End of Semester 2, 2020

Marking Guide_ACCT3000 Mock Final Exam Paper

PART A: MULTIPLE CHOICE QUESTIONS (10 MARKS)

ANSWER ALL QUESTIONS. EACH QUESTION IS WORTH 1 MARK.

Part A consists of ten (10) multiple-choice questions. Please indicate the answer
you believe to the best response to each multiple-choice question.

1. An adverse opinion is most likely to be appropriate when there is:

a. a scope limitation.
b. a misstatement confined to a specific item.
c. a disagreement with those charged with governance which is material
and pervasive.
d. inconsistent other information.

2. Which of the following bodies monitors the operation of the Auditing and
Assurance Standards Board?
a. Financial Reporting Council.
b. Companies Auditors and Liquidators Disciplinary Board.
c. Australian Securities Exchange.
d. All of the given answers are correct.

3. Your audit client is under intense pressure to meet an earnings target. Which
transaction assertion for purchases are you most concerned with?
a. Occurrence.
b. Completeness.
c. Classification.
d. Accuracy.

4. The audit test that would normally be regarded as a test of control is:
a. enquiries of third parties.
b. test of the specific items making up the balance in a given general ledger
account.
c. test of the additions to property, plant, and equipment by physical
inspections.
d. test of the signatures on purchase orders to a list of approved
signatories.

5. Which of the following procedures would an auditor most likely rely on to

verify management's assertion of completeness?
a. Comparing a sample of shipping documents to related sales invoices.
b. Reviewing a standard bank confirmation.
c. Confirming a sample of recorded receivables by direct communication with
the debtors.
d. Observing the client's distribution of payroll cheques.

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6. For a particular assertion, control risk is the risk that:

a. a material misstatement will occur in the accounting process.
b. audit procedures will fail to detect a weak control system.
c. control procedures will not detect a material misstatement that occurs.
d. the prescribed control procedures will not be applied uniformly.

7. In making judgements about materiality at the account balance level, the

auditor must consider the relationship between it and overall materiality. This
should lead the auditor to plan the audit to detect misstatements that:
a. are individually material to the statements taken as a whole.
b. are individually immaterial to the statements taken as a whole.
c. bring the cumulative total of known misstatements to the level of materiality
established by management.
d. may be immaterial individually, but may aggregate with misstatements
in other accounts to a material level.

8. Which of the following would NOT be considered to be a risk factor for

potential misstatements?
a. there is intense price competition in the industry of operation.
b. promotions are made on the basis of meeting reasonable targets.
c. an employee in the cash office was passed over for a promotion.
d. the internal control of segregation of duties was not practiced.

9. The risk of concluding control risk is higher than it actually is, is also known as:
a. risk of overreliance
b. risk of underreliance
c. risk of incorrect acceptance.
d. risk of incorrect rejection.

10. The auditor has assessed control risk as high. Which of the following is not true?
a. A predominantly substantive approach will be used.
b. The extent of substantive procedures will result in a costly audit.
c. The auditor will conduct extensive tests of controls.
d. The auditor is not placing reliance on the internal controls.

END OF PART A

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PART B - SHORT ESSAY QUESTIONS. (90 MARKS)

ANSWER ALL FOUR (4) QUESTIONS.

QUESTION 1 (15 Marks)

You are the external auditor for ABCM Pty Ltd, a merchandising company. You have
performed the following audit procedures:

(a) A random sample of creditors was selected from the invoices and reconciliations
(where appropriate) and agreed to the accounts payable ledger. (3 Marks)

(b) Developed a simple spreadsheet model to enable the recalculation of wages

expenses.
(3 Marks)
(c) Attended each monthly stock-take, selecting a sample of 130 items from the stock-
sheets and agreeing them to the physical stock in the warehouse. (3 Marks)

(d) Gathered external confirmation from the financial controllers of two debtors of
ABCM Pty Ltd, regarding a total outstanding amount of $60,000 at balance date.
(3 Marks)
(e) Asked one of your assistants to vouch the legal title documents pertaining to ABCM
Pty Ltd’s machineries in the factory. (3 Marks)

Identify the key assertion that you are most likely testing with each of the above
procedures and provide an explanation for your answer.

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Solution:

Key assertion Reason

tested
(a) Completeness The auditor is tracing from the underlying source
documents to the accounting records to check for any
potential understatement issues. Tracing is likely being
used to make sure, whether all the creditors that should
have been recorded, have been recorded. Hance, the
assertion of completeness.
(b) Accuracy The recalculation being performed here is to check the
dollar value (accuracy assertion) of the payroll expenses
recorded in the income statement.
(c) Existence Selected a sample of items from the stock sheets and
physically verified their existence in the warehouse to
confirm that the respective items of inventory which
have been recorded actually exist. This audit procedure
of conducting the audit trail from financial records to the
source is called vouching and is conducted to test for
overstatement issues.
(d) Existence External confirmation from the debtors is to verify and
confirm that the both the outstanding debtors exist at
balance date.
(e) Rights and Verifying whether the entity has legal title or equivalent
Obligations ownership rights to the machineries.

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QUESTION 2 (15 Marks)
Ulysses Polytropos Ltd is an Australian company which manufactures travel products
including suitcases, backpacks, wallets, hiking gear, clothing and other sundry travel-
related items. The market for these products is characterised by fashion conscious
customers, innovation in design, high levels of competition and product costs pressure
from cheaper but high quality-products from a variety of manufacturers around Asia. The
market continues to grow which creates new opportunities but also attracts new entrants
into the market. Ulysses Polytropos operates at the high quality, and high price, end of the
market and has in recent years seen a decline in demand for its products despite the overall
buoyant market. This has been attributed to demand for cheaper products as well as
domestic customers buying online from around the world. In order to address this decline,
the company has tried to change its research and development division but has struggled
to attract employees with the vision to take the company forward.

In order to reduce production costs, the organisation invested in new manufacturing plant
and reorganised the factory layout to create more efficient processes. This required a
significant investment, only some of which was able to be financed by long-term bank
loans. Ulysses Polytropos has fully drawn down on its bank overdraft facility, the banks
are unwilling to provide further funds and, in order to manage cash flows, creditor
payment days have extended, leading to difficult relations with some key suppliers who
will no longer do business with the company.

The forecast for the coming 12 months shows the cash position worsening so additional
funds will be required to allow the company to continue meeting its obligations. The
directors believe that it will take another 18 to 24 months to turn the business around and
move back into profitability. The bank overdraft is being reviewed in two months’ time
and the directors are confident that additional funds will be made available to allow the
company to continue to trade for the next two years and then they will see the business
become successful again.

Required:

1. Identify and explain any indicators that there are doubts about Ulysses Polytropos
Ltd’s ability to continue as a going concern. (7.5 Marks)

2. Audit risk is said to be a function of inherent risk, control risk and detection risk.
Explain audit risk. Define and differentiate between each of its components.
(7.5 Marks)

(Total 15 Marks)

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Solution:

1. Identify and explain any indicators that there are doubts about Ulysses
Polytropos Ltd’s ability to continue as a going concern.

Going concern indicators:

o There has been a decline in demand for the company’s products, if this continues then
it will be difficult to generate sufficient cash to survive as an organisation.

o The company is unable to recruit new research and development staff, this will make
it difficult to develop new innovative products to meet the changing demands of
customers.

o The company was unable to obtain the funds required to invest in new manufacturing
plant, this would indicate that either the company has insufficient assets to provide the
necessary security required by the bank or that the bank was not sufficiently confident
in the company’s prospects to lend further funds. The prospects of obtaining new
additional funds might be more difficult than the directors believe.

o The company is at its overdraft limit indicating immediate financial problems, the fact
that some suppliers are not getting paid on time suggests that the company is unable
to pay its debts today, it may be insolvent.

o The loss of key suppliers, the cash flow problems have meant that suppliers are no
longer trading with the organisation which may mean difficulty in getting supplies
leading to production problems.

o The forecast indicates continuing problems with cash flows for at least 12 months and
possibly as long as 24 months; this will place greater difficulty on paying suppliers.

All these difficulties indicate that the organisation is going to have difficulty convincing
the bank to provide additional funds. Without these funds, it would appear that the
company is unlikely to survive 12 months never mind the possibility of 24 months that
may be needed before things start to get better.

2. ASA 200 describes audit risk and its components. Audit risk (AR) is the risk that the
auditor gives an inappropriate opinion on financial statements that are materially
misstated.

The three components of audit risk are:

Inherent risk (IR) is the possibility that a material misstatement could occur in the absence
of related internal controls. This risk exists independently of the audit of a financial report.
The auditor cannot change the actual level of inherent risk.

Control risk (CR) is the risk that a material misstatement could occur and not be prevented
or detected on a timely basis by the entity’s internal control structure. Control risk is a
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function of the effectiveness of the client’s internal control structure policies and
procedures.

Detection risk (DR) is the risk that any remaining misstatements will not be detected by
the auditor’s substantive procedures. Detection risk is a function of the effectiveness of
audit procedures and their application by the auditor.

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QUESTION 3 (30 Marks)

Your client is Queenscorp Ltd, a diversified business operating throughout Australia.

Year- end was 30 June 2011, the auditor’s report was signed on 31 July 2011 and
the financial statements were mailed to shareholders on 14 August 2011.

During your subsequent events review you noted the following independent and
material items:

1. Queenscorp has been involved in a legal dispute with a competitor for a

number of years. The dispute relates to alleged breaches of copyright by
Queenscorp. On 27th July you discovered that Queenscorp had settled legal
action out of court on terms more favourable than expected.

2. On 10th July one of Queenscorp’s major product lines developed a fault that
rendered the product unusable. Queenscorp became aware of the fault on 30
July. Although the fault posed no safety risks to consumers, Queenscorp
decided to launch a full product recall on the following day.

3. Queenscorp has invested significant funds in developing a new type of

cholesterol- reducing margarine. On 7th July Queenscorp applied for a patent
for the margarine, only to discover that the competitor has lodged a similar
application previously. The granting of Queenscorp’s application is now in
doubt.

4. Queenscorp’s bank loan is conditional upon certain ratios being maintained

at all times. On 20th August you discovered that one of the ratios was
breached for a 24- hour period on 18th August.

5. In early June, one of Queenscorp’s largest debtors informed Queenscorp that

it was experiencing serious financial difficulties. On 5 July, Queenscorp was
informed that the debtor had gone into receivership. Preliminary reports
suggest Queenscorp will recover only 10 cents in the dollar of the outstanding
debt.

Required

(1) Describe your obligations as the auditor to each of the above subsequent events.
(5 X 2 Mark = 10 Marks)

Question 3 continued over the page

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Question 3 continued

(2) For each of the events described above, select the appropriate action from the list
below and justify your response:
A Adjust the 30 June 2011 financial report.
B Disclose the information in a note to the 30 June 2011 financial
report.
C Request the client recall the 30 June 2011 financial report for
revision.
D No action is required.

(5 X 2 Marks = 10 Marks)

(3) What additional information would you obtain in relation to each of the events
described above?

(5 X 2 Marks = 10 Marks)

(Total 30 Marks)

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Solution:

Period 1 events: Events after balance sheet date (30 June 2011) but before the date
of the audit report (31 July 2011).
Period 2 events: Events after the audit report date (31 July 2011) but before the date
the client issues financial statements (14 August 2011).

Period 3 events: Events after the client issues financial statements (14 August 2011).
Balance Sheet Date Audit Report Financials Issued

30/06/2011 31/07/2011 14/08/2011

1.
Requirements (1) & (2): A. This is a post balance date event relating to conditions
existing at balance date i.e. it is an adjusting event. Any loss or costs payable that
can be verified should be recorded as litigation costs or liability in the accounts. As
the dispute has been there for a number of years, the company would have a
contingent liability account for this dispute. This would have been transferred to
liability account which is incorporated within the financial statements as the legal
dispute has been resolved. This is a period 1 event (ASA 560. 6, 7, 8) wherein the
auditor has proactive responsibility. Hence, the auditor must request management to
adjust the 30 June 2011 financial report.

Requirement (3): The auditor will need to discuss with management regarding the
settlement of the legal dispute and review the evidence of what amounts have been
agreed upon to be paid etc. The auditor should also contact the audit client’s solicitor
about a solicitor’s representation letter regarding this before the audit report is due to
be signed so as to establish any loss that should be recorded in the accounts.

2.
Requirements (1) and (2): B. This is a post balance date event relating to conditions
existing after the balance date i.e. it is a non-adjusting event. This event occurred after
the balance date but before the audit report date. This is a period 1 event (ASA 560. 6,
7, 8) wherein the auditor has proactive responsibility. The appropriate action for the
auditor is to request that management disclose the facts in the financial report.

Requirement (3): The auditor should discuss with management about the faulty product
lines and the launch of a full product recall. The further evidence to be obtained
would be documentation to ensure that the dates given by the management were correct.

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3.
Requirements (1) and (2): B. This event occurred after the balance date but before the
audit report date. This is a period 1 event (ASA 560. 6, 7, 8) wherein the auditor has
proactive responsibility. The auditor should recommend the management to disclose
the event and its implications within the notes of the financial statements as
Queenscorp has invested significant funds in developing the new type of margarine.
The application has just been lodged and there is uncertainty about the results so there
isn’t a need for adjust in the financial report.
Requirement (3): The auditor should confirm the dates on which Queenscorp has
applied for a patent for a new type of margarine. The auditor should also confirm
with the patent registration office or discuss with a patent expert on the probability of
the granting of Queenscorp’s application as well as discuss with management the
implications of this event.

4.
Requirements (1) and (2): D. This event occurred after the financials were mailed
out to shareholders. This is a period 3 event (ASA 560.14) wherein the auditor has a
reactive responsibility. In period 3 events, auditors have a responsibility to examine
only events that come to their attention and that existed at the date of the auditor’s
report. Since the event i.e. a breach in one of the ratios for a 24-hour period occurred
after the audit report date, no action recommended for this year’s accounts.
Requirement (3): This event occurred after the financial reports have been mailed did
not exist at the date of the mailing of the financial reports; therefore it is of no concern
to you for this year’s accounts. The further evidence the auditor would seek would
be documentation and contracts to ensure that the dates given to you by the general
manager were correct.

5.
Requirements (1) and (2): A. This is a post balance date event relating to conditions
existing at balance date i.e. it is an adjusting event. In early June, the debtor has
informed Queenscorp that it has been experiencing serious financial difficulties and
it had gone into receivership on 5 July. This is a period 1 event (ASA 560. 6, 7, 8)
wherein the auditor has proactive responsibility. The auditor should request
management to adjust the provision for bad debts account or the trade receivables
account based on the preliminary reports that only 10% of the receivables are
recoverable.
Requirement (3): The auditor should obtain an external confirmation from that
particular debtor to ensure that it had gone into receivership and the amount that would

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be recoverable. The auditor should also confirm the date of receivership was in fact
before the date of the audit report.

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QUESTION 4 (30 Marks)

Consider each of the following independent and material situations. In each case ,
assume that the financial report has been prepared and audited for the year ended
30 June 2010.

(a) Range Ltd, (Range) holds several parcels of land in suburban Sydney that are
currently zoned non-residential. Range has valued land on a fair value basis
under AASB 116 Property, Plant and Equipment. This year, however, Range
revalued the land by adopting a registered valuer's estimate of the market value
of the land. This estimate included a substantial increase in value based on the
general community expectation that the land will soon be rezoned for residential
use.

(b) A part of Prize Ltd.'s operations are in South America. Recent government
changes have made it impossible for you to verify the key accounts of
inventory, property, plant and equipment and cash and related income statement
balances.

(c) Stonehouse Ltd.'s annual report includes a detailed graph showing sales and
profit figures for the past 10 years. However, there are some inconsistencies
between the graph and the figures in the audited financial report. Management
does not want to change the graph because it would involve increased printing
costs.

(d) Connect Ltd. (Connect) is a subsidiary of a Hong-Kong-based

telecommunications company, Link Ltd. (Link). Connect has suffered
significant losses during its five years of operation. In previous years this did
not pose a problem from an audit point of view, as Link pledged sufficient
cash each year to cover Connect's annual reporting costs. However, Link is
only able to pledge cash to cover three months of Connect's 2010 operating
costs. Connect has no realistic prospect of obtaining finance from any other
source. However, the directors are still hopeful of finding a financier and so
have not mentioned the problem in the financial report.

Question 4 continued over the page

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Question 4 continued

(e) The audit of Jones Ltd. Was extremely difficult, as the client did not maintain
appropriate books and records during the year. Although the statutory registers
were maintained, the accounting records were not updated for the first nine
months of the year, as the company was without an accountant during this
period. An accountant was employed in April and has tried to reconstruct
records from the details of receipts and payments available. However, the
accountant has been unable to reconcile the bank account and you are not
satisfied that all transactions that occurred during the year are reflected in the
financial report.

Required:

Assume that no adjustments are made. For each situation, identify the type of audit opinion
required and explain the basis of your answers. (Total Marks: 5 X 6 Marks = 30 Marks)

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Solution:

(a) Qualified opinion

Sufficient and appropriate audit evidence has been obtained (ASA 500.6). Valuing
the land as though it had already been rezoned residential does not appear to
represent its fair value (AASB 116). This uncorrected misstatement reflects on a
disagreement with management. The effect of this is material, but not so material
and pervasive as to require an adverse opinion (ASA 705.5). Hence, a qualified
opinion must be issued (ASA 705.7a).

(b) Disclaimer of opinion

Sufficient and appropriate audit evidence has not been obtained, resulting in a
limitation of scope (ASA 705.A8). You are unable to gain evidence on major
assets and their related income statement balances (that is, there is a serious
limitation on the scope of the audit). The undetected misstatements resulting from
the non- verifiability of these amounts is likely to be so material and pervasive
that it affects many aspects of the financial report, and so you are unlikely to be
able to express an opinion (ASA/ISA 705.9-10). Given the limitation of scope on
three key balances in the balance sheet and the income statement, it appears the
financial effect would be pervasive in nature (ASA 705.5). Therefore a qualified
opinion is unlikely to be appropriate. Hence, a disclaimer of opinion must be issued
(ASA 705.9-10).

(c) Unqualified Opinion with an Other Matter paragraph

The information accompanying the financial report is materially inconsistent
with the financial report (ASA/ISA 720.3). The additional printing costs are not
an acceptable reason for including incorrect information. The auditor must
issue an unqualified opinion with other matter paragraph (ASA 706.10).

(d) Adverse opinion

Sufficient and appropriate audit evidence has been obtained (ASA 500.6). There
is a going concern problem in that Connect does not know how it will fund its
operations past 2010. This uncorrected situation materially affects all the balances
in the financial report, and therefore has a material and pervasive effect on that
report (ASA/ISA 705.5). The going concern problem is not reflected in the financial
report. Hence, an adverse opinion must be issued (ASA 705.8).

(e) Disclaimer of opinion

Sufficient and appropriate audit evidence has not been obtained, resulting in
a limitation of scope (ASA 705.A8). The company did not maintain
appropriate books and records (other than statutory registers) throughout the
year. There is no evidence that all transactions which occurred during the year
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are reflected in the financial report. This represents a limitation of scope that is
so material and pervasive that you are unable to form an opinion on the financial
report (ASA 705.5). Hence, a disclaimer of opinion must be issued (ASA
705.9- 10).

END OF PART B

END OF EXAMINATION

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