Professional Documents
Culture Documents
B8AF108 - Revision - Autumn 2019 - QUESTION SOLUTION
B8AF108 - Revision - Autumn 2019 - QUESTION SOLUTION
Date:
Time:
INSTRUCTIONS TO CANDIDATES
1. Time allowed is THREE (3) hours
2. Question No.1 is compulsory
3. Answer THREE (3) questions only from the remaining FIVE
questions.
All questions carry equal marks
Section A
This question is compulsory
Question 1
You are head of the training department in your audit firm and a new group of interns have
just started. Many of these interns have not studied auditing to date.
Required:
(a) Discuss the key features of the internal and external audit, clearly distinguishing each
audit type. (10 marks)
(b) Outline the role of internal audit in maintaining standards of corporate governance.
(10 marks)
Total 25 marks
SOLUTION PART A
Internal audit basically provides an audit service to a company, but the auditors are employed
by the company and work there full time.
One of the objectives of good corporate governance is to ensure that the needs of all
stakeholders are met as far as possible and internal audit procedures meet the needs of the
owners of the business, its employees, and the business community at large, as well as the
needs of management. The main way in which internal audit exercises its function is by
enabling management to perform proper risk assessments in relation to corporate objectives
by means of properly understanding the strengths and weaknesses in all of the control
systems in the business.
The role of internal audit has expanded considerably in recent years and the scope of internal
audit is no longer routine or low level; internal audit is involved at all levels of management
and internal audit includes non-routine matters such as assisting in setting corporate
objectives and assessing performance against them.
10 marks
SOLUTION PART C
AUDITOR RIGHTS
Access to all books, records, documents and accounts of the company. The auditor
must exercise this right with discretion so as not to disrupt unnecessarily the
company’s operations. Equally, if the client refuses access to the records, auditors
would never seek access to them forcibly, or even through the courts. They would
instead consider either resigning or qualifying their audit report.
Access to all information and explanations, as required for the performance of their
duties.
To receive notice of, attend, and be heard at all general meetings on any part of the
business which concerns them as auditors. These powers enable auditors to tell the
members/shareholders reasons why they should not be removed or the reasons why
they decided to resign.
To be sent copy of notice of their removal and right to make a written representation.
Right to speak at AGM – It is obviously important for the proper discharge of their
duties that auditors should be aware first hand of what happens at meetings. The right
to speak at meetings does not, if exercised, relieve them of the duty to make a
comprehensive audit report to members. If the auditors’ competence is attacked, they
will stand or fall entirely on what they have put, or failed to put, in their audit report.
The right to make a written representation - This is in addition to their duty to make a
statement of circumstances. These rights ensure that the auditor cannot be removed
from office without having the opportunity of placing all the facts before members
e.g. to explain the reasons for qualifying the audit report. If the directors have lost
confidence in the auditors, this is not a valid reason for seeking the auditors removal,
what counts is the confidence of the shareholders.
2 x 2.5 marks
Section B
Answer any THREE questions.
(All questions carry equal marks).
Question 2
Sydney Ltd sells fruit to retailers throughout Ireland. Sydney Ltd has four delivery vans to
delivery to retailers. After speaking to the Directors of Sydney Ltd you learn that they are
concerned about the intense competition in the industry and that this was made more difficult
with the recent opening of budget supermarkets from Europe.
31/12/2016 31/12/2015
€’000 €’000
Revenue 22,446 19,092
Cost of sales (10,560) (12,760)
11,886 6,332
Expenses
Administration (3706) (3,960)
Selling and distribution (2,944) (2,068)
Interest payable (304) (316)
4,932 (12)
Required:
(a) Define the term analytical procedures, explaining the various types of analytical
procedures and the occasions when analytical procedures can be used. (10 marks)
(b) As part of your risk assessment procedures, discuss and provide FIVE possible
explanations for unusual changes in the Income Statement of Sydney Ltd. (15 marks)
Total 25 marks
SOLUTION PART A
Analytical procedures are used in obtaining an understanding of an entity and its environment
and in the overall review at the end of the audit. They can also be used as a substantive proce
dure.
'Analytical procedures' means the evaluation of financial and other information and the revie
w of plausible relationships in that information. The review also includes identifying fluctuati
ons and relationships that do not appear consistent with other relevant information or results.
Comparison of actual or anticipated results of the entity with budgets and/or forecasts, or the
expectations of the auditor in order to determine the potential accuracy of those results.
Comparison to industry information either for the industry as a whole or by comparison to ent
ities of similar size to the client to determine whether receivable days for example are
reasonable.
SOLUTION PART B
Net Profit
Overall, Sydney Ltds results have changed from a net loss to a net profit.
Given that revenue has only increased by 17% and that expenses at least administration
expenses appear low, then there is the possibility that expenditure may be understated.
Administration – fall 6%
A fall is unusual give that revenue is increasing and so an increase in administration to
support those sales would be expected.
Expenditure may be understated, or there has been a decrease in the number of administration
staff.
Question 3
You are observing the control procedures in relation to the purchase ordering system for the
car servicing department.
Goods or services are obtained by placing a purchase requisition with the centralised
purchasing department. Requisitions are sequentially pre-numbered, and the purchasing
department performs a weekly sequence check. All requisitions must be authorised by an
appropriate manager.
On receipt of a purchase requisition, a purchase officer agrees the manager’s signature to the
signatory list held on file and checks inventory levels where appropriate. Orders are placed
with suppliers using sequentially pre-numbered purchase orders.
Orders can only be placed with suppliers from the approved supplier list. Suppliers can only
be added to the approved suppliers list by the procurement team once the terms of the
contract have been agreed, and references obtained. Written confirmation is requested for all
orders placed, and the purchase officer agrees the quoted price against the agreed price list
and ensures any bulk discounts to which Speed Ltd is entitled, have been honoured.
(a) Discuss SIX of the controls in Speed Ltd’s purchase ordering system and discuss how
the auditor would test those controls.
(18 marks)
(b) Briefly explain the terms “integrated test facilities” and “embedded audit software”.
(7 marks)
Sequentially pre-numbered requisitions and Enquire of the staff responsible for the
sequence check performed by the sequence check that what they do to
purchasing dept: ensures that all requisitions evidence the control e.g. a log in the file
are fulfilled, preventing stock with a signature to confirm the sequence
outs/manufacturing delays. check has been performed for that week.
Requisitions are authorised and manager’s Inspect a sample of requisitions for the
signature agreed: ensures only necessary signature of an appropriate manager.
goods and services are procured.
Sequentially pre-numbered POs and weekly Review purchase orders for evidence of the
check by warehouse manager: to ensure that purchasing department’s weekly sequence
all goods and services ordered are received check such as a signature to confirm it has
so any missing purchase orders can be been performed.
followed-up.
Approved suppliers list: gives assurance For a sample of POs placed, agree the
about the quality of goods and services and suppler name to the approved suppliers list.
reliability of the suppliers.
Attempt to place an order with an
unapproved supplier. The system should
not allow it to proceed.
Written confirmation for all orders: ensures For a sample of purchase requisitions,
all and only necessary goods and services inspect the PO and written confirmation for
are received. the supplier.
Prices agreed to price list and for discounts: Inspect a sample of POs for evidence of
ensures that the correct prices are being prices have been agreed to price list such as
charged by the supplier and discounts are a signature of the person checking.
being obtained. Select a sample of orders and agree to the
authorised price list to test the effectiveness
of the control.
Any 6 x 3 marks
SOLUTION PART B
Integrated test facilities- this involves the creation of dummy ledgers and records to which
test data can be sent. This enables more frequent and efficient test data procedures to be
performed live and the information can simply be ignored by the client when printing out
their internal records.
Embedded audit software – this requires a purpose written audit program to be embedded into
the clients accounting system. The program will be designed to perform certain tasks similar
to audit software with the advantage that it can be turned on and off at the auditors wish
throughout the accounting year. This will allow the auditor to gather information on certain
transaction (material ones) for later testing and will also identify peculiarities that require
attention during the final audit.
2 x 3.5 marks
Question 4
Stationery Ltd – a stationery wholesaler, sells to retailers throughout Europe. Stationery Ltd
has 3,000 credit customers from small to large retailers.
ISA 505 External Confirmations deals with a number of different types of external
confirmations. A member of the audit team suggests using an accounts receivables circulation
letter to obtain audit evidence for Stationery Ltd. Audit software will be used in the audit of
Stationery Ltd.
From a review of last year’s audit file you have determined that last year there were 2 specific
allowances of €4,000 and €1,500 as well as a 5% general allowance.
Initial conversations with the client indicate that there are no specific allowances that are to be
made this year however they intend to reduce the general allowance from 5% to 3%.
You are aware that two of Stationery Ltd major customers went into administration during the
year and they are likely to be liquidated in the near future. Both of these customers owed
material amounts at the year end.
Required:
(a) Discuss positive and negative confirmations and the advantages and disadvantages of
each. (10 marks)
(b) Discuss the audit procedures you would perform to obtain sufficient and appropriate
evidence on the receivables balance using audit software. (15 marks)
Total 25 marks
SOLUTION PART A
Negative confirmations request a reply from the accounts receivable only if the accounts
receivable disagrees with the amount. Positive confirmations request a reply in any case.
Negative confirmations are generally only used with a representative sample of a large number
of small accounts where internal controls are strong.
Positive confirmations. There are two types of positive confirmation. In the first type, the
amount owed is stated by the client and the accounts receivable is asked to agree or disagree.
If the accounts receivable disagrees, he is asked to provide an explanation of why he disagrees
in the form of reconciling items. In the second type, the accounts receivable is asked to fill in
the balance. The advantage of the first type is that the accounts receivable may perform the
reconciliation. The principal disadvantage is the fact that the accounts receivable may simply
agree with any amount stated, particularly if it is understated. With the second type, the
accounts receivable is less likely to reply as more work is involved, but the amount stated
represents what is in the accounts receivable's records. It is not possible for the accounts
receivable to perform the reconciliation in this case.
10 marks
SOLUTION PART B
Substantive procedures for trade receivables
Obtain the receivables listing, cast it to verify arithmetical accuracy and agree the total to
the financial statements.
Confirm the trade receivables control account balance matches the sum of the individual
trade receivables ledger accounts.
For a sample of GDN around the year end trace to the sales invoice and ledger accounts
to ensure that the transactions have been recorded in the correct accounting period.
For non-responses to the direct confirmation test confirm cash has been received post
year end for the outstanding amounts.
Cash receipts recoded in the trade receivables ledger account should be traced and agreed
to their remittance advice as well as the cash book and bank statement.
Recalculate the general allowance based on the 3% figure to ensure arithmetical accuracy.
Discuss with management why the general allowance has reduced and assess the
reasonableness of the explanations provided and the reason for not making specific
allowances for the two customers in administration who owe material amounts at the year
end.
Inspect the aged receivables analysis to identify aged debts that may require a specific
allowance. Discuss with management any such balances and ensure specific allowances
are made if appropriate.
Trace and confirm that the specific allowances made in the prior year were either written
off or the cash was recovered in the current accounting period.
Consider and discuss with management the potential implications of failing to make
specific allowances on the audit opinion.
Compare a sample of individual trade receivables to their prior year balance and
investigate any unusual or unexpected changes between the balances.
15 marks
Question 5
ISA 560 Subsequent Events The auditor must respond appropriately to events that become
known after the date of the auditor’s report.
Exercise Ltd manufactures gym equipment. The company’s year end is 31 May 2019 with
profit before taxation of €4m.
On 10 June 2019 a legal claim was made against the company by a customer who sustained a
life changing injury while using the gym equipment in December 2018. On the advice of
legal experts Exercise ltd is considering making an out of court settlement of €350,000.
However, no adjustment or disclosure has been made in the financial statements.
Required:
(a) Discuss, with examples what you understand by the term subsequent events. (9 marks)
(b) Discuss whether the issue above is an adjusting or non-adjusting event, in accordance
with IAS 10, Events after the reporting period. (5 marks)
(c) Discuss the impact on the audit opinion if the directors refuse to make any adjustment in
the financial statements for the issue above. (8 marks)
(d) Discuss THREE audit procedures you would undertake with regard to subsequent events
at the completion and review stage of the audit. (3 marks)
Total 25 marks
SOLUTION PART A
ISA 560 Subsequent Events requires the auditor to obtain sufficient appropriate evidence that
events occurring between the date of the financial statements and the date of the auditor's rep
ort have been appropriately accounted for in accordance with IAS 10 Events After the Report
ing Period.
The auditor must respond appropriately to facts that become known after the date of the audit
or's report which may have caused them to amend their report if they were known at the date
of the report.
1. Those events that provide evidence of conditions that existed at the date of the
financial statements.
2. Those events that provide evidence of conditions that arose after the date of the
financial statements.
E.g. liabilities being incurred after the end of the year, warehouse fire after
year end. Legal issues after the year end.
If a non- adjusting event impacts the going concern assumption, the event becomes an
adjusting event as the going concern basis of preparation may no longer be appropriate.
For example, if the non-adjusting event is a fire which destroys the premises and inventory
and adequate insurance is not in place, the company may not be able to replace the plant and
equipment and inventory it needs to trade. It may not be able to buy or lease premises form
which to operate. In this case, the financial statements would have to be prepared on a break
up basis.
9 marks
SOLUTION PART B
The legal claim is within the scope of IAS 10, because it was received on 10 June 2019. This
date is after the reporting date (31 May 2019) but before the date that the financial statements
will be authorised for issue. The legal claim is an adjusting event because it provides
evidence of conditions existing at the end of the reporting period. As at 31 May 2019 the
claimant had used the gym equipment and sustained the injury.
SOLUTION PART C
Impact on the audit opinion.
The auditor must modify the audit opinion on the financial statements if the directors refuse
to make the relevant adjustments in the financial statements as requested by the auditors.
The financial statements are materially misstated with regard to the legal claim.
The auditor must express a qualified opinion (except for) opinion if they conclude that the
misstatement is material but not pervasive to the financial statements.
The auditor must express an adverse opinion if they conclude that the misstatement is
material and pervasive to the financial statements.
Given the size of the amount involved a qualified opinion may be appropriate in this
situation.
A ‘basis for qualified opinion’ paragraph will be required to explain the reason for the
modified opinion and will go below the qualified opinion paragraph.
8 marks
SOLUTION PART D
Audit Procedures
Enquire of directors if they are aware of any subsequent events that require adjustment in the
financial statements.
Enquiring into management's procedures for the identification of subsequent events.
Inspection of minutes of members’ and directors’ meetings.
Reviewing accounting records including budgets, forecasts and interim information.
Obtaining written representation from management that all subsequent events have been
considered in the preparation of the financial statements.
Inspection of correspondence with legal advisors.
Enquiring of the progress with regards to reported provisions and contingencies.
‘Normal’ post reporting period work performed in order to verify yearend balances:
– Inspecting after date receipts from receivables.
– Inspecting the cash book for payments/receipts that were not accrued for at the year-end.
– Inspecting the sales price of inventories.
3 X 1 mark
Question 6
The directors of Connected Ltd, owners of a social networking app made for sharing photos
and videos from a smartphone have approached your audit firm to act as their auditors.
Connected Ltd has a very relaxed culture to promote creativity and as a result have little or no
internal controls.
Connected Ltd prepares its financial statements in accordance with the International Financial
Reporting Standards (IFRS) but they are refusing to provide the auditors with all the back-up
documentation as they believe that it is confidential.
Auditors should only accept a new audit engagement if the ‘preconditions for an audit’
required by ISA 210 Agreeing the term of audit engagements are present.
(a) Describe the two key questions that the auditor should ask before accepting a new audit
engagement and recommend whether or not your audit firm should accept the audit of
Connected Ltd. (10 marks)
(b) ISA 210 Agreeing the terms of audit engagements explains the content and use of
engagement letters.
Describe the main sections of an engagement letter. (15 marks)
Total 25 marks
SOLUTION PART A
Since Connected Ltd have no answers to several of these questions decline the audit.
10 marks
SOLUTION PART B
The ISA confirms that an engagement letter should be obtained prior to audit work
commencing. The letter will normally be reviewed and signed by the auditor and
management each year, although this is not strictly necessary. Significant changes such as
new management at the client will mean that the letter is resent to remind management of
their responsibilities.
Engagement letter section Why is it there?
Objective and scope of the audit of financial To confirm that the auditor is carrying out
statements. an audit under appropriate legislation and
that the ISAs are used as the basis of the
audit work.
Responsibilities of the auditor To confirm that the auditor is responsible
for the audit; not for financial statement
preparation or to detect all fraud and/or
error.
Responsibilities of management To confirm that management are
responsible for the preparation of the
financial statements and to ensure that those
statements are free from material
misstatement.
Identification of the applicable financial So management and the auditor know what
reporting framework for the preparation of this framework is (e.g. use of IFRS).
the financial statements.
State the expected form and content of the To confirm that the report is based on the
auditor’s report. ISA’s.
Basis of fees To provide information to management that
the fees are calculated on time spent and
grade of staff used.
Management representations A note to management that representations
will be required at the end of the audit.
Request to management to confirm receipt The confirmation effectively completes the
of the letter contract between the auditor and
management.
When the auditor receives the engagement letter, countersigned by management, then the
audit can commence. 15 marks