do ensure each procedure
is clearly explained (other questions will have one mark per procedure and so less
detail is expected).
Part (c) be sure to mention limited assurance – 4 marks again implies four sentences.
Part (d) - think of factors affecting reliance like independence and ensure each point
is well-explained. You could use small headings to make each point clear.
Marking guidance
(a) The interim audit, as its name suggests, is that part of the whole audit that takes place
before the year-end. The auditor uses the interim audit to carry out procedures that
would be difficult to perform at the year-end because of time pressure.
The final audit, on the other hand, will take place after the year-end and concludes
with the auditor forming and expressing an opinion on the financial statements
for the whole year subject to audit. It is important to note that the final opinion
takes account of conclusions formed at both the interim and final audit.
Typical work carried out at the interim audit includes:
– consideration of inherent risks facing the company.
Tutor's Tips
Risk would be initially considered at the planning stage, but is, in fact, reassessed at
all audit stages.
– recording the system of internal control.
– carrying out tests of control on the company’s internal control system and
evaluating its effectiveness to determine the level of control risk.
– performing sufficient substantive testing of transactions and balances to be
satisfied that the books and records are a reliable basis for the preparation
of financial statements.
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AUDIT AND ASSURANCE
– identification of potential problems that may affect the final audit work.
A basic aim is to ensure as far as possible that there are no undetected
problems at the year-end.
Typical work carried out at the final examination includes:
– Follow up of items noted at the inventory count.
– Obtaining confirmations from third parties, such as bankers and lawyers.
– Analytical reviews of figures in the financial statements.
– Reviews of events after the reporting period.
– Consideration of the going concern status of the organisation.
Tutor's Tips
At the final audit the auditor would carry out tests to ensure that the conclusions
formed at the interim audit were still valid & also note the above answer is too detailed.
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ANSWERS
(b) Audit procedures adopted in the examination of the cash flow forecast would
include (ONLY 3 REQUIRED):
(i) Check that the opening balance of the cash forecast is in agreement with
the closing balance of the cash book, to ensure the opening balance of the
forecast is accurate.
(ii) Consider how accurate company forecasts have been in the past by
comparing past forecasts with actual outcomes. If forecasts have been
reasonably accurate in the past, this would make it more likely that the
current forecast is reliable.
(iii) Determine the assumptions that have been made in the preparation of
the cash flow forecast. For example, the company is experiencing a poor
economic climate, so you would not expect cash flows from sales and
realisation of receivables to increase, but either to decrease or remain
stable. You are also aware that costs are rising so you would expect cost
increases to be reflected in the cash forecasts.
(iv) Examine the sales department detailed budgets for the two years ahead and,
in particular, discuss with them the outlets that they will be targeting. This
would help the auditor determine whether the cash derived from sales is
soundly based.
(v) Examine the production department’s assessment of the non-current assets
required to increase the production of white bread to the level required
by the sales projections. Obtain an assessment of estimated cost of non-
current assets, reviewing bids from suppliers, if available. This would provide
evidence on material cash outflows.
(vi) Consider the adequacy of the increased working capital that will be required
as a result of the expansion. Increased working capital would result in cash
outflows and it would be important to establish its adequacy.
(vii) If relevant review the post year-end period to compare the actual
performance against the forecast figures.
(viii) Recalculate and cast the cash flow forecast balances.
(ix) Review board minutes for any other relevant issues which should be
included within the forecast
(x) Review the work of the internal audit department in preparing the cash
flow forecast.
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AUDIT AND ASSURANCE
(c) You would inform management that it would not be possible to give a report
on the accuracy of the cash flow forecast. The forecast is an assessment of cash
flows in the future which is uncertain, particularly in the second year.
The bank should be informed that the kind of report that you could give is a
limited assurance or negative assurance report. You would be able to state
in your report the kind of work you had carried out, the assumptions that
management had made and then to give a negative form of assurance in which
you would state, among other things, that nothing had come to your attention
that would cause you to believe that the assumptions do not provide a reasonable
basis for the cash forecast. You could then go on to say that the forecast has been
properly prepared on the basis of the assumptions. This is assuming that this kind
of opinion is appropriate in the light of the work you have performed.
(d) The external auditors would normally be able to use the work of the internal
auditors provided that:
– they are independent (in this case, of the accounting department and
finance director to whom the accounting department reports). It appears
that they have reported to the whole board, which would be a factor
increasing their independence. It would be even better if they had strong
links with the audit committee (if applicable).
– they are competent. Your firm would have formed a view in past years of
their reliability by considering the background (including qualifications and
experience, particularly as regards forecasting) of the internal audit staff and
by examining their reports and working papers. You may also have reviewed
some aspects of their work in the current year to the same end.
– effective communication, whether there is likely to be effective
communication between the internal auditors and the external auditor.
– they have exercised due professional care, the work would need to have
been properly planned including detailed work programmes, supervised,
documented and reviewed.
– the company is experiencing difficulties due to the economic down turn and it
requires the loan in order to expand. Management might place pressure upon
the internal auditors to present the cash flow forecast in a more favourable
light. This would impact the independence of the internal auditors.
Note: You would still take full responsibility for any report that you issue.
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ANSWERS
Tutor's Tips
In part (a) you need to explain the procedures and processes that take place during
an interim and final audit. You should divide your time equally between both interim
and final audit procedures. A simple list of procedures is not enough here, you need to
explain the procedures to obtain the marks. In part (b), use the scenario to add to your
standard range of advantages. Also ensure you explain your points, do not just list them.
Note the question asked for the benefits of what an audit committee does, not a
description of what it does, as the examiner noted:
“this was generally because they focused too much on the role of an audit committee
rather than the benefits, or failed to explain exactly how the company would benefit”.
In part (c), all you need to remember is that NEDs should be independent, have
relevant experience, and this should generate 3 pros or cons for each of the two
candidates relatively easily.
Marking guidance
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AUDIT AND ASSURANCE
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ANSWERS
Also he already has a full time job at a large company which on its own will use
up most of his time. Add to that his existing NED role and adding another NED
role might mean he cannot contribute the necessary time to another job.
Jacob Mallard (JM)
As a finance director JM should have the necessary accounting and audit experience
and knowledge to be able to contribute to the company’s audit committee.
JM also has experience in the retail sector which should prove helpful in
understanding the issues at another retail company, without the danger of being
a competitor.
However, JM wants a fixed 7 year role. All directors should be up for shareholder
votes at least every 3rd year, so a 7 year fixed role would breach this point and be
unacceptable.
Also JM is the brother of the company’s CEO, meaning he is not independent
due to the obvious familiarity threat. He might side with the CEO rather than
challenging him, because of the family relationship, or might trust the CEO too
much and lack the necessary scepticism to scrutinise the CEO properly.
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Tutor's Tips
This is a very typical independence threats and safeguards question. Make sure the
threats are explained not just stated, in terms of what might go wrong with the audit
if they are not addressed.
As the examiner report said:
“The best answers were those that identified the fact from the scenario which may
affect independence and from that identify which category of ethical threat this
created … explanation ½ marks were awarded if the candidate went on to explain
how this would affect the auditor’s independence”
Hence threat marks will be 0.5 for which type of threat (e.g. self interest) and 0.5 for
the explanation as above. As such the answer below has slightly too many threats (a
full mark answer only requires 5, not 6).
The answer below takes advantage of the links between some of the threats (note
the last point in particular) but it is possible to score full marks without going that far.
For mitigating the threats, again a full mark can only be scored if the suggestion
is clearly explained, not just stated. And be wary not to just resort to resigning in
response to each threat. Resignation is the last resort, not the first.
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ANSWERS
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AUDIT AND ASSURANCE
Tutor's Tips
Part (a) is typical of a ‘knowledge’ requirement in the exam. It is important to
recognise that an auditor has a duty of confidentiality towards a client. However
there are certain situations where an auditor may have a right or a duty to disclose
this information to third parties.
Part (b) is very typical of a requirement covering the ‘ethics’ part of the syllabus. You
are presented with a scenario and asked to explain the threats to independence. It
is very important to recognise that simply stating the threat e.g. ‘self interest’, is not
enough to obtain all of the marks. The threat must be explained.
It is important to state a safeguard for each threat. Setting out your answer in a
column format ensures a methodical approach.
182
ANSWERS
Marking guidance
(a) The ACCA’s code of ethics states that auditors should keep client information
confidential. There are however a few situations where the auditor may share
client information with third parties. This may be when they have:
• Right to disclose or;
• Duty to disclose.
RIGHT TO DISCLOSE
• When the client gives permission.
• When the auditor discovers something about the client that may be in the
public interest.
• When disclosure of information is necessary to protect the auditor’s interests
e.g. if defending themselves if the client sues for negligence.
DUTY TO DISCLOSE
• If auditor has actual knowledge or reasonable suspicion of money laundering,
terrorism, treason or drug trafficking offences
• If the ACCA are investigating the auditor’s work
• When the law demands information e.g. giving evidence in court
• Where a breach of laws and regulations needs to be disclosed in the
financial statements.
183
AUDIT AND ASSURANCE
(b)
184
ANSWERS
6. LV Fones Co
Tutor's Tips
This is a fairly standard ethical threats question. Note the easier theory marks in
parts (a) and (d). Parts (b) and (c) can easily be presented in columnar format.
Marking guidance
(a) Compliance with ACCA’s Code of Ethics and Conduct fundamental principles can
be threatened by a number of areas. The five categories of threats, which may
impact on ethical risk, are:
○ Self-interest
○ Self-review
○ Advocacy
○ Familiarity
○ Intimidation.
Examples for each category (Only one example required per threat):
○ Self-interest
• Undue dependence on fee income from one client
• Close personal or business relationships
• Financial interest in a client
185
AUDIT AND ASSURANCE
186
ANSWERS
○ Intimidation
• Threat of litigation
• Threat of removal as assurance firm
• Dominant personality of client director attempting to
influence decisions
• Pressure to reduce inappropriately the extent of work performed in
order to reduce fees.
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AUDIT AND ASSURANCE
(d) Prior to accepting an audit engagement the firm should consider any issues
which might arise which could threaten compliance with ACCA’s Code of Ethics
and Conduct or any local legislation. If issues arise then their significance must
be considered.
– The firm should consider whether they are competent to perform the work
and whether they would have appropriate resources available, as well as any
specialist skills or knowledge.
– The prospective firm must communicate with the outgoing auditor to
assess if there are any ethical or professional reasons why they should not
accept appointment.
– The prospective firm must obtain permission from the client to contact the
existing auditor, if this is not given then the engagement should be refused.
– The existing auditor must obtain permission from the client to respond, if
not given then the prospective auditor should refuse the engagement.
– If given permission to respond, then the existing auditor should reply to the
prospective auditor, who should then carefully review the response for any
issues that could affect acceptance.
188
ANSWERS
– In addition the audit firm should undertake client screening procedures such
as considering management integrity and assessing whether any conflict of
interest with existing clients would arise.
– Further client screening procedures would include assessing the level of
audit risk of the client.
Tutor's Tips
Part (a) just state four safeguards – standard ones like Chinese walls and reviews will
obtain easy marks.
Part (b) try and get a balance between advantages and disadvantages – technically a
pass can be obtained just explaining advantages or disadvantages but including both
will help you obtain the easier marks for both areas.
Part (c) is worth answering in table format – as threats and mitigation are required.
Marking guidance
189
AUDIT AND ASSURANCE
Self-interest threat
The engagement partner’s son The engagement partner should be
accepting a job as a sales manager in changed which will decrease the threat
Goofy Co may be seen as a self-interest to an acceptable level.
threat for the partner continuing
to audit this client. The partner
may be tempted not to question
documentation supplied by his son on
the assumption it is correct.
190
ANSWERS
Familiarity threat
A partner on the job for six years creates Partner rotation would resolve the
a familiarity threat, as he/she may have problem.
developed a very close relationship with
the accounts team at Goofy.
Audit fees renegotiations
The suggestion by Goofy Co that 20% Audit fees should continue to be
of the audit fees should be based on calculated in a totally independent way
profit after tax of the company would to get total audit fees, e.g. number in
lead to a perceived self-interest threat, the team, seniority, firm’s charge-out
affecting auditor independence. rates and total time on the job.
The auditor may not query the need
to decrease profit where evidence
suggests this is necessary, as the fee
payable will also decrease.
Tutor's Tips
Part (a) – note there are two things to do here – explain governance and then explain
why this is important.
Part (b) – use a table to show the weaknesses from the scenario with the corresponding
solution – remember stating the obvious is a way of obtaining an easy mark here.
In part (c) simply the explain the terms and give brief examples.
Marking guidance
191
AUDIT AND ASSURANCE
(a) Define
Corporate governance is the rules and/or guidance on how companies should be
managed and controlled by management and those charged with governance for
the benefit of the shareholder.
Why is it important? (Only 2 paragraphs needed)
Corporate governance gives guidance on directors’ responsibilities, how the board
of directors should be structured, broad issues to do with management of the
company, need for good internal controls and relationship with external audits.
The guidance in the corporate governance code should enable the company to
be managed more effectively for the long-term achievement of objectives of the
company and its shareholders.
Good corporate governance should help as most companies are managed and
controlled by directors on a daily basis while owned by shareholders who only
meet up annually and are not involved in running the company.
Shareholders need to ensure that their needs are taken into account by directors
and that there is a process in place for them to be informed as to how the
business is operating. Corporate governance gives directors and shareholders
guidance on this.
(b)
192
ANSWERS
193
AUDIT AND ASSURANCE
(c) Confidentiality
Auditors have a duty not to disclose client information that they may have
obtained during the course of their professional responsibilities as auditors.
Auditors and/or anybody related to them through family or business
relationships should also not personally gain from that information, e.g., through
buying of their client’s shares or selling information obtained by the auditors.
(i) There are circumstances when auditors have an obligation to disclose their
client information:
○ Client is involved in money laundering.
○ Client is suspected of sponsoring terrorism.
○ Client is suspected of treason.
○ The ACCA is investigating the firm.
○ There is a court order to release information.
(ii) Voluntary responsibility to disclose falls into two categories:
○ When client permission has been granted
○ When auditor feels it is in the public interest to disclose
9. Currant & Co (June 2012)
Tutor's Tips
Part (a) Note that the question does mention prevention and detection so two
comments on each of these areas will get the four marks on offer.
Part (b) is a typical threat and mitigation question so as usual use a table to clearly
show to threat and how it is mitigated.
Part (c) requires four benefits for four marks – while the scenario can be used to
generate ideas – marks will also be available for theory where points cannot be
found in the question.
Marking guidance
194
ANSWERS
195
AUDIT AND ASSURANCE
(b)
196
ANSWERS
Note: Although the client is not listed yet, it would be best for the auditors to take a
stronger stance (as if the client was already listed) so as to protect their independence.
This is because the client is about to be listed on the stock exchange and consequently the
level of scrutiny will be higher from regulators.
Orange’s directors have said that in The audit firm may simply continue
order for the audit firm to obtain all the performing only audit work. Alternatively,
assignments, the audit work must be it may accept all assignments after
performed quickly and with minimal assessing the likely level of fees and then
questions/issues. This would be perceived let the directors know that they cannot
as an intimidation threat. compromise on any questions during audit
work. If the directors still insisted, the
auditors may take a decision on resigning.
Luxury hotel The audit firm should decline the offer and
The finance director inviting the audit team explain why to the finance director. A less
to spend a weekend away with his finance extravagant thank you gesture could be
team as a gesture of thanks for their hard accepted, but definitely not a weekend in a
work may be perceived as bribery in return luxury hotel.
for a good report. This creates a self-interest
threat for the audit firm.
Loan The senior member of the engagement team
The finance director offering a short-term should decline the loan unless it is offered at
loan to a senior at a significantly reduced the normal interest rate given to the public.
interest rate would be perceived as creating
a self-interest threat to an engagement
team member that is able to influence the
audit work/result.
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AUDIT AND ASSURANCE
Tutor's Tips
This past question has 10 marks of knowledge and 10 marks of application. In future
Audit and Assurance exam papers, this amount of knowledge in one question is
unlikely, but that does not make it a bad question to practice.
In (a), note the question asks for steps – so, for example, listing the preconditions
for the audit is not enough. You need to say what action the auditor takes to ensure
those preconditions are in place.
In (b), the marks indicate only ½ mark per point so no need for detail and long
sentences. There are lots of items that could be listed here – the answer below is
split between the more easily remembered items at the top of the answer and the
less obvious ones further down.
Part (c) initially looks like a standard ethical threats question but there is one word
missing from the requirement – independence (or objectivity)! That means that
the threats might involve integrity, professional behaviour, confidentiality and
competence/due care as well. This is an easy issue to miss – requirements must
be read carefully, as it is easy to assume what it says based on other questions you
might have done that look the same but are slightly differently worded. Given the
marks, you are looking for 5 separate issues (as always there are a few more than
this, so you do not need to find them all).
Marking guidance
(a)
(i) Steps prior to accepting
○ Ask the potential client for permission to contact the outgoing auditor,
to check if there are any issues you need to be aware of that could
affect your acceptance decision (professional clearance).
198
ANSWERS
○ Assess whether there are any threats to your objectivity and if so whether
there are suitable safeguards that can be put in place to manage them.
○ Assess whether any conflicts of interest would be created between
Cinnamon and other existing clients, and if so whether these conflicts
could be successfully managed to an acceptably low risk
○ Assess the integrity of Cinnamon’s management, to see if they are likely
to be trusted to provide full evidence and honest explanations.
○ Research the company and the industry in which it operates, in order
to ensure that our firm has the competence to carry out the audit to a
sufficiently high standard.
○ Assess the likely level of risk and ensure the client is willing to agree to
an audit fee that reflects that risk.
○ Assess whether the firm has the staff and other resources necessary to
do the audit within the timeframe required by the client.
○ Assess the financial condition of the company to verify they are likely to
be able to pay the fees for the audit.
Note: With 5 marks available, only 5 of the above items are necessary.
(ii) Preconditions for an audit
According to ISA 210, the three preconditions for an audit are as follows:
○ The company must be using an appropriate accounting framework
(i.e. the correct set of accounting standards, such as IFRS for listed
companies in the UK).
○ The company must have a system of internal control in place to prevent
and detect material misstatements in the financial statements.
○ The directors must provide all books, records, information and
explanations as required by the auditor.
The auditor must take steps to verify that the accounting framework in
use is appropriate to the company’s circumstances. Also the auditor must
get confirmation from management that they accept responsibility for the
selection and use of that accounting framework, for the internal control
system and for ensuring all evidence is provided.
If the above is not resolved, the audit appointment should not be accepted.
(b) Engagement letter contents
– Responsibilities of the directors (e.g. to prepare true and fair
Financial Statements)
– Responsibilities of the auditors (e.g. to give an opinion on the truth and
fairness of the financial statements)
– How the audit fee will be calculated, and when it will be invoiced/paid
– Scope of the audit (e.g. which financial statements to report on, and whether
other reporting requirements exist)
– When and how the auditors and client will communicate/meet during the audit
– Whether the external auditors expect access to the work of the client’s
internal auditors, or other internal experts
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AUDIT AND ASSURANCE
Note: The items above are a good “core”, and most easily learned. But additional
items could include those below, should the marks require them:
– Which financial accounting framework (e.g. IFRS) the company is using
– An explanation that the assurance level in an audit is not absolute
– Explanation of the auditor’s liability position
– Availability of the “other information” (e.g. annual report) for reading during
the audit process
(c) Ethical risks
200
ANSWERS
201
AUDIT AND ASSURANCE
202
ANSWERS
Tutor's Tips
Audit risk and response questions come up at virtually every sitting. There are several
potential pitfalls for students.
Audit risks must be explained as audit risks – not business risks. Audit risks are either
risks the FS are materially misstated or are detection risks. Therefore explanations
must be in one of those two forms to be valid audit risks.
Responses demonstrate pure practical ability and as such are always done badly by a
significant number of students. As the examiner report stated (as it does at every sitting):
“auditor’s responses continues to be a poorly attempted area and once again
candidates are reminded ... should set out an approach the audit team will take
to address the identified risk ... responses given were sometimes too weak (e.g. in
response to the directors’ bonus being based on profits a weak response was to “audit
the profit and loss account”)”
The responses should be additional work the auditor would do because of the risk,
and should have enough explanation to gain a mark, not a half mark (in general, any
answer with less than 10 words is unlikely to be a full enough explanation).
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AUDIT AND ASSURANCE
Risks Responses
Asset Lives
Assets are at risk of overstatement, and Ask directors for evidence that there has
expenses of understatement, if the increase been a decision to delay replacing assets, in
in asset lives is an attempt to manipulate the form of board minutes, or instructions to
profits for the bonus, rather than a true department heads.
indication of assets being used for longer
than in the past.
Inventory Count
The count is due to take place 2-3 days On the final audit, time will be needed to
before the actual year end, meaning verify the sales and production/purchases
inventory is at risk of being over or during the final 2-3 days of December to
understated if the adjustments made are not verify the adjustments are accurate.
done accurately.
Fire Damage
Inventory is at risk of overstatement if the At final audit, enquire if the inventory has
$0.2m scrap valuation is incorrect (again, now gone and if so inspect the sales invoice
perhaps done to get the bonus). Given there / scrap paperwork to identify the sale price.
was a fire, there must be a risk the inventory If not yet gone, ask directors to justify the
has no value at all. valuation, potentially getting an auditor
expert to independently value the items.
Insurance Claim
It looks like receivables and other income are Inspect the latest correspondence wit the
at risk of overstatement by $0.7m, which is insurance company, and the insurance
more than 5% of profit and therefore material. policy, to assess the likelihood of a payout.
Under IAS 37, a contingent asset should be Ask directors to justify the inclusion of the
disclosed if probable, but only accounted for figures in the financial statements given the
as a receivable and revenue if virtually certain, lack of certainty from the insurer.
which does not seem the case here.
Bank Reconciliations
Bank is at risk of over or understatement at Time will be needed on the final audit to
the year end, because the bank reconciliation investigate these differences, and probably
differences could be hiding large offsetting to repeat the exercise for the year end
differences or perhaps fraud (including reconciliation. Any explanations from
attempts to manipulate profits for the bonus). directors will need to be treated with
The failure to sort out these differences also scepticism, given their failure to investigate
indicates weak controls in this area. fully so far (and the bonus).
204
ANSWERS
Risks Responses
Bonus
Revenue is at risk of overstatement and Any P or L items that have a degree of
expenses of understatement as directors subjectivity (revenue recognition, revenue
may try to manipulate results to increase the cut-off, inventory valuation, depreciation,
chance of earning their bonuses. provisions) should be handled by senior
members of the audit team who should
strive for as much external evidence as
possible (i.e. demonstrate scepticism).
Tight Deadline
The client wants the audit to finish earlier The audit will need to be carefully planned,
than usual. This creates detection risk, as with as much work carried out before the
the auditor might not spot errors if under year end on an interim audit as possible. We
time pressure. may also need to agree a higher audit fee
than normal so that additional staff can be
put on the audit to speed things up.
Tutor's Tips
This question is from the old exam structure, where most of the knowledge testing
was done in a single question. Any of the parts of this question could still be tested,
but not all together in a single question (and more likely now to be MCQ).
In (a), there are many correct answers – so try to choose two where you have enough
words to get an explanation likely to earn 1 mark not 0.5 marks.
In (b) we have a rarely asked “list”, meaning you need no explanations at all, as
each point is only 0.5 marks. In the current exam structure this could still happen,
but it is unlikely.
In (c), there are at least a dozen possible answers and you only need 5, so again
pick the ones where you have a decent explanation likely to earn you a mark. The
answer below stops after 6 points so you can see some variety, but other ideas would
include the company’s internal auditors/reports, budgets and management accounts,
brochures and website, discussions with management.
205
AUDIT AND ASSURANCE
206
ANSWERS
A visit to the company’s main locations, to help understand how the business
operates, its scale, potential laws and regulations it is likely to have to follow, and
hence potential risks of material misstatement.
Industry publications, to understand prospects for the industry, company’s
reputation and standing in the industry, main competitors, any reputation issues
about the company.
Discussions with the previous auditor and copies of their prior year working
papers (if possible) to help understand audit risks in the past, issues that arose
from the audit work, main matters communicated to the client.
13. Eagle Heating Co (December 2014)
Tutor's Tips
Audit risks must be explained in terms of their impact on the financial statements
potentially being misstated. No explanations, and half the marks are gone. Also, the
impact on the business is irrelevant – that would be business risks, not audit risks.
Responses are the auditor response, not the client’s response. These are audit risks
not business risks, as noted above. Note the examiner report comments:
“Unfortunately many candidates yet again focused on business risks rather than audit
risks with answers such as increased risk of theft and difficulties in counting inventory
arising due to the increase in inventory levels. These candidates then provided
responses related to how management should address these business risks. This
meant that out of a potential 2 marks per point, candidates would only score ½ marks
for the identification of the issue from the scenario.”
Marking guidance
207
AUDIT AND ASSURANCE
Risks Responses
Inventory Discounting
Inventory is at risk of being overstated. IAS On the final audit, review sales invoices post
2 requires it to be held at the lower of cost year end and compare prices achieved with
or NRV, and the company is reducing selling cost of each line of inventory to see if still
prices to maintain sales levels, meaning being sold at a profit.
on some products selling price might have
dropped below cost.
There is an expectation of higher Calculate inventory days on a line by line
inventory levels at the year end, basis and compare with prior year. For those
suggesting further discounting might be items that have the largest increase, discuss
required to sell these extra items. with directors what plans they have to try to
sell these items.
Legal Case
Provisions are at risk of understatement Discuss claim with directors and their legal
(or contingent liabilities at risk of under- advisors, and obtain written confirmation
disclosure) because the company is being from lawyers as to their assessment of the
sued by the ex FD and the company is unlikely likelihood of the claim succeeding, and the
to want to admit their guilt by accounting for potential amount.
this as a probable payout (or highlighting the
existence of their possible wrongdoing).
Admin Expenses Fall
Admin expenses are at risk of understatement Obtain breakdown of admin expenses and
because the figure for this year is compare list with prior year, discussing those
unexpectedly lower than the prior year. items that have fallen the most with directors
to help identify the reasons for the fall.
Purchase Ledger Controls
Trade payables are at risk of over or On final audit, check to see if the missing
understatement because for the past 3 reconciliations have caught up and that
months the usual reconciliations have not year end reconciliations were done, and any
taken place, meaning errors might have reconciling items have been investigated and
occurred and not been picked up. resolved. If not, substantive testing of trade
payables will need to increase, with more
suppliers asked to confirm their balances
direct to the auditors.
Internal Controls
The lack of a financial controller means Substantive testing is likely to increase in all
pressure will increase on other staff members areas of the audit as controls are likely to be
covering the workload, leading to an increase less reliable.
in control risk and more chance of errors in all
areas of the financial statements.
208
ANSWERS
Risks Responses
Going Concern
There is a risk of under-disclosure of On final audit inspect post year-end
significant threats to the company’s going management accounts and the most
concern status, as required by IAS 1. The recent bank statements to assess whether
company is struggling to sell its inventory performance continues to be a problem
without reducing prices, is at risk of losing a and whether cashflows are coming under
major customer to insolvency, and has a legal pressure as a result.
case to defend. All of these taken together
are likely to seriously worsen the company’s
cashflow position.
Tutor's Tips
Part (a). The question gives the mark scheme, so you need to identify and explain
each source for the mark. Identification is only writing the name of a document so
that won’t take long.
Part (b) is another standard risk question. So identify the risks from the scenario and
set-your answer as usual in a table format.
Part (c) is just five points for the five marks. If stuck use easy points such as cost
to gain marks.
Marking guidance
209
AUDIT AND ASSURANCE
(a)
210
ANSWERS
(b)
211
AUDIT AND ASSURANCE
212
ANSWERS
The skills of existing staff. If current staff can perform some of the internal audit
department roles, then this decreases the need for a separate department and/
or recruiting new staff members.
15. Kangaroo Construction Co (June 2013)
Tutor's Tips
Part (a). Although there are 5 marks here, the first two will be for definitions of
materiality and performance materiality. Then try and make some comments for
the remaining marks – not necessarily about both concepts individually; for example,
both are still determined using the auditor’s judgement.
Part (b) is the standard ratio question – table format please with 10 ratios.
Finally part (c) is a standard risk question – again table format with clear response
to each risk.
Marking guidance
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AUDIT AND ASSURANCE
Both materiality and performance materiality are set using the auditors’
professional skill and judgement; the ISA’s do not state exact materiality limits or
guidelines. The level of risk of misstatement will affect the auditors’ assessment
of materiality, with higher risk leading to lower materiality levels. However,
materiality is normally determined using a percentage of key figures such as
sales, net profit and total assets.
Finally, some items are deemed material by nature such as loans to directors and
the auditor will also ensure these are disclosed accurately, possibly to the nearest $.
(b)
(c)
Inventory valuation
Falling demand means that some houses Review actual selling prices of house
have a realisable value less than their post year-end to determine whether
cost. The risk is that inventory and profit realisable value is actually less than cost.
are both overstated as IAS 2 has not
been followed; inventory is not valued
at the lower of cost and net realisable
value. The increase in inventory days
from 64 to 99 days confirms this issue.
214
ANSWERS
215
AUDIT AND ASSURANCE
Tutorial note: Only five audit risks and responses were required.
16. Amethyst & Co (March/June 2016)
Tutor's Tips
Audit risk and response is one of the topics which are there in every exam, and
always carry lots of practical marks.
You will be able to do well in this if you understand 2 fundamental issues:
1. Audit risk is the risk for the auditor to give the wrong opinion.
Therefore when identifying audit risks, you need to refer to either why the auditor
might not find the mistakes in the financial statements or to what balance in the FS
could be wrong, how (over/under-stated) and why. Many students do not appreciate
this and instead suggest business risks to the company
2. The response is the auditor’s response to the identified risk, so you should
suggest something the auditor could do to ensure he finds the potential
misstatements. Most often you need to suggest audit tests, sometimes inclusion
of staff in the team or doing more work in the interim audit stage. But what fails
students is they either give very general responses or simply suggest what the
company should do to avoid the potential misstatements.
To score full marks make sure for each risk you do not just identify what could be
wrong in the accounts but also explain why.
This is what was noted in the examiner’s report: “a large number of candidates often
did not explain how each issue could result in an audit risk or impact on the financial
statements and therefore were not awarded the explanation ½ mark.”
216
ANSWERS
You also had to discuss outsourcing payroll by the client and its implications in
relation to audit risk. Also there was a pure knowledge part asking you to explain
audit risk and its components. Rather standard and a good source of marks for those
who understand the audit risk model.
217
AUDIT AND ASSURANCE
Risks Responses
Work in progress (WIP)
The continuous work in progress means that To ensure that WIP is valued appropriately
at year end there would be some significant by the company, use an expert to calculate
WIP balance. That might be misstated the percentage of completion and equivalent
because units could be at different stages of units of production, and compare his
completion and therefore difficult to value. valuation of WIP to the company’s.
PPE
Assets could be overstated, if the new plant Obtain the asset register to check which items
and machinery has been recorded at $720,000 from that order have been recorded in it at
but not all the assets have been received and year end, and physically inspect them on the
geared for use by the year end. company’s premises to confirm they are there
and in a usable condition.
Risks Responses
Loan
This is repayable over 5 years and there is a Inspect the loan agreement to find all
risk that the company has split it incorrectly relevant details and check the financial
between short- and long-term liabilities, as statements to confirm correct classification
well as under-disclosed the details regarding and adequate disclosure
the loan (IFRS 7 requires extensive disclosure
of all financial instruments)
Interest
As a result of the loan it is possible that the Obtain the interest details from the loan
interest expense of Aquamarine is misstated, agreement, to find out the interest rate
if some interest has been accrued and the percentage and type, and recalculate amounts
company has accounted for it incorrectly. to confirm accuracy.
Payroll
It is possible that payroll has been accounted With the client’s permission contact the payroll
for incorrectly and it is possible the auditor company and try to arrange access in order to
does not find out the mistakes, due to the assess and test their controls. If not possible,
outsourcing of the payroll function during the contact Coral’s external auditor and ask for
year to another company. their reports on the company’s controls.
Land and Buildings
It is possible that these are over-valued, if the Enquire with management on how the
company has not done the valuation properly revaluation was done, whether all assets of
in accordance with IAS16, or has deliberately the same class were included and whether it
pushed the values up, in order to improve its was carried out by a qualified, experienced
financial performance. and independent expert.
218
ANSWERS
Tutor's Tips
Part (a): This knowledge part of the syllabus is quite commonly examined, and quite
easy to do well on, if you think logically and relate it to planning in life in general.
Just make sure you appreciate the requirement wants you to discuss planning
benefits, rather than planning activities – something which some students had failed
to spot and as a result produced irrelevant answers
Part (b): This is a very common question and it is easy to score well on it, given you
understand the two main things:
1. Audit risks are the ones impacting the financial statements potentially being
misstated and not risks impacting the business (as those are called business risks).
2. Responses are the auditor response, not the client’s response.
To ensure you get a full mark you must also not just state what the audit risks are,
but also explain why. Please note the examiner’s comments below:
“Audit risk questions typically require a number of audit risks to be identified (½ marks
each), explained (½ marks each) and an auditor’s response to each risk (1 mark each)..”
Many students make the mistake to do only half of the work, and never realise why
they have not scored well in the exam.
As always there are more than the risks required, so read the whole story and cherry
pick the ones you find easier to explain as risks, as well as to suggest responses to.
Do not do more than the required (6 marks = 6 risks) as that means wasting time you
could have used scoring marks on other questions.
(a) Benefits of audit planning
Planning helps to ensure the auditor can arrange for the necessary staff and
other resources to be available as needed during the audit process.
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AUDIT AND ASSURANCE
Having an audit plan helps to direct the audit staff in what they have to do, and
also provides a checklist at the end of the audit to enable a review.
Planning minimises the risk of discovering audit risks late in the audit and
therefore running over time and missing client deadlines. The earlier audit risks are
spotted, the easier it is to allocate the time necessary to address them properly.
Planning helps to ensure the audit is carried out in a methodical and organised way,
which should ensure the process is efficient (thus maximising the profit the audit
assignment makes for the firm, whilst ensuring all necessary process is followed).
220
ANSWERS
(b)
Risks Responses
Raw materials purchases from Africa
Inventory, purchases and payables are Select a sample of GRNs from just
all at risk of being misstated, if they before and after the year end to
were recorded by the company using an confirm they were recorded in the
incorrect exchange rate. correct accounting period. Also for the
It is also possible these to be incorrect purchases before year end establish the
because the goods are usually in exchange rate that should have been
transit for 3 weeks, which could lead to used and recalculate the amounts to
cut-off errors. confirm their accuracy
221
AUDIT AND ASSURANCE
Risks Responses
Allowance for receivables
Receivables are at risk of being over- Calculate receivables days and compare to
stated because the usual 1% allowance for the ratio from prior year, analyse the aged
bad debts has not been made this year, receivables and inspect post-year end
based on the finance director’s judgement cash receipts; for unpaid debts inspect
and it is possible that it is still needed. correspondence with customers, to try to
assess the likelihood of bad debts.
Purchase ledger closure
Both purchases and trade payables Review purchases posted for the period
could be misstated due to the late 1-8 August and assess which accounting
closure of the purchase ledger, leading period they belong to, then trace them
to cut-off errors. back to the purchase ledger to ensure
they were recorded in the correct
accounting year.
222
ANSWERS
Tutor's Tips
Audit risk and response is one of the topics which are there in every exam, and
always carry lots of practical marks.
Part (a) examines your understanding and ability to explain audit risk. It is something
that appears frequently in exams for 4 – 5 marks normally.
Part (b) examines your ability to apply that knowledge in practical situations. You will
be able to do well in this if you understand 2 fundamental issues:
1. Audit risk is the risk for the auditor to give the wrong opinion.
Therefore when identifying audit risks, you need to refer to either why the
auditor might not find the mistakes in the financial statements or to what balance
in the FS could be wrong, how (over/under-stated) and why. Many students do
not appreciate this and instead suggest business risks to the company
2. The response is the auditor’s response to the identified risk, so you should suggest
something the auditor could do to ensure he finds the potential misstatements.
Most often you need to suggest audit tests, sometimes inclusion of staff in the
team or doing more work in the interim audit stage. But what fails students is
they either give very general responses or simply suggest what the company
should do to avoid the potential misstatements.
To score full marks make sure for each risk you do not just identify what could be
wrong in the accounts but also explain how it can be wrong and why. Try to be as
specific as possible
This is what was noted in the examiner’s report: “To explain audit risk candidates
need to state the area of the accounts impacted with an assertion (e.g. cut off,
valuation etc.), or, a reference to under/over/misstated, or, a reference to inherent,
control or detection risk. Misstated was only awarded if it was clear that the balance
could be either over or understated...”
The question also includes an Audit Ethics part which is normally quite easy to
answer well but still requires a bit of caution. When explaining the ethical threats
do not be vague suggesting that something could lead to the auditor not being
independent – instead explain WHY the auditor could be independent, referring to
the possibility of not reporting potential problems with FS or his opinion not being
trusted by others.
(a) Audit risk
Audit risk is the risk of the auditor giving the wrong opinion on the financial
statements and saying that they are true and fair, when they are not. This can
happen because the financial statements contain material misstatements which
the auditor fails to spot.
It can be represented by the audit risk equation:
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AUDIT AND ASSURANCE
Audit risk (AR) = Inherent risk (IR) * Control risk (CR) * Detection risk (DR)
Inherent risk is the risk of misstatements occurring due to the nature of the
company and its activities – the more complicated they are, the higher the
likelihood of mistakes in the accounts.
Control risk is the risk that the company’s controls fail to prevent or correct the
mistakes that have already occurred due to the nature of the company. The
weaker the company’s controls are, the higher control risk is.
Detection risk is the risk that the auditor fails to detect the mistakes which have
occurred due to the nature of the company and have gone past by the company’s
controls, so the auditor ends up giving the wrong opinion.
(b) Risks and Responses
Risks Responses
PPE
Assets could be overstated, warehouse Inspect the warehouse purchase
has been recorded at $3.2m but the agreement and correspondence
legal transaction has not completed by between the company and its legal
the year end. advisers to confirm the transaction
completion date. Then inspect the Asset
Register to confirm the warehouse has
been recorded accordingly.
Depreciation
There is a risk that depreciation is Compare the new useful economic life
understated and profit overstated, if of the assets to the one used generally
the extension of some assets’ useful in the industry, in order to assess
economic life was unreasonable and whether this change is reasonable. Also
only done in order to improve the obtain a management representation
company’s financial position. explaining the reasoning behind it.
Share issue
The company’s share capital could be Inspect the share issue document to find
misstated, if the issue of the preference out details regarding the price of the
shares has been recorded incorrectly. shares and enquire how this has been
If they have been issued at a premium, recorded in the company’s capital.
it is possible that the company has
included that premium in the share
capital account, instead of recording it
in the share premium account.
224
ANSWERS
Risks Responses
Revised credit terms
Provisions are at risk of being For the oldest debts inspect
understated, if some of the suppliers correspondence between Hurling Co
currently experiencing difficulties are and the customers to find out if they are
unable to pay and bad debts are not discussing payment and if it is likely to
provided for. be for the full amounts owed.
New customers
Receivables are at risk of being For a sample of new customer balances
overstated, if the credit limits of some at year end inspect post year-end bank
new customers are unrealistic, and statements and cash book, in order to
some of the sales made to them result find out if they have got paid within the
in irrecoverable debts but are recorded agreed credit terms.
as receivables.
Legal action
The company’s provisions could be Inspect correspondence between Hurling
understated, if there is a high likelihood Co and Petanque Co in order to find out
of the legal action re product Luge to if the customer is definitely going to sue
be successful. Or even if not being sued, the company, or if they are discussing
the company might be planning to pay any potential out-of-court settlement.
a compensation, but might not have
provided for it.
Detection risk
The finance director wants the audit The auditor should politely explain that
completed in a shorter period which the audit would be conducted as per the
could lead to the auditor rushing audit plan to ensure obtaining sufficient
it, not checking the FS in enough and appropriate evidence. Adding on a
detail and missing out some material couple of team members might assist
misstatements. with completing it a bit sooner without
compromising on the level of testing.
Dividend
The company’s profit could be The auditor should maintain a high
overstated in order to allow a healthy professional scepticism when auditing
dividend payment. So in order to balances that affect the profit calculation,
achieve this balances such as sales and try to increase samples tested.
revenue and assets could be overstated,
while costs (including depreciation)
could be understated.
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AUDIT AND ASSURANCE
(c)
226
ANSWERS
Tutor's Tips
Audit risk and response is one of the topics which are there in every exam, and
always carry lots of practical marks – make sure you are rock solid on your technique
and have covered a lot of questions on it in advance of your exam.
Part (a) is looking at some pure knowledge regarding the pre-acceptance stage of audit.
Part (b) looks at the planning stage and checking if you understand what audit
strategy means.
Part (c) examines your ability to apply audit risk understanding in practical situations.
You will be able to do well in this if you understand two fundamental issues:
1. Audit risk is the risk that the auditor gives the wrong opinion, as a result of the
risk FS are materially misstated (inherent and control risk combination) and the
risk that the auditor does not spot this (detection risk).
Therefore when identifying audit risks, you need to refer to either why the
auditor might not find the mistakes in the financial statements or to what balance
in the FS could be wrong, how (over-/under-stated) and why. Many students do
not appreciate this and instead suggest business risks to the company.
2. The response is the auditor’s response to the identified risk, so you should
suggest something the auditor could do to ensure he finds the potential
misstatements. Most often you need to suggest audit tests, sometimes inclusion
of staff in the team or doing more work in the interim audit stage. But what fails
students is they either give very general responses or simply suggest what the
company should do to avoid the potential misstatements.
To score full marks make sure for each risk you do not just identify what could be
wrong in the accounts but also explain how it can be wrong and why. Try to be as
specific as possible. Also note that this answer contains more than the required audit
risks and responses, to help you with ideas and to learn how to explain them properly.
This is what was noted in the examiner’s report: “To explain audit risk candidates
need to state the area of the accounts impacted with an assertion (e.g. cut off,
valuation etc.), or, a reference to under/over/misstated, or, a reference to inherent,
control or detection risk. Misstated was only awarded if it was clear that the balance
could be either over or understated...”
(a)
Three steps as follows:
Management have to confirm that an appropriate financial reporting framework
has been used for the preparation of the company’s FS (for example, at a listed
company the IFRS framework should be used).
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AUDIT AND ASSURANCE
Management need to confirm that according to them the company has effective
internal control systems, which are used to produce and protect the information
regarding the FS.
Management have to confirm that they will provide the auditor with access to
any information and evidence at any time the auditor finds it is appropriate for
conducting the audit.
(b)
CAATs
The audit strategy should consider the main approach to conducting audit tests,
for example the use of computers during the audit. When setting the audit
strategy the firm should decide to what extent it would use Computer Assisted
Audit Techniques (CAATs) for performing control and substantive testing.
Deadlines
The audit strategy should outline the major deadlines and the type of work that
should be completed within them. For example the deadlines for interim and
final audit and what type of work is expected to be completed within each.
Locations
The audit strategy document should consider the main locations and sites
on which the audit work should be performed, as well as allocating staff with
appropriate experience in the industry for the specific client.
(c)
228
ANSWERS
229
AUDIT AND ASSURANCE
Tutor's Tips
Audit risk and response is one of the topics that is there in every exam, and always
carry lots of practical marks.
In part (a) you must demonstrate that you understand what the auditor’s
responsibilities are regarding fraud and error and why this is important at the
planning stage of the audit. It is something that appears frequently in exams for 4–5
marks normally. Note here that the requirement was specifically asking you about
responsibilities regarding prevention and detection, so any points on reporting would
be just a waste of your time.
Part (b) examines your ability to apply that knowledge in practical situations. You will
be able to do well in this if you understand two fundamental issues:
1. Audit risk is the risk that the auditor gives the wrong opinion.
Therefore when identifying audit risks, you need to refer to either why the
auditor might not find the mistakes in the financial statements or to what balance
in the FS could be wrong, how (over-/under-stated) and why. Many students do
not appreciate this and instead suggest business risks to the company.
230
ANSWERS
2. The response is the auditor’s response to the identified risk, so you should
suggest something the auditor could do to ensure he finds the potential
misstatements. Most often you need to suggest audit tests, sometimes inclusion
of staff in the team or doing more work in the interim audit stage. But what fails
students is they either give very general responses or simply suggest what the
company should do to avoid the potential misstatements.
To score full marks make sure for each risk you do not just identify what could be
wrong in the accounts but also explain how it can be wrong and why. Try to be as
specific as possible.
This is what was noted in the examiner’s report: “To explain the audit risk candidates
need to state the area of the financial statements impacted with an assertion
(for example, cut-off/valuation, etc), or a reference to over/under/misstated, or
a reference to inherent/control/detection risk. For example, candidates often
correctly identified the financial accountant suing for unfair dismissal, this was
awarded ½ mark for identification, however, no further credit was awarded for the
explanation that ‘costs may not be included’. To be awarded the ½ explanation mark
candidates need to clearly state the implication, for example, that ‘provisions may be
understated’, or ‘provisions may not be complete.”
(a)
• Prevention
Prevention of fraud and error at the client is not the auditor’s responsibility: it is
management’s duty. The auditor is only responsible for providing recommendations
on prevention but their implementation lies with the company’s management.
• Detection
This is also not the auditor’s direct duty: it also lies with management. The auditor
is responsible for providing positive assurance that the FS show a true and fair view
of the company.
• Material misstatement
Therefore the auditor is responsible for the detection of any material misstatements
which can be caused either deliberately (fraud) or accidentally (error).
• Tests
So the auditor is responsible for assessing the likelihood of fraud and error at the
company and designing tests that can detect them and any material misstatements
they might have caused.
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AUDIT AND ASSURANCE
(b)
Inventory counts
Inventory could be misstated if the Obtain the GDNs and GRNs raised
adjustments between y/e and the between the count and y/e and review
counts are not made correctly or some the adjustments schedule to confirm they
of them are completely forgotten. have all been accounted for correctly.
Patent
Intangible assets seem to be Obtain the patent purchasing
understated as the cost of the patent documentation to confirm cost and
should have been capitalised instead duration, then trace to the accounts
of expensed as per IAS38. Also to see if the company has correctly
amortisation is understated as a result if adjusted its intangible assets balance
the incorrect patent treatment. and amortisation.
Share issue
Share capital could be overstated if Obtain details of the share issue and
the amount that is above the nominal nominal value of the shares and trace
value of the newly issued shares has the amounts to the relevant accounts to
not been taken to the separate share see if correctly allocated.
premium account.
Receivables
These could be misstated if there is still Enquire with management about what
some undiscovered fraud in relation to actions have been taken to uncover
the balances or if there have been some any fraud from last year, and also
mistakes when they got transferred to agree closing and opening receivables
the outsourcing company. balances to confirm the transfer was
made correctly.
232
ANSWERS
233
AUDIT AND ASSURANCE
Tutor's Tips
This type of requirement appears at virtually every sitting of Audit and Assurance.
This particular question is quite generous because there are many more than 5
deficiencies available, meaning sensible students will “cherry pick” the ones they are
most comfortable explaining.
In the answer below, the first 5 deficiencies seem the most obvious ones to spot
from the scenario.
Note that it is very easy to simply repeat the story and fail to explain the potential
damage to the company if the deficiencies are not repaired. For a full mark, note the
examiner report feedback:
Candidates should ensure that they consider the implication of the deficiency and to
identify the issues that will have a significant impact on the company.
Marking guidance
Deficiencies Recommendations
Requisitions are not authorised before A relevant manager should sign off all
they are turned into orders. Staff might requisitions before they are submitted
request goods for their own personal to the ordering department.
use rather than business use, leading to
unnecessary expense for the company
and reduced profits.
There is no check of current inventory The company should plan required
levels before requisitions become inventory levels to know when a reorder
orders. The company might order is needed to avoid running out, and
things they already have, which is the inventory system could then place
both wasteful and also likely to lead to automated reorders when needed. At the
unnecessary lack of storage space very least, a responsible official should
monitor inventory levels to ensure they
are not becoming excessive (or too low)
234
ANSWERS
Deficiencies Recommendations
The approved suppliers list is a strength, The purchasing director should review
but it was last updated 2 years ago and the list at least annually, putting out to
as such the company might be missing tender those items that are required
out on cheaper and better suppliers by the company on a regular basis to
because it has not bothered to consider ensure the best prices and terms are
alternatives for so long being achieved.
Invoices are not entered onto the system Invoices should be recorded somewhere
until the end of each week. There is a on receipt, and the accounting system
risk that invoices are misplaced or lost should be updated daily.
before being entered, and if nobody
realises this then the supplier will not get
paid. This can result in upset suppliers,
loss of prompt payment discounts, and
financial statements that understate
the true level of the company’s
liabilities (the last one making cashflow
management difficult).
Invoices are paid 60 days after being Supplier payment policy should be
entered. This seems to be the standard reconsidered taking into account
approach, but some suppliers might the availability of discounts, supplier
offer attractive early settlement preference, and the company’s own
discounts (which would be lost), and cashflow forecasting needs. A simple
some might expect quicker payment and 60-day policy for all invoices is too
therefore refuse to supply further goods. simplistic to be effective.
When goods arrive, there is no check When goods arrive, they should be
of whether the goods had ever been compared with the purchase order to
ordered. As a result, the company is at ensure the correct goods have been
risk of taking goods it does not need. received. Only then should a delivery be
On top of this, the invoice is also not signed for. When the invoice arrives, it
checked back to the order, meaning should be compared to the order to verify
these unnecessary items would then get prices and other terms are as agreed.
paid for, resulting in unnecessary waste
and reduced profits.
By giving invoices a reference number As well as the supplier reference code,
based on supplier codes, invoices purchase invoices should have an
will not be in sequence. As such, any automated sequential number attached,
sequence gaps cannot be used to and the accounting software should be
identify missing invoices, increasing programmed to check the completeness
the risk of invoices getting lost and of the sequence on a regular basis.
not entered onto the system, thus
understating liabilities and leading to
suppliers not getting paid
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AUDIT AND ASSURANCE
Deficiencies Recommendations
There is no evidence that orders are All orders should be marked as
ever chased once they have been outstanding on the system until they
placed. If orders do not arrive on time, have been received. On a regular basis,
production might get delayed leading to the system should produce a list of
customers not receiving goods on time unreceived orders starting with the
and refusing to pay. oldest ones first, and a manager should
investigate potential hold ups with
each supplier.
Invoices are not checked against the Upon receipt of each invoice, the clerk
GRN before being entered onto the should check that there is an authorised
system or before being paid. The GRN showing the goods have been
company could be paying for goods that received, and should initial the invoice
it has never received, which is inefficient to evidence this check as well as adding
and will reduce profit. the GRN number to the invoice.
Tutor's Tips
A short practice question – make sure that weaknesses are identified from the
question and appropriate recommendations made to overcome these.
Marking guidance
236
ANSWERS
Tutor's Tips
Part (a) is a very popular requirement on systems and controls. You are asked to
spot four weaknesses in a sales system, state the effect of the weakness and finally
suggest a control to mitigate the weakness. Using a column approach for this part of
the question ensures a methodical answer that covers all parts of the requirement.
You may not have encountered a company selling seeds and other agricultural
products before but providing you know how a generic sales system works you
should be able to apply your knowledge to the scenario. Note there is two marks
available for presentation.
Part (b) is a relatively straightforward knowledge requirement stating the benefits for
the company of having an audit committee.
237
AUDIT AND ASSURANCE
Marking guidance
(a)
238
ANSWERS
239
AUDIT AND ASSURANCE
Tutor's Tips
Part (a) asks for control objectives over and ordering, despatch and invoicing system.
The best way to approach this is to think about the potential problems that could
arise and then your control objectives should address these issues. E.g. a problem is
that we sell to un-creditworthy customers, the control objective should be ‘to ensure
we only sell to creditworthy customers’.
Part (b) asks for audit tests over the sales and despatch system. Use the information
in the question to design tests that simply test the processes that are described
and there are plenty of easy marks available. Remember to explain why you are
performing the test to achieve the marks available.
Marking guidance
240
ANSWERS
241
AUDIT AND ASSURANCE
Tutor's Tips
Part (a). Remember these are SFP assertions so don’t explaining Income Statement
only assertions like occurrence.
Part (b) note the evidence and how that evidence will help the auditor make a
conclusion must be included in the answer.
Part (c) is slightly strange as it appears you need knowledge of kitchen hygiene to
answer the question! Perhaps not, think of the kitchen as a store of food (inventory)
then this opens the door to comments such as raising valid orders!
Part (d). The appropriate reporting format is shown in the question “possibility not
a probability” so follow this to explain the impact on the financial statements and
audit report.
Marking guidance
(a) As regards accounts payable (SFP assertions-CRAVE) there are many different
assertions that have to be addressed. Some relevant assertions are set out below:
Rights and obligations – Accounts payable represent amounts actually due by the
company, that is, there is an obligation, taking into account:
– the actual performance of services for the company; or
– transfer of title in goods transferred to the company; and
– cash payments or other genuine debit entry.
Accuracy – Accounts payable have been correctly valued taking into account original
transaction amounts and such matters as trade discounts and local sales tax.
242
ANSWERS
Existence – The original transaction amounts are valid and the liability exists.
Completeness – All accounts payable are recorded in the accounting records.
Tutor's Tips
The importance of assertions lies in the fact that they provide objectives for the
auditor and enable the evidence search to be carried out in a logical fashion. The
auditor will determine the assertions that are made about a particular figure
appearing in the financial statements. This provides a series of objectives about that
audit area and then the auditor searches for evidence to prove that each objective is
met and that the assertion is valid or invalid.
(b) Evidence collected by the auditor to enable a conclusion to be formed on the
likelihood of the claim being successful (that is, whether a provision would be
necessary according to IAS 37 Provisions, Contingent Liabilities and Contingent
Assets) includes:
Evidence Explanation
(i) Obtain the written claim by This would tell you the reason why
the customer. the claim was being made and
provide other relevant details, such
as whether the customer dined in the
restaurant or purchased carry-out
food, and the date when the alleged
food poisoning took place.
(ii) Review the controls in force This would be to ensure that the
over purchases and food company controls appeared to be
preparation (see (b) above). effective.
(iii) Obtain written reports This would provide evidence about
concerning any inspections any problems that had arisen affecting
that had been carried out by food quality. Discuss with management
company staff or third parties the actions that were taken to correct
in the food store and food any problems that had arisen.
preparation areas.
(iv) Discuss the matter with the This would provide evidence from
company’s lawyers to obtain a professional third party as to the
their view on the likelihood of likelihood of the claim succeeding
the claim being successful. and the reasons why the lawyers had
reached their conclusion.
(v) Discuss the matter with the This is internal evidence and should
company’s lawyers to obtain be approached with professional
their view on the likelihood of scepticism, but it would provide the
the claim being successful. auditor with the views of an informed
group of people.
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AUDIT AND ASSURANCE
Evidence Explanation
Obtain management
representations regarding
the likelihood of the claim
succeeding.
Note: Marks would also
be available for additional
points such as:
- Review of board minutes
to assess management’s
view of the likelihood of the
claim succeeding
- Discussions with management
about any previous claims
and their outcome.)
(c) Controls that the company has in place to reduce the risk associated with
purchases of food and its preparation in the kitchen, together with relevant audit
procedures on controls testing, would include the following:
Tutor's Tips
For a restaurant it is important that food quality is good and in particular that it does
not present any danger to the customer arising from deterioration or poor practices
in its preparation.
244
ANSWERS
(d) As you have concluded that the likelihood of the claim being successful is only
possible, it would be appropriate for the company to explain the contingent
liability by way of note as required by IAS 37, giving a description of the nature
of the contingent liability, an estimate of its financial effect, an indication of
the uncertainties relating to the amount and timing and the possibility of any
reimbursement.
If the company includes a note of this nature, there would be no need to modify
your audit opinion, however if the litigation is viewed to be exceptional then an
emphasis of matter paragraph might be appropriate.
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AUDIT AND ASSURANCE
However, if the contingency is not disclosed, the auditor would modify the audit
opinion on the grounds of an ‘except for’ disagreement and include in the report
the required details of the contingent liability.
The auditor should try to persuade management to include the disclosure before
issuing the modified opinion.
Tutor's Tips
An ‘except for’ qualification would be appropriate as the contingent loss is material
only, that is, the uncertainty is not major.
Tutor's Tips
Part (a) is a theory question – if you are not sure on the answer do review the
suggested solution!
Part (b). Be careful – this is not a weakness question but a strength question. So you
need to find what is good in the system and then explain how controls are improved.
Finally, part (c) is a difficult theory question. The answer is quite long – so use this as
a learning exercise on testing rather than an example of what you need to write in
the exam itself.
Marking guidance
246
ANSWERS
(a) The auditor obtains an understanding of the entity, its control environment and
its detailed internal controls:
(i) to identify and assess the risks of material misstatements, whether due to fraud
or error, at the financial statement and assertion levels. Risks would include
inherent risk and control risk. An important objective would be to determine
the extent to which the auditor would rely on the internal control system.
(ii) to provide a basis for designing and implementing responses to the assessed
risks of material misstatement in the financial statements. This would involve
the design and performance of the audit procedures required to form an
opinion on the truth and fairness of the financial statements. An important
objective would be to determine the extent and nature of audit procedures
to reduce detection risk, and therefore audit risk, to an acceptable level.
(iii) to set the scene for identifying assertions and collecting sufficient
appropriate evidence to prove that the assertions are reasonable.
Tutor's Tips
Marks would also be available for additional points and answers must be written in
paragraphs to gain a full mark, NOT bullet points as bellow:
• To assess the adequacy of the accounting system as a basis for preparing
financial statements
• To assess whether competent to perform the audit
• To understand relevant law and regulations impacting the entity
• To consider the reliability of various evidence sources.
(b) Strong points in the control environment of Letham Co in respect of non-current
assets are set out below, together with explanations as to their impact on
control risk:
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AUDIT AND ASSURANCE
(c) (i) Great care must be taken in selecting the starting point for audit testing. The
test that the internal auditors performed, namely, selecting a representative
sample of purchase invoices for testing to the non-current assets register
and to the updating movements on the annual budget, proves merely that
register and budget are in agreement with the purchase invoices issued.
It is therefore not a good test to prove the completeness of purchase
invoices and therefore of the entries in the register and budget. In addition,
the purchase invoices are issued by many different suppliers and there is no
common serial number to enable the company to ensure that all purchases
are accounted for.
248
ANSWERS
(ii) A more appropriate test would be to make the selection from goods
received notes (GRNs), as the issue of a GRN is normally the point at which
liability is accepted and is in any event the document used to update the
non-current assets budget.
In other words, it is important to identify your audit objective and then to
decide on what sample will be the most appropriate to aid you in meeting
that objective. The GRNs would be traced to the recorded purchase invoices
to ensure that the latter were complete and then to the entries in the non-
current assets register and to the updating entries in the budget to ensure
that these too were complete.
An additional appropriate test would be to select a sample of plant and
equipment visible on the shop floor and trace them to the non-current
assets register to identify whether they have been:
○ included in the register
○ noted against the budget as purchased
○ paid for by tracing purchase invoice through to payment.
Tutor's Tips
The auditor would of course wish to prove that the GRNs are complete and might
select a sample of purchase orders and trace them to the GRNs to ensure GRNs have
been prepared in each case or the order rejected for good reason. Another appropriate
test on the GRNs would be to prove that the numbering sequence was complete. This
list is not exhaustive and other completeness procedures may be appropriate.
27. Greystone Co (December 2010)
Tutor's Tips
Part (a). This question includes a letter format (for 2 marks) as well as the standard
deficiency, effect and recommendation requirement. The deficiency, effect,
recommendation section can be produced as an appendix if this is easier. Note the
standard format for the letter in the answer – these are easy marks if a letter is required.
Part (b) is actually a theory question. Remember there are always standard
procedures that can be performed on any year-end balance like analytical review and
getting evidence of existence. Make sure your answer looks like it relates to payables
by mentioning this balance in each procedure!
249
AUDIT AND ASSURANCE
Marking guidance
250
ANSWERS
Appendix:
Tutor's Tips
There are more issues within the scenario but after writing enough to gain full marks,
you have to move on to the next question.
Also be aware that in this requirement you were awarded 1 mark for ech weakness
described and 1 mark for explaining its implication. In current exam questions you
should put the weakness and implication inside the same column within the table
(called “Deficiency”) and would get 0.5m for each of these explained correctly.
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Tutor's Tips
Part (a). Go through the scenario carefully, there will be plenty of controls here.
Remember to look for signatures and sequentially numbered documents as key
controls. Documents can then be inspected to see the signature or the numbering
checking as easy tests of control.
Part (b) actually a theory question. Remember there are always standard procedures
that can be performed on any year-end balance like analytical review and getting
evidence of existence. Make sure your answer looks like it relates to receivables by
mentioning this balance in each procedure!
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ANSWERS
Marking guidance
(a)
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Tutor's Tips
Part (a) is pure knowledge/theory. Just read the question carefully – any 2 methods
can be chosen and only a mark for explaining each, with another mark each for
advantages and disadvantages. As always use the marks to understand how much to
write for each part of the requirement.
Part (b) only has 2 marks available and yet there are a lot of potentially correct
answers here. Don’t get carried away – it only asks for 2 objectives. Also make sure
it is objectives you are giving, not procedures. An objective would usually be in the
form “to ensure that…”.
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ANSWERS
Part (c) is a very common exam requirement, and being practical and worth 12 marks
needs a solid exam technique. For deficiencies, scan the scenario for things it says
are not being done, and whenever a clerk is mentioned make sure they are not doing
anything that looks like it needs authorisation. For recommendations, be clear, and
avoid simply restating the deficiency in reverse. Try to say who, how, how often etc
the control should be done.
Marking guidance
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256
ANSWERS
Deficiencies Recommendations
For telephone orders, inventory levels Staff taking orders by phone should
are not checked until after the phone be able to access the inventory
call from the customer is finished. system to check stock levels before
There is a risk that customers who accepting the order. Ideally, they
think they have completed an order should be able to “tag” the items
are not happy to be telephoned back for the customer, to ensure the
telling them the inventory does not goods are not subsequently sent to
exist. Also, there is a risk that some someone else.
customers never get the call back,
upsetting them even more.
Order forms are not filled in during Staff taking orders should have the
customer telephone calls. Writing standard order forms in front of
the order details on plain paper runs them, and should fill them in during
the risk that some essential order the call in a systematic way so that all
details are not requested as there is fields are completed.
nothing to prompt the sales staff to
ask the right questions. This would
then require a follow-up call to a
customer, which might annoy them
due to the inconvenience and delay
to the order.
The order forms are not sequenced. Order forms should be automated
As a result, if an order form goes with a pre-inserted sequential
missing there is no obvious reason to numbering system, and the system
spot it is missing, leading to orders should flag any gaps in the sequence
not being fulfilled and customers of order forms recorded.
becoming upset.
Customers are able to exceed pre- Rather than giving an extra 10%
arranged credit limits. Credit limits credit limit across the board, all
will have been set based on a credit credit limits should be formally
scoring system, so allowing them reviewed on a case-by-case basis.
to breach these limits increases the This review should be done by
risk of bad debts and therefore loss management, and the review should
to the company. be repeated on a quarterly basis
to ensure limits remain relevant to
current conditions.
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Deficiencies Recommendations
Clerks are manually giving discounts All discounts arranged with clients
to customers. Clerks are not senior should be entered on master files
enough to be able to authorise such by a senior member of staff and
things and might award discounts password protected to stop anyone
to their friends, leading to loss to altering them. The discounts should
the company. Also, doing discounts therefore appear on invoices
manually makes it difficult to avoid automatically without any need for
errors, and if customers do not manual intervention.
get discounts they are entitled to,
customer goodwill may be lost.
In addition to the two clerks who If extra staff are needed, it would
usually do the invoicing, additional be best if additional clerks were
staff are now assisting them due hired (or transferred from within
to the volume of work. If these the business) on a permanent basis,
additional staff have not had the given training before they start this
necessary training, there is a risk work, and have their work reviewed
of them making mistakes leading for at least the first month to ensure
to upset customers and potentially they are not making mistakes.
mistakes in the accounting records.
When goods are despatched, they Before sending goods to customers,
are not being checked back to the the original order forms should be
initial customer order. This increases available in the warehouse so that the
the risk that the wrong goods are GDNs can be checked against them.
sent to customers, which will annoy
them and lead to a future loss of
business. Also, if nobody checks back
to the initial order, there is a risk that
no order exists and the goods being
despatched are in fact being stolen.
Tutor's Tips
This question is potentially tough, as parts (a) and (b) require a total of 11 points to
be found from the scenario, noting which are good and which are bad. As a result,
there are not as many “spare” points as usual for an internal controls question.
For control strengths and deficiencies, there must be an attempt to explain the
positive or negative impact on the business, or only a half mark will be earned, as the
examiner report notes below:
“however some candidates did not clearly explain the deficiency in terms of how it
affects the business”
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ANSWERS
Generally speaking, automating processes is a strength, as long as the auto calcs are
then manually sample-checked (another strength). Authorisation in advance, sequencing
of things, putting things in writing, and segregation of duties are also strengths.
For deficiencies, look for anything the story says is “not” being done, the
involvement of clerks in anything that looks important etc.
Part (c) is dangerous. Substantive procedures questions are rarely done well, and this
one requires only analytical procedures, so if your procedures are not “compare”
they are unlikely to get any marks. Also remember that any procedure needs to be
explained as to why you are doing it, not just stated.
(c) Strengths
Each employee has a sequentially numbered clock card. Clocking in and out
should accurately record hours worked, and sequencing of the cards should
mean that it is easier to track whether there are fake employees in the system.
Payroll calculations are automated, and a sample are manually checked.
Automating takes out the risk of human error, which should lead to more
accurate figures, and the manual sample checks help to ensure the automated
process itself has no bugs.
The bonuses are communicated in writing. This makes it clear who is to be paid
what, and provides evidence of the decision and amounts, meaning errors are
less likely and easier to check should they occur.
The pay list is checked before payments are made. This should help to reduce
the risk of fake employees being paid, or employees being paid amounts
much higher or lower than expected, which helps to reduce the risk of fraud,
unnecessary overpayments, or upset employees due to underpayments.
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Deficiencies Recommendations
No Supervision
Staff could clock in their colleagues, Given the 24 hr nature of the business,
or clock in and then go home, because it would be wise to install cctv by the
nobody is supervising the clocking clocking in machines to observe the
in process. This could lead to paying process and so that staff know they are
for hours not worked, and profits being monitored.
reducing as a result.
Dining Breaks
Staff do not have to clock out for Either move the clocking in machines
dining breaks and therefore could take to enforce clocking out for breaks,
extended breaks, meaning they are being or someone may have to manually
paid for hours not worked, again leading supervise breaks in half hour rotations
to reduced profits for the company. to make it easier to ensure nobody
exceeds half an hour.
Temp Staff
Production supervisors can hire such staff, All staff hires should require the HR
and might hire family or friends who are department to be involved, including
not qualified, or simply invent fake hires taking id and checking whether people
and then keep the money themselves. are suitable for the work.
Overtime Checks
These checks are done after the work Overtime should be authorised in
has been done, meaning unnecessary advance, and preferably not by the
overtime might be worked leading to production supervisor but by a manager.
inefficiency and reduced profits. The production director should review
Also the checks are done by the total overtime monthly to ensure it is
production supervisor, who might invent not excessive.
fake overtime and then keep the excess
pay, especially for staff paid in cash.
Clerk Inputs Bonuses
Clerks are junior staff, and might make The bonuses should be checked
mistakes inputting this information. after input by the Finance Director
They might also be pressured into (alternatively the input should be
giving bonuses to colleagues that have password protected so that only the FD
not been earned. can put the information onto the system.
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ANSWERS
Deficiencies Recommendations
Cash Payment – ID
When staff are paid in cash no ID checks For those paid in cash, they should be
are done. Whilst the person doing this required to provide id each time and
claims to know all staff well, they will then sign for their pay.
not know new staff or temps, leading to
potential mistakes and handing money
to the wrong people.
Lack of Segregation of Duties
The payroll manager both checks for The manager should fill out an error
errors and then amends those errors report and if errors exist a director
themselves. They might make mistakes, should check them and then make/
or invent errors so they can manipulate authorise the correction.
their own pay or that of friends.
Tutor's Tips
This type of requirement appears at virtually every sitting of the paper. This
particular question is quite generous because there are many more than 5
deficiencies available, meaning sensible students will “cherry pick” the ones they are
most comfortable explaining.
Notice here you are also required to suggest tests of control, which are not always
necessarily part of this type of question.
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AUDIT AND ASSURANCE
Be careful not to simply repeat the story and fail to explain the potential damage to
the company if the deficiencies are not repaired. For a full mark, note the examiner
report feedback: “Candidates were able to identify the internal control deficiency
from the scenario however some candidates did not clearly explain the implication
of the deficiency. Additionally some candidates did not understand or incorrectly
identified deficiencies, e.g. renting space in the warehouse to third parties or
completing inventory count sheets in ink”
Also to score well on the recommendations ensure you suggest procedures
matching the identified deficiencies, and do not just repeat each deficiency in the
recommendation.
With tests of control remember you are testing the procedures suggested in
the recommendation, not suggesting anything general or instead suggesting
substantive procedures.
(a) (i) (ii) and (iii) Deficiencies, recommendations and control tests over inventory count
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ANSWERS
These are not flagged after Each bay should be Inspect a sample of
being counted which means flagged by the team when counted areas to see if they
that it is possible that a it has been counted and have all been flagged. In
team forgets they have when the teams finish the end of the day observe
counted it and counts it counting all allocated bays a few teams to see if they
again or it gets counted by they should double check compare the flagged bays
another team by mistake. that all the ones they were to what was allocated to
As a result inventory would responsible for based on them in their paperwork.
be overstated. the paperwork have a flag.
Inventory sheets
They contain inventory Teams should be given In the morning before
quantities entered in count sheets which are the count begins, inspect
advance, extracted from sequentially numbered a sample of count
the inventory records. and contain the product sheets to check what
As a result due to codes but no quantities. information has been
negligence or laziness already entered on them.
counters might simply
accept the numbers
on the sheets without
making the effort to count
properly and if there are
some discrepancies, they
would not get found.
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Tutor's Tips
This question has a standard controls deficiencies/recommendations requirement.
Whilst the range of deficiencies in the scenario involves some of the usual issues – a
lack of sequenced documents, clerks able to change important information, lack of
segregation of duties etc. – there are not many more than 7 to find, making it quite
tough to get close to full marks.
The key in part (a) is explaining the issues found, in terms of the potential damage to
the company if the deficiencies are not fixed, and making sensible recommendations
(try to say who should do it, or how, or when).
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ANSWERS
Note a covering letter is required. Easy marks if you have revised its content, but the
need to provide a letter format means you have quite a lot to do to earn the marks
without going over time.
The answer below aims to put 7 achievable deficiencies first, then the harder to
explain ones later.
Part (b) is a standard substantive procedures requirement. The scenario tells you a
little about the company’s revenue and that should provide clues to add to the tests
you know from memory to verify revenue. Think which assertions are worth testing,
and make sure each procedure is explained not just stated.
(a) Documenting the sales system
Narrative notes
This method involves the auditor writing down a detailed description of the
system, including how the system works, what stages and controls are there and
how they operate.
Advantage
This is a simple method and the information recorded is easy to both read and
understand by all audit team members. This could be especially beneficial to
junior audit staff.
Disadvantage
If the process being documented is very detailed, the notes could turn out very
long and time consuming to both prepare and then read.
Questionnaires
The auditor has a pre-prepared list of questions on the sales system controls, which
get answered by the client. There are two types that the auditor can use: Internal
Controls Questionnaire (focusing on the client’s control procedures) and Internal
Controls Evaluation Questionnaire (focusing on the client’s control objectives)
Advantage
The use of questionnaires is a comprehensive, simple and quick way to both
understand and record the client’s sales system.
Disadvantage
A downside of this would be if the client has some unique control procedures or
objectives, questions on which are not included in the standard questionnaire –
then the auditor might never find out about specific controls
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(b)
Deficiencies Recommendations
Credit Limits
These are set by sales staff, based on Credit limits should be set using a
their own judgement of a customer’s credit score checking agency and then
creditworthiness. Given they have authorised by the sales director. Once
targets to meet it is possible for them set the credit limits should be reviewed
to rate some unreliable customers as and updated on a regular basis.
creditworthy just to hit targets. This
might lead to some bad debts and even
cash flow problems.
10% Discounts
These are again granted by sales staff A sales manager should review and
without requiring authorisation and authorise any discounts proposed by
if given too often and sometimes his sales staff to eliminate the chance of
unnecessarily, they could lead to loss of random discounts being given.
revenue which would have otherwise
been earned by the company.
Master File
Sales staff enter data on the customer Access to the master data file should
master data file which is never reviewed be restricted. Sales staff should only
by anybody. This means they might make propose the credit limits to their
mistakes which remain undiscovered or managers, who after authorising them
deliberately change something about a should record them on the system.
client (credit limit/prices etc)
Orders Finalisation
Orders are taken and finalised at the When visiting their customers sales staff
customers’ premises. The sales persons should bring some electronic device that
do not seem to check if the items is connected to the company’s inventory
ordered are actually in stock. So it is system and they should always check
possible that for some orders there is what items are available before
no inventory available and Heraklion is finalising an order.
unable to despatch these within three
days as advertised and that would
upset customers.
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ANSWERS
Deficiencies Recommendations
Order Forms
The order pre-printed paper copies Orders should be entered straight into
are not sequentially numbered but just the system using the sales person’s
based on the sales person’s ID. The electronic device. The system would
copies are just two and one is left with automatically number them and provide
the customer. If the company’s copy goes details to all relevant departments such
missing the order details will be lost, as warehouse, sales and accounts. That
the company would look unprofessional would make the process more effective
asking the customer about them. And and efficient.
what is worse the company might not
even realise something has gone missing
due to the lack of sequential numbering,
upsetting customers and potentially
damaging reputation.
GRNs
GRNs are filed in the warehouse, Upon despatch a copy of each GRN should
it appears currently the accounts be sent to the accounts team by the
department does not get any copies warehouse employees, who should also
of these. That means accounts would sign the warehouse GRN copy with their
not know when it is time to invoice initials to confirm that this has been done.
customers, which might lead to some
sales being despatched but not invoiced,
therefore losing revenue.
Overdue Invoices
These are chased only when over 90 days There should be a couple of staff working
old which is far too late, by this point it as credit controllers, whose job would be
might have become impossible to recover to send monthly statements to customers
those debts. Also the person dealing with and chase up any invoices that are not
them is the sales person, who could be paid within the 30 day credit term period.
busy with hitting his sales targets and
neglecting this additional duty.
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Tutor's Tips
This question contains a short knowledge-based requirement (part a) which could
give you easy marks if you understand what exactly you are required to do. The key
in it is to realise you need to describe 4 different types of control procedures (as
opposed to 4 control procedures) in terms of the meaning of each type of procedure,
as well as to provide only a brief example of each.
In part (b) you have the type of requirement appears at virtually every sitting of AA.
This particular question might seem a bit scary asking for 8 deficiencies but given the
long story as well as the freedom to choose deficiencies from the different control
systems of the company it actually becomes easier as you keep reading through
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ANSWERS
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AUDIT AND ASSURANCE
(b)
Deficiency Recommendation
Tangible NCA
The assets of the company have not been The Tangible NCA should be reconciled to the
physically verified in a long time, and only Asset Register annually, ideally dedicating a
a small proportion has been confirmed as specific time period in which this could be done.
exiting so far. This is bad as over time some of
the PPE could have got stolen or misplaced,
without anybody realising, leading to fraud
and/or inaccurate accounting records.
IA team
The team is understaffed, and many of its While looking to hire/train more IA staff, the
members are new and lack experience. As a company could consider outsourcing the
result their work could be quite inefficient function for a short period of time.
and just not good enough in order to assist
management, resulting to wasting too
much money on salaries and not making
the most out of it.
HR workload
The HR department has been overworked, The company could hire some temporary
resulting in the Payroll department setting HR staff to assist in the busy period or look
up new employees on the system. This could to relocate some existing staff to HR but not
allow for potential fraud as if the same person allow them access to the payroll system,
is responsible for setting up new joiners and ensuring segregation of duties is in place.
paying them, he could easily defraud the
company by paying some fake employees.
Payrises
The recent payrises have been agreed only Payrises to staff should be suggested by each
by the HR director. This is not a sensible thing departmental manager, and if they are quite
as he could be biased and decide to pay too significant they should be reviewed by the
much to people he likes (including himself), board or the very least by the finance director,
not using appropriately the company’s funds in order to make them effective.
for remuneration.
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ANSWERS
Credit limits
These are all established by the A credit control department should
company’s sales staff and also remain be established and be responsible for
static in the system once set. This could setting up as well as updating credit
be bad as sales people would benefit limits of clients. They could use an
from higher credit limits meaning they external credit check agency for credit
can make more sales and earn higher score assessment as well as review past
pay. Additionally the financial position payment history of each existing client.
of some quite good customers at the
moment could deteriorate in time. Both
of these could lead to bad debts for the
company or at the very least some cash
flow problems.
Valuable inventory
This is stored in warehouse areas, the The code to each site should be
entry to which requires a code, however different, and further it should get
the code is the same for all warehouses. updated at least every 3 months.
This could increase fraud, making it
easier for some staff to steal, if the code
becomes known by a lot of people in a
lot of locations.
Bank reconciliation
Only when the sum of the reconciling Any reconciling items which are
items is significant, these get considered significant individually
investigated by the financial controller. should also be provided to the financial
This isn’t good because it is possible controller so he investigates what has
individual items to be significant on their caused them too.
own but cancel out when added together
– and so potential problems could
remain unnoticed, resulting in potential
upset of customers, suppliers, etc.
Invoice payment
This is approved only after 75 days since Reconcile supplier statements monthly
receipt of invoice, which is far too late. and get all invoices paid in line with the
As a result suppliers could get unhappy specific supplier’s credit terms.
and decide to withdraw credit terms,
which would be damaging both to the
relationship with them as well as the
company’s cash flow.
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Tutor's Tips
This question examines two of the three key topics in the AA exam: internal controls and
substantive procedures. These are guaranteed to come up every sitting and for a great
amount of marks and you really need to make sure you are capable of tackling them.
Part (a) examines a little bit of professional ethics. It is something that appears rather
frequently in exams for 4-5 marks normally and is quite a nice requirement to have
in a question.
Part (b) is rather tricky. If you are not careful you could think that it is asking
about substantive procedures and if you describe these then you have lost 5
marks down the drain.
Part (c) is a standard internal controls requirement where you should be able to
do well if you keep in mind that for every deficiency you have to say both what the
company’s weakness is as well as why you think it could harm the company. Also with
each control test suggest a specific action (rather than say “check”) which tells the
marker HOW the auditor can check if the control is working. Keep it simple and to the
point and remember that anything that gives you evidence of the FS being correct is
not a control test.
Part (d) is a fairly standard substantive procedures requirement. Pure knowledge and
good technique of explaining substantive tests can easily get you full marks here.
Again, as with almost everything, make sure you say what you would do to check,
and why you would do it.
(a)
– Permission
The auditor should inform both clients and obtain permission from them first, in
order to make sure they are aware of the potential conflict of interest and happy
with him to proceed.
– Teams
The auditor should use two different teams for the two clients, ideally from two
different offices, in order to reduce the likelihood of confidentiality leaks due to
audit staff passing on sensitive information to each other, whether willingly or
accidentally.
– Training
Staff included on each of the two teams should receive an additional
training in confidentiality, in order to be aware of the extra sensitive nature
of these engagements.
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ANSWERS
– Files
Strict security and limited access to the audit files of the two clients should be
imposed, in order to reduce the risk of information leaks.
– Hot review
A third independent partner should oversee the two engagements and carry
out a hot review before the audit reports are signed, in order to identify any
problems and get them resolved in a timely manner.
(b)
– Previous audit documentation
Review the existing system notes and flowcharts from last year in order to assess
their completeness and quality: if these are poor then they should not be relied
upon in this year’s audit.
– Discussion with management
The auditor should enquire with management if any changes to the control
systems have been implemented and have an in-depth discussion about anything
new that might have been introduced.
– Staff enquiry
The auditor could also enquire with different staff within the company trying to find
out from them if there have been any new procedures introduced in the past year.
– Documented processes
The auditor should read any manuals or guides used to document processes within
the company, looking for something new that has been introduced in the past year.
– Deficiencies and recommendations
The auditor should also review the management letter provided last year as a
result of the audit of the company’s control systems. It will be highlighting the
deficiencies discovered and recommendations for their improvement, which can
suggest to the auditor where changes might have been made.
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(c)
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ANSWERS
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AUDIT AND ASSURANCE
(d)
– Recalculation
For a sample of pages from the purchase day book (PDB) recalculate totals, in
order to confirm accuracy.
– Analytical procedures
Compare this year’s other expenses figure to last year’s, adjusting for inflation, in
order to investigate any unexpected differences.
– Completeness
For a sample of GRNs (and the respective POs) trace them to the purchase
invoices and the invoices to PDB, to ensure they are all included in it.
– Occurrence
For a sample from PDB, trace back to purchase invoices and then back to GRNs
and POs, to ensure the purchases took place.
– Cut-off
For GRNs raised just before year-end trace them to the purchase invoices and
the invoices to the PDB, to ensure they are included in this year’s purchases.
Repeat for the other side of year-end, to ensure they are not included.
– Analytical procedures
Calculate GPM and OPM and compare them to last year’s ratios and to budget,
as any unexpected differences could indicate cost misclassification.
– Recalculation
Recalculate the prepayments and accruals in order to confirm their accuracy.
35. Raspberry Co (March/June 2018)
Tutor's Tips
This question is heavily focused on the topic of Internal controls, which is very
popular and loaded with many marks in the AA exam.
Part (a) requires you to identify and describe the positive things that are done by
the company in relation to its payroll. If you want to score full marks therefore, you
need to say not only what is good from what they do, but also why it is good for
the company. To make sure you score full marks, you should pay attention to the
examiner’s comment on this: “To explain why the control is key, candidates must
explain how the control will prevent or detect and correct a misstatement. For example,
to explain the fact that the company operates a separate human resources and payroll
department as a key control candidates must state ‘it would reduce the risk of fictitious
employees being set up’ to be awarded the ½ mark, explanations such as ‘this is good
segregation of duties’ was not a sufficient explanation to be awarded credit.”
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ANSWERS
The requirement is also checking if you understand control tests and can apply them
to the payroll system. Here remember you need to suggest something that can
give you evidence if the control actually works. Do not try getting evidence that the
payroll balance is correct and do not just say “check” – instead make sure you say
HOW to check if the payroll controls are effective.
Part (b) will inevitably feature in each exam. So again remember that with each
deficiency you need to not just point out the company’s weakness, but explain why
it could harm the company. Also remember that in your recommendations you must
add a bit of detail as to how the control procedure you are suggesting could work:
things such as who can do it, when they can do it, how exactly, how often and so on.
Part (c) is quite a frequent requirement too. Here you need to think about what
internal auditors can do within a company, it might help you if you try to relate it to
the context of the facts in this scenario and not just dump any pre-memorised roles
of internal auditors.
Finally a bit of substantive testing in part (d) where you can succeed not by having
memorised tons of substantive procedures but by understanding the meaning of
these and what they try to achieve. If you do and apply some common sense being
guided by the scenario, you can come up with a few sensible procedures that can
give you evidence on the specific balance. For full marks remember you usually need
to say what you will do (0.5 mark) as well as why you will do it (0.5 mark)
(a)
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AUDIT AND ASSURANCE
278
ANSWERS
(b)
Deficiency Recommendation
Student loans
The repayment forms for these are Some clerks should be hired to reconcile
filled in by the respective employees government statements and review
and paid directly to the government. If any student loan forms filled in by
nobody keeps track of amounts repaid employees. The payroll manager should
and ones still outstanding, this could on a sample basis agree repayment
lead to the company overpaying the forms to be processed with the
government and wasting further time reconciled government statements.
trying to claim funds back.
Production bonus amount
This is determined by the production Introduce a documented production
supervisors. As a result higher amounts bonus scheme that is based on pre-set
could be unfairly given to people they like standards and criteria.
and not to others who truly deserve it.
Holiday request forms
These are not always filled in and/or Automate the holiday request system
authorised. As a result staff could be so the clock-in card details link to it
taking extra holidays and getting undue and track how many days in the year
pay from the company. an employee has worked. The system
should automatically flag up someone’s
absence in case they have already used
up their holiday entitlement and are
absent again.
Cash packages
These are distributed by production Cash packages should be collected from
supervisors who hand the cash in to an office where the employee can enter
anyone without getting any proof of ID. only after swiping their own ID card and
As a result someone could pretend to be they should show that photo ID card and
another employee and claim their pay, sign for their package when receiving it.
or the clerk could be handing out pay to
friends who haven’t earned it.
Monthly salary and wage costs
Despite a variance analysis carried out Salaries and wage costs should be
monthly, nobody looks at the detail of broken into components and then
payroll costs and how the actuals of compared actual vs budgeted. Any
the different components compare to significant differences should be
the planned. As a result there could be investigated by the company.
errors or fraud hidden within an overall
figure that matches the budget.
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AUDIT AND ASSURANCE
280
ANSWERS
• Last year
Confirm the income tax payable accrual from this y/e to the accrual from last y/e,
adjusting for pay rises, joiners and leavers. If any unexpected differences found,
investigate further with management.
• Disclosure
Review the disclosure notes regarding the accrued income tax payable in order to ensure
if it is adequate and in line with the relevant accounting standards and local legislation.
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Tutor's Tips
This type of question might not appeal to you, if you do not understand the essence
of substantive procedures.
Testing two issues you should demonstrate your ability to relate to them, but also
having to suggest substantive procedures on equity (something not frequently
examined and therefore something you are unlikely to have memorised) means you
have to think how what you know about substantive procedures could be applied to
equity, and what matters you might have to prove about it.
The examiner showed disappointment in the examiner’s report regarding
performance on this question: “Performance was particularly disappointing for
equity. Most candidates were unable to tailor their knowledge of general substantive
procedures to the specific issues in the question requirements, or provided test of
controls rather than substantive procedures or provided vague tests.”
282
ANSWERS
(ii) Equity
Since the shares were issued at a premium, confirm that the nominal value has
been recorded as share capital and the amount above the nominal value as a
premium in the share premium account.
Inspect the company’s cashbook and bank statements to confirm receipt of
proceeds for the issued shares.
For any shares not paid up in full, confirm that they have been recorded as
partly paid shares.
Inspect the notes to the financial statements to confirm adequate disclosure of
the share issue.
37. Obtaining audit evidence (March/June 2016)
Tutor's Tips
This question is testing your knowledge and understanding of substantive
procedures, and your ability to apply it to bank balances.
To generate more ideas you can think of the substantive tests you can use (AEIOU) or
the assertions you need to prove regarding balances, or even the things which could
be your evidence in the tests. Describing any of these would allow you to suggest
substantive procedures.
For full marks remember you need to describe the meaning of each procedure, and not
an assertion (1 mark), and then give an example applying to bank balances (1 mark).
The examiner’s report noted the following: “…some candidates giving examples of
the procedures rather than a description. Some candidates incorrectly provided
financial statement assertions…”
The question required pure knowledge which means if you are well prepared you will
definitely do well in it.
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284
ANSWERS
Tutor's Tips
Part (a) of this question is a test of knowledge. Each component is worth a mark so a
mark worth of description is required – typically 2-3 lines of writing, not 5-6 words.
Part (b) of the question is testing if you know what a test of control is – i.e. observing
a control taking place, or inspecting evidence that a control has taken place (e.g.
a signature on a document), or enquiring if a control takes place. The big possible
mistake here would be to provide substantive procedures by mistake and not test
the control procedures at all.
Marking guidance
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Finally, controls that are not monitored tend to fail or simply stop getting done.
Management should monitor controls at a high level, but it is likely that internal
audit would be needed to check controls are working on a more continual and
operational level.
(b) Tests of Control
Pick a sample of new assets from the asset register and inspect minutes of capital
expenditure committee to verify these assets were authorised. (Alternatively,
inspect purchase orders for evidence of signature of a committee member).
Pick a sample of assets from the register and note the unique serial number.
Physically inspect actual assets to verify same number is on each asset.
Use computer software to check the numbers on the asset register are all unique
and there are no copies.
Inspect a sample of GRN to verify there is a signature present from a responsible
official showing the nature of the expenditure has been reviewed.
Inspect internal audit reports and other related documents that they keep to see
evidence of the results of their asset existence checks (note it may be possible to
observe the internal auditors carrying out these checks).
Try to gain access to the register using passwords that are not on the authorised list
(e.g. passwords belonging to other members of staff who should not have access).
39. Pineapple Beach Hotel Co (June 2012)
Tutor's Tips
Try and use the question scenario to generate points for each audit area here – but
also don’t forget easier marks such as recalculating depreciation and enquiring of the
directors what their views on the provision required are.
Marking guidance
Depreciation
Recalculate the whole year’s depreciation charge and compare with management’s
own depreciation charge to ascertain how reasonably accurate their calculation was.
Ask management to explain any material difference between my calculations and
theirs, inspecting records further to corroborate their answers.
286
ANSWERS
Compare management’s policy to hold the assets for approximately ten years with
comparable company’s policy on similar assets in the same industry.
Inspect details of their budgets for the next year or two to ascertain that they are not
planning to replace any of the new assets already. This may be an indication that the
policy is not realistic.
Talk to an independent expert and enquire how long the assets are likely to last if
they are in constant use all the time the leisure facility is open.
Food poisoning
I would obtain the original claimant’s letter and read through it to understand what
the claim is about and the circumstances relating to the food poisoning. I would
confirm if there is any expert, e.g. medical doctors’ report backing their claim.
I would request for my client’s lawyer’s reply to the claimant and understand his
reasoning to them leading to his conclusion that the claim is unlikely to be successful.
I would request board minutes to read through them and understand management’s
views and conclusion relating to the claim and ask the management whether they
plan to create a provision or make a disclosure on the matter.
I would obtain a written representation from management confirming their belief
that the matter is unlikely to succeed and review all evidence available to assess how
reasonable this conclusion is.
40. Rose Leisure Club Co (December 2012)
Tutor's Tips
As in similar questions, use the scenario to generate points such as the dates for cut-
off testing and for receivables what further work is needed on the non-replies from
the circularisation. In other words there are specific areas that need more work from
the question; do focus on these rather than state generic points.
Marking guidance
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288
ANSWERS
41. Newthorpe
Tutor's Tips
As with any audit procedure question always try and use the scenario to generate
points. For example, if the redundancy cost is based on years service then agree this
to HR records or if the service contract states the redundancy to be paid, then see
the service contract!
Marking guidance
(a) Audit procedures to verify the net realisable value of PPE and inventories:
– Select a sample of plant that has been sold and agree the selling price to a
sales invoice;
– Where items are yet to be sold agree estimated selling price to a sales
invoice for a similar item that has already been sold or to an industry
journal/trade press;
– Obtain a breakdown of the costs to sell a sample of fixed assets and ensure
these costs have been; deducted from the selling price in order to determine
net realisable value;
– Review the list of costs to sell to ensure they include all reasonable selling
costs such as commission and any modification costs that need to be
incurred to sell the asset;
– For inventories that have already been sold, agree the selling price to post
year-end sales invoices;
– For inventories still in stock, agree the estimate of post year-end selling price
to industry journals or sales invoices for similar items;
– Enquire of management as to whether certain items if inventory require
completion or modification before being sold. Obtain a breakdown of these
costs and trace them to the calculations of net realisable value to ensure
they have been taken into account.
(b) Audit procedures to verify the redundancy cost:
– Agree the redundancy terms to a sample of employee contracts to ensure
the liability has been calculated on an accurate basis;
– Obtain a list of the names of employees transferred to other factories
and compare this to the list of names of employees who have been paid
redundancy to ensure that no one who has been transferred has been paid
redundancy thereby overstating the cost;
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Tutor's Tips
This question is a comprehensive evidence question covering many of the liabilities
on the Audit and Assurance syllabus: payables, accruals and legal provisions.
If you are struggling to think of audit tests, don’t forget to use the assertions
(completeness, accuracy etc) and the audit tests (analytical review, enquiry,
re-calculation etc) to help you to generate ideas.
With regards to provisions and estimates in general there is some useful advice for
their audit in ISA 540: testing management’s process, review of subsequent events
and obtaining an independent estimate are just some of the ideas you can use to
help to generate ideas.
Marking guidance
(a) The auditor’s judgement about the sufficiency of audit evidence obtained is
affected by the following factors:
Risk
The more risky a balance is, the more evidence will be needed. For example,
more evidence will be needed for a legal provision, which involves an element of
judgement than for a sundry expense.
Materiality
The more material a balance is, the more evidence will be needed. More evidence
will be required for director’s emoluments than for window cleaning expenses.
290
ANSWERS
Procedure Reason
Calculate trade payable days year on A significant increase in days may
year and follow up on any significant suggest that the company has cash flow
difference with regards to normal problems which could eventually effect
credit terms. its going concern status.
A significant decrease in days may
suggest payables are understated.
Inspect the trade payables ledger for To ensure that the payables ledger is
debit balances and remove these to the complete.
receivables ledger.
Cast the trade payables listing. To ensure it is accurate.
Review the post year-end cashbook To ensure year-end payables are
for large payments. Trace the details complete.
of these payments to the purchases
ledger. If they relate to pre-year-
end purchase, there should be an
equivalent payable in the pre-year-end
payables ledger.
Select a sample of payables and trace To ensure the payables exist.
to an invoice and goods received note.
Obtain the supplier statements To ensure that payable balances are
for a sample of payable balances complete and accurate.
and reconcile the balance per the
statement to the payable ledger.
Select a sample of pre-year-end To ensure deliveries received
goods received notes and trace to the before the year-end have been
payables ledger. recorded as a liability.
Agree the total on the payables To ensure the payables balance is
list to the nominal ledger and the complete, exists and is accurate.
financial statements.
Review the payables listing for names This may indicate that a certain
of known suppliers and follow up on debt has been omitted and the
any missing suppliers. ledger is incomplete.
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AUDIT AND ASSURANCE
(ii) ACCRUALS
Procedure Reason
Compare last year’s accruals listing This may show whether or not an
with this years and follow up on any accrual has been deliberately omitted.
missing suppliers.
Select a sample of pre-year-end GDNs To ensure that accruals have not
that have not yet been invoiced and been understated.
trace to the accruals ledger.
Re-perform calculation of any rent, To ensure the calculations are accurate.
rates or utility accruals.
Procedure Reason
Obtain an independent estimate To ensure that the provision is reasonable
of the legal provision from the in light of the lawyer’s estimate.
company lawyers.
Review customer complaints file and To ascertain whether further provisions
correspondence to see if there have may be needed for other court cases.
been any similar accidents that may
lead to court action.
Review legal correspondence post To ensure provision was adequate in
year-end for evidence of the case light of the actual costs incurred.
being settled.
Review any insurance policies that may So that any contingent assets can be
provide some reimbursement. correctly disclosed.
Tutor's Tips
This is another typical audit evidence type question.
Parts (a) and (b) are requirements based upon your knowledge and ability to explain the
financial statement assertions and then the factors affecting the sufficiency of evidence.
Part (c) requires you to use the scenario to identify appropriate risks and responses
– present these in a table as this is a standard question requirement and makes it
easier for you and the marker to identify the points being made.
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ANSWERS
Marking guidance
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294
ANSWERS
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Tutor's Tips
Parts (a) to (c). These can be written as a standard deficiency, reason, control
required type of question – so in columnar form. Note the requirement is slightly
strange in that four procedures are required but only three weaknesses. This doesn’t
normally happen in the exam, but if you can think of two controls for one weakness
that will obviously save time answering the question.
Parts (d) and (e) also link together. Note that the audit procedures given must link
to sales invoicing; else simply define each type of procedure and then give the
example below this.
Finally part (f) is mainly “theory”. Note that the question does state a bank
reconciliation is being performed so some procedures can be linked to this.
Otherwise think of the standard audit procedures that will be carried out on bank
such as obtaining a bank letter or even just casting the bank reconciliation for
arithmetical accuracy.
296
ANSWERS
Marking guidance
297
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298
ANSWERS
299
AUDIT AND ASSURANCE
Tutor's Tips
Parts (a) and (b) are linked so it is acceptable to place these in a table. For the types
of audit procedure, you can use the memory jogger AEIOU to get these. Providing an
example may be more difficult; stick to easy comments here where possible such as
enquiry simply asking the directors to explain changes in figures.
Parts (c) and (d) are also linked so again use a table for the answer. The risks will be in
the scenario. Having identified these don’t be afraid to use some common sense to
state the impact on the audit. So if there is a difficult audit area like bad debts, then
allocate more time and more experienced staff to carry out this part of the audit.
Marking guidance
300
ANSWERS
301
AUDIT AND ASSURANCE
Tutor's Tips
Parts (a) and (b) are linked so it is acceptable to place these in a table. For the types
of audit procedure, you can use the memory jogger AEIOU to get these.
Part (b): Try and think what internal audit do – reviewing controls and detailed
substantive procedures – then link these points to fraud – each may detect or
provide evidence on the extent of fraud.
Part (c) hopefully isn’t difficult. Cost is always a problem! Then independence as a
common audit problem. There’s two points.
Part (d) is theory – if you can remember the syllabus for other areas of internal audit
then use that – else try and think of other areas outside of auditing the accounts that
could be investigate – and that will mean IT, management accounts, legal situations
etc. to generate marks.
Marking guidance
302
ANSWERS
(a) (i)
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AUDIT AND ASSURANCE
(ii)
Tutorial note: Only five procedures and example audit procedures were required.
(b) The internal audit department could assist the directors in preventing and
detecting fraud and error in the following ways:
– Establishing an internal audit department in itself will be a deterrent to
employees to commit fraud due to the increased likelihood of that fraud
being detected.
– Assessing the adequacy of the internal control systems over cash and other
assets and making recommendations to improve those controls where
weaknesses are found.
– In hotels where fraud is suspected, carrying out detailed substantive
procedures to try and determine the extent of fraud.
(c) The limitations of maintaining an internal audit department include:
– The ongoing cost of the department after any fraud investigations have been
completed. The directors must consider whether this ongoing cost is at least
matched by the benefit of maintaining the department.
– The possibility of lack of independence of the internal audit department.
As employees of the company the internal audit department cannot be
completely independent, which may limit their effectiveness.
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ANSWERS
– Whether employees of Bush-Baby will accept and cooperate with the new
internal audit department; lack of cooperation may limit the effectiveness of
the department.
(d) Additional functions that the internal audit department could undertake include:
– Value for money audits: Ensuring Bush-Baby is obtaining value for money in
areas such as supplies of food/drink or even capital expenditure.
– IT audits: Ensuring that IT systems are working efficiently (all of Bush-Baby’s
hotels are linked by an IT network) and/or providing recommendations for
the improvement of those systems.
– Review of financial statements in terms of compliance with laws and
regulations or assisting the external auditors (where requested) in ensuring
the accuracy of those financial statements.
– Ongoing testing of controls in individual hotels such as ensuring petty cash
balances are accurate by surprise counts and testing controls over cash
balances in each location.
– Ensuring assets are correctly recorded (that is fixtures and fittings in
restaurants and beds and other furniture in hotel rooms) to confirm the
accuracy of the asset records.
47. Hummingbird Scents Co (December 2014)
Tutor's Tips
This question has a standard controls deficiencies/recommendations requirement.
Whilst the range of deficiencies in the scenario involves some of the usual issues – a
lack of sequenced documents, clerks able to change important information, lack of
segregation of duties etc. – there are not many more than 7 to find, making it quite
tough to get close to full marks.
The key in part (a) is explaining the issues found, in terms of the potential damage to
the company if the deficiencies are not fixed, and making sensible recommendations
(try to say who should do it, or how, or when).
The answer below aims to put 7 achievable deficiencies first, then the harder to
explain ones later.
Part (b) is a standard substantive procedures requirement. The scenario tells you a
little about the company’s revenue and that should provide clues to add to the tests
you know from memory to verify revenue. Think which assertions are worth testing,
and make sure each procedure is explained not just stated.
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Marking guidance
(a)
Deficiencies Recommendations
Brenda
Brenda controls all stages of the sales A second clerk should be allocated some of
process, and this lack of segregation of Brenda’s duties, for example Brenda could
duties means that any errors (or fraud) she is take orders and the second clerk could
making are unlikely to be noticed, leading to process payments.
losses for the company, or upset customers
due to mistakes.
Control Account
The control account is only reconciled once The control account should be reconciled to
per year. If there are errors on customer the list of customer balances on at least a
accounts, or a fraud is taking place, this monthly basis, by a responsible official (not
could mean it takes 11 months before it is Brenda, who would be checking her own work).
discovered, making it harder to investigate
and correct the problem.
Courier
The switch to the local courier is no doubt The company should perform a cost benefit
saving money, but late deliveries mean analysis on this decision and might need to
the benefits may be outweighed by upset reverse it. If the local courier is retained, it
customers going to alternative suppliers. should be set delivery targets and have its
money reduced for each late delivery, to help
incentivise it to perform better.
306
ANSWERS
Deficiencies Recommendations
Price changes
Both Brenda and the other clerk are making Any price changes should be made by
manual pricing changes to the system or a responsible official, with passwords
to invoices. Clerks might make mistakes, or protecting the master files to stop others
might give favoured customers lower prices making these changes.
in exchange for bribes (e.g. free hotel stays), For the hotel pricing, their contracted prices
leading to loss to the company. could be set up on the master file to avoid
any need for manual changes.
Order Numbers
Order numbers are based on the customer Order numbers are based on the customer
account number, meaning they are not in account number, meaning they are not in
their own sequence. Missing/lost order their own sequence. Missing/lost order
documents would become harder to spot, documents would become harder to spot,
leading to upset customers who never leading to upset customers who never
receive their goods. receive their goods.
GRN Numbers
GRN Numbers are also not sequenced, GRN should receive an automatic sequential
meaning it is hard to note any missing number when they are raised, and the
ones. As a result inventory records are at sequence should be checked automatically
risk of being wrong because it is hard to by the inventory system to highlight
tell if all GRN are on the system, meaning missing GRN numbers, which could then be
orders might be accepted for goods that investigated.
do not exist (or turned down despite goods
existing) meaning upset customers.
Credit Limits
It seems that credit limits are only set when The FD should review credit limits for
a new customer is set up, but then never customers on a regular basis, perhaps
reviewed. If limits are too high the company quarterly or half yearly, based on the
might experience more bad debts than it customers’ payment record.
can afford, but if the limits are too low they
will miss out on additional sales orders.
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Deficiencies Recommendations
Invoicing of Online Orders
Invoices are being raised automatically as Invoicing should continue to be automated,
orders are placed online. Whilst this looks but should be triggered by the creation of
efficient, it means that customers are being the GDN, not the sales order, as despatch is
invoiced before goods are despatched, where the revenue is being earned.
meaning sales are being recognised too early.
As a result, the revenue figure reported is at
risk of being overstated due to this cut off error
Trade Customer Statements
No statements are generated for trade The system should automatically email
customers. This means that mistakes on the monthly statements to all customers, with
system are less likely to be picked up, and also a request for the customer to contact the
customers might be slow to pay if not chased. company should they wish to query anything.
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ANSWERS
Tutor's Tips
Part (a) is pure knowledge, and there are more than 4 factors available as answers, but
remember as always that to score a whole mark explanations are needed, not just a list.
Part (b) is harder. It is possible to score a lot of marks without ever reading the
stories, because the audit work on these areas tends to be standard across
companies whatever their circumstances, but if your memory is poor the stories
have some useful clues. There is no WIP (so no marks for testing it). There are 12
locations (implying you need to decide which to visit) and internal audit will be at all
12 (implying you can liaise with them at locations you do not attend). For R+D, you
are told the projects are at varying stages (so check if they are on track to finish) and
given an amortisation policy (so test it).
In all cases, explain the test do not just state it, as per the examiner report:
“a significant number did not expand to explain the purpose of obtaining this information”
Part (c) should be straightforward. There is a material misstatement, only affecting
one thing in the financial statements, so the conclusion for the audit report can
only be one thing! Remember that when modifying an audit opinion there will be a
second mark available for mentioning the Basis For Opinion explanation.
(a) Factors
Evidence gathered by the auditor themselves is more reliable than that provided by
the client because the client might have altered the evidence before providing it.
Evidence gathered from 3rd parties is more reliable than evidence from within the
company as the 3rd party has less incentive to provide misleading information.
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AUDIT AND ASSURANCE
310
ANSWERS
Obtain last GRN and GDN numbers at the end of the day, so that these can
be used for cut off testing at the final audit after the year end.
At end of stocktake, obtain copy of completed stock count sheets for use on
the final audit visit after the year end.
(ii) R+D
Discuss the progress of each of the R+D projects with Development staff,
to assess if each project is on track to be finished or if problems exist which
might stop the products from ever being sold.
Inspect market research records to assess the likelihood of each of the
products under development achieving sales of sufficient size to pay back
the investment in developing them.
Observe the testing of prototypes, and inspect recent test results, to assess
if there are any complications in making new products work properly.
Inspect board minutes for any evidence of the company’s intention to
finish each project (e.g. planning a launch date would suggest a project is
supported and nearly finished).
Compare project budgets to company’s available cashflows (e.g. forecasts) to
assess if company has financial ability to complete each of the projects.
Obtain a breakdown of the costs of each project and check the costs add up,
agreeing larger items to invoices to verify the costs belong to the project,
and are not research by nature.
Assess reasonableness of amortisation rate of 5 years by analysing the sales
history of previously developed products, and comparison with similar
products from competitors.
Recalculate amortisation charge for the year to ensure in line with the
stated policy.
(c) Audit Report
The development costs are not immaterial, as they represent 11.8% of profit.
Hence their mistreatment in the financial statements is likely to influence
shareholders.
If the IAS 38 criteria are not met, the financial statements are currently
materially misstated so the client needs to be informed that the correction needs
to be made and the costs written off to the P or L.
If the FD refuses to make this correction, the impact on the audit report (see
below) should be discussed with the company’s audit committee 9if it has one).
The audit opinion will be qualified “except for” due to the material misstatement
in failing to apply IAS 38. Only two figures are affected, so this would not be
considered a pervasive misstatement.
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AUDIT AND ASSURANCE
The mistake should be explained and quantified in the Basis of Opinion section
directly below the Opinion in the audit report.
49. Elounda Co (September 2016)
Tutor's Tips
Part (a) is not hard to pass, given that any reliance on an expert would need
qualifications, experience and independence to assess. But getting to 5 separate
factors is more of a challenge.
In part (b)(i) make sure to realise there are 2 things to test – the revaluations, and
the new warehouse acquired. The second of these in particular should provide easy
marks. Part (b)(ii) is tougher but again break it down. The story tells you that WIP is
valued at % completion x standard costs, giving you two separate elements to test.
The key with these substantive procedure questions is best understood from the
examiner comments:
“Many candidates were unable to tailor their knowledge of general substantive
procedures to the specific issues in the scenario and question requirements. Many
candidates spotted the terms property plant and equipment and inventory and
proceeded to list all possible tests for these areas. This is not what was required and
hence did not score well. The scenario was provided so that candidates could apply
their knowledge; however as in previous questions and diets it seems that many did
not take any notice of the scenario at all. As addressed in other examiner’s reports
candidates must strive to understand substantive procedures. Learning a generic list
of tests will not translate to exam success as they must be applied to the scenario.”
For (c), there is a similar issue to (a). Some marks are relatively easy to get but
squeezing 5 separate points out is difficult. Again, use the story. Client has said
they do not wish to change something despite it being wrong, so ask them for
their reasons. You are not told of the size of the mistake, so materiality needs to be
considered etc.
Audit reports are a technical area and historically students simply have not
learned or understood them enough, as you will note from the frustration in the
examiner’s comments:
“Yet again future candidates are reminded that audit reports is a key element of the
syllabus and hence an understanding of how an audit report can be modified and in
which circumstances, is considered very important for this exam”.
(a)
(i) Substantive Procedures – PPE
Reliability of Valuer
He is clearly not independent of Elounda, so his reliability and competence
must be carefully assessed. This could be done by obtaining some proof
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ANSWERS
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Aged Inventory
Inspect the year-end aged inventory report to identify any old items that
might become obsolete and need discounting in order to sell. They might
have been overvalued if their NRV has fallen below cost.
(iii) Substantive Procedures – Loan
Loan Agreement
Inspect the loan agreement and read the notes to the financial statements
to ensure correct disclosure of the loan as a current liability and of all other
relevant details, including any security.
Interest
Recalculate the interest charge on the loan to confirm accuracy of the
interest expense balance in the financial statements.
Repayments
For any amounts already repaid during the year, agree those to both the cash
book and bank statements of Elounda.
Bank Confirmation
Contact the bank to obtain confirmation of the closing balance on the loan at
year end and agree that to the financial statements.
(b) Procedures on Going Concern
Bank letter
Obtain a bank letter confirming Elounda’s current account balances and
overdrafts, and agree the bank balances to the cash book, in order to establish
how much cash the company has in its accounts at present.
Cash flow forecast
Inspect the company’s cash flow forecast to establish the company’s
expectations for the coming year and assess if the assumptions on which it is
based are reasonable. Also obtain a credit score report on Elounda in order to
assess its ability to raise further cash via loans if necessary.
Ratios
Calculate liquidity and gearing ratios which can give some indication of the
company’s position. If liquidity is poor and gearing is high it means the company
is facing high financial risk which makes its future more uncertain.
Loan agreement
Inspect the existing loan agreement(s) and any covenants attached to them,
to see if there are any requirements which the company must satisfy and
determine if any of those have been breached.
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ANSWERS
Management representation
Enquire with management on why there were defaults on the loan repayment
last year, whether they are able to repay the bulk amount in January and to
confirm the company’s going concern status after the $800,000 repayment.
50. Airsoft Co (March/June 2017)
Tutor's Tips
This question is testing your knowledge and understanding of substantive
procedures, and your ability to apply it to a variety of Financial Statements items.
The requirements are fairly standard and often appear during the exam
To generate more ideas you can think of the substantive tests you can use (AEIOU) or
the assertions you need to prove regarding balances, or even the things which could
be your evidence in the tests. Describing any of these would allow you to suggest
substantive procedures. And as always, using some logical thought and common
sense about how you can prove something, is your best ally, combined with your
essential accounting knowledge.
For full marks remember you usually need to say what you will do (0.5 mark) as well
as why you will do it (0.5 mark)
The examiner’s report noted the following: “…As addressed in previous Examiner’s
Reports candidates must strive to understand substantive procedures. Learning a
generic list of tests will not
translate to exam success – procedures must be tailored to the specific requirements
of the question…”
The question also contains a brief requirement testing your knowledge on contents
of audit reports.
Overall the question requires pure knowledge (although the scenarios could help you
generate ideas) which means if you are well prepared you will definitely do well in it.
(a)
Select a sample of GRNs, trace them to their respective purchase invoices and
trace the invoices to the Payables ledger, to ensure they are all recorded.
Perform supplier circularisation, asking a sample of suppliers with year-end
balances to confirm how much they think the client owes them.
Compare the list of payables and the list of accruals at year end to the list of payables
and list of accruals from last year end and investigate any significant differences.
Inspect invoices and credit notes issued in the beginning of the new year to
ensure that there is nothing else that needs to be accrued.
Obtain supplier statements and reconcile items to the payables ledger balances.
Investigate any differences.
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AUDIT AND ASSURANCE
(b)
Use audit software to select a sample of suppliers for supplier circularisation.
You can use the software for the selection of a random sample or to re-arrange
supplier balances by size or by age etc.
Audit software can be used for recalculation of the total payables balance by
adding up all the individual payables balances.
Audit software can be used in analytical procedures, including calculating the
payables days ratio and comparing it to last year’s ratio.
(c)
Contact the company’s bank and ask for a bank letter, which details all the
company’s bank accounts and balances at year end.
Compare the list of company’s bank accounts at the start of the year to the list
of bank accounts at the end of the year, to identify if any accounts have been
closed or new accounts have been opened by the company.
Re-perform the year-end bank reconciliation to see if the outcome is the same as
the one from the client’s year-end bank reconciliation
From the year-end bank reconciliation and agree the “balance per bank
statement” to the year-end bank statement balance, as well as the “balance per
cashbook” to the year-end cashbook balance.
For any reconciling items from the year-end bank reconciliation, inspect post
year-end bank statements and cashbook to see if they have cleared.
(d)
Read the notes regarding remuneration disclosure in order to ensure that they
are adequate and in line with the accounting standards and local legislation.
Trace a sample of monthly payments to directors from the payroll records to the
bank statements and cash book to confirm the amounts.
Agree the remuneration of directors to their service contracts with the company,
to ensure the amounts are correct.
(e)
Key Audit Matters (KAM) paragraph is a compulsory part of the standard audit
report for listed companies and is located underneath the Basis for Opinion section.
It is used to communicate in detail to shareholders matters considered
significant during the audit and provide them with greater understanding of
those, should they require to discuss them further with management and those
charged with governance.
Identifying the matters considered significant involves a lot of judgement by the
auditor and it normally relates to matters which have taken a lot of time during
the audit and a lot of discussion with the Audit Committee.
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ANSWERS
Examples of such matters are things such as going concern testing, revaluation,
changes in accounting policies, and any areas of higher risk of material
misstatement.
The paragraph describes the issues, how the auditor addressed them and what
conclusions he arrived at as a result of the tests.
51. Dashing Co (September/December 2017)
Tutor's Tips
This question is heavily focused on substantive procedures, which is also one of the
topics that is there in every exam, and always carries lots of practical marks. Like in
this question you will be seeing a few different requirements in your exam asking
about a variety of substantive procedures on different balances/issues.
In this question specifically you have to link your procedures to the scenario for a
best quality answer. If you don’t pay attention to what the question says, you might
miss out some very important matters (and therefore marks) – for example, not
noticing that receivables circularisation is not a scoring option. Also make sure that
in part (b) you pay attention to the specific assertions you have been asked to prove,
rather than dump any random substantive procedures you know.
Part (d) is testing your knowledge on audit reports. As usual you can expect a small
number of marks in your exam for such question type, so if you follow the suggested
structure and think carefully about what is going on in the scenario, you should be
able to do well in it. Don’t forget to calculate materiality and state why the issue is/is
not material for an easy mark!
(a)
Permission
The audit firm needs to obtain permission from the company’s finance director that
allows it to contact the company’s customers with receivables balances at year-end.
Breakdown
The auditor needs to obtain a breakdown detailing the customers with such
balances and what items are included in them.
Sample selection
The auditor should select an appropriate sample for testing, that could include
some old or unusual balances that are at a higher risk of being wrong.
Letter
Given that this is positive circularisation, the letter to be sent out should require
customers to respond to the auditor’s request and write back the amounts they
think they owe to Dashing Co. If no response is received, the auditor could follow
up by another letter or a phone call.
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AUDIT AND ASSURANCE
(b)
(i) Valuation
Recalculation
Add up the individual receivables balances at year-end to confirm that their
total matches the total receivables balance, confirming valuation.
Overdue receivables
For the oldest receivables inspect correspondence between the client and
their customers, in order to find out if they are discussing any payment
amounts and dates, and assess if the balances are likely to become bad debts.
(ii) Completeness
GDNs
For a sample of GDNs raised before year-end and their sales orders, trace
them to the relevant invoices and then trace the invoices to the receivables
ledger, to confirm that they are all recorded.
Analytical procedures
Compare the list of receivables at this year-end to the list from the previous
year-end and enquire with management about any significant differences, in
order to ensure that nothing is missing.
(iii) Rights and obligations
Sales invoices
For a sample of receivables balances, trace them to the relevant sales
invoices and inspect the invoice details to ensure that they have been
issued by your client company and in the customer’s names, to confirm the
company’s right to receive payment for them.
Bank statements
For a sample of older receivables, inspect post year-end cash book and bank
statements to see if they are being paid to your client, confirming their right
to the balance.
(c)
Board minutes
Inspect minutes from board meetings in order to confirm the company’s decision
about the closure of the specific site and the planned redundancies.
Recalculation
Obtain a breakdown of the items that make up the redundancy provision and
recalculate the total, to confirm its accuracy.
318
ANSWERS
Announcement
Inspect a copy of the announcement re the closure of the site and the employee
redundancies, in order to confirm that it took place before year-end and
therefore requires a provision, rather than a disclosure of a contingent liability.
Correspondence with employees
Inspect correspondence between the company and the employees being made
redundant, in order to see if any of them have been offered and accepted an
alternative employment. This would mean that such employees would need no
redundancy pay and should not be included in the provision.
Employee contracts
For a sample of redundant employees inspect their employment contracts to
confirm important matters that are used in the calculation of their redundancy
pay, such as age, pay and length of service.
(d)
Issue
The issue is that currently the provisions balance is understated and therefore
the profit overstated by $195,000 ($305,000 - $110,000).
Materiality
($195,000/$2.6m) × 100% = 7.5% of PBIT > 5%
($195,000/$18m) × 100% = 1.1% of total assets > 1%
Therefore the issue is material.
Audit report
The impact on the audit report would be that it needs to be modified, given that
now a material misstatement would exist in the final FS.
Audit opinion
Given that the issue is material but not pervasive, if uncorrected then the
audit opinion would be modified as qualified “Except for” due to a material
misstatement.
Basis for opinion
In this paragraph, located after the Opinion section in the audit report, the
auditor would explain the reason for the qualification of his opinion with
reference to the accounting standards breached and quantify the effect on the
profit, if the misstatement was corrected.
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AUDIT AND ASSURANCE
Tutor's Tips
This question is testing your knowledge and understanding of substantive procedures,
and your ability to apply it to a variety of Financial Statements items and different
scenarios. The requirements are fairly standard and often appear during the exam.
To generate more ideas you can think of the substantive tests you can use (AEIOU) or
the assertions you need to prove regarding balances, or even the things which could
be your evidence in the tests. Describing any of these would allow you to suggest
substantive procedures. And as always, using some logical thought and common
sense about how you can prove something, is your best ally, combined with your
essential accounting knowledge.
For full marks remember you usually need to say what you will do (0.5 mark) as well
as why you will do it (0.5 mark).
The examiner’s report noted the following: “…As addressed in previous Examiner’s
Reports candidates must strive to understand substantive procedures. Learning a
generic list of tests will not translate to exam success – procedures must be tailored
to the specific requirements of the question…”
The question also contains a brief requirement testing your knowledge on contents
of audit reports.
Overall you can pass the question relying just on knowledge but of course the
scenarios could help you generate ideas and make stronger, more relevant points.
Which means if you are well prepared and have practised a lot of past papers, you
will definitely do well in it.
(a)
• Research
Obtain the breakdown of the $1.9m cost and inspect some of the invoices that make
it up, in order to confirm that no research cost has been capitalised rather than
expensed as per IAS38.
• Product inspection
For a sample of newly developed products carry out a physical inspection to confirm
that they are actually complete or on track for completion as per their development
schedule. One of the IAS38 criteria for capitalisation requires evidence that the
product development will complete.
• Funds and resources
If there are any incomplete developments, inspect bank statements and minutes
from board meetings to find out if the company has the required resources and a
plan in place for financing the product completion.
320
ANSWERS
• Success on market
Inspect the most recent market research carried out by the company and if
necessary seek an expert opinion to find out if the newly developed products are
likely to be in high demand. Another criteria for capitalisation of IAS38 requires
evidence of market success.
• Amortisation
Compare the chosen policy and useful economic life (UEL) by the client to the
standard ones for the industry and the ones used by their main competitors, in order
to confirm they are reasonable. Recalculate charge for accuracy.
(b)
• Analytical procedures
Compare the company’s depreciation policies and the new useful economic lives
(UEL) of assets to those of their main competitor: if the changes are in line with what
their competitor is using, this might be an indication that it is reasonable.
• User manuals
For the changed assets inspect any user manuals and manufacturer’s guarantees
they come with in order to see if their UEL is indicated in there. This could justify the
changes made by the client.
• Past disposals
Review previous asset disposals by the company. If there have been frequent
losses/gains on disposal that could indicate that the previous UEL of the assets was
unreasonably estimated.
• Inspection and observation
Inspect some of the PPE with updated UEL and observe them in use to get an idea
of whether or not they seem to be in a good working order and if this matches their
UEL. Assets which are looking worn out or are not working properly are unlikely to
last much longer.
• Expert
Seek the opinion of an independent expert who can confirm whether or not such
updates to Gooseberry’s PPE seem reasonable.
(c)
• Service contracts
Review the directors’ service contracts to confirm the requirements of the bonus
clause included in them and how exactly according to it the bonus amounts should
be calculated.
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AUDIT AND ASSURANCE
• Bank statements
The bonuses should have been the month following y/e. Inspect the February bank
statement to confirm the amounts to the accruals and the directors’ contracts.
• Previous year
Compare the directors’ bonuses and the assets based in which they were calculated
for this year to the bonuses and calculation basis for last year, in order to investigate
further any unexpected differences.
• Competitor
Compare the directors’ bonuses to those of a main competitor who has also
performed well for the past year, in order to see if the bonuses paid by the two
companies are of a similar nature and similar amounts.
• Local legislation
Review the local legislation requiring bonus disclosure and inspect the notes to
Gooseberry’s FS in order to confirm that disclosure is adequate.
(d)
• Intangible assets
If the project does not meet the IAS38 capitalisation criteria, it should be expensed.
Its current incorrect treatment means that expenses are understated and assets are
overstated by $440,000.
• Next year
Despite the finance director’s (FD) belief that the project would meet the criteria
next year, the amount of $440,000 should be expensed in this year’s FS, given that
currently the criteria is not met. Should this indeed happen next year, any new
development costs incurred should be capitalised in next year’s FS.
• Materiality
($440,000/$6.4m) × 100% = 6.9% of PBIT > 5%
($440,000/$37.2m) × 100% = 1.2% of total assets > 1%
Therefore the issue is likely to be material.
• Audit opinion
Given that there is an uncorrected misstatement which is material but not pervasive,
the audit opinion should be modified (qualified “except for” due to a material
misstatement)
• Basis for opinion
In this paragraph, located underneath the opinion section, the auditor will explain the
reason for the qualification, referring to the accounting standards breached, the correct
treatment and the effect on profit the misstatement would have had if it got corrected.
322
ANSWERS
323
AUDIT AND ASSURANCE
Tutor's Tips
This question is a typical substantive procedures scenario based question. Very
popular and hopefully very easy if you learn how to use the story to generate ideas.
If you are asked to suggest procedures on specific issues in the story, just think about
how you can check anything in it: check every fact, every amount, every date.
What you should not do is try to provide a list of pre-learned procedures without
paying attention whether they are appropriate for the specific story, as suggested by
the examiner’s report:
“If the scenario discusses events at two different companies it is expected that the
specific audit procedures relevant for each company will be discussed individually,
rather than answering the question with a list of general procedures.”
To make your answer stronger try to link it as closely as possible with the story, use
to your advantage any dates and refer to facts mentioned wherever possible.
Event 1 – Fire
This subsequent event is non-adjusting, as the damage to the company was not done
before year end. However due to its materiality it requires disclosure in the notes to
the financial statements.
The damage caused by the fire is more than 5% of the profit before interest and tax
therefore it is material. Calculation: ($0.65m/$7.9m)*100% = 8.2% PBIT
Procedures
Visit the site of the fire and inspect its state (if it has not been cleared out yet) to get
evidence of the damage and try to assess its extent.
For the damaged vehicles inspect the repair bills sent to the company or the quotes
received for repair/replacement of those vehicles, in order to confirm the estimated
figure of $650,000.
324
ANSWERS
Obtain the insurance policy and inspect the details relating to compensation, to find
out in what situations no payout would be given to the company, and determine
whether expecting to receive compensation is realistic.
Event 2 – Inventory
This is an adjusting subsequent event, because the defective batch of cereal was
already in stock at year end and the company was suffering from the $865,000 fall in
its net realisable value ($915,000 original price - $50,000 scrap value)
The reduction in inventory value is more than 5% of the profit before interest and tax
therefore it is material. Calculation: ($0.865m/$7.9m)*100% = 11% PBIT
Procedures
Inspect the inventory records at year end, in order to confirm how much of the
defective ‘Loopy Green Loops’ was in stock at that point.
Review any internal communication on the matter to confirm it was discovered
in February, the level of damage discussed as well as any other details, relevant
to the problem.
Obtain a written management representation which confirms management’s
reasoning to believe that the defective cereal can now be sold for $50,000
54. Mercury Motoring Co (September/December 2015)
Tutor's Tips
In (a), the only danger is that you copy out the information in the question rather
than adding to it, meaning you would only score 0.5 marks for each point. There
are plenty of indicators that the company might be in trouble, and most of them
surround the most obvious going concern issue, cashflow problems.
This question was on the December 2015 paper, and the year end was September
2015 (updated in the question to make the dates relevant to this year). That is useful
information for part (b), because the position of the company might have improved
or worsened in the 2+ months that have passed since the year end, which generates
the first 3 procedures in the answer (and hence a pass).
Dates are frequently relevant to AA answers, so students are advised to watch
them carefully.
There are lots of textbook answers for going concern procedures, but marks will be
more safely earned by addressing the going concern issues in the scenario provided
wherever possible. Markers like students who address the specific issues in the story,
rather than working from memory. As always, the answer below has too many points
in it, to help you see a range of ideas.
Note how every procedure is explained not just stated, to get the full mark each time.
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AUDIT AND ASSURANCE
326
ANSWERS
Compare actual post year-end performance with the first two months of the
cashflow forecast, to help assess if the forecast is proving to be realistic.
Inspect the most recent post year-end correspondence with suppliers to assess
if further disputes over payments, or threats to change to cash on delivery,
have taken place.
Inspect board minutes, especially those post year-end, for an up to date
assessment of what the directors are planning to do to resolve the multiple
cashflow problems.
Ask directors and production staff about whether new products are under
development that might help to soften the blow should the law change happen
and the company loses a major product in the near future.
Read government announcements about the potential law change, to assess the
likelihood of it happening and if so the likely timescale.
Ask the directors to extend the cashflow forecast by 3 months to September
2021, and to perform a sensitivity analysis based on taking out the costs and
revenues relating to the product that might become illegal, to assess the true
position of the company should that happen.
Inspect correspondence and loan agreement with the bank to assess the
likelihood of further finance being available, or the loan repayment date being
extendable, should the company be unable to repay it (and potential penalties/
action if they do not).
Discuss the legal case with the company’s lawyers to assess likelihood of loss,
and the potential costs to the company.
55. Chestnut & Co (June 2015)
Tutor's Tips
This question’s requirement needs to be carefully read. For each 5 mark story, there
are four things to do – what is the issue / materiality / one audit procedure / impact
on audit report. Most of these will therefore only earn 1 mark maximum, but one
of them needs to earn 2 marks for full marks overall. The issues and materiality are
too simple to earn 2 marks, and only one procedure is asked for – so the audit report
explanation seems to be the best area to gain another mark.
Remember, whenever the audit opinion is modified, the basis for opinion will need
an explanation of that modification.
For procedures, weaker student scripts tend to want to discuss everything with
directors – despite this being the weakest form of audit evidence that exists.
Wherever possible, choose something else.
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AUDIT AND ASSURANCE
Marking guidance
Palm
The existence of a dispute indicates that some or all of the outstanding amount is
doubtful, and as such a provision for doubtful debts is almost certainly appropriate.
Receivables cannot be held at more than their recoverable amount.
The balance is 1.2% of revenue and 7.3% of PBT both of which are material to the
company’s financial statements.
The balance was last checked in April at which point no money had been received.
Given it is now June 2020, useful procedures would be:
– Inspect latest bank statements and cashbook to see if any amounts have
been received from the client recently relating to the year-end balance.
– Inspect correspondence between our client and the customer to establish the
current position regarding the dispute to assess likelihood of it being received.
Note – getting a management representation confirming their belief it will be paid
... a valid procedure, but a very weak form of evidence, and with only one procedure
required, go for something more reliable.
If no provision is put into the accounts, the audit opinion will need to be qualified “except
for”, due to this material misstatement. The Basis For Opinion paragraph underneath the
Opinion will explain the mistake and quantify its impact on profit and assets.
Ash
The lack of a stocktake attendance means that the usual level of audit evidence to assess
existence, completeness and valuation of inventory has not been obtained. This is likely
to mean that sufficient appropriate evidence has not been obtained for inventory.
Inventory represents 5% of revenue and 21.3% of PBT, both of which are material to
the company’s financial statements.
The internal auditors attended the year end count, and it is often possible to rely on
their work, so:
– Obtain the internal audit records from the year end count to assess how well
the stocktake went, and the level of mistakes and therefore adjustments to
records that were required to correct the inventory figures, checking that these
adjustments were correctly made before final inventory figures were calculated
328
ANSWERS
Note, again only one procedure is needed, and the above seems the best. It might be
wise to check today (June 2020) inventory records against actual inventory to see if
the system is keeping an accurate record – but that does not guarantee the year-end
figures were accurate.
If sufficient alternative evidence cannot be obtained, the audit opinion will again be
qualified “except for” this material lack of evidence over inventory. The Basis For
Opinion section, below the Opinion, will explain the missing evidence and the reason
for non-attendance at the year-end count.
56. Violet & Co (December 2012)
Tutor's Tips
For this question, remember to follow the requirement through – there are three
things to do for each event so don’t spend too long on any one area.
Marking guidance
329
AUDIT AND ASSURANCE
(iii) The lack of sufficient appropriate evidence on sales and receivables will
mean that the audit report will need modifying.
If alternative procedures provide some evidence on sales and receivables
then a material but not pervasive qualification will be required.
However, as the situation appears to be pervasive to the financial
statements, then a disclaimer will be appropriate.
In either situation a basis of opinion paragraph will be added to the audit
report to explain the reason for the qualification and the lack of evidence
that caused this.
(b) Fuchsia Enterprises Co
(i) Fuchsia has a number of going concern indicators, including profit being
turned into a loss, loss of market share and net cash outflows. This indicates
that the financial statements have to be prepared on a break-up basis or, more
likely, that a disclosure note is needed explaining the going concern situation.
Materiality is partly dependent on the extent of disclosure and the auditor’s
judgment on whether Fuchsia is a going concern.
(ii) Discuss the situation with management and obtain reasons for their opinion
that finance can be obtained and no disclosure is necessary in the financial
statements. Record these reasons in the representation letter.
Obtain evidence of financial support from the finance provider (eg loan
offer) and ensure this is adequate to meet Fuchsia’s financial needs for the
next 12 months.
Review cash flow forecasts to determine whether the cash requirement of
$3.2 million is accurate.
(iii) If management refuse to disclose the going concern situation, or disclosure
is made and is inadequate, then a modified report will be required with a
material qualification on the lack of disclosure.
However, if the auditor is still not satisfied that Fuchsia is a going concern, and
the financial statements are produced on a going concern basis then an adverse
opinion will be required, as the situation is pervasive to the financial statements.
In either situation, the basis of opinion paragraph will explain the reason for
the qualification.
330
ANSWERS
Tutor's Tips
In parts (a) and (b) mention materiality, evidence and then the effect on the audit
opinion to make sure all sections of the question are answered.
Part (c) is really a theory question – so any procedure such as reviewing board
minutes or reviewing interim financial statements post year end will attract marks.
Part (d). Do mention materiality and whether modification is needed (and why)
for easier marks
Marking guidance
331
AUDIT AND ASSURANCE
Materiality
$0.03m × 100% = 4% of profits
$7.5m
$0.3m × 100% = 0.4% of sales
$78m
From the above two calculations, I would conclude the matter is immaterial
compared to both profits and sales, considering the lower limits of 5% and 0.5%
respectively.
Opinion
I would therefore still give Humphries Co an unmodified report saying that the
financial statements show a true and fair view even if the above matter was not
adjusted by management.
(b) Lawsuit
Their financial statements include a disclosure of the lawsuit. However, there
should have been a provision as a definite amount is now known. So the financial
statements do require an amendment.
Inspection
External auditors could inspect the correspondence from suppliers to confirm
that the likely amount they are willing to accept is $0.6m and not the previous
amount of $1m.
Nature of matter
The financial statements include a disclosure on the above lawsuit. It should
include a provision about the likely amount to be paid to settle the case. I
consider the financial statements to be misstated.
Materiality
$0.6m × 100% = 8% of profits
$7.5m
$0.6m × 100% = 0.8% of sales
$78m
From the above two calculations, I would conclude the matter is material
considering both calculations are above the lower limits as noted in part (iii)
above the receivables conclusions.
Opinion
I would modify my report with an “except for” opinion saying the rest of the
financial statements show a true and fair view except the accounting treatment
of the lawsuit.
332
ANSWERS
333
AUDIT AND ASSURANCE
Chapter 8 Reporting
58. Ethical threats, going concern (June 2013)
Tutor's Tips
This is a short revision question on definitions which will normally appear as parts of
a longer question. Make sure you can write out the points quickly / if uncertain of
the knowledge then use the question for revision.
Marking guidance
(a)
334
ANSWERS
Tutor's Tips
This question is very typical of the type of exam question that examines
subsequent events and audit reports. It is very important to understand the
difference between adjusting and non-adjusting post balance sheet events, as this
is a very popular requirement.
Marking guidance
335
AUDIT AND ASSURANCE
Event 1: FIRE IN THE WAREHOUSE DESTROYS 60% OF INVENTORY HELD FOR RESALE:
(a) Additional procedures
– Speak to management to find out the cause of the fire and the date it happened.
– Estimate the value of inventory destroyed in the fire.
– Inspect insurance documents for likelihood of compensation being received
to replace the damaged stock.
– Consider the impact of the loss of the stock on the company’s going
concern status.
– Inspect the rental agreement for the warehouse for penalty clauses that
may be imposed in the case of damage to the warehouse. Consider the need
for a provision.
(b) Amendments to the financial statements
– The fire in the warehouse is a non-adjusting post balance sheet event as it is
evidence of conditions arising after the year-end.
– The damaged inventory should not be written down before the year-end
however the event must be disclosed in a note
– The note should describe the nature, timing and financial effect of the incident
– Should the incident cast doubt on the going concern status however, the
financial statements must be adjusted by the addition of a note to explaining
the doubts over going concern.
(c) Audit report
– If the directors make the correct disclosure about the incident then there is
no need to qualify the audit opinion as there is no disagreement.
– However, the auditors may consider modifying the audit report by the
addition of an emphasis of matter paragraph to bring the incident to the
shareholder’s attention.
– If the incident casts doubt on the ability of the company to continue as a
going concern, and the directors fail to disclose these doubts, then the audit
opinion will be modified due to a disagreement.
– If the directors make the necessary disclosure over going concern then
there will be no change to the audit opinion however the audit report will
be modified by the addition of a “Material Uncertainty Relating to Going
Concern” paragraph.
336
ANSWERS
337
AUDIT AND ASSURANCE
Tutor's Tips
Part (a) has numerous potential answers and only four are needed. Since each item
requires an explanation, it makes sense to choose four elements that you have
something to say about, rather than four where there is little to add (or where the
explanation is harder).
In the answer below, the elements are not in order of the audit report, but in order
of how relatively easy they are to recall and gain marks for.
Note how the examiner is testing whether you understand the audit report contents,
rather than whether you have memorised it.
In general, it is highly unlikely that any answer that provides a list of 3-4 word points
will score anything on the Audit and Assurance exam. You must therefore explain
the elements, not just list them.
Please note that the content of audit reports has changed since this question was
originally set.
For part (b), the trickiest problem is coming up with 6 separate points – especially
3 separate procedures, given the only obvious thing to confirm is the receipt of
correspondence from the customer. You should practice using idea generation
techniques such as AEIOU (for types of audit test) to help raise additional ideas.
Part (c) – provide an explanation of the two types of assurance – try and keep to one
sentence if possible. The examples below show all the comments that could be made.
Part (d) – try and get two comments on external and two on internal audit to provide
a balanced answer.
Part (e) – four points (for the four marks). Two if possible on interim audit and two on
final will get the marks here.
338
ANSWERS
Marking guidance
339
AUDIT AND ASSURANCE
A date is provided to show when the audit report was signed. Events happen
to companies on a continuous basis, so the date helps the reader understand
what the auditor would have known at the time of giving their opinion, and what
events happened afterwards and so were not known.
A location for the auditor’s office is provided. This helps make clear which
office was responsible for the work, which may help establish liability should a
negligence case be brought, and also helps any shareholders who might wish to
contact the auditors.
Note it would also be possible to mention an “other reporting requirements”
section, an Other Information section, or a Key Audit Matters section. The first of
these would depend on the laws of the country in which the company was based,
and the last two would be standard content for any listed company.
(b) Accounting Adjustment
The information about the customer’s financial problems was received after the
year end and therefore is an “Event After the Reporting Period” (EARP), governed
by IAS 10. The IAS states that any event giving information relevant to the year-
end position of the company is an adjusting event.
It is barely a month after the year end, so if the customer is in trouble now
(December 2020) it was almost certainly in trouble at 31 October 2020, meaning
the information received is an adjusting event and the receivable should be
either provided for or written off, because assets should be stated at no more
than their likely recoverable value.
The balance represents 7.4% of PBT so is material and therefore if not written off
would require a qualified audit opinion, so an adjustment is required to avoid this.
Procedures
Inspect recent correspondence between client and customer to verify the recent
news that they are unlikely to pay any of the balance.
Inspect the most recent financial statements of the customer to assess their
financial position, as this might suggest there is some chance of the balance
being received.
Ask the directors to provide a written management representation confirming
that they do not intend chasing payment and are resigned to writing it off.
Inspect post year end bank statements to verify that no money was received
from this customer in the past month, as this may mean the year-end balance
has fallen and the write off is not for the whole amount.
340
ANSWERS
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AUDIT AND ASSURANCE
61. Assurance engagements and financial statement amendments (June 2013) – amended
Tutor's Tips
Part (a) just needs five elements of an assurance engagement so state these and
provide an explanation - try and limit this to one sentence as this will be sufficient to
get the mark.
Part (b): For each event say whether or not an adjustment is needed referring to
the accounting standard to justify your choice. Then make the audit procedures
as specific to the question as possible - for example in part (ii) writing to Panda's
insurers rather than just obtaining a letter from an insurance company.
Part (c): Mention materiality then the two paragraphs of the audit report that will
change (opinion and basis of opinion) to get the marks here.
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ANSWERS
Marking guidance
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AUDIT AND ASSURANCE
(b) Event 1
Inventory with a value of $.85m is now worth $.1m. As this inventory was
included in the financial statements at the year-end, this is potentially an
adjusting event after the reporting period.
The amount of the write-down is $.75m, it represents 13.4% of profit and 1.4% of
turnover and so it is material.
IAS 2 requires that inventory is valued at the lower of cost and net realisable
value. As the net realisable value of inventory is less than cost this inventory
must be written down by $.75m in the financial statements.
Audit procedures:
– Inspect the inventory listing at the year-end and ensure that the inventory is
included in this listing.
– Inspect the quality control report on the inventory to confirm the poor
quality and that write-down in value is required.
– Enquire of the directors what action they propose to take regarding the
inventory, reminding them that this is a material error and will result in an
audit report modification if appropriate action is not taken.
– Enquire of the directors how they have arrived at the scrap value of $.1m
and consider whether this amount is reasonable compared to other evidence
such as selling price of similar scrap.
– Inspect the inventory list/enquire of the directors whether there is any
similar inventory that may also need to be written down.
Event 2
An explosion after the year-end has caused $.9m of property and inventory to
have nil value. While this is an event after the reporting period, it does not affect
the statement of financial position as it was not foreseen at this time; the event
is therefore non-adjusting although it may need disclosing due to its significance.
The damaged assets represent 16.1% of profit before tax and 1.6% of revenue
and so they are material. The assets will need writing down to nil value but as
this is a non-adjusting event, not in the financial statements to 30 April 2020.
Audit procedures:
– Obtain a schedule of damaged assets and agree this to the asset registers at
the year-end, ensuring that the assets remain in the registers at this date.
– Inspect the insurance documentation to confirm that there is no value for
the damaged inventory.
– Obtain written confirmation from Panda’s insurers (with directors’
permission) that the loss is not covered by insurance.
– Enquire of the directors how they determined the $.9m value of assets.
Obtain evidence such as year-end inventory listing and asset values from
registers to try and confirm this.
– Enquire of the directors how they propose to disclose the event in the
financial statements.
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ANSWERS
(c) The damage to the assets as a result of the explosion is material to the financial
statements to 30 April 2020. Therefore, the matter must be disclosed in the
financial statements.
If the directors do not make a disclosure, then the audit reported will be
modified on the basis of a material but not pervasive qualification. The opinion
paragraph will start “except for”.
The audit report will also include a basis of qualified opinion paragraph which
will explain the qualification including disclosing the detail on the subsequent
event that has occurred.
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Thirty-mark questions
62. Minty Cola Co (December 2013)
Tutor's Tips
This question is a mix with practical marks following the 5 marks of theory in part (a).
For part (a), try to think through a 5-point explanation of audit risk to identify where
each of the 5 marks can be earned.
For part (b), the key is how you explain the risks. You must ensure your explanations
are audit risks not business risks. So explanations must focus on why the company’s
financial statements might be wrong, or why the auditors might not detect that
they are wrong. Also note the date is early December, 4 weeks before the client’s
year-end. Bear in mind that responses to risk do not generally happen today – the
responses can take place post year-end during the final audit, by which time new
events will have taken place.
Part (c) is substantive procedures, so if you are struggling for ideas think through
the usual ideas lists for this syllabus area (AEIOU for types of test, DADA3 for types
of evidence).
Part (d) try and get four good audit procedures for each section; 1 mark being
available for each procedure.
Marking guidance
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ANSWERS
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AUDIT AND ASSURANCE
Risks Responses
Assets and expenses (repairs) are both Obtain an analysis of the refurbishment
at risk of misstatement. The $5m spent costs and inspect invoices to
on refurbishing seems to be a mix of assess whether they are repairs or
repair (and hence expenses) and new improvements/replacements.
assets, and often there is a fine line
between which is which, meaning the
split of costs is at risk of being incorrect.
Control risk over inventory, non- The audit team should aim to attend as
current assets and payroll is increased many locations as possible, especially
by the increase in the number of newer ones, and increase substantive
locations in use, because it is harder testing of payroll, assets etc at those
to monitor numerous locations at locations. The auditors will also need
the same time. This increases the risk to identify the controls in place at
of misstatement in these financial these new locations and assess their
statement areas. effectiveness.
The increased number of locations The external auditors should consult
also increases detection risk in these with the client’s internal auditors as
areas, especially inventory as it may it might be possible to share out the
be difficult for the audit firm to have locations so that at least one set of
enough staff available to attend all 15 auditors visits each stocktake, and then
sites at the year-end. rely on each other’s results.
Non-current assets are at risk of Ownership documents should be
overstatement if rented warehouses verified for all new warehouses
have been treated as assets rather appearing in the asset register, and
than rental expense (note, the opposite ownership should be confirmed with
mistake is also possible, but given the the Land Registry or similar authority.
management get a bonus based on
assets, asset overstatement would
seem the more likely risk).
The new accounting system gives rise The results of parallel running should
to increased risk of misstatement in be obtained and reviewed for evidence
all areas of the financial statements. of whether problems arose, and
Balances might have been wrongly whether these problems were resolved
transferred from the previous system, and any errors corrected.
and also new systems often create errors
when first used, as staff learn the new
system and bugs get noticed and fixed.
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ANSWERS
Risks Responses
Receivables are at risk of Management should be asked to
overstatement because there is explain why they believe no bad debts
currently no provision for doubtful will now happen, and post year-end
debts. Whilst it is hoped that the new aged receivables should be analysed
credit controller can help to reduce and older items discussed with the
bad debts, eliminating them entirely credit controller and investigated.
seems unlikely. The decision not to
have a provision might be linked to
management desire to keep asset
values high, to protect their bonuses.
Intangible assets are at risk of Launch plans should be discussed with
overstatement. Development costs management and verified with board
should be capitalised, but only if the minutes, and post year-end sales of
development projects are expected the new product should be verified
to be finished and the products on the final audit, if the launch has
considered likely to sell enough to occurred by then.
recoup the development costs. Whilst
the new product seems close to
market, problems with one of the other
products (see below) might mean that
the launch is held back and that sales
suffer as a result.
Inventory is at risk of being overstated The auditors should ask the directors
by $1m, a material misstatement as this what plans they have for this inventory
is slightly more than 1% of revenue. If to establish the likelihood of it being
a drinks product has a bad taste, the disposed of, and on the final audit visit
most likely result would seem to be post year-end should investigate the
disposing of it, meaning it has an NRV latest progress (as disposal might have
of zero (which should therefore be its occurred by then).
carrying value, until it is disposed of).
Provisions for refunds are at risk of On the final audit, review post year-
understatement. If the product is end payments to customers who
faulty and was sold, some customer complained about this product,
complaints are likely to generate ensuring a provision is put into the
payments or replacement drinks Statement of Financial Position to
products, and directors might not have reflect the total likely payments.
provided for this outcome at all.
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Risks Responses
All assets are at risk of overstatement When auditing assets, treat any
because of the bonus scheme for evidence from management with
management. Many assets have increased professional skepticism.
subjective valuation rules (including Get additional supporting evidence
many noted above) and this gives to corroborate any management
scope for directors to try to manipulate representations, and aim for 3rd party
the figures to increase those values. evidence rather than internal evidence
wherever possible.
350
ANSWERS
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AUDIT AND ASSURANCE
352
ANSWERS
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AUDIT AND ASSURANCE
If you require any further information on the above, please do not hesitate
to contact us.
Yours faithfully
Global Audit Co.
(c) Substantive analytical procedures
354
ANSWERS
(d)
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AUDIT AND ASSURANCE
Tutor's Tips
Part (a) is a standard explanation of deficiency and recommendation question (note
there is no separate identification mark which you can get in similar questions – so
just identify the deficiency using a heading). There are lots of deficiencies in the
scenario so read through this, explain the problem and how to overcome it (that is
the recommendation).
Part (b) is theory. Inventory is a common examination topic so if you are not sure of
these procedures they are worth learning.
Part (c). Imagine the inventory listing – then think what a computer can do with
this – recalculate it, select items etc. and this should help see appropriate CAATs
for this answer. Parts (ii) and (iii) need individual sentences for advantages and
disadvantages. Note that marks are split evenly so no more than 4 advantages and
disadvantages are required, and of course failure to include four of each will limit the
marks that can be obtained.
Marking guidance
356
ANSWERS
(a)
Deficiencies Recommendations
Supervision of count
The warehouse manager plans to supervise A manager from another department in Lily
the count. This is inappropriate as the Windows must supervise the count, only
manager is not independent of the inventory referring to the warehouse manager to
and may therefore hide any discrepancies. resolve queries such as inventory location.
Count methodology
There is no clear method to counting apart Clear instructions are needed that both
from “up then down each aisle”. This means team members are to count inventory
that count errors may be made, especially if independently and then compare and
one team member does not check the counts reconcile their counts to provide an accurate
of the other. inventory total.
Involvement of internal audit
Internal audit will be involved in counting. Internal audit should only check the counts
This means there will be no independent that have taken place to ensure the count is
check on the count. complete and accurate.
Inventory not on count sheets
Any items of inventory not on the count The extra count sheets must be pre-
sheets is to be recorded on separate sheets numbered and the numeric sequence
which are not pre-numbered. Lack of control checked and missing sheets located at the
means that sheets can be lost and the end of count.
inventory therefore not recorded.
Completion of sheets
There is no mention of the count sheets having All count sheets must be signed by both
to be signed. This means, in case of queries, it counters when counting is complete. The
will not be possible to trace who performed supervisor must ensure all sheets have been
the count to assist in resolving that query. signed when they are returned.
Damaged goods -1
Damaged goods are to be noted on the count All damaged goods must be labelled in the
sheets only; they are also not to be moved warehouse as such and later transferred to a
to a separate location. This means that the separate area using appropriate machinery.
damaged windows etc will be difficult to
identify in the warehouse.
Damaged goods - 2
Damaged goods will need valuing at net As noted above, damaged goods must be
realisable value. If they are not separately separately identified so when they are
identified then this valuation cannot take place. moved to a separate location, valuation can
take place efficiently.
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AUDIT AND ASSURANCE
Deficiencies Recommendations
Continuous production
Lily Windows operates a continuous If production cannot be stopped then
production system, hence inventory will be raw materials and windows being worked
moved during the count. There is a danger of on must be separately identified using
double-counting inventory that has moved, appropriate labels. These will be counted at
or even omitting inventory that is moved the end of the count and included in work-in-
before being counted. progress or finished goods as appropriate.
Deliveries
It is not clear what happens to deliveries Any deliveries made during the day must
made during the count. There is a risk that be placed in a separate location and then
deliveries may be omitted from the count. counted at the end of the day.
Work-in-progress
This is to be assessed by the warehouse Any assessment by the warehouse manager
manager. There is an assumption this amount must be verified independent, for example by
will be immaterial. However, the manager internal audit to ensure valuation is accurate.
may make incorrect assessment of the work As noted above, it will be better if the
in progress making this undervalued. manager is not involved in the count; but his
specialism may be needed for this valuation.
Raw materials
Raw materials quantities were determined The specialist used in previous years must
by a specialist in previous years but the be employed again to determine raw
manager will undertake the task this year. material quantities.
There is a risk that the manager does not
have the expertise to determine quantities
correctly and therefore inventory will be
under- or over- stated.
358
ANSWERS
Record the last GDN and GRN numbers for the year for use on the final audit.
Observe the warehouse manager valuing work-in-progress and consider whether
that valuation appears reasonable.
Observe the warehouse manager estimating raw material quantities and
re-perform important procedures such as gauging the height of sand piles.
(c)
(i) Audit procedures using CAATs
• Re-calculate the list of inventory to ensure arithmetical accuracy
• Calculate inventory days and then compare this figure to prior year.
The audit team can then consider whether inventory days are over
or under stated compared to last year
• Select a sample of inventory for use on inventory count or
valuation testing
• Prepare an aged inventory listing to identify any old or slow moving
inventory that may require NRV testing
(ii) Advantages of using CAATs
• Enables the auditor to test all of the inventory ledger quickly. The
provides significant time savings compare to manual testing
• Cost effective in terms of being able to repeat the same programme
tests in each year after initial setup.
• Tests the actual computer records rather than copies of those
records (such as computer printout)
• Decrease in human error which provides a better qualify of
audit evidence
(iii) Disadvantages of using CAATs
• High initial cost due to the need to setup the software and the
programmed procedures.
• Possibly that the inventory system programme at Lily is not
compatible with the audit firm’s software meaning that bespoke
programmes may need to be written
• Significant risk that if testing is performed on the client’s live data
that corruption of that data will occur
• However, if testing is performed on copy files then there is the risk that
those files may not be the originals limiting the usefulness of testing
Tutorial note: Other valid comments in these sections will obtain credit.
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AUDIT AND ASSURANCE
Tutor's Tips
Part (a) is a difficult theory question – quite an obscure and detailed part of the
syllabus – if you know the pre-conditions list them quickly else move on – there are
easier application marks in the other sections.
Part (b) needs risks identifying from the scenario with a safeguard. A table format is
the best way of presenting the answer.
Part (c) appears difficult – but remember there are some basic safeguards to ensuring
that audit teams are kept separate like Chinese walls and confidentiality agreements
– these will get easy marks for explaining them.
Part (d) (i) is a typical ratio question – set out appropriate ratios in a table so the
marker can see these clearly.
Part (d) (ii) is another application style question – again a table can be used to
present a clear answer.
Marking guidance
(a) Preconditions
Preconditions are checks the auditors must make prior to accepting a new audit
client. These questions are in addition to the ethical and practice considerations.
– Does management agree to use an acceptable financial reporting framework
that is IFRS?
○ No – Decline the audit
○ Yes – go to (ii)
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ANSWERS
(b) Threats to independence and objectivity arising from the provision of other
services and how those threats should be resolved
Non-audit services may only be provided where
• A reasonable and informed third party would not regard independence as
being impaired
• Appropriate safeguards are put in place
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AUDIT AND ASSURANCE
362
ANSWERS
(ii)
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AUDIT AND ASSURANCE
Tutor's Tips
Part (a). This is a very typical independence threats and safeguards question. Make
sure the threats are explained not just stated, in terms of what might go wrong with
the audit if they are not addressed.
In (b), there are 4 marks for explaining auditor duties re prevention and detection of
fraud. As the examiner report states: the question did not require an explanation of
directors’ responsibilities. Unfortunately many candidates wasted time providing this
and there were no marks available for this.
It is also worth noting that these purely knowledge questions often get answered
badly because students simply do not know their audit standards. Any ISA could
come up for 4-5 marks, and it is good exam preparation to write your own 4-5 point
summaries for each ISA.
Part (c) is the most important at 12 marks and is a standard risk and response
question. As a result, the standard slip-up possibilities exist.
Risks must be explained in terms of their impact on the financial statements
potentially being misstated. No explanations, and half the marks are gone. Also, the
impact on the business is irrelevant – that would be business risks, not audit risks.
Responses are the auditor response, not the client’s response. These are audit risks
not business risks, as noted above.
As always there are more than the 6 risks required, so read the whole story and
cherry pick the ones you like best. In the answer below, the first 6 risks presented
are some of the more obvious ones, with harder ones coming later in the answer.
Remember you only need 6 of them.
In (d)(i), the question asks for the PURPOSE of review assignments. Easy to score zero
here by describing what a review is, rather than WHY it is done.
Marking guidance
364
ANSWERS
(a)
Threats Actions
Bethan’s Role
Bethan has been rotated off this audit as her Bethan should play no role in this audit
independence can no longer be assumed. If for a minimum of two years, a cooling off
Bethan does the file review she is at risk of period to help her familiarity with the client
ignoring weak audit work either to please reduce. A different partner, with no links to
a client with whom she is too familiar, or this client, should perform the review.
because she is reviewing an audit approach
she herself designed and which the new
partner has simply continued with.
Fees
With fees above 15% and likely to do so again It might be possible to reduce our fees
next year, there is a self-interest threat and from his client by giving up some of the
intimidation threat. We might ignore errors in tax or non-audit work we do for them and
the financial statements 9 or be pressured to this should be discussed with the audit
do so by the client) under the fear of losing such committee. If we cannot reduce the fees
a large contribution to our firm’s total revenues below 15% of our firm’s total recurring
fees, we may have to consider resignation.
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AUDIT AND ASSURANCE
Threats Action
Outstanding Fees
Outstanding fees create a self-interest threat We should discuss the outstanding
and an intimidation threat. We might ignore amounts with the client’s audit committee
financial statement errors, or be pressured to and seek payment of them before starting
do so, in the hope of keeping the client happy any further audit work.
so that the old fees get paid.
Also, audit staff might know this audit manager The proposed audit team needs to be
well, meaning the audit team might fail to audit reviewed, and anyone too close to the
their work either due to not wanting to upset a audit manager should be replaced. It might
friend or through trusting their work too much be best to outsource the audit to another
(lack of professional scepticism brought on by office of our firm where the manager might
familiarity). have no close colleagues.
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ANSWERS
To ensure a full fraud assessment, the subject should be discussed with all
members of the engagement team (typically at the audit planning meeting).
The auditor cannot be held responsible for fraud prevention or detection, but if
the auditor discovers fraud during the audit process this should be reported to
management and to the audit committee, which in itself should help to prevent
fraud repeating in the future.
(c) Risks and Responses
Risks Responses
Development Costs
The entire $1.8m of costs have been Obtain a breakdown of the $1,8m of costs on
capitalised. There is a risk that intangible a project by project basis. Compare current
assets are overstated and expenses project status against the initial project plan
understated because IAS 38 says these cost to see if the projects are on track. Inspect
are only capitalised if the projects are likely market research results to get evidence
to be finished and the new products are likely as to the sellability of the products once
to sell enough to recover the development development is finished.
costs. Projects early in their development
are less likely to reach a conclusion, and the Also inspect invoices for a sample of
bank covenants (see below) also provide an development costs to verify the costs do
incentive to capitalise costs that might better indeed belong to the development project.
be recorded as expenses.
New Loan
The loan will attract interest. Being a new Obtain loan agreement, calculate year
loan, interest is accruing but might not have end interest accrual and compare to
been paid yet, so there is a risk that finance accruals in financial statements to verify
charges and accruals are both understated at accurately included.
the year end.
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AUDIT AND ASSURANCE
Risks Responses
Loan Covenant
A loan covenant based on profits provides The audit team should be warned to increase
an incentive for the company to overstate the professional scepticism in all areas of
revenues and understate expenses to avoid subjectivity relating to the recognition of
triggering an early loan repayment. revenue and expenses (e.g. the capitalisation
of development costs, recognising all losses
caused by the fraud, being realistic about
the cost of returned goods).
Sales Returns
Revenue is at risk of being overstated Review all post year end returns and match
and provision for refunds understated if to initial sales invoice. If sale was before
items returned post year end have not year end, advise client of the need to cancel
had their corresponding sales cancelled it out and provide for the refund.
out at the year end.
Poor Stocktake
Inventory is at risk of over or understatement Given the control weaknesses over
as a result of the company’s poor quality inventory, increased substantive testing on
stocktake at the year end. If goods continued inventory will be required to try to confirm
moving during the count they may have been year end valuations.
double-counted or not counted at all.
Gain on Disposal
There is a risk that the gain on disposal Obtain the sales invoices and cashbook
has been wrongly calculated, leading to an entries relating to the disposal and recalculate
overstatement of profit. This is especially risky the gain on disposal to verify its accuracy.
given the loan covenant relating to profit.
Other Risks Re Loan
The loan is due for repayment over 10 Obtain loan repayment schedule and
years, meaning there is a risk of mis- check the split of payments is correctly
classification between current liabilities and reflected on the face of the Statement of
long term liabilities. Financial Position.
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ANSWERS
Risks Responses
Inventory
The post year end returns suggest a problem Talk to company’s quality control
with inventory quality. Inventory may be department about the reasons why returns
overstated at the year-end if returned items are increasing, and enquire as to whether the
with faults have been included at full cost, company has checked unsold items to see if
or (more likely) if items as yet unsold also other faulty items are in the warehouse.
have faults yet to be spotted.
Gain on Disposal
The $210k gain might indicate that assets Review company’s depreciation policies for
are being depreciated too quickly and are plant and machinery. In particular, look for
therefore understated at present. evidence of fully depreciated assets on the
register that are still being used.
New FD
The new FD previously worked in a very Ensure audit staff with industry experience
different industry, and also was Financial are included on the team, and instruct
Controller not an FD. This might suggest a them to maintain their professional
lack of experience and industry knowledge, scepticism in any areas of industry
increasing the risk of accounting errors, specialism, subjective estimates etc., or
especially in industry specific areas. where the new FD has changed processes
or policies from the previous FD.
Fraud
The company’s Profit or Loss is likely to Ask company for a report from the fraud
contain errors if the fraud losses have not investigation to understand what fraud
been included, or if there are additional took place, and ask whether any internal
fraud items that have not yet been investigation has begun into further
discovered. This could impact virtually examples of fraud that might have occurred.
anything in the financial statements.
(d)
(i) Purpose of Review Engagements
Review engagements are intended to provide a limited level of assurance on
a subject matter.
Audit engagements are required to provide reasonable assurance, a
relatively high level. Audits are a legal requirement for company financial
statements (for most companies), with a relatively high level of assurance
required because of the importance of financial statements to shareholders.
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AUDIT AND ASSURANCE
Also, review engagements are useful where there is either not enough
detailed evidence for a full audit to take place (e.g. a review of company
forecasts) or where there is not enough time to do detailed work (e.g. a due
diligence assignment on a takeover target).
(ii) Levels of Assurance
In an audit, the auditor carries out detailed testing in order to obtain
reasonable assurance. This will involve analytical procedures, inspecting
documents, recalculating figures etc. Because of the detail of the testing, the
auditor is able to provide positive assurance in their opinion, stating whether
they believe the figures are, or are not, true and fair.
In a review, the testing is less detailed and typically relies only on analytical
procedures and enquiry of management. As a result the assurance level is
limited meaning the auditor’s opinion is phrased in negative terms – that
nothing was seen during testing to suggest the figures were not true and fair.
67. Blair & Co (December 2011) - amended
Tutor's Tips
In (a), make sure each idea is a fully explained sentence, not just 4 or 5 words of list.
If short of ideas, ask yourself why you plan anything!
Also make sure you read the question – it is asking for the reason for planning, as the
exam report noted:
“some candidates focusing on what was done at the planning stage rather than
explaining the importance of planning”
In (b), it would seem that procedures are needed to check the fraud that we know
about, and to then consider how it might have happened (to help assess the
likelihood of other frauds of a similar nature). “Procedure” does not say substantive
or control test, meaning both can be used in the answer. As always explain the
purpose of each procedure, don’t just state it.
As usual with a scenario question, many students ignored it and wrote answers from
their memory, or advised the company as to how to stop such frauds repeating, as
the examiner reported:
“ - Providing a long list of general payroll substantive procedures, such as “recalculate
statutory deductions” rather than tailoring their answer to the scenario.
- Listing internal controls that management should implement to prevent future
frauds from occurring, rather than the procedures to be conducted by the auditor in
the circumstances.”
Students need to remember that auditing is a practical exercise and memorising
standard procedures is not going to help much on exam day.
Part (c) is a standard weaknesses question so read the scenario carefully and make
practical suggestions for overcoming each weakness.
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ANSWERS
Part (d) is quite difficult - note the requirement is for substantive procedures so
ensure that your answer provides these rather than tests of controls.
Finally in (e), note that the redundancy provision will be a one-off event so standard
systems testing will not be of use here. Focus on the provision itself and how these
will be calculated and disclosed in the financial statements.
Marking guidance
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AUDIT AND ASSURANCE
372
ANSWERS
Tutor's Tips
Always stop after writing enough to obtain full marks. However more answers could
be about (i) wage pay-out (ii) starters/leavers.
(d) Substantive procedures on payroll change – AEIOU
Accuracy assertion
Analytical procedures
The external auditors (EAs) should review the monthly payroll change, compare
to the budget and prior year, incorporate any increase and then discuss any
unexpected fluctuations with management.
Recalculations
The EAs should recalculate the gross pay and net pay for a representative sample
of employees and verify the accuracy of what the payroll department had
calculated earlier.
The EAs should recalculate the deductions too, e.g. payroll tax for a
representative sample of employees and verify the accuracy of what the payroll
department had calculated earlier.
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Inspection
The EAs should inspect the total wages and salaries expense per the payroll
system and match this with the detailed trial balance, investigating any
difference found.
Completeness assertion
The EAs should request a list of starters/leavers from the HR manager, agree
their start/leaving date to supporting documentation and ensure that their first/
last pay packet was accurately calculated and completely recorded.
For a representative sample of months during the year, agree the total list of net
pay of salaried employees off the payment system back to the bank transfers and
records kept in the company.
For a representative sample of weeks during the year, agree the total list of net
pay of employees paid wages back to cash withdrawn from the bank and all
records of cash paid.
(e) Substantive procedures – reducing provision (AEIOU)
Enquiry
Ask management and/or employees to confirm that the redundancy
announcement was made before the year-end or after.
Enquiry/Inspection
Ask management to provide us with the personal files of all the employees
affected and inspect the files to obtain details relating gross pay, notice periods,
gratuity agreements, etc.
Recalculations
Use the above information to recalculate the redundancy provisions figure that
should be included at year-end, compare to what management had calculated,
and ask them to explain any material difference.
Inspection/Board minutes
Inspect Board of Directors’ minutes to ascertain that the amount is likely to be
paid and that the Board is satisfied with the amount and disclosure.
Tutor's Tips
You could write about (i) obtaining management representation on redundancy
provisions and/or (ii) reviewing the statement past year-end. Always stop after
writing enough for the marks available.
A redundancy provision is a one-off event. Analytical procedure is therefore an
unlikely way of gathering audit evidence here, as this procedure is more suitable for
events that happen continuously/have a trend.
374
ANSWERS
Tutor's Tips
Part (a) is standard theory question. If you are not sure of the reasons then do
review the suggested solution.
Part (b). This question includes a letter format (for 2 marks) as well as the standard
deficiency, effect and recommendation requirement. The deficiency, effect,
recommendation section can be produced as an appendix if this is easier. Note
the standard format for the letter in the answer – these are easy marks if a letter is
required. Note only 4 points are allowed in the answer. If you write more than this
then the best 4 will be marked.
Part (c) is again theory. Note that the question concerns written representations (not
evidence) so it’s the letter from management to the auditor at the end of the audit
that must be commented on.
Finally in part (d), 6 good procedures will obtain the marks available. There are many
points that could be made – but as said 6 are sufficient.
Marking guidance
(a) Auditors need to communicate with those charged with governance for the
following reasons:
– It enables the auditor to ensure those charged with governance understand
the work of the auditor while at the same time ensuring a good working
relationship between the two parties.
– It helps the auditor obtain information relevant to the auditor from those
charged with governance such as changes in internal control systems.
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AUDIT AND ASSURANCE
(b)
An Audit Firm
1701 Star Lane
Anywhere
The Directors
Fox Industries Co.
15 Rabbit Street
Anywhere
6 June 2020
Dear Sirs
Audit to 30 April 2020 – Deficiencies in Internal Controls
As part of our normal communications to you during our audit we write to bring to
your attention deficiencies in internal controls identified during our audit procedures
on the purchases and payments systems along with potential implications of those
deficiencies and recommendations for improvement (see Appendix 1).
Note that this list is not meant to be comprehensive and is for use by the
directors of Fox Industries only.
Please do not hesitate to contact us with any queries.
Yours faithfully
An audit firm
Appendix 1
376
ANSWERS
377
AUDIT AND ASSURANCE
378
ANSWERS
Discussion/Persuasion
Have a discussion with management to try and persuade them to write off the
balance from Yellowmix Co. and let them know the impact it will have on the
auditor’s report if not written off.
Additional audit procedures – warranty provision
Review events after reporting period
Review the events after the reporting period to ascertain and assess the level
of claims that have been made up to as near as possible to the day the audit
report is signed.
Previous year review
last year’s estimates to compare how reasonable it was (actual claims compared
to estimated claims at year-end).
Board minutes inspection
Inspect the board minutes to assess the board of directors’ assessment of the
warranty provisions and/or claims and their evaluation on whether reasonable.
69. Hawthorn and Newshire (part June 2015)
Tutor's Tips
Part (a) is all about assertions and substantive procedures. If there is one area of F8
that causes problems for students it is this one.
Marks will disappear rapidly if you do not understand what the assertions mean (and
plenty of students don’t), or do not realise the assertions for Profit or Loss are not
exactly the same as for the Statement of Financial Position, or get your directions
mixed up between completeness and occurrence. If you then misread the question
and start giving tests for purchases or receivables instead of revenue...
Part (b) is all about substantive procedures, but this time with 3 little scenarios to
audit. It is not an easy question. A lot of tests are required, they will all have to be
detailed enough to be clear, and in each case some technical understanding of the
issues will be required (especially in the first two).
Substantive procedures make or break many Audit and Assurance candidates. As the
examiner states:
candidates must strive to understand substantive procedures, learning a generic list of
tests will not translate to exam success as they must be responsive to the scenario.
Despite this being reiterated at every sitting by tutors and by the examiner, many
students seem to ignore it and just memorise tests without knowing the purpose of
them. This is a total waste of time
Part (c) is a basic definition question so you will need to reproduce your accounting
knowledge here.
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AUDIT AND ASSURANCE
Finally (d) needs to focus on the IAS37 event – as noted above, do try and make
procedures clear and ensure that they relate as far as possible to the scenario.
Marking guidance
(a) Assertions
The assertions relevant to events and transactions (i.e. the Profit or Loss)
are as follows:
Cut Off
Events and transactions appear in the correct accounting year.
Completeness
All events and transactions that happened have been included within the
financial statements, along with any related disclosures.
Occurrence
All events and transactions which have been included in the financial statements
and disclosures did happen to the company in question.
Accuracy
The figures relating to the events and transactions have been correctly recorded
in the financial statements.
Classification
Events and transactions have their accounting entries recorded under the correct
headings in the financial statements.
Presentation
Items have been correctly aggregated, or separated within the financial
statements, and any disclosure notes are understandable.
380
ANSWERS
Revenue Examples
To test cut off, pick a sample of GDN just before the year end and find
corresponding sales invoices. Inspect pre-y/e sales day book to verify these sales
were included. Repeat exercise for GDN just after the y/e, verifying invoices not
included in pre y/e sales day book.
To test completeness, pick GDN from throughout he accounting year and trace to
sales invoice to verify invoice is in sales day book.
To test occurrence, pick a sample of sales invoices in sales day book during year
and trace back to GDN and sales order to verify a customer did want the goods
and that they were supplied.
(also to check occurrence, review post y/e returns and credit notes issues
to customers, as some pre y/s sales may have been cancelled post y/e and
therefore did not in fact “occur”)
To check accuracy, pick a sample of sales day book pages and recalculate page
totals to verify correct. Trace these totals to Revenue T Account to check correct
figures are present.
To check classification, obtain list of assets sold during year and review revenue
accounts to ensure that no gains on disposal have been mixed in with sales revenue.
To check presentation, read disclosure note on revenue recognition policy to
ensure note is clearly explained.
(b)
(i) Supplier Statements
Compare balance on each supplier statement with client’s purchase ledger
balance, and if balances agree check each item as well between the two
documents in case there are compensating errors.
Where balances do not agree, review correspondence between client
and supplier to help understand any disputes that might have existed at
the year end.
Inspect most recent post y/e supplier statements to see if any disputes/
differences existing at y/e have now been resolved (i.e. balances now agree).
If supplier claims additional y/e balance due to extra invoices, check invoice
back to GRN to see if goods did arrive at client before y/e or afterwards (as it
may be a cut off error on supplier’s part).
(ii) Bank Reconciliation
Agree “balance per bank statement” back to year end bank statement
and to bank report from the bank, to confirm accuracy of balance used in
reconciliation.
Agree “balance per cashbook” back to year end cashbook to agree accuracy
of balance used in reconciliation.
381
AUDIT AND ASSURANCE
382
ANSWERS
Tutor's Tips
Part (a) is not hard to pass, given that any reliance on an expert would need
qualifications, experience and independence to assess. But getting to 5 separate
factors is more of a challenge.
In part (b)(i) make sure to realise there are 2 things to test – the revaluations, and
the new warehouse acquired. The second of these in particular should provide easy
marks. Part (b)(ii) is tougher but again break it down. The story tells you that WIP is
valued at % completion x standard costs, giving you two separate elements to test.
For (c), there is a similar issue to (a). Some marks are relatively easy to get but
squeezing 5 separate points out is difficult. Again, use the story. Client has said
they do not wish to change something despite it being wrong, so ask them for
their reasons. You are not told of the size of the mistake, so materiality needs to be
considered etc.
Parts (d) and (e) are mainly theory based showing that you do need some detailed
knowledge to obtain a pass standard in some Audit and Assurance questions.
383
AUDIT AND ASSURANCE
Marking guidance
384
ANSWERS
(b)
(i)
Obtain most recent valuation reports and check that the figures match the
non-current asset register for each asset.
Compare the asset register list of buildings with recent valuation reports to
verify that all buildings have been revalued at least once in the past 5 years.
Inspect revaluation reserve to verify that valuation surpluses are being
posted there, and not included in the P or L.
Inspect purchase documents for the warehouse to verify the company’s
name is on it, the purchase date was May, and the amount paid matches the
asset register.
Inspect bank statements and cashbook to match the amount paid to the
asset register.
Compare depreciation policy for the warehouse with that of similar
companies with warehouses, to assess its reasonableness.
Recalculate depreciation charge for the year by using the disclosed
depreciation policy and pro-rating it for the 8-9 months of the accounting
year the asset was owned for.
Inspect title deeds to verify the client owns the warehouse as at the year
end, verifying this with Land Registry records.
(ii)
Obtain a list of the various stages of completion that a car could be at, and
for a sample of cars inspect them (perhaps with an expert to assist) at the
inventory count to assess if the completion % in the count records matches.
Check that the calculations on the WIP schedule are correct by
reperformance, and check the total of the WIP correctly adds up.
Compare the standard costs with recent purchase invoices for parts, and labour
rates from payroll / HR, to assess if standard costs are being kept up to date.
Observe cars being produced to check that the labour hours reported in
standard costs match current actual production times.
Review the results of variance analysis on production costs to help assess if
standard costs are in line with actual costs.
(c) Steps
Assess the materiality of the error as a percentage of key financial statement
figures such as profit.
If the mistake is not material in its own right, add it to the schedule of
uncorrected errors, and at the end of the audit aggregate it with all other errors
to see if the overall effect is material.
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AUDIT AND ASSURANCE
If the matter is material in its own right, ask the directors to justify why they do
not want to correct it, explaining that you will need to modify the audit opinion if
it is not put right.
If the directors continue to refuse to correct it, modify the audit opinion with
a qualified “except for” opinion (this assumes that this one solitary error is not
pervasive, which would seem unlikely).
Add an explanation and quantification of the error in the Basis For Opinion
paragraph directly below the Opinion in the audit report.
(d) The need for internal audit in corporate governance
In a rules based system, such as the USA, companies are required to have sound
internal control systems, which in many cases will mean having an internal audit
department to monitor those controls. The directors also have to present a
report on the effectiveness of the internal control system each year and internal
audit will assist with determining this effectiveness.
In a compliance based system, such as the UK, internal audit is required for larger
quoted companies as part of the listing requirements, not company legislation.
Compliance is expected, although non-compliance will elicit an explanation in
the company’s annual report as to why internal audit has not been established.
For other companies in a compliance based system, internal audit is best
practice; although many companies will still choose to establish this department
as a good internal control.
(e) Role of internal and external auditors – differences
Objectives
The main objective of internal audit is to improve a company’s operations,
primarily in terms of validating the efficiency and effectiveness of the internal
control systems of a company.
The main objective of the external auditor is to express an opinion on the
truth and fairness of the financial statements, and other jurisdiction specific
requirements such as confirming that the financial statements comply with the
reporting requirements included in legislation.
Reporting
Internal audit reports are normally addressed to the board of directors, or other
people charged with governance such as the audit committee. Those reports are not
publicly available, being confidential between the internal auditor and the recipient.
External audit reports are provided to the shareholders of a company. The report
is attached to the annual financial statements of the company and is therefore
publicly available to the shareholders and any reader of the financial statements.
386
ANSWERS
Scope of work
The work of the internal auditor normally relates to the operations of the
organisation, including the transaction processing systems and the systems to
produce the annual financial statements. The internal auditor may also provide
other reports to management, such as value for money audits which external
auditors rarely become involved with.
The work of the external auditor relates only to the financial statements of the
organisation. However, the internal control systems of the organisation will
be tested as these provide evidence on the completeness and accuracy of the
financial statements.
Relationship with company
In most organisations, the internal auditor is an employee of the organisation,
which may have an impact on the auditor’s independence. However, in some
organisations the internal audit function is outsourced.
The external auditor is appointed by the shareholders of an organisation,
providing some degree of independence from the company and management.
71. Kiwi & Co (June 2012)
Tutor's Tips
Part (a) requires responsibilities of directors and auditors – these can be stated as
individual points.
Part (b) sort of gives the game away; there are 3 marks available with an audit
generally having three main stages (planning, collection of evidence and closedown/
reporting) so the three places to use analytical procedures are????
Be careful with parts (c) and (d). The former needs going concern indicators while
the latter is audit procedures. The points will be similar but do make sure they are
allocated to the correct section.
Part (e). In (i) state the obvious, the auditors will have to report their concerns
to the directors and opinion regarding disclosure of information in the financial
statements about going concern. For reporting in (ii) do mention materiality and
then the type of opinion.
Finally for the different types of assurance in (f), do comment on what level of
assurance is being given and provide an example of assurance work. If time, a few
more marks can be obtained for stating benefits of providing assurance on a cash
flow forecast.
387
AUDIT AND ASSURANCE
Marking guidance
388
ANSWERS
389
AUDIT AND ASSURANCE
Dividend withdrawal
The directors have decided not to pay the final dividends to equity
shareholders. This may upset them, which could lead to them selling their
shares and/or not putting any more equity in the company at a time when the
company needs more money.
(d) Going concern audit procedures
We should ask senior management how they plan to deal with the bank’s
demand on the whole loan repayment. Are they in talks with this bank or
another bank to get another loan? We would then attend a meeting with the
bank they are in talks with to listen in and gauge their chances of getting a loan.
We would review post year-end sales and cash inflows to assess whether it is
improving or still declining. If declining, we would ask management about any
plans they have to turn sales and cash flows around.
We would inspect board minutes to ascertain whether the board has contacted
or is planning to contact key shareholders for additional funds.
We would contact the company lawyers to ascertain whether any lawsuits from
suppliers or other source has been directed at the company and how they are
dealing with suppliers’ cases.
We would inspect the overdraft agreement to find out whether the company still
has more or it has exhausted its limit, and also find out if they have breached any
condition attached to this overdraft.
(e)
(i) Auditors (Kiwi and Co.) have the responsibility to report to the directors of
the company they audit whether the use of going concern assumptions is
appropriate in the prevailing circumstances.
Auditors have a duty to audit disclosures around going concern and report
whether appropriate or not to the directors of Strawberry.
If auditors discover any events or circumstances that cast doubt on the ability
to continue trading, they have a responsibility to report this to directors.
(ii) Nature of matter
Since the auditors believe the company is not a going concern and the
directors have not amended the financial statements, the auditors will
conclude the financial statements are misstated.
Materiality
The going concern problem is a problem that affects the entire future of the
company and so we conclude it to be material and pervasive.
Opinion
We would modify my opinion, saying the financial statements do not show
a true and fair view, i.e., an adverse opinion. We would expect the financial
390
ANSWERS
391
AA
Specimen exam
AUDIT AND ASSURANCE
Specimen exam
This is the specimen exam paper produced by ACCA in 2016. It includes objective
testing questions in Section A in paper-based format. These questions have been
retained in their original format. Examples of Computer Based Examination format
objective testing questions are included in this Question Bank.
394
SPECIMEN EXAM
2. In relation to the audit engagement partner holding the role for eight years and
her son’s offer of employment with Maldini:
Which of the following safeguards should be implemented in order to comply
with ACCA’s Code of Ethics and Conduct?
A. The audit partner should be removed from the audit team
B. An independent review partner should be appointed
C. The audit partner should be removed if her son accepts the position
D. Buffon & Co should resign from the audit
3. In line with ACCA’s Code of Ethics and Conduct, which of the following factors
must be considered before the internal audit engagement should be accepted?
1. Whether the external audit team have the expertise to carry out the
internal audit work
2. If the assignments will relate to the internal controls over financial reporting
3. If management will accept responsibility for implementing appropriate
recommendations
4. The probable timescale for the outsourcing of the internal audit function
A. 1, 2 and 3
B. 2 and 3 only
C. 1 and 4 only
D. 1, 3 and 4
Which of the following options correctly allocates the above statements to the
relevant auditor?
External Internal
A 2, 3 and 4 1 only
B 1 and 4 2 and 3
C 2 and 4 1 and 3
D 2 only 1, 3 and 4
395
AUDIT AND ASSURANCE
5. If the internal and external audit assignments are accepted, what safeguards,
if any, are needed in relation to the basis for the fee?
1. As long as the total fee received from Maldini is less than 15% of the firm’s
total fee income, no safeguards are needed
2. The client should be informed that only the internal audit fee can be based
on profit after tax
3. The fees should be based on Maldini’s profit before tax
4. No safeguards can be applied and this basis for fee determination
should be rejected
396
SPECIMEN EXAM
In order to verify the depreciation expense for the year, you have been asked
to perform a proof in total. This will involve developing an expectation of the
depreciation expense for the year and comparing this to the actual expense to
assess if the client has calculated the depreciation charge for the year correctly.
What is the expected depreciation expense for the above assets for the year
ended 31 December 2019 and the resultant impact on non-current assets?
A. Depreciation should be $10,660, assets are understated
B. Depreciation should be $18,583, assets are understated
C. Depreciation should be $9,111, assets are overstated
D. Depreciation should be $12,549, assets are overstated
7. The audit assistant who has been assigned to help you with the audit work on
non-current assets has expressed some uncertainty over why certain audit
procedures are carried out and specifically is unsure what procedures relate to
the valuation and allocation assertion.
Which of the following audit procedures are appropriate to test the
VALUATION assertion for non-current assets?
1. Ensure disposals are correctly accounted for and recalculate gain/
loss on disposal
2. Recalculate the depreciation charge for a sample of assets ensuring that it
is being applied consistently and in accordance with IAS 16 Property, Plant
and Equipment
3. Review the repairs and maintenance expense accounts for evidence of items
of a capital nature
4. Review board minutes for evidence of disposals during the year and verify
that these are appropriately reflected in the non-current assets register
A. 1 and 2
B. 1, 3 and 4
C. 2, 3 and 4
D. and 3 only
Food poisoning
Balotelli’s directors received correspondence in November 2019 from a group of
customers who attended a wedding at one of the company’s hotels. They have
alleged that they suffered severe food poisoning from food eaten at the hotel
and are claiming substantial damages. Management has stated that based on
discussions with their lawyers, the claim is unlikely to be successful.
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AUDIT AND ASSURANCE
8. In relation to the claim regarding the alleged food poisoning, which of the
following audit procedures would provide the auditor with the MOST reliable
audit evidence regarding the likely outcome of the litigation?
A. Request a written representation from management supporting their assertion
that the claim will not be successful
B. Send an enquiry letter to the lawyers of Balotelli to obtain their view as to the
probability of the claim being successful
C. Review the correspondence from the customers claiming food poisoning to
assess whether Balotelli has a present obligation as a result of a past event
D. Review board minutes to understand why the directors believe that the claim
will not be successful
Trade receivables
Balotelli’s trade receivables have historically been low as most customers are
required to pay in advance or at the time of visiting the hotel. However, during
the year a number of companies opened corporate accounts which are payable
monthly in arrears. As such, the trade receivables balance has risen significantly
and is now a material balance.
9. As trade receivables is a material balance, the audit partner has asked that the
audit team carry out a trade receivables circularisation.
Which of the following are benefits of carrying out a trade receivables
circularisation?
1. It provides evidence from an independent external source
2. It provides sufficient appropriate audit evidence over all relevant
balance assertions
3. It improves audit efficiency as all customers are required to respond
4. It improves the reliability of audit evidence as the process is under the
control of the auditor
A. 1 and 2
B. 1, 2 and 4
C. 2 and 3
D. 1 and 4 only
398
SPECIMEN EXAM
10. The results of the trade receivables circularisation carried out by the audit team
on balances as at 31 December 2019 are detailed below. You have been asked to
consider the results and determine if additional audit procedures are required.
399
AUDIT AND ASSURANCE
11. To explain to the board the content of the audit report, the audit partner has
asked you to provide details as to why certain elements are included within an
unmodified report.
Which of the following explains the purpose of the ADDRESSEE element of the
unmodified audit report in line with ISA 700 Forming an Opinion and Reporting
on Financial Statements?
A. It demonstrates the point at which sufficient appropriate evidence has
been obtained
B. It clarifies who may rely on the opinion included within the report
C. It explains the role and remit of the audit
D. It sets out the location where the auditor practises
12. The audit assistant assigned to the audit of Cannavaro.com wants a better
understanding of the effect subsequent events have on the audit and has made
the following statements:
1. All material subsequent events require the numbers in the financial
statements to be adjusted
2. A non-adjusting event is a subsequent event for which NO amendments to
the current year financial statements are required
3. The auditor’s responsibilities for subsequent events which occur prior to the
audit report being signed are different from their responsibilities after the
audit report has been issued
4. The auditor should request a written representation confirming that all
relevant subsequent events have been disclosed
13. The audit engagement partner has asked you to make an initial assessment of
the materiality of the issue with the outstanding receivables balance with Pirlo
Co and to consider the overall impact on the financial statements.
Which of the following correctly summarises the effect of the outstanding
balance with Pirlo Co?
400
SPECIMEN EXAM
14. The audit engagement partner requires you to perform additional procedures
in order to conclude on the level of any adjustment needed in relation to the
outstanding balance with Pirlo Co.
Which TWO of the following audit procedures should be performed to form a
conclusion as to whether the financial statements require amendment?
1. Discuss with management the reasons for not amending the financial statements
2. Review the cash book post year end for receipts from Pirlo Co
3. Send a request to Pirlo Co to confirm the outstanding balance
4. Agree the outstanding balance to invoices and sales orders
A. 1 and 2
B. 1 and 4
C. 2 and 3
D. and 4
15. The finance director has asked you to outline the appropriate audit opinions
which will be provided depending on whether the company decides to amend or
not amend the 2019 financial statements for the issue identified regarding the
recoverability of the balance with Pirlo Co.
Which of the following options correctly summarises the audit opinions
which will be issued depending on whether or not the 2019 financial
statements are amended?
(30 marks)
401
AUDIT AND ASSURANCE
402
SPECIMEN EXAM
Required:
(a) Explain audit risk and the components of audit risk. (5 marks)
(b) Using the minutes provided, identify and describe SEVEN audit risks, and
explain the auditor’s response to each risk, in planning the audit of Milla Cola
Co. (14 marks)
(c) Identify the main areas, other than audit risks, which should be included
within the audit strategy document for Milla Cola Co; and for each area
provide an example relevant to the audit. (4 marks)
The finance director has requested that the deadline for the 2019 audit be
shortened by a month and has asked the audit engagement partner to consider
if this will be possible. The partner has suggested that in order to meet this new
tighter deadline the firm may carry out both an interim and final audit for the
audit of Milla to 30 September 2019.
Required:
(d) Explain the difference between an interim and a final audit. (3 marks)
(e) Explain the procedures which are likely to be performed during an interim
audit of Milla and the impact which it would have on the final audit. (4 marks)
(30 marks)
17. Baggio International Co (Baggio) is a manufacturer of electrical equipment.
It has factories across the country and its customer base includes retailers as
well as individuals, to whom direct sales are made through their website. The
company’s year end is 30 September 2019. You are an audit supervisor of Suarez
& Co and are currently reviewing documentation of Baggio’s internal control in
preparation for the interim audit.
Baggio’s website allows individuals to order goods directly, and full payment
is taken in advance. Currently the website is not integrated into the inventory
system and inventory levels are not checked at the time when orders are placed.
Inventory is valued at the lower of cost and net realisable value.
Goods are despatched via local couriers; however, they do not always record
customer signatures as proof that the customer has received the goods. Over the
past 12 months there have been customer complaints about the delay between
sales orders and receipt of goods. Baggio has investigated these and found that,
in each case, the sales order had been entered into the sales system correctly
but was not forwarded to the despatch department for fulfilling.
Baggio’s retail customers undergo credit checks prior to being accepted and
credit limits are set accordingly by sales ledger clerks. These customers place
their orders through one of the sales team, who decides on sales discount levels.
Raw materials used in the manufacturing process are purchased from a
wide range of suppliers. As a result of staff changes in the purchase ledger
department, supplier statement reconciliations are no longer performed.
Additionally, changes to supplier details in the purchase ledger master file can be
undertaken by purchase ledger clerks as well as supervisors.
403
AUDIT AND ASSURANCE
In the past six months, Baggio has changed part of its manufacturing process
and as a result some new equipment has been purchased, however, there are
considerable levels of plant and equipment which are now surplus to requirement.
Purchase requisitions for all new equipment have been authorised by production
supervisors and little has been done to reduce the surplus of old equipment.
Required:
(a) In respect of the internal control of Baggio International Co:
(i) Identify and explain SIX deficiencies;
(ii) Recommend a control to address each of these deficiencies; and
(iii) Describe a test of control Suarez & Co would perform to assess whether
each of these controls, if implemented, is operating effectively.
Note: The total marks will be split equally between each part. (18 marks)
(b) Describe substantive procedures Suarez & Co should perform at the year end
to confirm plant and equipment additions. (2 marks)
(20 marks)
18. Vieri Motor Cars Co (Vieri) manufactures a range of motor cars and its year end
is 30 June 2019. You are the audit supervisor of Rossi & Co and are currently
preparing the audit programmes for the year-end audit of Vieri. You have had a
meeting with your audit manager and he has notified you of the following issues
identified during the audit risk assessment process:
Land and buildings
Vieri has a policy of revaluing land and buildings, this is undertaken on a rolling
basis over a five-year period. During the year Vieri requested an external
independent valuer to revalue a number of properties, including a warehouse
purchased in January 2019. Depreciation is charged on a pro rata basis.
Work in progress
Vieri undertakes continuous production of cars, 24 hours a day, seven days a
week. An inventory count is to be undertaken at the year end and Rossi & Co will
attend. You are responsible for the audit of work in progress (WIP) and will be
part of the team attending the count as well as the final audit. WIP constitutes
the partly assembled cars at the year end and this balance is likely to be material.
Vieri values WIP according to percentage of completion, and standard costs are
then applied to these percentages.
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SPECIMEN EXAM
Required:
(a) Explain the factors Rossi & Co should consider when placing reliance on the
work of the independent valuer. (5 marks)
(b) Describe the substantive procedures the auditor should perform to obtain
sufficient and appropriate audit evidence in relation to:
(i) The revaluation of land and buildings and the recently purchased warehouse;
and (6 marks)
(ii) The valuation of work in progress. (4 marks)
(c) During the audit, the team has identified an error in the valuation of work in
progress, as a number of the assumptions contain out of date information.
The directors of Vieri have indicated that they do not wish to amend the
financial statements.
Required:
Explain the steps Rossi & Co should now take and the impact on the audit report in
relation to the directors’ refusal to amend the financial statements. (5 marks)
(20 marks)
End of Question Paper
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AUDIT AND ASSURANCE
Section A
1. D
2. A
3. B
4. C
5. D
6. A
7. A
8. B
9. D
10. B
11. B
12. D
13. C
14. A
15. D
Rationale
1. Statement 1 – Partner has been in role for eight years, contravenes ACCA’s Code of
Ethics and Conduct and represents a familiarity threat.
Statement 3 – Providing internal audit services raises a self-review threat as it is likely
that the audit team will be looking to place reliance on the internal control system
reviewed by internal audit.
Statement 4 – This represents fees on a contingent basis and raises a self-interest
threat as the audit firm’s fee will rise if the company’s profit after tax increases.
Statement 2 – Is not a threat to independence and therefore D is the correct answer.
2. If the engagement partner’s son accepts the role and obtains shares in the
company, it would constitute a self-interest threat but as the partner has already
exceeded the seven-year relationship rule in line with ACCA’s Code of Ethics and
Conduct, the partner should be rotated off the audit irrespective of the decision
made by her son. As Maldini is a listed company, an independent review partner
should already be in place. It is unlikely that the firm needs to resign from the
audit (due to stated circumstances) as the threats to objectivity can be mitigated.
Therefore option A is correct.
3. Statement 1 is inappropriate as the external and internal audit team should be
separate and therefore consideration of the skills of the external audit team is not
appropriate in the circumstances.
Statement 4 does not apply in that the timescale of the work is not relevant to
consider the threats to objectivity.
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SPECIMEN EXAM
Statement 2 and 3 are valid considerations – as per ACCA’s Code of Ethics and Conduct
providing internal audit services can result in the audit firm assuming a management
role. To mitigate this, it is appropriate for the firm to assess whether management will
take responsibility for implementing recommendations. Further, for a listed company
the Code prohibits the provision of internal audit services which review a significant
proportion of the internal controls over financial reporting as these may be relied
upon by the external audit team and the self-review threat is too great.
Therefore option B is correct.
4. Internal audit are appointed by the audit committee (external audit usually by
the shareholders) and it is the role of internal audit to review the effectiveness
and efficiency of internal controls to improve operations. External audit looks at
the operating effectiveness of internal controls on which they may rely for audit
evidence and a by-product may be to comment on any deficiencies they have
found but this is not a key function of the role.
Therefore statements 1 and 3 relate to internal audit.
The external auditor’s report is publicly available to the shareholders of the company
(internal audit reports are addressed to management/TCWG) and the external
auditor provides an opinion on the truth and fairness of the financial statements.
Therefore statements 2 and 4 relate to external audit.
C is therefore the correct answer.
5. The proposal in relation to the fees is a contingent fee basis which is expressly
prohibited by ACCA’s Code of Ethics and Conduct and therefore the only viable
option here is to reject the fee basis – D is therefore correct.
6. Depreciation should be calculated as:
Therefore the correct answer is A and assets are currently understated as too much
depreciation has currently been charged.
Option B is based on depreciation being applied for a full year instead of for the
relevant months.
Option C is based on depreciation not being charged in the month of acquisition (i.e.
seven and four months).
Option D is based on depreciation for the exercise bikes being divided by the three
years instead of allocated on a monthly basis.
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AUDIT AND ASSURANCE
7. Test 4 is a test for existence and test 3 is for completeness. All other tests are
relevant for valuation. Option A is correct.
8. While all procedures would be valid in the circumstances, only the written
confirmation from the company’s lawyers would allow the auditor to obtain an
expert, third party confirmation on the likelihood of the case being successful. This
would provide the auditor with the most reliable evidence in the circumstances.
Therefore B is the correct answer.
9. As per ISA 505 External Confirmations, the evidence obtained from the trade
receivables circularisation should be reliable as it is from an external source and
the risk of management bias and influence is restricted due to the process being
under the control of the auditor. Therefore 1 and 4 are benefits and option D is
therefore correct.
Customers are not obliged to answer and often circularisations have a very low
response rate. A circularisation will not provide evidence over the valuation assertion
for receivables and therefore 2 and 3 are drawbacks of a circularisation.
10. A is incorrect as the balance with Laurel Co would need to be followed up due
to the dispute.
C is incorrect as this represents a payment in transit and the payment would need to
be agreed to post year-end bank statements – if the cash was received pre year end
this would represent a cut-off issue as this should no longer be included in receivables.
D is incorrect as the sample chosen should be verified even if there is no response. As
per ISA 505, the auditor should adopt alternative procedures.
Therefore B is the only statement which is true as this does represent a timing
difference (invoice in transit) and should be agreed to a pre year-end invoice.
11. Addressee – sets out who the report is addressed to – usually the shareholders –
and is there to clarify who can place reliance on the audit opinion. B is therefore
the correct option.
12. Statement 1 is false as not all subsequent events will require an adjustment to
the numbers within the financial statements. IAS 10 Events after the Reporting
Period makes a distinction between an adjusting and non-adjusting event. Only
material adjusting events would require an amendment to the figures within the
financial statements.
Statement 2 is false as while a non-adjusting event would not require a change to
the numbers within the financial statements, IAS 10 may require a disclosure to be
made. If the non-adjusting event is material, non-disclosure could still result in a
modification to the audit report.
Statement 3 is true as the auditor is required to carry out procedures up to the date
of the audit report to gain sufficient appropriate audit evidence that all relevant
subsequent events have been identified and dealt with appropriately. After the audit
report is issued, the auditor does not need to actively look for subsequent events but
is only required to respond to subsequent events which they become aware of.
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SPECIMEN EXAM
Statement 4 is true as ISA 560 Subsequent Events requires the auditor to obtain
written confirmation from management/those charged with governance that all
subsequent events have been identified and dealt with in accordance with the
appropriate reporting framework.
D is therefore correct.
13. The outstanding balance with Pirlo Co is likely to be irrecoverable as the customer
is experiencing financial difficulties.
The balance is material at 7·4% of profit before tax and 2·5% of revenue.
Currently profit and assets are overstated by $285,000. Therefore the correct option is C.
14. Writing to the customer/agreeing to invoices, while valid procedures during the
audit to verify the existence of an outstanding balance, would not allow the auditor
to assess the recoverability of the balance which is the key issue in determining
whether an adjustment is required. Therefore options 3 and 4 are incorrect.
Post year-end cash testing is the best way for the auditor to assess if the balance is
recoverable wholly or in part and therefore the cash book should be reviewed for
any receipts which will change the assessment of the debt after the year end. The
issue should also be discussed with management to understand their reasons for
not wanting to amend the financial statements as this may be due to a change in
circumstances.
15. The debt with Pirlo Co should be provided for and is material to the financial
statements at 7·4% of profit before tax and 2·5% of revenue. This represents
a material misstatement which is material but not pervasive. As such, if no
adjustment is made the auditor will be required to provide a qualified ‘except for’
opinion. If the required change is made, then no material misstatement exists and
therefore the auditor will be able to issue an unmodified opinion.
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AUDIT AND ASSURANCE
Section B
16.
(a) Audit risk and its components
Audit risk is the risk that the auditor expresses an inappropriate audit opinion
when the financial statements are materially misstated. Audit risk is a function
of two main components being the risks of material misstatement and detection
risk. Risk of material misstatement is made up of two components, inherent risk
and control risk.
Inherent risk is the susceptibility of an assertion about a class of transaction,
account balance or disclosure to a misstatement which could be material, either
individually or when aggregated with other misstatements, before consideration
of any related controls.
Control risk is the risk that a misstatement which could occur in an assertion
about a class of transaction, account balance or disclosure and which could be
material, either individually or when aggregated with other misstatements, will
not be prevented, or detected and corrected, on a timely basis by the entity’s
internal control.
Detection risk is the risk that the procedures performed by the auditor to reduce
audit risk to an acceptably low level will not detect a misstatement which exists
and which could be material, either individually or when aggregated with other
misstatements. Detection risk is affected by sampling and non-sampling risk.
(b) Audit risks and responses
410
SPECIMEN EXAM
At the year end there will be inventory The auditor should assess which of
counts undertaken in all 15 warehouses. the inventory sites they will attend the
It is unlikely that the auditor will be counts for. This will be any with material
able to attend all 15 inventory counts inventory or which have a history of
and therefore they need to ensure significant errors.
that they obtain sufficient appropriate For those not visited, the auditor will
audit evidence over the inventory need to review the level of exceptions
counting controls, and completeness noted during the count and discuss with
and existence of inventory for any management any issues which arose
warehouses not visited. during the count.
Inventory is stored within 15 The auditor should review supporting
warehouses; some are owned by Milla documentation for all warehouses
and some rented from third parties. included within PPE to confirm
Only warehouses owned by Milla ownership by Milla and to ensure non-
should be included within PPE. There current assets are not overstated.
is a risk of overstatement of PPE and
understatement of rental expenses if
Milla has capitalised all 15 warehouses.
A new accounting general ledger system The auditor should undertake
has been introduced at the beginning of detailed testing to confirm that all
the year and the old system was run in opening balances have been correctly
parallel for two months. There is a risk recorded in the new accounting
of opening balances being misstated general ledger system.
and loss of data if they have not been They should document and test the
transferred from the old system correctly. new system. They should review any
In addition, the new accounting management reports run comparing the
general ledger system will require old and new system during the parallel
documenting and the controls over this run to identify any issues with the
will need to be tested. processing of accounting information.
Milla has incurred expenditure of $4·5 Obtain a breakdown of the expenditure
million on developing a new brand and undertake testing to determine
of fizzy drink. This expenditure is whether the costs relate to the
research and development under IAS 38 research or development stage. Discuss
Intangible Assets. The standard requires the accounting treatment with the
research costs to be expensed and finance director and ensure it is in
development costs to be capitalised as accordance with IAS 38.
an intangible asset.
If Milla has incorrectly classified
research costs as development
expenditure, there is a risk the
intangible asset could be overstated
and expenses understated.
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AUDIT AND ASSURANCE
The finance director of Milla has Extended post year-end cash receipts
decided to release the opening balance testing and a review of the aged
of $1·5 million for allowance for receivables ledger to be performed to
receivables as he feels it is unnecessary. assess valuation and the need for an
There is a risk that receivables will allowance for receivables.
be overvalued, as despite having a Discuss with the director the rationale
credit controller, some balances will be for releasing the $1·5m opening
irrecoverable and so will be overstated allowance for receivables.
if not provided against.
In addition, due to the damaged inventory
there is an increased risk of customers
refusing to make payments in full.
A large batch of cola products has Detailed cost and net realisable value
been damaged in the production testing to be performed to assess
process and will be in inventory at the how much the inventory requires
year end. No adjustment has been writing down by.
made by management.
The valuation of inventory as per IAS
2 Inventories should be at the lower of
cost and net realisable value. Hence it is
likely that this inventory is overvalued.
Due to the damaged cola products, a Review the breakdown of sales of
number of customers have complained. damaged goods, and ensure that
It is likely that for any of the damaged they have been accurately removed
goods sold, Milla will need to refund from revenue.
these customers.
Revenue is possibly overstated if the
sales returns are not completely and
accurately recorded.
The management of Milla receives a Throughout the audit, the team will
significant annual bonus based on the need to be alert to this risk. They
value of year-end total assets. There will need to maintain professional
is a risk that management might feel scepticism and carefully review
under pressure to overstate the value of judgemental decisions and compare
assets through the judgements taken or treatment against prior years.
through the use of releasing provisions.
412
SPECIMEN EXAM
413
AUDIT AND ASSURANCE
414
SPECIMEN EXAM
17.
(a) Baggio International’s (Baggio) internal control
415
AUDIT AND ASSURANCE
416
SPECIMEN EXAM
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AUDIT AND ASSURANCE
In addition, Rossi & Co should meet with the expert and discuss with them
their relevant expertise, in particular whether they have valued similar land and
buildings to those of Vieri in the past. Rossi & Co should also consider whether
the valuer understands the accounting requirements of IAS 16 Property, Plant
and Equipment in relation to valuations.
The valuation should then be evaluated. The assumptions used should be
carefully reviewed and compared to previous revaluations at Vieri. These
assumptions should be discussed with both management and the valuer to
understand the basis of any valuations.
(b)
(i) Substantive procedures for land and buildings
• Obtain a schedule of land and buildings revalued this year and cast to
confirm completeness and accuracy of the revaluation adjustment.
• On a sample basis, agree the revalued amounts to the valuation
statement provided by the valuer.
• Agree the revalued amounts for these assets are included correctly
in the non-current assets register.
• Recalculate the total revaluation adjustment and agree correctly
recorded in the revaluation surplus.
• Agree the initial cost for the warehouse addition to supporting
documentation such as invoices to confirm cost.
• Confirm through a review of the title deeds that the warehouse is
owned by Vieri.
• Recalculate the depreciation charge for the year to ensure that for
assets revalued during the year, the depreciation was based on the
correct valuation and for the warehouse addition that the charge
was for six months only.
• Review the financial statements disclosures of the revaluation to
ensure they comply with IAS 16 Property, Plant and Equipment.
(ii) Substantive procedures for work in progress (WIP)
• Prior to attending the inventory count, discuss with management
how the percentage completions are attributed to the WIP, for
example, is this based on motor cars passing certain points in the
production process?
• During the count, observe the procedures carried out by Vieri staff
in assessing the level of WIP and consider the reasonableness of the
assumptions used.
418
SPECIMEN EXAM
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AUDIT AND ASSURANCE
Marking Scheme
Marks
Section A
Questions 1–15 multiple choice (each question is worth 2 marks) 30
Section B Marks Marks
available awarded
16 Milla Cola Co
(a) Component of audit risk
Explanation of audit risk 2
Explanation of components of audit 3
risk: Inherent, control and detection risk
5
(b) Audit risks and responses (only 7
risks required)
$5 million expenditure on 2
production process
Inventory counts at 15 warehouses at 2
year end
Treatment of owned v third party 2
warehouses
New general ledger system introduced 2
at the beginning of the year
Release of opening provision for 2
allowance for receivables
Research and development expenditure 2
Damaged inventory 2
Sales returns 2
Management bonus based on asset values 2
Max 7 issues, 2 marks each 14
(c) Audit strategy document
Main characteristics of the audit 1
Reporting objectives of the audit and 1
nature of communications required
Factors which are significant in directing 1
the audit team’s efforts
Results of preliminary engagement 1
activities and whether knowledge
gained on other engagements is relevant
420
SPECIMEN EXAM
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AUDIT AND ASSURANCE
422
SPECIMEN EXAM
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AUDIT AND ASSURANCE
Immaterial – schedule of 1
uncorrected adjustments
Material not pervasive – qualified opinion 1
Basis for qualified opinion paragraph 1
Opinion paragraph – qualified ‘except for’ 1
Restricted to 5
Total marks 20
424