ACCA

Paper AAA (International/UK)

Advanced Audit & Assurance
Revision Mock Examination
March 2019
Answer Guide

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Answer 1

Tutorial help and key points

(a)
This question is a common audit planning style question, using the business risk approach.
Business risks should focus on potential damage to the company and should not simply
repeat facts from the question. You must ADD analysis for each risk. There are not that
many risks available from the written part of the scenario, so explanations are very
important. Also, some ratio or trend calculations would help highlight additional business
risk areas.
(b)
Risks of material misstatement should focus on why the FS might be wrong, so most of
them should be mentioning the IAS/IFRS that might be breached. Specify which figures
are at risk, whether over/under (avoid “misstated” as examiner feels it is too vague), and
say why. There are only 4 required, but a lot more than 4 are available, especially if you
choose to use analytical procedures (i.e. calculate ratios and trends, as per part (a)).
Part (c) is a typical audit tests question so AEIOU and DADA3 will help (although with
Development Costs, a knowledge of the IAS 38 criteria is even more useful).
Part (d) is the rarely examined ISA 402. Note question asks for impact on the audit
planning, so ensure your answer does exactly as requested.
Part (e) is again a regularly asked requirement. The underlying knowledge should not be
hard, but the key is to explain WHY each issue is a threat, so you can demonstrate your
understanding.

Marking scheme
In part (a), each business risk scores 0.5 for being simply identified, with up to an
additional 1 mark depending on the quality of the explanation.
In part (b), up to 2 marks available for each valid risk of material misstatement, with 0.5
marks for each FS area identified as at risk (over or under), 0.5 per correctly explained
relevant accounting rule, and a max of 1 mark for the explanation of why.
In part (c), up to 1 mark per valid test, with 0.5 if not explained.
In part (d), 1 mark per valid point made if explained, and if relevant to audit planning.
In part (e), up to 2 marks per point made, depending on the depth of explanation.
Note that in (a) and (b), no calculations were requested so there are no marks for them
on their own merit. Calculations used as part of a risk explanation will get 0.5 marks each.
In all cases, answers should be in sentences – not a shopping list of 2–3 words or brief
notes which would not answer the question set. These would score few if any marks.

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 Professional marks, as always, are 1 mark for BN format, 1 for a valid intro, 1 for
headings / paragraphs structure, and 1 for quality/clarity of writing. These marks are
either 1 or 0, no half marks.

BRIEFING NOTES

To: Les Zamora

From: Audit Manager

Date: 4 March 2019

Subject: Audit Planning – Sinton Medical

Introduction

As requested, I have prepared an analysis of business risks relating to Sinton Medical,

analysed four risks of material misstatement for their financial statements for the forthcoming
year end of 31 March 2019, suggested audit procedures to test their capitalised development
costs, and highlighted issues caused by their payroll now being outsourced. I have also added
observations regarding the two audits you asked me to review.

(a) Business risks

Out of Date Product Range

The company’s sales have recently been falling because competitors with better
technology are producing better and cheaper products. If the company fails to address
this issue quickly they will continue to lose market share and customers will become loyal
to the new suppliers making it hard to win them back.

Inventory days have risen from 77 to 122, indicating that the company is finding it harder
to sell its inventory quickly. This might be linked to the above point, and may indicate that
their reputation has been damaged by failing to keep up with technology. They might have

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 to take a loss on selling these items, if they can sell them at all (in which case disposal
costs might have to be incurred).

Falling Sales Margins

As noted above, competitors are selling better quality products and more cheaply. This
implies that as well as sales falling for our client, profit margins are going to be lowered if
they want to compete. In this industry a high level of R+D is going to be essential in order
to keep up with technological change, and if margins are falling the availability of funds
for this R+D is going to come into question. The operating margin has fallen from -6.7%
to -90%, and such losses cannot be financed for long.

R+D

At present, despite a heavy investment in developing new products, nothing new has been
launched. Many new products in this industry require licences before they can be sold,
and if those licences have not yet been applied for, there could be many months of delay
before any new product starts to generate the revenue to replace falling sales of older
products. The high investment, coupled with no additional incoming revenues, must surely
be causing major cashflow problems and might hurt their ability to invest in further R+D
going forward.

Patent Breaches

Competitors are accusing the company of using trade secrets to develop new products,
because our client has recruited their R+D staff. If these claims have any merit, it could
seriously harm our client’s ability to launch much needed new products, thus causing
further cashflow problems. Even if the claims are false, any legal process will cause a delay
of some sort.

As well as delays to new products, legal cases cause legal costs and if our client is found
guilty there will also be compensation to pay, again harming their cashflows. Losing legal
cases also causes reputation damage, which the company can ill afford given its other
problems, and might result in it becoming increasingly difficult to attract the R+D expertise
they need to move forward.

Wrongful Dismissal

There is already another legal issue, with two ex-directors suing for wrongful dismissal.
As with the patent issue, this is going to cause legal costs to be incurred, and the nature
of the claims suggests that current directors may have to put some time into the legal
process, when they really need to be focussing on getting new products to market.

If the two ex-directors win, compensation is likely to be significant, given their seniority,
further damaging cashflow, and causing further reputation damage.

I note the board plan to leave any out of court settlement to the last possible moment.
This might prove to be a good tactic if the two drop their case, but equally it might end

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 up costing the company more, and increase the risk of adverse publicity (compared with
a confidential out of court settlement now, for example).

Unhappy R+D Staff

The claims from competitors relating to stealing of trade secrets seem to have upset the
R+D staff who were recruited and some have stopped coming to work due to illness.
Whether or not they are actually ill is not relevant – if these key R+D staff are not
motivated to attend work (or worse still, resign), R+D progress is going to be slowed
meaning even more delays to new products being launched, further hurting cashflows.

Potential Grant Repayment

The company received a grant to construct new buildings in a depressed area of the
country and should have 250 staff employed there by 1 May 2019 at the latest. However,
no such construction has begun, and with less than two months to go before May it would
appear unlikely that the deadline will be met. There must therefore be a realistic risk that
the grant will have to be repaid, and given other cashflow problems noted above it is
unclear as to whether the company would be able to afford to repay it, if needed.

There must also be a risk that the government would penalise the company, accusing it
of getting the grant under false pretences, meaning they might have to pay back more
than the initial sum received.

Foreign Exchange Risk

The company sells worldwide. As a result it is at risk of foreign exchange losses if its home
currency moves in the wrong direction, and even if there are no losses there is inherent
cashflow uncertainty over future revenues when exchange rates are subject to change. It
may be that the company sells in so many countries that exchange gains and losses tend
to balance out, or it may be that they have hedging strategies in place to mitigate this
risk.

Outsourcing of Payroll

The company outsourced its payroll at the start of the accounting year. At present we do
not know the reasoning behind this, but if it was done to reduce costs there is a risk that
the chosen supplier might not be of the highest quality leading to breaches in tax rules,
or late payment of staff. The company cannot afford to upset the tax authorities, or its
staff, in addition to all the other challenges it currently faces, as this could lead to penalties
or staff refusing to work or leaving.

Liquidity

The current ratio has fallen from 1.3 to 1.1, which implies a worsening liquidity position.
This might suggest the client is finding it harder to meet its obligations, which could lead

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 to suppliers refusing to supply, banks refusing to lend, and therefore an even tighter
cashflow position going forward.

Receivables days have risen from 107 to 175, which shows a further cashflow pressure
being caused by the client’s inability to get customers to pay. If this problem
continues, and customers become used to paying later, it may be very difficult
to reverse the trend, leading to even worse cashflow pressures in the near
future.

Payables days have risen from 225 to 289, together with the new (and expensive) loan,
and new share issue, are all indications of a company that is struggling to raise cash
through operations. If they continue to pay suppliers later than usual, they are at risk of
those suppliers demanding cash up front, or refusing to supply at all. There is a limit to
the amount of expensive loans a company can afford to finance.

Poor cost control

Other operating costs are up 170%. Given sales are falling, this increase seems both odd
and very worrying. The company cannot afford to be overspending on top of its other
problems, as it will further damage their cashflows.

(b) Risks of Material Misstatement

● There is a risk that intangible assets are overstated, and expenses understated, if
research costs have been capitalised within the Development costs. The company
seems to be capitalising all such costs so there must be a genuine risk that some
research costs have been included, especially as sales are falling and there will be a
clear incentive to protect profits. Under IAS 38, research costs should be expensed,
not capitalised.
● A further risk of intangible assets being overstated (and expenses understated) arises,
because under IAS 38 development costs are only capitalised if certain criteria are met
– there must be an expectation that development projects are going to finish, and that
the products are successfully launched and make enough money to cover the costs of
developing them. There are clear barriers to the company completing projects, such
as potential patent claims from competitors and cashflow issues, and until licences are
obtained some of the products cannot be sold at all. As such, capitalising all such costs
on the assumption that all development projects will be successful seems a little
optimistic.
● Provisions and expenses are at risk of understatement, and contingent liabilities at risk
of under-disclosure. Under IAS 37, if the company has incurred an obligation before
its year end (legal, or constructive), and future payments are deemed probable and
can be estimated, then a provision and associated expense need to be recorded. It is
not known whether the two ex-directors have a valid claim for wrongful dismissal, but
if the company is already planning an out of court settlement than a provision would
seem appropriate as a payout seems likely. The claims of breached patents from
competitors seem to be at a far earlier stage, and more of a threat than reality for
now, but if the claims are true and patents have already been breached, or are
breached before the end of the accounting year, a provision may be required.

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 Where a claim is possible rather than probable, a contingent liability disclosure note
would be required instead. The company are unlikely to want to disclose any
suggestion of patent breaches, causing a risk of under-disclosure.
• Deferred income is at risk of overstatement, and provisions of understatement,
because there seems to be a risk that the company is already unable to meet the
terms and conditions of the grant received last year. They still have a few weeks to
comply, but if they have already decided not to construct the facility before the
deadline, the obligation to repay might already have been created. Under IAS 20, on
receipt a grant should be credited to deferred income and then released to match the
expenses it is designed to help pay for. Assuming the grant remains in deferred income
for now, if the company is likely to have to repay it then it should be moved to
provisions, as per IAS 37. If a repayment is possible rather than probable, there is a
risk of under-disclosure of this contingent liability.
• Payroll expenses and payroll liabilities are at risk of over or understatement. At the
start of the year, payroll was outsourced to a service provider. There is a risk that
errors occurred when figures were transferred across, or that if the service provider’s
performance is not being monitored, errors have occurred during the year.
• Sales revenue, receivables and exchange gains/losses are all at risk of over or
understatement if overseas sales on credit are in foreign currencies. Revenue would
need to be retranslated at the date of each transaction, and errors might have
occurred. At the year end, any receivables balances in forex would need to be restated
at year end rates as required by IAS 21, and this might not have happened, or errors
might have been made.
• Inventory is at risk of overstatement and cost of sales is at risk of understatement.
Under IAS 2 it should be valued at the lower of cost or NRV. Given it is looking
technologically obsolete, backed up by the increase in inventory days from 77 to 122,
there is a risk it will be sold below cost, or potentially not at all.
• Receivables are at risk of overstatement and expenses of understatement. Receivables
days have increased from 107 to 175, which suggests problems collecting debts. There
is a risk that there are bad or doubtful debts included at full value within receivables.
Under IFRS 9 they must be held at their expected recoverable value.
• Any assets used to manufacture old technology products are at risk of impairment,
and therefore assets would be overstated and expenses understated. Assets should be
held at no more than their recoverable amount, which is the higher of value in use
(which has surely reduced with falling sales) or NRV. Writedowns may have not been
done (e.g. to avoid alarming investors)
• There is a risk of overstated revenues and assets, and understated expenses and
liabilities. The company has recently done a share issue and got a new loan, and may
have been manipulating the accounts in order to ensure these fundraising events were
successful.

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(c) Procedures
• Obtain breakdown of development costs capitalised for each project, pick samples and
inspect invoices to assess whether the costs have elements of research expenses
included.
• Seek legal opinion as to the likelihood of the claims about patent breaches being true,
to assess whether these claims could stop some development projects ever being
completed.
• Inspect project plans for each development project to assess the cash needed to bring
them to completion, and compare with the company’s cashflow forecasts to assess
whether the company has the finance available to complete all of the projects.
• Inspect board minutes to assess whether the board remain fully committed to financing
all current development projects, obtaining a written management representation to
confirm this commitment.
• Discuss current projects with the company’s marketing department to establish if any
projects have launch dates or advertising campaigns planned, to help assess which
projects seem most likely to reach completion.
• Inspect market research reports to assess likely future sales potential for each new
product under development.
• Inspect correspondence with licensing authorities for evidence that the company is
trying to get new products licensed, and for evidence of any problems in doing so, to
help assess whether products under development will ever reach market.
• Enquire of product development staff whether testing of new products under
development is going well and to plan, and inspect test results to establish if any
problems are arising that could delay completion
• Discuss the two “ill” staff with the HR department to try to establish whether a
continued absence could further harm the company’s ability to complete its current
development projects.
• On the final audit, follow the progress of those development projects that were
incomplete as of 31 March 2019 to see if they remain on track to be completed, or
have fallen behind.
(d) Outsourcing – Impact on Planning
Our primary issue here is the need to collect sufficient appropriate evidence regarding
payroll expenses and payroll liabilities in the financial statements.
For our substantive procedures, we will need access to the payroll records. As part of our
audit plan, we need to discuss this with Sinclair Medical and ask them to either get the
payroll records back from Payroll Bureau in time for our audit fieldwork, or arrange with
Payroll Bureau for a suitable time for us to visit them so we can do our audit work on our
client’s records at their premises.
We will also wish to assess the controls over production of the payroll figures, and this is
going to be more difficult because the relevant controls are those at Payroll Bureau, not
our client. It may be possible for us to visit Payroll Bureau and document, assess and test
their controls but they are under no legal obligation to allow us to do this. We should ask

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 our client to discuss this possibility with their payroll supplier, as the year end is almost
here and we would need to do this controls work as soon as possible.
If we cannot check their controls ourselves, an alternative would be for us to contact
Payroll Bureau’s external auditors (assuming they have any) as they are likely to have an
understanding of the quality of the controls at their client. It may be possible to get that
audit firm to provide us with a report as to the reliability of Payroll Bureau’s controls, on
which we could then rely in deciding how much we can reduce our substantive procedures.
Such a report (a “type 2” report) would need arranging in advance and will need the
involvement and agreement of both our client and their payroll provider, so we ought to
plan this as soon as possible if it is a route we wish to explore.
A further alternative to assess controls at Payroll Bureau is to assess how our client chose
this supplier, and how they have monitored the service provided over the past year. If
our client put the service out to tender, and if since selecting them they have checked
quality of work, there may be enough documentary evidence available to help us assess
Payroll Bureau ourselves.
If we cannot get enough evidence about controls, we would have to plan to do extensive
substantive testing of payroll figures and this will mean planning to start work as soon as
possible, may require more staff on the audit, and may contribute to a higher audit fee.
(e)

Issues

(i) Bidwell plc

Revenue is typically a material figure in a set of financial statements. It is also an
area that can be subjective and require professional judgment, and is a prime area
where fraud can take place. This makes revenue an area that is typically at high
risk of misstatement, so any suggestion it is low risk would need clear evidence as
to why.
IFRS 15 has also recently been issued, and any change in accounting rules can
add to the risk of misstatements.
There is no evidence of any tests of control having taken place. In fact the
manager’s comments show a lack of professional scepticism over revenue at this
client, probably not helped by the manager having involved for the past 10 years.
This seems to have created a familiarity threat that has affected the manager’s
judgment.
The failure to provide documentary justification of the conclusion re low risk is a
failure in quality control. It also suggests that sufficient appropriate evidence will
not have been collected, both because the person doing the audit work was almost
certainly too junior to be judged as fully competent, and because just doing
analytical procedures is not sufficient in terms of detail. There is a risk therefore
that the audit opinion on this client is incorrect and that revenue might be
materially misstated.
Given the client is listed, it would have required a second independent partner to
quality review the audit files before the audit report was signed by the engagement

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 partner. It is concerning that neither of these two partners queried the lack of work
done on revenue.
It might be the case that there are mitigating circumstances, so before any
conclusions on quality are drawn the engagement partner and quality control
reviewer should both be interviewed. It might be the case that additional work has
been done but the working papers are not on the audit file, for example (although
this is a sign of poor record keeping at the very least).
It is also important to question why the same audit manager has been on this
client for so long, and why work that appears so poor, and delegated to someone
too junior, was not picked up in the detailed audit plan.
Given all of the problems and failings above, the firm appears to have been
negligent in this audit and must therefore be at risk of being sued.
It would be sensible to review other audit files involving this engagement partner,
this manager, and this quality control review partner, to see if this was a one-off
incident or signs of repeating problems within the firm, and those involved may
need to be reprimanded for their poor work.
It would be wise to run additional training sessions to ensure all staff are aware of
the importance of avoiding such failings.

(ii) Manning plc

It seems that the underlying problem with this audit is that new clients have been
taken on by the firm without first checking that the firm had the resources to do
the additional work. As such, pre-appointment procedures need to be reviewed
and potentially strengthened to avoid such problems happening in the future.
In being unavailable, the manager in particular has failed to provide appropriate
supervision on the audit. The audit senior may indeed be fully qualified, but it was
only recent and that suggest a lack of experience and therefore at least some
supervision needed.
The assessment of independence has been carried out after the audit, meaning
there may have been threats to independence and if so these will not have been
managed with appropriate safeguards. This may mean audit work carried out was
unreliable, meaning the audit opinion’s integrity is at risk.
The assessment of independence is fundamental, and as such should have been
concluded on by the engagement partner, not a recently qualified senior. The
failure to do this, and the failure of the engagement quality control reviewer to
pick this up, are both very concerning and suggest flaws in the review processes
within the firm.
The audit is finished, and at present the existence of any ethical threats is
unknown. A full independence assessment should be done immediately, and if
threats are discovered then a full review of the audit work should be redone to see
if these threats might have impacted on the audit opinion.
As with the first scenario, the audit firm seems to have been negligent in delegating
such a crucial task to someone relatively junior, and in allowing the task to be
done far too late in the process. The firm is again at risk of being successfully sued.

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 The engagement partner needs to be reprimanded, and training of all staff (in
particular the partners) is required to reinforce the failings discovered and the
importance of doing a full independence review in advance of accepting new clients
or being reappointed at existing ones.
It would also be wise to review all other audit files from around the time that the
new clients were accepted, as the problems on this audit may well have repeated
elsewhere.
A staffing review should take place, to see whether the firm has enough resources
for its increased client load. If not, either new staff must be hired as a matter of
urgency, or it might be necessary to resign from some clients.

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Answer 2

Tutorial help and key points

This non-audit question covers two potential non-audit assignments, a due diligence
exercise and reporting on non-financial performance data (in this case a mix of social,
environmental and operational data).
In part (a), ensure you understand the requirement before answering. It is matters to
consider before accepting an appointment ... and must use the specific information in the
scenario. Simply repeating a long list of memorised issues from a textbook will score
almost nothing. The list must be tailored to the information given to score the marks
needed for a pass. Suggesting things irrelevant to an existing audit client (e.g. integrity
of client, understanding of industry) will score no marks.
In part (b), it is a much easier to score with textbook knowledge, but the scenario can still
be used. For example, Abbott’s most recent year end was 9 months ago, meaning the
most recent 9 months of performance will not have been audited yet.
In part (c), the scenario outlines the types of data being reported, so think of standard
audit procedures (AEIOU) that might be used to verify such data.
Marking scheme
In part (a), up to 1.5 marks for each issue covered, other than threats to independence
with up to 3 marks, dependent on how well each is tied to the scenario.
In part (b) up to 1.5 marks for each area of investigation, subject to the depth of
explanation provided.
In part (c), up to 1 mark per procedure (1/2 mark only if no explanation)

(a) Matters to consider

Time and Deadlines
There is only a four-week window for this work to be planned, completed and reported
on. In addition that window started today, meaning time is short and the deadline is
very close. It may be very difficult to carry out enough work within the timeframe,
especially as the target is based overseas, and our existing staff are likely to be working
on other clients in the short term.
Taking staff off other assignments may compromise the deadlines and quality on other
work, as well as upsetting other clients.

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 Competence
The target company is in the same industry as our client so we clearly understand the
industry. If we have a transactions advisory department we have probably been involved
in due diligence work before.
However, the target is overseas and we might lack the local knowledge about the
country where it is based, and the laws, regulations and culture to which it is exposed.
Having said this, as part of a global network of firms it should be possible to acquire any
missing knowledge from network firms in that country (if there are any), and potentially
outsource some of the work to them, if they have the appropriate staff available within
the window.
Threats to Independence
The client is keen to use our firm because of the audit relationship. This might imply
that our firm is already quite familiar with the management of Gregory Co, and taking
on this additional work is likely to increase that familiarity threat and put the audit
relationship under threat.
There are also potential self review threats going forward, as the future audits are likely
to come across evidence that the due diligence team saw during their work and
expressed an opinion on. Future audit staff might not be keen to highlight errors made
in the due diligence work, especially if the takeover goes ahead and then Abbott Co
under-performs.
There is also a self-interest threat. Our firm might feel it is best to recommend the
takeover as it means the client becomes larger, and increased future audit fees are
likely.
If the company has not acquired anything before, they may well rely on our experience
and advice a lot. This creates a management threat, as we may end up effectively
making the acquisition decision for them. If we are seen as making management
decisions for an audit client, shareholders might conclude that we are not as separated
from management as we should be as auditors.
We can help manage these threats by ensuring the staff who do the due diligence work
are not the same people who do the audit, although this could be difficult as the client
seems to like our firm and may be hoping to see the same audit staff they already know.
The client’s expectations will need to be carefully managed in this respect.
Liability
It seems that Gregory Co are seeking a bank loan, and there is a strong chance that the
due diligence report will be provided to the bank to give assurance the acquisition is
sensible. If we are made aware of this before reporting, we are at risk of being held
liable to the bank.
We should investigate whether we the client will allow us to put a disclaimer into our
report, or otherwise restrict who can read the report.
Level of Assurance Required
Due diligence, unlike an audit, has no rules as to how much assurance should be
provided. The client might be satisfied with us simply collecting an agreed list of factual

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 information for them (zero assurance), or more likely they will want us to provide some
assurance as to the current financial and legal status of the target company.
The assurance level will affect the amount of work we need to do, and therefore the fee,
so will need to be agreed in advance.
(b) Areas to investigate
Financial Performance and Position
The most recent year end of the target company was 9 months ago, and presumably
the financial statements of that year end were audited. As such, it should be relatively
safe to rely on that information being reliable, as with the previous years of financial
statements which we would want to review, to highlight key trends in performance, and
to highlight contingent liabilities, bank loans and other relevant information to a buyer.
We may also need to do some work verifying the reliability of the past 9 months of
management accounts. It might be the case that some testing of these figures has
already been done, e.g. by Abbott’s internal auditors, but whether or not this work is
enough to rely on is another matter.
Forecasts
If our client goes ahead, they are buying Abbot’s present state but also its future
prospects. We would assess their forecasts carefully against industry forecasts, and
check the assumptions used in their preparation, as well as checking the calculations
and checking whether they appear complete.
We will need an element of scepticism here – if Abbott Co have been trying to effect a
sale, their figures might be deliberately optimistic to attract a buyer.
If the company has an order book we should get evidence to verify the orders are firm
and unlikely to be withdrawn. If the company has negotiations with potential customers
that have not reached firm orders yet, we should examine correspondence for evidence
of the likelihood some of these will turn into firm orders.
Current Owners of Abbott Co
Abbott is a subsidiary within a group. We will need to understand what services Abbott
currently gets from its parent and whether or not these are on commercial terms. For
example, Abbott might be able to use office space in the parent company premises, or
share IT servers, telephone systems, and staff facilities. They might be getting all of this
for free from the parent company, meaning Gregory Co would then need to supply these
services after the acquisition or replace them at usual commercial rates.
Contracts
An organisation is largely the sum of its contracts. If no contracts existed at all,
immediately after buying a company all the staff might leave, customers might leave,
suppliers might stop supplying and banks might withdraw loans etc.
We will need to go through the terms and conditions of all key contracts such as:
o Key staff, to see what notice periods they are on, whether a change of ownership
allows them to leave, or triggers a bonus to be paid etc

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 o Building leases, as a change of ownership of a company often means new credit
checks on the new owner, which if failed could lead to the lease being terminated
or lease payments rising
o Supplier contracts, for a similar reason to leases above. Suppliers might choose to
stop supplying on credit if they do not trust the new owner’s ability to pay
o Customer contracts, to see how long customers are tied in, whether they have
warranties or other forms of guarantee that the new owner might become
responsible for etc
o Regulatory licences, as a change of ownership may require these to be reapplied
for, and if licences are a requirement to operate then losing one would be a
significant headache
Legal Issues
We would need to investigate if there are any outstanding legal claims against the
company. These could cause significant costs as well as reputation damage for the new
owner.
Claims
Any claims made by the management of the target company will need to be checked,
including awards won, claims to have a strong reputation etc. Such claims can often
have a large impact on the valuation of a company.

(c) Procedures to test Performance data

o Physically observe the presence of recycling bins on company premises and
compare the ratio of recycling bins with non-recycling bins to help verify the
percentage of waste the company claim to be recycling.
o Inspect invoices for waste disposal and identify the quantity of waste being recycled
v the quantity being disposed of without recycling, to verify the percentage being
disclosed.
o Ask company staff about the company’s recycling to assess if the percentage being
claimed matches staff responses.
o Inspect human resources documentation, including timesheets, sick notes as
relevant to help verify the number of days lost to staff sickness.
o Compare staff sickness rates with other companies, to assess if they appear
reasonable.
o Physically inspect production premises to establish how much plant and machinery
is out of service at the present time as a proportion of the total plant and machinery
owned, to help assess if the claims published appear reasonable.
o Inspect invoices for replacement parts and repair and maintenance to verify dates
when assets were out of use, and to establish how long they were likely to have
been out of use.
o Speak to production staff to enquire how often machinery breaks down to see if it
ties in with the published data.

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 o Inspect maintenance plans for assets to help assess the normal level of
maintenance time expected.
o Read board minutes to identify and major incidents where key equipment was out
of service and causing production problems.
o Inspect customer satisfaction reports, complaints logs, and customer
correspondence to help verify customer satisfaction scores.
o If customer satisfaction scores are based on customers filling in some form of
survey, obtain these surveys and recalculate the scores to compare with those
published.
o Survey industry literature to see if the reputation of the company in independent
journals ties in with the satisfaction data being published.
o If emissions data is being collected automatically, inspect the data reports from
the testing equipment to verify that it agrees to what is being published (in all
likelihood some expert help will be required to check emissions data).

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Answer 3

Tutorial help and key points

Part (a) of this question is new, but students should be expecting to be tested on it (and
if you have read the examiner article on new format audit reports, there is no excuse!).
With 5 marks available and a 2-part requirement, it looks like you need 2 or 3 examples.
Part (b) requires some thought. There are 4 issues but no split of the 14 marks, meaning
the best assumption is around 3-4 points need to be made for each one. The audit report
implications are probably the easier bit, as this is examined very regularly. Students who
have forgotten that auditors need to communicate all important issues with the client’s
audit committee (“those charged with governance”), including significant control
deficiencies (ISA 265) but also anything else important from the audit process (ISA 260)
may not realize what the question is getting at in that respect.
Note the client is not listed, so Key Audit Matters are not relevant to part (b).
Part (c) of the question touches on one of the technically harder audit standards. For 6
marks, try to plan an answer that makes 6 separate points. Subsequent events include
those before and after the audit report is signed, so splitting your answer plan into two
3-mark questions makes a lot of sense.
Marking scheme
In all parts, up to 1 mark per valid point (1/2 mark if no explanation). In part (b), no
more than 4 marks can be scored on any one of the four scenarios.

(a) Key Audit Matters

Key audit matters are those issues that took up the most time and effort during the
audit. As such they represent those things that were discussed at length with the
company’s audit committee (or with the board in general). KAMs are required for all
listed company audit reports.

The auditor should go through the matters discussed with the audit committee and
select those as KAM that they believe to be the most important for shareholders to be
told about, to help understand the audit and FS.

For each KAM, the auditor should explain in the audit report why the matter is
considered significant to shareholders, how the auditor addressed the matter (e.g. the
test carried out) and the conclusions of these tests.

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 Examples will include matters of great subjectivity, significant events or transactions,
or matters that are complicated. As such, specific examples are likely to include:

• Impairment assessment on assets, especially intangibles as the valuation of these

is typically harder to assess

• Whether to recognise something as a provision or a contingent liability, given this is

based on probabilities of future events occurring

• The effect on the FS of big changes in accounting rules or accounting policies

(b) Inventory Count

The problems at the inventory count represent a significant deficiency in internal

controls, and as per ISA 265 such deficiencies should be communicated to those charged
with governance in writing, along with an explanation of the consequences of these
deficiencies and recommendations for improvement in the future.

Consequences are likely to include:

- The risk of theft not being discovered, meaning anyone stealing is free to continue

- Misstated inventory records, meaning the company might run out of items and not
realise, leading to upset customers and operational problems

- Additional external audit work (and fees) as a result of the increased substantive
procedures needed

- Potentially material misstatements in inventory in the financial statements (although

not on this occasion it seems – see below).

Recommendations would include the need for clear stocktake instructions, a pre-count
meeting with counting staff to verify all know what they should be doing, adequate
supervision of the count process etc.

It seems that the auditors are satisfied the financial statements have not been affected
by these control problems, so there is unlikely to be any impact on the audit report to
the shareholders.

Borrowing Costs

Under IAS 23, borrowing costs incurred to finance construction of an asset are part of
the cost of that asset and should therefore be capitalised. Construction lasted for half
of the year and so $125,000 of the costs should be capitalised, meaning at present
profit and assets are understated.

The figure represents 1% of PBT and <1% of assets and therefore is not material to the
financial statements.

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 This error should be added to the statement of unadjusted errors and supplied to those
charged with governance. The aggregate effect of all such unadjusted errors should be
calculated, and those charged with governance advised as to whether the combined
effect is material.

As it stands, the error is immaterial and therefore there would be no impact on the audit
report. If there are other immaterial errors not mentioned in the question, there might
need to be an modified opinion, but based on the information given no such modification
is required.

Going Concern

Under IAS 1, any significant threat to going concern should be disclosed in a financial
statement note by the company. The company has done this, and other accounting
entries relevant to the situation appear to be satisfactory.

As such, the financial statements are not materially misstated and no modification is
needed to the Opinion in the audit report.

However, immediately after the Basis For Opinion section, an additional section needs
to be added titled “Material Uncertainty Related to Going Concern” (MURGC). This
paragraph will need to:

- Highlight the disclosure note in the financial statements

- Make clear that the auditor agrees with the content of that note

- Make clear that the audit opinion is not affected by this matter.

Since the addition of this paragraph will modify the audit report, and the MURGC is a
relatively new concept in audit reporting, the report to those charged with governance
will need to explain why this paragraph has been added (i.e. to comply with recent
changes to ISA 570).

Integrated Report

The integrated report is part of “other information” – the items attached to the audited
financial statements but not themselves subject to an audit.

The auditor must read all such documents (and this seems to have been done) to
highlight any content which might be inconsistent with the financial statements and
which might therefore undermine them, and the audit report.

In this case, the sentence talks of significant growth but profit is down on last year, and
revenue and assets have barely changed. Whilst this could be because actual growth
has been cancelled out by the provision for the investigation, the sentence as it stands
appears rather misleading and those charged with governance should be informed of
this, and the need to change it (or at least clarify it).

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 If this is not changed, the audit opinion in the audit report will remain unmodified, but
an Other Matter paragraph will need to be added lower down the report, highlighting
the inconsistency and making clear that the opinion on the financial statements is not
affected.

If this paragraph is added to the audit report, an explanation of why it has been added
will need to be added to the report to those charged with governance, so that they
understand the rationale behind our audit report before it is issued to shareholders.
(c) ISA 560 – Subsequent Events

Subsequent Events are those events that occur after the company’s year-end, but before
the AGM.
For those events occurring between the year end, and the signing of the audit report,
the auditor has an active audit duty. This means that the auditor needs to be seeking
audit evidence to verify these events, and to be able to assess their potential impact on
the financial statements being audited.
Under IAS 10, Events After the Reporting Period (EARP) are those events that occur
between the year end and the date the directors sign the financial statements. Such
events can give additional information about the figures or disclosures within the
financial statements of the recently completed year end (“adjusting events”). For those
EARP that are irrelevant to the previous accounting year, no adjustments are necessary
– but if a non-adjusting event is material, IAS 10 requires a disclosure note in the
financial statements.
Therefore, since these EARP are happening up until the financial statements are signed
by the directors, the events need to be actively audited to see if they are adjusting or
disclosable.
If, before signing the audit report, material misstatements are found in the financial
statements, and the client refuses to correct them, the auditor can modify the audit
opinion as appropriate.
After the signing of the audit report, the auditor has a “passive duty” up until the AGM.
This means no audit work is undertaken, but if the auditor is told that there is a material
problem with the financial statements, this cannot be ignored. Until the AGM, the
financial statements have not been authorised by the shareholders and so there is still
time to correct them.
If a material misstatement is communicated to the auditor after the audit report has
been signed, and the client indicates they are not going to correct it, the auditor should
communicate with the shareholders as soon as practicable to explain that their audit
report is wrong and should be ignored. If the AGM is close, the matter could be reported
by the auditor there, but if the AGM is still some time away a separate letter to
shareholders and (if listed) a stock exchange announcement would be best.

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 If the client agrees to correct this “late” misstatement, the auditor will need to check
that the correction has been done properly, check that the client has not altered
anything else in the financial statements, and then extend active audit duty from the
date of the original audit report up to today – because if the financial statements have
been corrected and reissued, the IAS 10 period extends up to the new date, and the
auditor has not yet audited this “gap” where there might be additional adjusting or
disclosable events.

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