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Question 1

Assume the date is 5 September 2022.

1. ‘The role of an auditor is to assure users that the figures in the financial statements are
100% accurate’.

Explain what is meant by the ‘expectations gap’ and why the above statement is
incorrect. (3 marks)

2. Your firm is undertaking the external audit of Planne plc (Planne). A USB memory stick
containing information about Planne was stolen last month from an audit team member.
Sensitive data about the client was subsequently published on the internet by an activist
group.

Outline the legal, professional and ethical issues arising from the above scenario and
set out the safeguards that should be introduced by your firm to prevent such data
breaches occurring in the future. (4 marks)

3. An audit engagement letter sets out the key terms of an audit engagement.

For a non-listed company, list the compulsory items that must be included in an audit
engagement letter in accordance with International Standards on Auditing (UK).
(3 marks)

4. Todds LLP (Todds) has been the external auditor of Barntree plc (Barntree) for a
number of years. The next audit will be for the year ending 31 December 2022.

The audit manager on the audit of Barntree for the year ended 31 December 2021 left
Todds and became the financial controller of Barntree on 1 June 2022.

The finance director of Barntree became an audit partner at Todds on 1 August 2022
and would like to be a member of the audit team of Barntree for the year ending 31
December 2022.

Identify the ethical threats that arise from the above scenario, stating why each is a
threat. State from which date the former finance director could become a member of the
audit team of Barntree in accordance with the FRC Ethical Standard. (4 marks)

5. The 'Independent Review into the Quality and Effectiveness of Audit' conducted by Sir
Donald Brydon made a recommendation to extend the scope of the audit to include
alternative performance measures, such as earnings before one-time charges.

State three issues for auditors of extending the scope of the audit to include alternative
performance measures. (3 marks)

6. ISA 315, Identifying and Assessing the Risks of Material Misstatement requires an
auditor to identify risks at the financial statement level and at the assertion level for
classes of transactions, account balances and disclosures.

Medikitz Ltd (Medikitz) manufactures and supplies medical goods, which must meet
strict quality criteria. The market has become very competitive and new legislation
introduced a price cap for these goods. The finance director recently departed due to a
disagreement with the managing director over failures in the implementation of a new
financial reporting system. Consequently, a lack of supervision of credit control staff
resulted in amounts owed by credit customers not being followed up for three months.

Identify three risks of material misstatement at the financial statement level for
Medikitz. (3 marks)
Total: 20 marks
Question 2

Assume the date is 5 September 2022.

Componente plc (Componente), a UK listed company, is a manufacturer of components for

electronic devices, such as mobile phones, tablet PCs and laptop computers. Historically,
Componente’s main business has been the manufacture of components to design
specifications provided by customers. Componente has four manufacturing operations
located in mainland Europe and Asia, and a head office and finance function in London.

You are the audit senior of A&C LLP (A&C) responsible for planning the audit of the financial
statements of Componente for the year ended 30 June 2022. The engagement partner has
identified the following two areas as significant risks for this audit:

(1) Supplier settlement discounts

(2) Development costs.

Materiality for the audit has been set at £805,000.

Supplier settlement discounts

Componente makes its purchases from over 100 different suppliers. Approximately half of
contracts with suppliers offer a discount for prompt payment (5% for payment within two
weeks of the invoice date).

Componente´s policy is to take advantage of the discount as far as possible. In line with this
company policy, all purchases are recorded net of the settlement discount, on the grounds
that it is expected the discount will be taken. If the discount is subsequently not taken, a
manual adjustment is made when the payment is processed. Componente operates a
payment run twice a month.

During last year´s audit it was found that, due to cash flow issues, the discount was not
always taken, and as a result there was a material misstatement of cost of sales and year
end trade payables. This was corrected before the financial statements were authorised for
issue and did not result in a modified audit opinion. Componente continued to experience
similar cash flow issues in the year ended 30 June 2022.

In recent months, a staff shortage in the finance function has put pressure on the finance
team and resulted in delays in recording supplier invoices on the system. During the systems
review, a member of the audit team identified a prompt payment discount recorded for a new
supplier which does not offer discounts.

The following information has been extracted from the draft financial statements for the year
ended 30 June 2022:
2022 2021
(draft) (audited)
£’000 £’000
Cost of sales 423,410 407,680
Trade payables 55,790 56,070
Development costs

During the year ended 30 June 2022, Componente began the development of components
for a new tablet PC of its own, with the intention of entering commercial production in 2023.
Componente´s finance director determined that the IAS® 38, Intangible Assets criteria for
capitalisation of the development costs were met on 1 March 2022, and £1,426,000 of
relevant costs incurred after that date were capitalised. The costs capitalised include
component material costs, design staff salaries, an allocation of overheads, depreciation of
equipment used for the development and an allocation of senior management time.

Supply chain review

Componente experienced some supply chain disruption during the year ended 30 June 2022,
due to factors beyond management’s control. Componente’s management has requested
that your firm’s management consultancy division undertakes a detailed supply chain review.
The aim of the review would be to identify weaknesses and points of difficulty in the supply
chain and make recommendations to improve the efficiency of supply. Componente’s
management has proposed a fee of £80,000 for this work.

The average audit fee chargeable to Componente for the years ended 30 June 2020, 2021,
and 2022 is £414,000. A&C’s total annual fee income for the year ending 30 June 2023 is
expected to be £7.6 million. This includes a £444,000 audit fee and £200,000 of recurring
non-audit services work relating to Componente but excludes the supply chain work.

Requirements

1. Set out the matters you should consider, as part of your audit planning, arising from
Componente having manufacturing operations located in mainland Europe and Asia,
and a head office and finance function in London. (5 marks)

2. Justify why the audit partner has identified items (1) and (2) as significant risks for the
audit. For each significant risk, describe the procedures that should be included in the
audit plan to address those risks.

Present your answer using the following subheadings:

• Supplier settlement discounts

• Development costs. (22 marks)

3. Explain the professional and ethical matters your firm should consider in determining
whether to accept the supply chain review work. (8 marks)

Total: 35 marks
Question 3

Assume the date is 5 September 2022.

Albadawn Ltd (Albadawn) designs and manufactures fashion clothing which is sold to online
and high street retailers. Albadawn’s unique selling point is that only a limited quantity of
each design is made. The concept has proved very popular and Albadawn has experienced
high growth.

Your firm has been the auditor of Albadawn since its incorporation and is preparing for the
final audit of Albadawn’s financial statements for the year ending 30 September 2022.

Your firm recently completed the interim audit. Three issues were identified during testing of
Albadawn’s systems and processes that indicate control deficiencies:

(1) New equipment acquired during the year was recorded in the general ledger, but not all
items were recorded in the asset register.

(2) Albadawn’s designers are under pressure to develop new fabric pattern designs quickly.
A review of correspondence with Albadawn’s lawyers has revealed that Albadawn is being
sued for the use of copyrighted pattern designs that can be found on the internet.

(3) During the year, Albadawn trialled using a cloud-based sales and credit control system,
integrated with the general ledger. This system is only being used to record sales to new
customers while it is being trialled, with the aim of using it for all sales in the future. The
existing sales and credit control system runs on the in-house computer network, with monthly
postings to the general ledger as a manual journal.

Albadawn is planning a listing on the UK Stock Exchange during the year ending 30
September 2023. Albadawn’s management has indicated that it would be happy for your firm
to continue as external auditor. Your firm has not previously audited a listed company and the
partners are concerned about the additional reporting requirements, partner/audit firm
rotation and the risk of liability for the firm.

Requirements

1. For each of the three issues identified above that indicate control deficiencies, outline
the possible consequences, and provide recommendations to address them, suitable
for inclusion in your firm’s report to those charged with governance of Albadawn.

Present your answer using the following subheadings:

(1) Recording of new equipment

(2) Use of copyrighted pattern designs
(3) New sales system. (12 marks)

2. Explain how:

• the auditor’s report of a listed entity differs from the auditor’s report of a non-listed
entity, and

• the partner/audit firm rotation rules could affect your firm. (4 marks)
3. List circumstances that could lead to liability claims against your firm relevant to the
audit of Albadawn. Describe methods that your firm and the audit profession can use to
limit liability. (6 marks)

Total: 22 marks
Question 4

Assume the date is 5 September 2022.

Lightmode Ltd (Lightmode) produces a range of lighting for industrial use (eg, lamps and
torches) and has clients worldwide. Lightmode reports under IFRS® Standards.

Lightmode experienced a reduction in the volume of business in the year ended 30 June
2022 due to technological advances. However, all inventory lines continued to be sold and
there were quantities of all lines in the warehouse at the year end.

You are the audit senior on the audit of Lightmode for the year ended 30 June 2022.
Lightmode’s general ledger is available in your firm’s data analytics software.

Materiality for the audit has been set at £265,000.

Data derived from the audited financial statements for previous years showed:

Year ended 30 June 30 June

2021 2020
days days
‘Liquidity’ ratios:
Credit period (Trade receivables/Income x 365 days in period) 57.2 57.3

‘Inventory and Production’ ratios:

Inventory days (Inventories/Cost of sales x 365 days in period) 382.0 386.4

Lightmode allows its customers an eight-week credit period. Inventory days in 2021 and 2020
are typical for Lightmode’s business due to its unreliable supply chain, long lead times and
import delays.

The equivalent 30 June 2022 year-end ratios can be found in the ‘Metrics’ module of the data
analytics software. An initial analytical review using these ratios has identified trade
receivables and inventories as areas of concern. Relevant components of these ratios
include:

Account name Account code(s)

Sales ledger control account (Trade receivables) 701090 (Asset)
Stock (Inventories) 651009 to 651099 (Asset)

A review of Lightmode’s personnel files has revealed that Yolanda Usman (Y Usman), a
sales/receivables ledger supervisor, was dismissed from Lightmode on 16 August 2022.
Lightmode discovered that Y Usman had been passing sensitive information to her brother’s
firm Usman Industries Ltd, a customer of Lightmode, to help negotiate cheaper prices.

Lightmode’s financial controller, Martin Chan (M Chan), posts year end manual journal
adjustments to record the balances for closing inventories (Accounts 651009 to 651099). M
Chan was taken ill before the finalised figures for all inventory accounts became available
and has not yet returned to work.
Requirements

1. In your firm’s data analytics software:

• Use the ‘Metrics’ module to explain why trade receivables and inventories have been
raised as areas of concern.

• Use the ‘Explore’ module to identify any transaction(s) of concern relating to

receivables and account balances of concern relating to inventories. Explain why
those transactions or account balances are a concern. (12 marks)

Note: No marks will be awarded for points identified by using other modules in your
firm’s data analytics software.

2. Assuming you conclude that receivables and inventories are materially misstated, and
management refuse to amend the financial statements:

• state, with reasons, the implications for the auditor's report,

• describe the elements that would be included in the opinion paragraph in line with
the relevant guidance, and

• list the matters that you would communicate to those charged with governance in
respect of this issue. (11 marks)

Total: 23 marks