Mock Exam (Exam Practice)

Audit and Assurance

Time allowed: 3 hours 15 minutes

This question paper is divided into two sections:

Section A – ALL 15 questions are compulsory and MUST be attempted

Section B – ALL THREE questions are compulsory and MUST be attempted

Section A – ALL 15 questions are compulsory and MUST be attempted

Each question is worth 2 marks.

The following scenario relates to questions 1-5

You are the audit manager of Steve & Co and you are planning the audit of BJ Electronics
Co, a listed company, which has been an audit client for several years and specializes
in manufacturing luxury home appliances. From the planning notes you can ascertain
the following information.

The employees of BJ Electronics Co are entitled to purchase company products at a

discount of 15%. The members of the audit team have in previous years been offered
the same level of discount.

1. The situation above would result in which ethical threat.

A Self-review threat
B Self-interest threat
C Intimidation threat
D Familiarity threat

2. During the year the chief accountant of BJ Electronics resigned and not replaced
for three months. Due to not having a suitable staff to fill the position, a qualified
audit senior of Steve & Co was seconded to the client for three months.

Which of the following statement is/true?

(1) No ethical threat arise if the Audit senior is seconded to the BJ Electronics
for three months because he understands the business and it also help him
to do the audit of the client.
(2) This will result in a self review threat because the audit senior has performed
a significant amount of work and will review own work.
(3) The audit senior should be removed from the audit team after he was
seconded to the client.

A 1, 2 and 3
B 1 and 3 only
C 1 and 2 only
D 2 and 3 only

3. The fee income derived from BJ Electronics was boosted by this engagement and
along with the audit and tax fee, now accounts for 19% of the firm’s total fees.

The situation above will result in which ethical threat.

A Self interest
B Self Review
C Familiarity
 D Intimidation

4. From a review of files you come to know that the finance director and the partner
known each other for many years and spent time together on many occasions with
their families.

The situation above will result in which ethical threat.

A Self interest
B Self Review
C Familiarity
D Intimidation

5. The 20% fee from previous year audit is still outstanding and despite of many
reminders the client has not sent the payment.

Which of the following actions should be taken by Steve & Co.?

A This may result in a self-interest threat and the audit firm should resign
from the audit.
B It’s an indicator of intimidation threat and the audit firm should think about
a legal action against the client.
C They should send the client another reminder.
The following scenario relates to questions 6–10

Trillion is a listed company operates in pharmaceutical industry, the company was a

family business until it got listed in stock exchange three years ago. You are a newly
appointed non- executive director in the board of 6 executive and 4 non-executive
directors.

6. How many directors and non-executive directors should be in a board of a

listed company?

A Equal Number of executive and non-executive

B 70 percent executive and 30 percent non-executive
C 100 percent of executive directors

7. Mr. Griss is the CEO and the Chairman of the company for last 7 years now he has
decided to retire and make his younger brother the ceo and the chairman of the
company.

What are the guidelines of UK Combined Code of Corporate governance for

the position of CEO and chairman.

A They should be held by the same individual

B Two separate individuals should hold these positions
C It’s not compulsory for a listed company to have both positions filled all
the time.

8. The company has no audit committees in place but Mr. Griss has ordered you to
form an audit committee with Mr. Brick, the finance director of the company as its
head and one executive and one non-executive director as its member.

Who can become the member and head of an audit committee?

A Executive directors only

B Non-executive directors only
C Both executive and non-executive directors

9. Once established the audit committee will have many objectives.

Which of the following does NOT form part of the audit committee’s
objectives?

A Safeguarding the privacy of whistleblowers

B Appointing the external auditor
C Monitoring the independence of the external auditor
D Implementing a policy on the supply of non-audit services by the external
auditor

10. The company also intends to establish the internal audit department as well.
Which of the following is not the Role of Audit committee regarding the
internal audit department?

A Appoint the head of internal audit department

B Set the scope of internal audit department
C Appoint all the employees in internal audit department
The following scenario relates to questions 11–15

You are the audit manager in the firm of HJKL & Co, a firm of chartered certified
accountants. You are planning the audit of Xono Co, which is a chain of Chinese
restaurants and has 12 restaurants across the country.

All the restaurants are owned by Xono Co and have always been included in the financial
statements at cost less depreciation. The restaurants are depreciated over 30 years.
However, you know from discussions with management that the company intends to
include one of the restaurants, in central area of the major city, at a revalued amount
rather than cost in the current accounting period. The revalued amount is much more
than the current values of the restaurant in the assets register.

The Management of the company is not using the independent valuation; Management
has explained that the reason for the revaluation is because the restaurant is in an area
where property prices have raised much more quickly compared to other locations.

11. One of the team member have made the following notes in relation to the
valuation of the restaurant.

(1) Xono can revalue the restaurant at the central area of the city while
continuing to recognize its other restaurants at cost less depreciation.
(2) The revaluation will be a change in accounting policy, so the auditors will
need to consider the disclosures made in this respect.
(3) The restaurant at central area should be depreciated at the revalued
amount.
(4) We need to make sure that all refurbishment cost is capitalize.

Which TWO of the above statements are correct?

A 1 and 3
B 2 and 4
C 2 and 3
D 1 and 4

12. Which of the following assertions are relevant to the audit of tangible non-
current assets?

(1) Existence
(2) Occurrence
(3) Classification
(4) Presentation

A 1 only
B 1, 3 and 4
C 2, 3 and 4
D 1, 2, 3 and 4
13. Which audit procedure will provide appropriate audit evidence in respect
existence of noncurrent assets?

A For a sample of assets selected by physical inspection, agree that they

are listed on the non-current assets register.
B For a sample of non-current assets listed on the non-current assets
register, physically inspect the asset.
C For a sample of assets on the assets register, recalculate the depreciation
in accordance with the entity’s accounting policies.
D For a sample of assets on the assets register, inspect relevant purchase
invoices.

14. Which of the below factors influence the auditor's judgment regarding the
sufficiency of the evidence obtained?

(1) The materiality of the account

(2) The size of the account
(3) the source and quality of the evidence available.
(4) The amount of time allocated to the audit

A 1 and 3
B 2 and 4
C 2 and 3
D 1 and 4

15. Which of the following written representations MUST the auditor obtain,
to comply with the requirements of ISA 580?

(1) The selection and application of accounting policies are appropriate

(2) All transactions have been recorded and are reflected in the financial
statements
(3) Significant assumptions used in making accounting estimates are
reasonable
(4) Management has provided the auditor with all relevant information agreed
in the terms of engagement.

A 1 and 4
B 2 and 4
C 1, 2 and 3
D 1, 2, 3 and 4
Section B – ALL THREE questions are compulsory and MUST be attempted

Question 16
Part (a)

It is very important for Auditors to understand the Audit risk before finalizing the planning
of audit.

Required:

(i) Explain Audit Risk and its components.

(3 marks)

(ii) Define ‘professional judgment and describe two areas where professional judgment is
applied when planning an audit of financial statements.
(3 marks)

You are an audit senior for Rio & Co. were recently appointed as external auditors of Handy
Car Co for the year ending 31 June 20X7 and you are in the process of planning the audit.

Handy Car principal activity is the manufacture and sale of expensive high quality cars which
are largely sold to wealthy individuals and luxury hotels. Each car is crafted by hand in the
company's workshop. Manufacturing of each car only begins once a customer order is
received, as each customer will usually want their car to have a unique feature or to be in a
unique style.

The business is family run and all the shares in Handy car are owned by the three joint
Managing Directors. The directors are three brothers, Bill, Adam and Steve Jones and they
have a number of other business interests as well. As a result they only spend a few days a
week working at the company and rely on the small accounts department to keep the finances
in order and to keep them informed. There is no finance director but the financial controller is
a qualified accountant.

Handy car requires customers who place an order to pay a deposit of 50% of the total order
value at the time the order is placed. The cars will take 6 to 8 weeks to build, and the remaining
50% of the order value is due within a week of the final delivery. Risks and rewards of
ownership of the cars do not pass to the customer until the cars are delivered.

Cars also come with a guarantee and the financial controller has made a provision in respect
of the expected costs to be incurred in relation to cars under guarantee.

Although the company does have some employees working in the workshop, it often uses
external subcontractors to help make the cars in order to fulfill all its orders. These
subcontractors should invoice Handy car at the end of each month for the work they have
carried out, but sometimes do not get round to it until the following month.

The company undertakes a full count of raw materials and other parts at the year end. The
quantities are recorded on inventory sheets and the financial controller assigns the costs
based on the cost assigned in the previous year or, if there was no cost last year, using the
latest invoice.

It is expected that work in progress will be insignificant this year, but there will be a material
amount of finished goods awaiting dispatch. Steve Jones will estimate the value of these
finished goods and has said he will take into account the order value when doing so.

There has been steady growth in sales in recent years and, in January 20X7 Handy car
purchased a building close to its existing workshop. The managing directors plan to turn this
into another workshop which should more than double its existing manufacturing capacity.
The new workshop is currently undergoing extensive refurbishment in order to make it suitable
for car manufacturing.

The purchase of the new premises was funded by a bank loan repayable in monthly
installments over 12 years and has covenants attached to it. These covenants are largely
profit related measures and if they are breached the bank has the option to make the
remaining loan balance repayable immediately.

Part (b)

Required

(i) Identify and explain EIGHT audit risks in respect of the financial statements of
Handy car for the year ending 31 March 20X7. For each risk suggest a suitable audit
response.
(16 marks)

(ii) Describe Rio & Co’s responsibilities in relation to the physical inventory count that
will take place at the year-end
(4 marks)

The workshop currently in use is owned by the company and will be included in the financial
statements at its revalued amount rather than at cost. The company has always adopted this
policy for land and buildings and the valuation of the workshop is to be brought up to date at
31 March 20X7 by an external valuer

Prat (c)

Required

Describe the procedures the auditor should carry out to gain evidence over the
adequacy of the value of the workshop and the related disclosures included in the
financial statements.
(4 marks)
(30 marks)
Question 17
CJ and Co., a private company, owned by its directors, manufactures wooden window frames,
doors and staircases for domestic houses. It has prepared draft accounts for the year ended
30 September 20X7 and you are concerned that they indicate serious going concern
problems. The statements of profit and loss and statements of financial position for the last
five years (each ended 30 September) are given below.

Income Statement
20X2 20X3 20X4 20X5 20X6
$'000 $'000 $'000 $'000 $'000
Sales 625 787 1,121 1,661 1,881
Cost of sales (478) (701) (962) (1,326) (1,510)
Gross profit 147 86 159 335 371
Other expenses (88) (86) (161) (240) (288)
Interest (6) (9) (58) (90) (117)
Net profit/(loss) 53 (9) (60) 5 (34)

Statement of Financial Position

20X2 20X3 20X4 20X5 20X6
$’000 $'000 $'000 $'000 $'000
Assets
Current assets
Inventory 67 133 181 307 449
Trade accounts receivable 91 240 303 313 364
158 373 484 620 813
Net current assets 89 161 544 600 587
Total assets 247 534 1,028 1,220 1,400

Liabilities and shareholders' funds

Current liabilities
Trade accounts payable 90 317 355 490 641
Lease creditor 10 65 211 269 365
Bank overdraft 14 28 98 92 59
114 410 664 851 1,065
Non-current loan – – 300 300 300
410 410 964 1,151 1,365
Shareholders' funds 17 17 17 17 17
Reserves 116 107 47 52 18
133 124 64 69 35
Total liabilities and
shareholders’ ‘funds 247 534 1,028 1,220 1,400
The company has been in business for about Thirty years. In January 20X3 it decided to build
a new factory on a site leased from the local authority which would allow a major increase in
sales.

This new factory with new equipment was completed a year later. The factory was financed
by a non-current loan of $300,000 from a merchant bank and an increase in the bank
overdraft.

The loan from the merchant bank is secured by a fixed charge on the leasehold factory and
the bank overdraft is secured by a second charge on the leasehold factory, a fixed charge on
the other non-current assets and a floating charge on the current assets.

The company purchases its main raw material, wood, from timber wholesalers. It sells around
75% of its production to about 12 local and national builders of new domestic houses. The
remaining sales are mainly to smaller builders with a very few sales to local builder’s
merchants.

Required

(a) In relation to the accounts above, list and briefly describe the factors which indicate that
the company may not be a going concern. You should also highlight certain figures and
calculate relevant ratios in the accounts.
(13 marks)

(b) Describe the investigations and checks you would carry out, in addition to those
described in part (a) above, to determine whether the company is a going concern.
(7 marks)

(20 marks)
Question 18
Internal controls are an integral part of every business to make best use of available resources
and maximizing profit.

You are the audit manager of Blick & co, a firm of chartered certified accountants. Your firm
has recently been appointed as auditor of BNH, a private company that owns and runs a chain
of superstores across the country selling DIY products which includes tools and equipments
which help common individuals perform day to day tasks themselves. BNH has very few
controls over the inventory because the management of the company trusts the local store
managers to make good decisions regarding the purchase, sales and control of inventory, all
of which is performed locally. Pricing is generally performed on cost plus basis.

Each super market has its own computer system installed which is used to prepare the
monthly accounts, these accounts are then sent to the head office every 2 months. There is
no integrated inventory control, sales or purchasing system and no regular inventory counting
is conducted. The management accounts are prepared after every six months.

BNH have experienced a surge in trading in recent years and number of stores has also
increased. However BNH have found it difficult to maintain the quality of staff. The board has
now decided to invest in more up-to- date systems.

Required

(a) Describe the issues that you might expect at BNH due to poor internal controls.
(12 marks)

(b) Make four recommendations to the board of BNH for the improvement of internal controls.
And explain the advantages of each recommendation.
(8 marks)

(20 marks)