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Summary of Audit & Assurance - Application - Level - Question - Bank - With Immediate Answers
Summary of Audit & Assurance - Application - Level - Question - Bank - With Immediate Answers
rrent issue
1 Short form questions
1 The IFAC has issued professional ethical guidance. The fundamental principles form part of this
guidance. What do the principles cover and at whom are they aimed? (2 marks)
2 If the regular fees from a client company or group of companies constitute a substantial
proportion of the fee income of an audit firm, a self-interest threat is likely to arise so as to
impair objectivity.
Set out the safeguards a firm should use to recognise this threat and the procedures available to
offset it. (2 marks)
Safeguards re fees To recognise threat
Before accepting/retaining audit, consider whether total fees represent a large portion
of total annual fee income of the firm (such as, in UK, more than 10% annual fee
income or more than 5% for listed company/public interest company)
Regularly review situation as client profile changes
To offset threat
Consider whether firm could be open to criticism and either
– Refuse appointment, or
– Introduce safeguards, including independent review and disclosure to ethics
engagement partner and those charged with governance
Must refuse assignment if total fees regularly become a large portion of the firm‟s total
annual fees.
3 You are the auditor of Harmony Ltd of which the share capital is owned 40% each by David
Dennis and his wife, Diana, and 20% by Edward Endersby, its three directors.
David and Edward have fallen out with each other after an argument during a round of golf. You
have now been requested by Edward to provide him with details of reimbursement of expenses
to David and Diana for the last financial year. You are working on the audit and all the
company‟s books and records are in your office.
State, with reasons, how you would respond to Edward‟s request. (2 marks)
Reimbursement expenses
Overdue fees
Overdue fees constitute a self-interest threat to independence
Issue of unqualified report this year may increase chance of collecting overdue fees
Ideally arrange for settlement of the overdue fees
If not settled and fees are
– Significant
– In dispute
consider resigning from the engagement
If do not resign apply appropriate safeguards (e.g. second partner review)
6 Your client has asked why the audit report your firm has issued on its financial statements talks about „true
and fair‟ rather than „correct‟ given that you had spent two weeks on site reviewing all its accounting
records.
Explain why this type of opinion has been given on the financial statements. (2 marks)
Concept of assurance
In an assurance engagement an assurance firm is engaged to express a conclusion designed to
enhance the degree of confidence of the intended users other than the responsible party about the
outcome of the evaluation or measurement of a subject matter (e.g. financial or operational
information, systems or behaviour) against criteria.
The conclusion is an expression of assurance, or comfort, about the subject matter which has been
examined
Degree of comfort given depends on amount of work performed by the assurance firm
It may be reasonable assurance or limited assurance
The greater the examination of the supporting evidence, the greater the degree of assurance
provided
8 A fraud has recently been discovered, involving the chief buyer in the purchasing department of Rodney
Ltd and a purchase ledger clerk in the accounts department over a period of two years. The managing
director of Rodney Ltd has written to the company‟s auditors claiming that they had a responsibility to
detect frauds during the course of their audits, and requesting an explanation as to how they could have
missed it.
What points should the auditors make in response to the managing director? (2 marks)
Points re fraud
Duty is to report on financial statements
No responsibility as such to detect fraud
An audit conducted in accordance with BSAs obtains reasonable assurance that the financial
statements are free from material misstatement whether caused by fraud or error
Auditors may not find material frauds
Frauds involving collusion harder to detect
Responsibility set out in engagement letter
Management is responsible for implementing and monitoring the system of control
9 Dimension Ltd is a software company providing e-commerce solutions to business. It was incorporated
on 1 April 20W8 and revenue has doubled each year. Rapid expansion is expected to continue for the
next few years.
This growth requires heavy investment in working capital, particularly work in progress and receivables,
and the company will be seeking a substantial increase in the borrowing facility from its bankers when
the present facility is due for annual review in September 20X1.
List the benefits that the company may obtain from the statutory audit. (2 marks)
11 The „expectation gap‟ is the possible difference between an auditor‟s actual responsibilities and those
assumed by readers of an audit report.
What are the main misunderstandings in respect of the audit made by lay users of accounts?
(3 marks)
Expectation gap misunderstandings
Principal ethical issue
Confidentiality
13 You are the auditor of Royale Limited, a manufacturer of fireworks. Following a disappointing last
three months of trading, the company has requested an extension to its overdraft facility from its
bankers. The bank has in turn asked your firm to provide a report on the company‟s working capital,
focusing on the recoverability of trade receivables and inventory.
Explain the benefits and limitations to both the bank and Royale Limited of obtaining the working
capital report. (4 marks)
Benefits
To the bank
Saiful Islam Mozumder, Manager Finance & Accounts, Organic Group,
mozumder@organic-crop.com Cell-01711-981920
Reduces uncertainty as to reliability of the information/increases credibility
Reduces the risk of management bias/independent
Enables bank to determine risk in advancing more money to Royale
To Royale
Enables them to obtain the overdraft which may not be possible without the report
Limitations
To the bank
Not all receivable and inventory balances will be looked at by your firm
Possibility of collusion or misrepresentation
Evidence likely to be persuasive rather than conclusive/assurance not absolute – reasonable
or limited level of assurance depending on scope of work
Report may not highlight full extent of problem/lack of sufficient information
Inherent limitations of accounting system/integrity of data
14 Briefly describe what you understand by the terms „reasonable assurance‟ and „limited assurance‟.
(2 marks)
Reasonable assurance
Objective is a reduction in assurance engagement risk to an acceptably low level in the
circumstances
Conclusion expressed positively
High level of assurance
'In our opinion……….'/True and fair
Not absolute level of assurance
Limited assurance
Objective is a reduction in assurance engagement risk to a level that is acceptable in the
circumstances but where the risk is greater than for a reasonable assurance engagement
Conclusion expressed negatively
'Nothing has come to our attention…….'
15 State the types of pronouncement issued by the International Auditing and Assurance Standards Board
and describe in what kind of engagement each of these is relevant. (3 marks)
IAASB pronouncements
International Standards on Auditing (ISAs) – applicable to audit engagements
International Standards on Review Engagements (ISREs) – applicable to review engagements
International Standards on Assurance Engagements (ISAEs) – applicable to assurance engagements
which are not audits or reviews
International Standards on Related Services (ISRSs) – applicable to other non-assurance
engagements
International Standards on Quality Control (ISQCs) – applicable to all engagements carried out
under any of the IAASB‟s standards
16 One of your clients, Selhurst Ltd, is a small company which is not legally required to have a statutory
audit.
Explain the benefits of a statutory audit for a small company such as Selhurst Ltd. (3 marks)
17 State three types of threat to an auditor‟s objectivity and independence identified by the IFAC‟s Ethical
Standards. For each give an example of how the threat might arise for an auditor. (3 marks)
18 In the past few years the cash flow position of your firm has altered considerably.
After a relatively stable period your firm found itself in a bad financial position. One of your fellow
partners discussed this problem with a major client during a golfing weekend. As a result the client
offered your firm a low interest loan. Fortunately, the position changed and your firm never took up
the client‟s offer. Now your firm is financially sound and would be in a position to make a reciprocal
offer to the client, should he need it.
Why are practice loans to/from clients prohibited under the IFAC‟s Ethical Standards? (1 mark)
19 Mrs Wallace is the audit partner in her firm for Racdale Ltd. She has just been appointed a trustee of
the Racdale Family Trust, which owns 20% of the shares in Racdale Ltd. She replaces the family
solicitor who has just retired.
In addition, Mr Netwater, the audit manager for Racdale Ltd, has given one month‟s notice that he will
be leaving the firm to become finance director of the company.
State the threats to independence that these situations pose, and the safeguards that the firm should
employ to maintain objectivity. (3 marks)
20 State what you should do if you identify money-laundering activities during the course of an audit.
(1 mark)
Money laundering
Report to Bangladesh Bank under section 24 of Banking Companies Act 1993, for violation
of Money Laundering Act of 2002
21 The following is an extract from an independent accountant's unmodified report on a profit forecast:
„Based on our examination of the evidence supporting the assumptions, nothing has come to our attention
which causes us to believe that these assumptions do not provide a reasonable basis for the forecast.‟
Describe the level of assurance provided by this statement and explain how and why it differs from the level
of assurance provided by an audit report on annual historical financial statements. (4 marks)
22 Your firm acts as auditor to Columbus Ltd, a retail car dealer. During the course of your audit for the year
ended 30 June 20X5, you discover that the company‟s sales manager, assisted by the accounts clerk, has
Responsibilities
Auditor responsibilities
No responsibility to prevent fraud
Responsibility to detect material misstatements in the financial statements whether due to
fraud or error
Must design audit procedures to obtain reasonable assurance that financial statements are
free from material misstatement whether caused by fraud or error
Management responsibilities
Steps re non-compliance
Fully document findings
Discuss with directors
Formally report findings to directors
If directors involved, report to audit committee or take legal advice
Report to appropriate 3rd party authority where there is a statutory duty
Resign, as last resort and make statement of circumstances on resignation
Mac
Marking guide
Marks
(a) Benefits (each) ½
Maximum 6
(b) Nature of assurance 2
Level of assurance provided by forecast 3
How it differs 4
Why it differs 3
Available 12
Maximum 9
Total marks available 15
3 Criticisms of auditors
Following high profile corporate failures, auditors have been criticised by various interested
parties in connection with
(1) Their responsibility for the detection of fraud
(2) The provision of non-audit services to their audit clients
(3) The period of time for which they can act as auditors for a client.
Requirement
Outline the current regulatory and professional requirements in respect of the matters identified in (1) to
(3) above and state how they might be further changed by the regulatory bodies. Set out the case for
and against changes to the current regulatory and professional requirements. (15 marks)
Criticisms of auditors
Marking guide
Marks
A lower quality of services (the auditor would not be in possession of the whole picture)
Increased costs due to a lack of pooling of background information
A loss of convenience/one stop shop for clients
A lack of comfort for clients from having services provided by a trusted source.
It may also impair the ability of firms
To recruit high calibre personnel who value the broad-based training provided by
firms undertaking a variety of services
To audit tax and computer systems
To draw upon the wider intellectual capital which currently exists in firms.
(3) Period of time for which auditors can act for a client
Current regulatory and professional requirements
Auditors are appointed from the conclusion of the AGM to the conclusion of the next AGM with no limit
on the number of reappointments.
There are professional requirements in the IFAC Code of Ethics which do not allow the engagement
partner or other key employees to act for a continuous period of more than seven years (for listed
clients).
Possible further changes
Fixed-term appointments/mandatory rotation (of audit firms, as opposed to audit partners) could be
introduced.
Case for change
There is currently a risk of familiarity/complacency – auditors who get too close to their clients may lose
their independence, objectivity, scepticism and become complacent.
Rotation stimulates the auditors‟ courage and independence because there is no expectation of a long-term
relationship and hence they do not fear dismissal.
4 Alpha Ltd
Alpha Ltd, a listed company, operates a policy of putting its audit and related services out to tender
every five years. Following submissions from a number of firms of accountants, the audit committee
of Alpha Ltd recommended that your firm be appointed to provide the following services.
The statutory audit of the annual financial statements.
An independent review of the interim financial information which will be circulated to
shareholders together with your firm‟s independent review report. The independent review
will be restricted to making enquiries of management, applying analytical procedures to the
financial information and assessing whether the accounting policies and presentation have
been consistently applied unless otherwise disclosed.
Consultancy services in respect of the implementation of a new financial information
technology system.
Your firm has not previously acted for Alpha Ltd but does act as auditor for one of its major competitors.
Requirements
(a) Identify and explain the professional and ethical issues that should have been identified by your firm in
relation to the provision of the services, outlined above, to Alpha Ltd and outline the safeguards
that should be in place in order to address these issues. (14 marks)
(b) Comment on the level of assurance provided by the report on the interim financial
information, and explain how and why it differs from the level of assurance provided by the
statutory audit report on
the annual financial statements. (6 marks)
(20 marks)
Alpha Ltd
Marking guide
Marks
The auditor will have access to confidential information which is not in the public domain – this
information must be protected.
Safeguards
General
Obtain professional clearance from the retiring auditors.
Separate engagement letters must clearly set out management and auditor responsibilities for each
assignment, the scope of work, the content of the reports and the level of assurance provided.
Ensure that fees do not become a large portion of the firm‟s total annual fees.
Confirm in writing to those charged with governance that appropriate safeguards are in place.
Saiful Islam Mozumder, Manager Finance & Accounts, Organic Group,
mozumder@organic-crop.com Cell-01711-981920
Independent partner review of the audit.
Consultancy services (if it is acceptable to act at all)
„Informed management‟ is designated by Alpha Ltd.
Management must acknowledge in writing that they take responsibility for the overall system of
internal control.
Rigorous review of the system by the audit team.
The audit firm must not make or appear to make management decisions.
Separate teams and partners.
Competitor
Tests of controls
Tests of detail
Going concern review.
5 Mart Ltd
You work for a firm of auditors which has seven offices throughout Bangladesh. The firm‟s largest
client in terms of fee income is Mart Ltd, a company which has grown steadily through a mixture of
organic growth and acquisition of companies in the same industry sector.
Your firm has acted for this client since its incorporation 20 years ago and, in addition to the
statutory audit, provides a range of non-audit services, including tax planning (for the company
and its individual directors) and consultancy work in respect of Mart Ltd‟s acquisition policy.
Earlier this year the finance director of Mart Ltd retired and was succeeded by a former member of
your firm‟s staff who had managed the audit of Mart Ltd for the preceding four years.
Requirements
(a) Discuss the ethical and professional issues raised by the situation described above and identify the
measures which should be implemented by your firm in order to mitigate any threats to objectivity
which might arise. (10 marks)
Saiful Islam Mozumder, Manager Finance & Accounts, Organic Group,
mozumder@organic-crop.com Cell-01711-981920
(b) Set out the implications for audit firms and their clients if the provision of all non-audit services to
audit clients is banned and mandatory periodic rotation of audit firms is introduced. (6 marks)
(16 marks)
Mart Ltd
Marking guide
Marks
(a) Ethical and professional issues and measures to be implemented to mitigate any threats
to objectivity
Issues Safeguards
The fact that this client generates the Regular review should be performed to
largest fee income and additional services ensure that regular fees do not become a
are provided gives rise to a fee large portion of total annual fees income.
dependency/self-interest threat.
Fear of losing such a large fee may influence External quality control review to be done.
the auditors‟ judgement.
Acting for a client for 20 years gives rise to Periodic rotation of senior staff.
familiarity/trust/complacency threats.
The auditors may be over-influenced by the Per IFAC Code of Ethics, if Mart Ltd is a
personality and qualities of the directors and listed company, engagement partners are
management, and consequently too required to be rotated after seven years.
sympathetic towards them.
The auditors may become too trusting of
management representations so as to be
insufficiently rigorous in testing them because
they are too familiar with the issue.
(b) Implications for audit firms and their clients if the provision of all non-audit
services to audit clients is banned and mandatory periodic rotation of audit
firms is introduced Audit firms
Non-audit services
Although a ban on the provision of non-audit services removes the threats to objectivity, it may
impair firms‟ ability to
Recruit high calibre personnel who value the broad-based training provided by firms
undertaking a variety of services
Audit tax and computer systems
Draw upon the wider intellectual capital which currently exists in firms.
This may result in a loss of income.
Mandatory rotation
Rotation stimulates the auditors‟ courage and independence because there is no expectation of
a long-term relationship (i.e. they do not fear dismissal).
However, there will be increased risk due to the number of first time audits as the auditors
may miss things due to their lack of experience with a particular client.
Their clients
Non-audit services
The use of a different firm may provide different perspectives/skill sets.
However, it may result in
A lower quality of services as the firm will not be in possession of whole picture
6 Gardenvale Ltd
Gardenvale Ltd is a company which operates a chain of garden centres specialising in the
retailing of high quality garden products and the provision of landscaping services. Following
Gardenvale Ltd
Marking guide
Marks
Payroll costs and associated expenses for sales, technical and administrative staff
Sales commissions
Establishment costs for the local office
Depreciation
Miscellaneous expenses
At 30 September 20X6, Beeches Technologies Ltd had 24 overseas subsidiaries, at which
audit work was performed as follows:
Number
Full audit by your firm 8
Limited review by your firm 5
No work 11
24
No new subsidiaries are expected to be established before 30 September 20X7.
With the exception of the two largest subsidiaries (at which your firm performs a full
audit), all of the subsidiaries are of similar size. The costs of each smaller subsidiary
represent approximately 0.5% of the
group‟s total cost base. Where a full local audit is not required, the subsidiaries are
visited on a rotational basis, each subsidiary being visited at least once every three
years.
You called the group financial controller of Beeches Technologies Ltd in order to arrange
a planning meeting. She informed you that she has just returned from investigating a fraud
at the group subsidiary in Madrid, a location where your firm performed limited review
procedures two years ago and no work in the prior year.
The financial controller in Madrid misappropriated the equivalent of CU150,000 over a
three-year period by using company cheques and bank transfers to pay his own personal
expenses. These were reported as company expenses in the profit and loss account
submitted to Beeches Technologies Ltd. Whilst the amount involved is not material to the
group as a whole, it is very significant to the local subsidiary.
The group financial controller told you that the group finance director has expressed
concern that the audit work performed did not uncover the fraud and has asked for a
meeting with the audit partner to discuss this. You have arranged a meeting for this
Friday.
Requirements
(a) Prepare the following schedules to assist the audit partner in his preparations for Friday‟s
meeting:
(i) A list of questions you believe the audit partner should ask in order to ensure that he has
significant information about the fraud to assess its impact on the audit for the year ending
30 September 20X7. (8 marks)
(ii) A summary of the most important controls you would expect the group to have in place
to prevent and detect the misappropriation of funds by subsidiary employees. (10
marks)
(b) Using the Beeches Technologies fraud as an example, compare and contrast the
responsibility of the auditor in respect of fraud with the expectation of company
directors and the general public in this
area. Your answer should refer to any duty the auditor has to report fraud. (14 marks)
(32 marks)
Marking guide
Marks
Information to be included
4 What are the three main considerations for an auditor when considering the acceptance and
continuance of client relationships and specific audit engagements? (2 marks)
Considerations
5 List the principal items to be agreed in an engagement letter between an assurance firm and a person
commissioning an assurance engagement. (2 marks)
Principal items
Professional enquiry
Rights on removal
8 The current auditors of Meldrew Ltd will not be proposed for re-appointment at the annual
general meeting to be held on 12 October 20X9. The directors were extremely unhappy at the
additional disclosures in the financial statements for the year ended 31 December 20X8 concerning
the status of the company as a going concern. The auditors had insisted upon these before they
would express an unqualified opinion.
As a result your firm has been asked to accept appointment as auditors of Meldrew Ltd. All
the shareholders of the company are directors.
Set out the matters your firm ought to consider and the procedures to follow before it should
Before accepting appointment as auditors
Matters to consider
Whether the going concern issue likely to be present for future accounting periods
Whether the going concern disclosures made were warranted
Whether Meldrew will give permission to contact incumbent auditors
Whether current auditors agree with reason given by Meldrew for not wishing to reappoint
Likely independence from Meldrew and therefore able to carry out objective audit
Nature of Meldrew‟s business
– Whether any special expertise required
– Whether have necessary expertise
Timing/resource requirements to be able to perform audit competently
Procedures to follow
Discuss with directors current going concern status
Review prior year‟s accounts re whether going concern disclosures were necessary
Request permission to contact incumbent auditors
If permission refused decline appointment
Write to incumbent auditors enquiring if any matters that affect appointment of firm as auditors
Review response received for any relevant matters. Are their reasons for non-
appointment in accordance with those of Meldrew?
If significant matters which affect appointment with which firm does not feel it can deal, then
do not accept engagement
If incumbent does not respond, telephone or fax to request a response. If no response is
forthcoming, send a recorded delivery letter stating that „no matters‟ will be assumed
unless advised otherwise, within a specified time
In absence of any response, consider refusing appointment
Review prior year accounts to ascertain amount of work likely to be necessary,
whether any technical expertise likely to be required and probable level of fee income
Compare estimated time required with current resources to ascertain whether
sufficient staff available at required times
Compare estimated level of fee income with current recurring fee income to ascertain
whether the fee income would become a large portion of the total annual fee income of the firm
9 An audit partner has consulted a colleague regarding a question of judgement concerning the audit
of his client. The audit partner has prepared a working paper in respect of this matter, recording
details of facts known at the time, the reasoning for his conclusion and conclusion reached.
State why the partner should record this information in the working paper in respect of this matter.
(2 marks)
Why recorded
Evidence in case partner's judgement is questioned subsequently (e.g. defence in litigation)
Particularly by a third party who may have the benefit of hindsight
10 A mature student has recently joined your firm on a training contract. She has told you that in her
previous job, she was allowed to work on her own with little supervision and no review of her work.
She does not understand the importance of the review process in your firm.
State the reasons why assurance and audit work is reviewed by more senior staff and partners.
(3 marks)
Reasons for review
Confirm work properly recorded in accordance with
– Firm‟s procedures (quality control)
– Engagement plan
Confirm all contentious/judgemental areas have been highlighted for consideration
Assurance work carries duty of care to client
Audit work carries duty of care to 3rd parties/protection against litigation
Audit is regulated activity and governed by BSAs
Functions of an audit committee
Monitor the integrity of financial information
Oversee the company‟s internal control and risk management systems
Monitor and review the effectiveness of the company‟s auditors
Monitor the implementation of agreed auditor recommendations
Facilitate communication between internal and external auditors
Set performance indicators for internal and external auditors
Make recommendations in relation to the appointment, re-appointment and
removal of external auditors
Approve the remuneration and terms of engagement of the auditors
Develop and implement a policy on the engagement of the external auditor to supply non-
audit services
Review and monitor external auditors independence
Feedback to main board (including annual report on its activities)
Oversee investigation of suspected fraud and value for money initiatives
9 Sleeper Ltd
Your audit firm has recently been invited to accept appointment as external auditor to Sleeper Ltd, a
company that owns and operates a number of mobile phone stores in the four major cities of Bangladesh.
You have not previously acted for Sleeper Ltd, but your firm is auditor to Zelig Ltd, a company which also
Requirements
(a) Identify and explain the professional ethical issues which you might need to consider in
deciding whether or not to accept appointment as external auditor to Sleeper Ltd.
Recommend the possible
safeguards that could be put in place to resolve these issues. (6 marks)
(b) Set out the responsibilities and rights, including those under the Companies Acts, of the
current auditors of Sleeper Ltd in relation to the proposed change in professional
appointment.
(3 marks)
(c) Set out the respective duties of both the management and external auditors of Sleeper
Ltd in relation to the prevention and detection of fraud, and outline how these duties are
discharged.
(6 marks)
(d) List the financial statement assertions, other than existence, which are relevant to
the audit of inventory and, for each one listed, outline one relevant audit procedure
to test that assertion in respect of Sleeper Ltd. (6 marks)
(21 arks)
Sleeper Ltd
Marking guide
Marks
(a) Confidentiality 1½
Conflict of interest 1½
Safeguards 3
Intimidation 1½
Safeguards 2
Marks available 9½
Maximum 6
(b) Rights 2
Responsibilities 1½
Marks available 3½
Maximum 3
Firm's own procedures for accepting new clients/do not accept if threat too high
Firm's annual review procedures/review of threat to independence
Overall control environment within the audit firm
Notify your firm's audit compliance principal of potential threat
(b) Rights
Consider whether any inventory held for third parties or on consignment/sale or return basis
Confirm inventory fully paid for and owned by client
Completeness
10 Gemini Ltd
Described below are situations that have arisen in companies which are external audit clients of your firm.
(1) During the year ended 31 May 20X2 your firm commenced a five-year contract to provide
internal audit services for Gemini Ltd. Over the course of the year the internal audit team
carried out a risk assessment exercise and an evaluation of the internal control systems
supported by tests of control.
(2) Leo Starr, the managing director and majority (80%) shareholder of Taurus Ltd, received
an offer from Sagittarius Ltd, also an audit client, for the entire share capital of Taurus Ltd.
Leo Starr has agreed in principle to sell his shares to Sagittarius Ltd. The purchase
consideration is likely to consist of an initial cash payment based on the net assets of
Taurus Ltd as at 31 August 20X2, and a deferred cash payment contingent on the
operating profit growing by an average of 5% over the next two years. Leo Starr and the
management of Sagittarius Ltd have requested, independently, that your firm acts as
advisors in respect of the negotiations and provides an assurance report on the calculation
of the amount of the net assets at 31 August 20X2.
Requirements
(a) Describe the purpose of quality control measures in respect of the provision of assurance and
advisory services. (6 marks)
(b) Discuss the ethical and professional issues raised by the situations described above, and
identify the quality control measures your firm should implement in order to mitigate
any threats to objectivity
which might arise from the provision of the services described above. (12 marks)
Gemini Ltd
Marking guide
Marks
(a)Purposes (each) 1
Maximum 6
11 Hairsay Ltd
Hairsay Ltd is a company which operates six hairdressing salons. The company does not grant
credit facilities and customers pay by cash, cheque or debit or credit card. All branches have
tills in which takings are lodged, and receipts are issued when requested by customers.
He is worried that other cash handling irregularities may be occurring and is anxious to have a system
in place which will prevent any misappropriation of cash takings.
Requirements
(a) Outline the matters to be included in the letter of engagement which your firm should send to the
management of Hairsay Ltd prior to commencing the independent review of the company‟s cash
handling procedures. (5 marks)
(b) Using Hairsay Ltd‟s fraud as an example, compare and contrast the responsibilities of the auditors in
respect of fraud with the expectations of the managing director. (5 marks)
(c) Prepare a checklist of questions which you would ask in order to establish whether there are any
shortcomings in Hairsay Ltd‟s policies and procedures which increase the risk of misappropriation of
cash. (6 marks)
(16 marks)
Hairsay Ltd
Marking guide
Marks
12 Wrapper Ltd
Your firm, which has six partners, has been invited by Mr Packer, the managing director and majority
shareholder of Wrapper Ltd, to accept appointment as auditor of the company and also provide assistance
with the preparation of the financial statements and the corporation tax computation.
The principal activity of Wrapper Ltd is the production of paper carrier bags, serviettes, coffee cups and lids
which are sold to customers operating in the fast food sector. Wrapper Ltd was incorporated on
1 October 20X4 and the financial statements will cover the 15 month period to 31 December 20X5.
Although the company's revenue and assets are below the thresholds for statutory audit purposes, the
company's bankers require the annual accounts to be subjected to a full audit.
Mr Packer started the business using a combination of money inherited from his grandfather and a bank
loan. The loan agreement includes a covenant specifying that the company's debt equity ratio should
not exceed parity (i.e. 1:1).
The accounting records are computerised and the company uses software which was developed by IT
Systems Ltd, a company owned by Mr Packer's brother. The software has been customised to integrate
inventory control with receivables and payables. IT Systems Ltd also provides support for the company‟s
computer systems. The accounting records are maintained by Mrs Carlton, assisted by Mrs Biggs who
Marking guide
Marks
Marks
14 Wavenden Ltd
Your firm has been asked by the directors of two companies to accept appointment as auditors.
The directors of Wavenden Ltd have become dissatisfied with the service of the existing
auditor, mainly due to the lack of urgency that he appears to display in his dealings with
the company. He has been notified of their wish to replace him and has been asked for
his resignation.
This has not been received and the directors now wish to remove him from office.
The financial statements for the year ended 30 September 20X0 showed inventories of
CU25,000. Inventories at cost were CU50,000. A review of obsolescence was not
performed but, on the recommendation of the company‟s accountants, the cost was
written down by 50% on the grounds of prudence. The directors admit that obsolete
inventories rarely exceed 10%, but there are no satisfactory audit procedures that could
Saiful Islam Mozumder, Manager Finance & Accounts, Organic Group,
mozumder@organic-crop.com Cell-01711-981920
be adopted to confirm the true figure at that date.
Requirements
(a) Set out the steps that both Wavenden Ltd and your firm should follow in order to complete the
process of the appointment of your firm as its auditors. (13 marks)
(b) In respect of the issue over inventory, reach a conclusion on whether you would modify
your audit report on Wavenden Ltd for the year ending 30 September 20X1, on the
basis that no other matters arise which affect the opinion. You should give reasons for
your conclusion and describe any additional statements which would need to be made in
the audit report. (8 marks)
(21 marks)
Wavenden Ltd
Marking guide
Marks
15 Benson Ltd
Benson Ltd is a medium sized entity, managed by its owners who bought it out from a large
limited company six years ago. The share capital is owned by four directors. One of the
original directors, Andrew Fisher, has recently passed away and his shares and his place on the
board have been taken up by his son, John Fisher.
A large loan from the bank which helped to finance the management buy out was paid off in
the previous period. This year, the directors have negotiated another loan from the bank to
help finance an expansion into Europe.
You work for a firm of chartered accountants called Andrews, Baker and Co (ABC). ABC
became involved with Benson at the time of the buy out when they provided advice to two of
the (current) directors. They have been involved with the business ever since, acting in the
capacity of tax advisers, management consultants, and personal tax advisers for all the
directors. They have also been involved in some special projects for Benson, taking part in an
investigation due to a suspected fraud two years after the MBO, and putting together
projections and budgets for the potential expansion into Europe.
ABC were invited to tender initially for the audit, but their tender had the highest fee, and Mr
Fisher senior, who was the managing director at the time, strongly believed that an audit was a
statutory necessity which the company should obtain as cheaply as possible. The audit was given
to a smaller firm of auditors, XYZ, but ABC were engaged to provide what Mr Fisher always
termed, 'the useful stuff – worth paying for'.
The fee income from Benson has been considerable over the years. Two years ago, when the work
Marking guide
Marks
The only references to fees in the question are that the fee income from the client is high, and
that in one year, when a special assignment was taken on, they represented 20% of the fee
income.
This does not necessarily mean that the fee income including the audit fee will be a large
portion of the total annual fees of the firm, but it certainly suggests that it is possible. As a
minimum, it suggests that it may no longer be appropriate to undertake the special assignments,
and that a review of fee income will be required.
It is impossible to conclude precisely whether ABC were acting unethically in accepting the audit
work. However, the indication is strong that the firm is not independent in relation to the audit
due to the high level of other services, and the fees that they bring in. This is despite efforts which
have been made to preserve independence, notably appointing a different audit engagement
partner.
If Benson were to float on a Stock Exchange, then the rules of independence would become
more stringent. In such a case, fee income would have definitely been large enough for the
audit to be refused.
Maintaining independence from such companies is considered extremely important and it appears
unlikely that ABC would be able to justify that they were independent of Benson Ltd for the
purposes of its audit. Were it listed, and hence if it achieves a listing, they will have to re-appraise
their relationship with the client.
(c) Quality control procedures and policies
The audit engagement partner is a key feature in quality control processes in relation to
individual audits. ICAB guidance on quality control focuses on two aspects of quality control:
Marking guide
M
a
r
k
s
Investigations may involve current Different teams should carry out the
clients. work, possibly involving specialists.
Advisory work may turn into decision The advisory role should be constantly
making. and carefully reviewed to ensure that
this does not happen.
„Informed management‟ should be
appointed at Healey Ltd.
The advisory work should be carried
out by a different team.
Saiful Islam Mozumder, Manager Finance & Accounts, Organic Group, mozumder@organic-
crop.com Cell-01711-981920
The firm should seek legal advice in respect of these contracts and ensure that their liability
exposure is not too great. As the work is not audit work, they are entitled to negotiate limitations
on their liability and should do so.
In particular it may be necessary to limit liability in the event of the company making acquisitions which
then go wrong. The firm should make clear that any investigations they carry out are restricted to the
present time and that they cannot be held liable for the results of future, unknown events.
(c) Direction, supervision and review of audit work (this is mandatory under BSA 220)
Hot review by an independent partner of the audit file before audit report signed
Separate team used for audit and other services
Cold reviews of audits with points forward for improvements in future years.
Saiful Islam Mozumder, Manager Finance & Accounts, Organic Group, mozumder@organic-
crop.com Cell-01711-981920
Section 3: Planning assurance engagements
17 Short form questions
1 In the context of BSA 600 Using the Work of Another Auditor, state what is meant by the terms
“principal auditor” and “other auditor”. (2 marks)
Principal auditor
The auditor with responsibility for reporting on the financial statements of an entity when those
financial statements include financial information of one or more components audited by another
auditor.
Other auditor
An auditor, other than the principal auditor, with responsibility for reporting on the financial
information of a component which is included in the financial statements audited by the
principal auditor. Other auditors include affiliated firms, whether using the same name or not,
and correspondents as well as unrelated auditors.
2 Your firm is the principal auditor of Narberth Group Ltd. The financial statements of one of the
components which will be included in the financial statements of Narberth Group Ltd has been
audited by another firm of auditors who have modified their audit report on the component‟s
financial statements.
State the matters that should be considered, in respect of the above issue, by the principal auditor
when reporting on the financial statements of Narberth Group Ltd. (2 marks)
The nature and significance (materiality) of the matter which is the subject of the modification to
the financial statements of Narberth Group Ltd.
Whether the matter which is the subject of the modification can be resolved when preparing the
financial statements of Narberth Group Ltd.
3 The risk that the financial statements are materially misstated can be broken down into detection
risk, inherent risk, control risk and audit risk.
Explain what information an auditor uses to evaluate each of these components of risk during the
planning of an audit. (2 marks)
4 The external auditor of Thorpe Ltd has assessed the internal audit department of the company, and
concluded that its organisational status and the scope of its function are satisfactory. As a result he has
Saiful Islam Mozumder, Manager Finance & Accounts, Organic Group, mozumder@organic-
crop.com Cell-01711-981920
decided to make use of the department‟s work which is relevant to him to reduce the extent of his
audit procedures.
On what other matters must he assure himself, and how should he obtain this assurance, in order to
reduce his own work? (3 marks)
Matters
Whether internal audit work is performed by persons having adequate
technical training/proficiency as internal auditors
Whether internal audit work is properly planned, supervised, reviewed and documented
Procedures
5 Drusus Ltd has a financial year end 31 March 20X7 and it formed an internal audit department in September 20X6.
This new department was headed by the company‟s senior management accountant, and his deputy was then
promoted to senior management accountant.
You have performed an assessment of the department and are satisfied with all aspects of its organisational
status, scope of operations, technical competence and professional care.
Since its formation the internal audit department has completed the following work.
(1) Documentation of the new purchases system which was introduced on 1 April 20X6.
(2) Tests of control on the purchases system from 1 October 20X6.
(3) Preparation of a report in February 20X7 on significant weaknesses revealed by the tests of control. Its
recommendations were implemented in full in March 20X7.
(4) Preparation of detailed reports for the board of directors on the monthly management accounts since July
20X6.
To what extent might you be able to make use of this work during your audit, and what effect would it have on the
selection and scope of tests in the areas concerned? (4 marks)
Saiful Islam Mozumder, Manager Finance & Accounts, Organic Group, mozumder@organic-
crop.com Cell-01711-981920
Use of internal audit work
7 After obtaining a general understanding of the legal and regulatory framework applicable to the entity and the
industry and how the entity is complying with that framework in accordance with BSA 250,
what further audit procedures should the auditor perform to help him identify those instances of non-
compliance which should be considered when preparing financial statements? (3 marks)
Procedures re non-compliance with laws and regulations (BSA 250 paras 18 and 23)
Enquire of management whether entity is in compliance with laws/regulations
Inspect correspondence with relevant licensing/regulatory authorities
Obtain written representations that management has disclosed to the auditor all known actual or
possible non-compliance with laws/regulations whose effects should be considered when preparing
financial statements
8 Why do auditors carry out preliminary analytical procedures at the planning stage of an audit?
(1 mark)
Analytical procedures
9 One of your existing audit clients has recently acquired a subsidiary company, Jade Ltd, and has
appointed you as its auditor. Jade Ltd is a developer of computer games software, an industry with
which neither you nor your firm is familiar.
From what sources would you obtain knowledge about Jade Ltd and the industry in which it operates?
(3 marks)
Sources of knowledge
10 In the draft accounts of Gough Ltd, the gross profit percentage (i.e. gross profit as a % of sales) has
fallen from 44% in the previous year to 39% in the current year.
The following information has been obtained.
(1) Closing inventories have been understated due to the omission of some items from the physical
inventory count.
(2) Revenue has declined because the company has not reduced its prices to combat cut-price
competition.
(3) Purchases have increased due to a large receipt of raw materials on the last day of the year.
Describe what effect each of these matters would have on the gross profit percentage, and
whether it helps to explain the fall. (3 marks)
11 Your firm has recently acquired a new audit client, which has an internal audit department. The
department has conducted a rolling programme of tests of financial controls over all areas
affecting the financial statements, and you seek to rely on its work to reduce the extent of the
audit procedures you will carry out.
On what aspects of the internal audit department and its work will you need to satisfy yourself in
order to be able to place the necessary reliance? (2 marks)
12 You have conducted analytical procedures on the draft accounts of Blunt Ltd for the year
ended 31 October 20X1. Two of your findings are as follows.
(1) The gross profit margin has decreased from 29% for the previous year to 23% for this year.
(2) The current ratio has decreased from 1.6 at the previous year end to 1.2 at this year end.
The directors had expected a decrease in both these measures but not by as much as shown above.
Indicate what errors might be incorporated within the draft accounts to produce these
unexpected variations, and in which areas you would carry out extra audit work in order to
reach a conclusion.
(3 marks)
Unexpected
variations Errors
indicated
13 Auditors should have a sufficient knowledge of the business of the entity to be audited.
What sources of information would assist the auditor in identifying related parties? (2 marks)
14 During the course of the audit of your client Sloth Ltd you notice a balance within receivables
entitled „advances against directors‟ expenses‟. The company‟s managing director, who is familiar
with the concept of materiality, has questioned your need to audit this balance, which at the year
end stands at CU12,500. The company‟s retained profit for the year is CU1.3m.
Prepare brief notes to the managing director explaining your audit approach in respect of this item.
(2 marks)
Audit work – ‘advances’
15 Your client, Neral Ltd, is a family owned and run haulage business. The managing director‟s
brother runs a manufacturing business, Jaron Ltd, which uses Neral Ltd for its distribution
requirements.
You are planning the audit of Neral Ltd. Identify the audit risks in respect of this relationship
between the two companies and state how you would plan to address these risks. (3 marks)
Audit risks and procedures to
address Audit risks
Non disclosure
Transactions not at arm‟s length
Procedures to address
Identify full list of related parties at commencement of audit from prior year working papers
Review minutes of meetings of shareholders and directors
List names from statutory books
Make enquiries with directors and staff during audit
17 You are planning the audit of Berlini Ltd, a manufacturer of air conditioning units, for the year ending 30
September 20X0. The company requires the financial statements to be signed by 31 October 20X0.
The finance director has supplied you with copies of the company‟s monthly management accounts for
the first eleven months of the financial year.
Explain how you would seek to make use of these management accounts in your audit planning, and what
factors might limit their usefulness. (4 marks)
18 Woodruff Ltd is currently involved in a large scale construction project to develop part of the
waterfront in a medium-sized Gloucestershire town. A review of the current risk factors has
highlighted three key issues.
(1) A number of the subcontractors it plans to use may not complete the work within the specified
timescale.
(2) Although not within a flood plain area, the development will be at risk from flooding.
(3) Although the benefits from the project will be significant, Woodruff Ltd is concerned about the
funding required and is unhappy about the overall level of risk it will have to face.
What risk control strategies could Woodruff Ltd use to deal with the above issues? (3 marks)
Risk control strategies
(1) Ensure contracts with sub contractors specify deadlines for each piece of work completed
Saiful Islam Mozumder, Manager Finance & Accounts, Organic Group,
mozumder@organic-crop.com Cell-01711-981920
Include penalty clauses in all contracts for financial recompense for any overruns
(2) Take out insurance cover against flooding. (Premiums likely to be high given recent
floodingproblems in Bangladesh)
Build responsibility for flood protection into contracts of subcontractors as far as possible and
ensure compensation for flooding is agreed
(3) Consider finding a joint venture partner to join the project. Additional funding would
bemade available and the risks of the project would then be shared (although the returns
would then also be shared)
19 At your planning meeting with the finance director of Dent Ltd, you are informed that the chief
accountant has been formally reprimanded for authorising payment of the servicing bill for his wife‟s
car. The matter was discovered by accident. The amount was only CU80 and no further action was
taken.
Explain the effect this might have on your audit planning. (2 marks)
Effect on planning
Not material in itself, if isolated incident
But, less reliance on effective operation of control system
Particularly involving chief accountant (CA)
Extra testing where CA has authorised payments
Doubt cast on representation made by CA in all areas
20 Grim Ltd has had an internal audit department of six persons for several years. Previously you have
been able to reduce your audit work by placing reliance on its work.
During the last three months of the year ended 30 November 20X9 four of the personnel, including
the department head and deputy head, left the company and replacements were recruited.
Before the departures the department had conducted tests of the control systems in all areas for the
first nine months of the financial year.
Since the appointment of the new members of the department, it has conducted an overall review of
the strength of the system of control as recorded in the procedures manual, and reported to the board
on recommendations for improvements.
Describe the effect these matters might have on the reliance you place on the work of the internal audit
department for the year ended 30 November 20X9. (3 marks)
21 Set out the principal audit objectives to be satisfied by tests of control of a company‟s system.
(2 marks)
Audit objectives of tests of controls
22 Your firm has acquired a new audit client. From the information that you gained in order to present
your audit proposal, you are hopeful that internal controls are strong and you will be able to place
reliance on them to reduce your substantive procedures.
List the steps you should follow before you are in a position to determine the combination of tests of
control and substantive procedures for the audit plan. (3 marks)
Steps to determine combination of tests
23 When planning to use the work of experts and in assessing the results of the work of experts,
to what matters should the auditor pay attention? (3 marks)
Using
experts
Planning
Assess the experts’
Independence
Objectivity
Professional qualifications
Experience
Resources
Scope of assignment
Assessing results of work
Assess appropriateness of audit evidence re financial statement assertions, especially
24 Struction Ltd designs and constructs conservatory extensions for domestic homes, operating
throughout the United Kingdom. It has administrative and works premises in Devon, and
employs a network of local subcontract building companies for all work on site.
Identify the risks from its customers to which Struction Ltd is exposed from this method of operation.
(3 marks)
Risks
25 Your firm has recently acquired a new audit client, Dilbert Ltd, and you have been assigned to
draft the audit plan.
The audit manager has briefed you on the firm‟s knowledge of the business that he has compiled
from visits to the company, discussions with management and the previous auditors, and from
industry and other sources.
Set out which components of the audit strategy or plan would be influenced by this information.
(3 marks)
Components of audit strategy and plan influenced by knowledge of business
Risk assessment
Initial materiality
Reliance on controls v substantive procedures
Analytical procedures v detailed testing
Level and time of staff required/budget
Nature, timing and extent of procedures
Specific areas of attention
Use of CAATs
27 You have planned the audit of Craig Ltd for the year ended 31 March 20X2 based on the year
end management accounts. The week before the audit work is due to start the chief
accountant informs you that the directors are concerned by the likely amount of corporation
tax on the profits shown, and provides you with a schedule of 60 journal entries and the
resulting draft financial statements.
The effect of the journal entries is to reduce gross profit by 20%, net profit by 65%, and net
assets by 15%.
Explain how this information will affect the nature, timing and extent of the audit procedures in
your audit plan. (4 marks)
Effect of journal entries
28 During the planning of the audit of Milten Textiles Ltd, the financial controller asked to have a
quiet word with you. She tells you that she suspects the payroll clerk is defrauding the company,
as she is regularly going on exotic holidays, buying new cars and spending substantial sums of
money on home improvements. There is only one payroll clerk who manages the single monthly
payroll run.
What would be the impact on your audit approach in respect of the information provided by the
financial controller? (3 marks)
Suspected fraud
Look for evidence of weaknesses in the systems (e.g. from previous management letter)
Increase professional scepticism
Evaluation/testing of controls over payroll system to identify weaknesses
Increase substantive work/sample sizes on wages/payroll costs (e.g. leavers deleted properly,
existence checks on employees)
Investigate any apparent override/circumvention of procedures
Engage payroll clerk in conversation and query lifestyle
Consider impact on other areas (e.g. bank payment approvals)
29 You have completed the tests of control in your audit. The only deviations found were that there
was no evidence that one particular control had been operated in three cases out of 25 tested.
Explain what considerations will determine whether you are able to reduce the substantive
procedures in the area of this control. (2 marks)
Consideration re reduction in substantive procedures
Reasons for deviations (e.g. person responsible on holiday isolated error)
Whether deviation indicates
– Lack of operation of control, i.e. control failure
– Or just lack of evidence, e.g. no initials evidencing check performed
Whether quantitative error(s) arose as a result of the deviations (confirming lack of operation of
control)
Whether extended tests prove satisfactory, i.e. no further deviations found
Whether compensating control exists – so monetary errors did not arise
30 At the audit planning meeting for the year ended 28 February 20X4 with the finance director of
Malbec Ltd, you ascertained that payroll processing, which had been outsourced for a number of
years, was brought back in-house in December 20X3.
Management was not satisfied with the performance of the service provider and repudiated the
contract. The service provider had been responsible for making payments to the employees and the
monthly remittances to NBR. Two of Malbec Ltd‟s accounts clerks have been trained in payroll
processing (4 marks)
Risks re payroll processing Risk
Misstatements of payroll costs and liabilities to NBR
Unrecorded interest for late payment
Unrecorded provision for damages/breach of contract or disclosure as contingent liability for
damages
How addressed
18 Santander Ltd
Your firm has recently been appointed as auditor to Santander Ltd, a company whose principal business
activity is the manufacture and installation of children‟s playground equipment.
You are planning the company‟s audit for the year ending 31 October 20X5. Your audit manager has
arranged a planning meeting next week with the company‟s finance director.
Your audit manager has given you the following extracts from the company‟s management accounts for the
ten months to 31 August 20X5 and the comparative period to 31 August 20X4. He has asked you to
provide him with notes based on this information to assist him in his meeting:
(1) Operating results
10 months to 10 months to
31 August 20X5 31 August 20X4
CU‟000 CU‟000
Revenue 17,228 14,328
Cost of sales 10,854 8,024
Gross profit 6,374 6,304
Operating costs 3,207 2,915
Operating profit 3,167 3,389
(2) Balance sheet extracts
As at As at
31 August 20X5 31 August 20X4
CU‟000 CU‟000
Inventories 3,110 1,765
Trade receivables 4,996 3,400
(3) Additional information
The company‟s principal customers historically have been local government authorities and schools
based in Bangladesh. The company has, however, within the past twelve months expanded its
customer base to include hotel and house developers based in South Asia. Previously the company felt
these customers were in economies which were too politically unstable to trade with. Business in
these countries is conducted both in £ sterling and in the local currency.
Due to increases in the number of personal injury claims, legislation was introduced in Bangladesh on 1
January 20X5 which requires the use by Santander Ltd of softer materials in the construction of its
playground bases. These new materials are approximately 30% more expensive to Santander Ltd than
the traditional ones that they replace. The introduction of the new legislation had a twelve month lead-
in period, but the company‟s managing director announced in February 20X5 that in order to keep
ahead of the competition, all new playground installations were to use the new material with
immediate effect.
Requirements
(a) State the reasons why it is important for auditors to carry out audit planning. (3 marks)
(b) Identify the main sources of information that are available to an auditor when planning an audit.
(4 marks)
m
a
r
k
s
)
Santander Ltd
Marking guide
Marks
Tutorial note
This answer is the marking plan produced by the examiner. The examiner has confirmed that the style of this
19 Apparel Ltd
You are planning the audit of Apparel Ltd for the year ended 30 November 20X5.
The principal activity of the company is the retailing and wholesaling of outdoor
clothing, footwear and equipment. All goods are sold under one of the company's
two brands:
The Comfy brand which targets the everyday consumer offering family
orientated products at mid market prices; and
The Elite brand which targets the specialist market for the serious outdoor
consumer offering more technical clothing, footwear and equipment at a
higher price.
Apparel Ltd sources its products from suppliers based in Europe and, more
recently, China. The company sells its products through its own retail outlets and
also wholesales to independent retailers.
In February 20X5, the company completed the implementation of a new dynamic
warehouse management system. The implementation commenced in 20X4 and was
introduced in stages to avoid any disruption to the business.
You are preparing for your planning meeting with the finance director and have
obtained, in advance of the meeting, a copy of the draft financial statements for the
year ended 30 November 20X5. Following your preliminary review, you have
identified the following extracts from the financial statements as matters of
significance to discuss with management.
Income statement
Years ended 30 November
20X5 20X4
Draft Actual
CU000 CU000
Revenue
Own retail outlets 53,447 45,968
Wholesale 45,539 39,159
98,986 85,127
Requirements
(a) In respect of the information provided above, prepare planning notes on matters which you wish to
discuss with management. Your notes should refer to the results of your analytical procedures.
Apparel Ltd
Marking guide
Marks
(a) Revenue issues 3
Gross margin issues (including calculations) 5
Operating margin issues (including calculations) 4
Inventory issues (including calculations) 2½
Receivables issues (including calculations) 3½
Payables issues (including calculations) 3½
Marks available 21½
Maximum 16
(b) Consistency/corroboration 2
Presentational/disclosure issues 3
Additional work 1
Marks available 6
Maximum 4
Total marks available 20
Financial statements are consistent with the auditor‟s understanding of the business
Review procedures corroborate conclusions formed during the course of the audit
Any previously unrecognised risk of material misstatement/ financial statements give a true
and fair view/can issue unmodified audit report
Auditor may need to re-evaluate planned audit procedures/post balance sheet date work
Any new factors which may affect the presentation/disclosures in the financial statements
Presentation adopted in the financial statements may have been unduly influenced by the
desire to present matters in a favourable/unfavourable light (prepared using
acceptable/consistent/appropriate accounting policies)
Potential impact on the financial statements of the aggregate of uncorrected misstatements
Tutorial note
This answer is the marking plan produced by the examiner. The examiner has confirmed that the style
of this answer is appropriate for use by students in the examination.
20 Holly Ltd
You have recently been appointed auditor to Holly Ltd („Holly‟) and are in the process of planning the audit
for the year ending 30 April 20X6. Holly owns and operates a chain of 50 high street coffee shops located
throughout Dhaka, and a further 20 located in the rest of Bangladesh.
Holly‟s main expenses are the cost of coffee sold, premises costs, the cost of leasing the coffee making
machines, and staffing the shops. Holly meets these costs centrally, with all permanent staff salaries paid
monthly by direct bank transfer. Each shop is run on a day-to-day basis by a shop manager, who is
responsible for sourcing any food sold and other consumable goods locally and taking on any casual staff
needed to cover peak periods. Both these expenses are generally met using cash from the till. The company
made the decision to source goods locally both to encourage local management autonomy and to support
the local economies where each shop is based. Shop managers have bonus incentives linked to the annual
profit of their shop.
Holly has recently set up its own internal audit department, having previously outsourced this function to
their previous auditors. Several of the senior posts within the department were created by transferring
established long-serving staff members from Holly‟s main finance department.
Requirements
(a) Outline the factors that need to be taken into account by an external auditor when evaluating an
internal audit function and its work. (5 marks)
(b) Identify, with reasons, from the situation outlined above, circumstances that should be taken into
account when planning the external audit of Holly. (12 marks)
(17 marks)
Marking guide
Marks
(a) Factors to take into account when evaluating an internal audit function and its work
Organisational status/no operational responsibilities/free to communicate with external auditor
Scope of the function – is it wide enough to be useful/no limitation of scope?
Do management act on the recommendations of internal audit?
Do internal audit personnel have adequate training/competence/qualifications?
Internal audit sufficiently independent/senior level reporting lines/access to
board/audit committee
Sourcing consumables locally could lead to buying at too high a price/ collusion with suppliers
Lack of consistent quality of purchases could damage company‟s reputation
Expenses met in cash increase risk of misappropriation/lack of adequate
documentation for expense
Casual staff paid in cash
Casual staff could lead to breach of withholding tax rules – fines/interest
Incentive scheme for managers
Incentive scheme could lead to understatement of costs/overstatement of profit
Assets held under leases
Check for appropriate accounting treatment of leases
Tutorial note
This answer is the marking plan produced by the examiner. The examiner has confirmed that the
style of this answer is appropriate for use by students in the examination.
21 Garments Ltd
You are planning the audit of Garments Ltd for the year ending 30 June 20X1. Historically, the principal
activity has been the manufacture and wholesaling of fashion clothing, on a credit basis, to retailers.
However, early in 20X0, the company diversified into retailing and opened two retail outlets selling fashion
clothing to the general public. No credit facilities are granted to customers of the retail outlets.
During your planning meeting with the finance director, the following matters were highlighted as the major
changes since the last audit.
Expansion of retailing operations
As a result of the success of the retailing business, the company expanded its operations and opened ten
additional retail outlets during the year ending 30 June 20X1. The management accounts indicate that the
retail operations will amount to at least 20% of the company‟s revenue for the year ending 30 June 20X1.
Increase in overdraft facility
The overdraft facility was increased to help to fund the expansion. The company is currently trading at its
overdraft limit as a result of the increased volume of business. The directors are seeking to increase the
facility and are negotiating with the company‟s bankers.
Garments Ltd
Marking guide
Marks
Expansion of retailing
operations
The company has increased With multiple locations Perform branch visits
the number of its locations there is a risk of non- (including cash counts),
from 2 to 12. adherence to
Review and test check
management policies.
procedures/ controls.
This side of the business is Management may lack
relatively new. experience and a track
record such that
controls may not yet be
in place.
The company retails fashion The risk of shrinkage Attend physical inventory
clothing. These represent may mean that inventory count (at year end if
desirable goods susceptible to records do not reflect undertaken; alternatively,
theft. In addition, fashion actual inventories. observe counting
inventories are susceptible to procedures if system of
Risk of inventory
trends. continuous or periodic
obsolescence.
counting).
Review adequacy of count
instructions, in particular
identification of
– Differences between
physical and book
inventories
– Slow-moving lines.
Ascertain level of
differences between
physical and book
inventories.
Obtain evidence of action
taken in respect of
differences.
Review inventory
movement reports/age
analysis.
Review post year end
movements and selling
prices.
Increase in overdraft facility
The company is at its The overriding risk is Monitor negotiations with
overdraft limit and is seeking that the bank may the bank/ inspect
to increase its facility. withdraw the overdraft correspondence with the
facility. bank.
This could lead to Review management‟s
window-dressing and, if plans, including cash flow
the company is unable to and profit forecasts.
pay its debts as they fall
Obtain written evidence of
due, to going concern
management‟s strategy for
problems.
alternative sources of
funding.
Curson Ltd
Marking guide
Marks
Shrinkage – risk 1½
Shrinkage – controls 5
Cash – risk 1
Cash – controls 4½
Logistics/reorder levels - risks 2½
Logistics/reorder levels - controls 3
Computer system – risks 1
Computer system – controls 3
Asset management – risk 1
Asset management – controls 1
Laws/regulations – risk 1½
Laws/regulations – controls 1½
Profitability – risks 2
Profitability – controls 2
Personnel – risks 2
Personnel – controls 4
Marks available 36½
Maximum 22
Saiful Islam Mozumder, Manager Finance & Accounts, Organic Group, mozumder@organic-
crop.com Cell-01711-981920
Risk
Shrinkage
– Theft of inventories
– Damaged or poor quality/obsolete products.
Control procedures
Security measures in place on vehicles and in stores.
Inventories checked for quantity and quality for acceptance to retail site.
Staff trained in correct and careful handling techniques.
Managers only allowed to change inventory quantities and locations on privilege access codes, and
such transactions logged and reviewed by higher level management/security personnel.
Electronic tagging used for higher value goods.
Store detectives patrol sites.
CCTV used to keep high value items under surveillance.
Packaging designed to minimise damage.
Insurance policy taken out against theft of inventories.
Independent review of inventory ageing reports.
Risks
Theft of cash.
Fraudulent consideration accepted in exchange for goods.
Control procedures
Physical security over cash office, safe and cash collection equipment.
CCTV used to keep tills under surveillance.
Each cashier to have user ID and access password.
Floats checked at beginning and end of shifts.
Cash counted independently and held securely until collected.
Bankings carried out by protected security personnel and not retail staff.
Staff informed of floor limits for cheques, guarantee cards and credit/debit cards.
Consideration not to be accepted without on-line validation and checking of signatures
to credit/debit cards.
Regular independent reconciliations between amounts banked and sales data, and
discrepancies followed up.
Risks
Logistics processes fail to deliver the right inventory to the right place at the right time in
the right condition.
Re-order levels not set at appropriate levels resulting in stockouts/overstocking.
Control procedures
Computerised planning and forecasting systems based on prior experience and monitoring
of current trends.
Regular review of re-order levels by head office.
Orders over a given size must be authorised by an experienced manager.
Inventories are physically counted at intervals and results used to correct book records.
Saiful Islam Mozumder, Manager Finance & Accounts, Organic Group, mozumder@organic-
crop.com Cell-01711-981920
Differences investigated.
Approved suppliers with service level requirements included in contracts.
Risk
Loss of computerised systems resulting in business interruption.
Control procedures
Insufficient experienced staff to service retail processes (losing staff because of low pay).
Failure of remuneration policy to result in increased revenue.
Control procedures
Tutorial note
A columnar approach could have been adopted. However, since there are more controls than risks this may not
have worked very well.
23 Builda Ltd
You are in charge of the audit of Builda Ltd for the year ending 30 June 20X3 and are
Saiful Islam Mozumder, Manager Finance & Accounts, Organic Group, mozumder@organic-
crop.com Cell-01711-981920
responsible for preparing the programme of work to be undertaken by the audit staff.
Builda Ltd is a small building company which specialises in the building of new houses. It has 24
employees and normally builds between 25 and 30 houses a year. All employees are salaried, and
the payroll is processed by the business services section of your firm. Employees‟ salaries are paid
directly by electronic transfer into their bank accounts each month. Your firm also prepares the
annual statutory accounts from the books and records maintained by the company.
All the shares in the company are owned by Eddy Brick, the managing director, who is actively
involved in running the company. He draws a salary from the business and awards himself a bonus
once profits have been determined. The company has a history of increasing retained earnings as
Eddy Brick is very prudent, and his remuneration is modest compared to company profits. The
company has no borrowings and surplus cash is invested on the money market.
The company owns a small amount of non-current assets comprising plant and equipment and motor vehicles.
Inventories are the largest asset in the balance sheet comprising undeveloped land and work in progress, which
represents houses at various stages of completion at the balance sheet date. The land was purchased several
years ago and is included in the balance sheet at cost. Costing records are not maintained and the work in
progress is based on Eddy Brick‟s and his site manager‟s estimate of direct costs and overheads based on the
stage of completion of each house as at the balance sheet date.
The company accounts for the sale of a property only when notified by its lawyers that contracts have been
exchanged. Receivables represent amounts owed by
Customers for completions of sales
The local authority for deposits paid, by Builda Ltd, which are released once access roads to the sites are
completed
NBR for VAT.
The company is normally in a VAT repayment situation as the sale of new houses is zero rated for VAT
purposes, but the company is allowed to reclaim VAT on its purchases and expenses, and consequently
submits monthly VAT returns.
Payables represent amounts owed to trade suppliers and NBR in respect of payroll withholding taxes, and
deposits from customers which have been paid to Builda Ltd via its lawyers. Eddy Brick is keen to maintain good
relationships with the company‟s suppliers and to pay them on time. There is no purchase ledger, but Eddy
maintains a file of unpaid invoices which he reviews on a daily basis. He pays an invoice as soon as he receives
the supplier‟s delivery note from the site manager indicating that the materials have been delivered to, and
accepted on, the building site.
There are no cash transactions as all payments are made by cheque, and Eddy Brick is the only cheque
signatory. Receipts and payments are recorded in an analysed cash book which is prepared, on a monthly basis,
by a freelance accountant, who also undertakes monthly bank reconciliations. Receipts and payments are
recorded from details on the completion statements from the company‟s lawyers, remittances from NBR, and
cheque stubs.
The accountant also prepares a day book, in respect of the purchases and expenses invoices, in order to
analyse the VAT to support the VAT returns which he completes on a monthly basis. The company is subject
to periodic inspections by the VAT Commissioner in respect of VAT and recent inspections have not
identified any problems.
Requirements
(a) Identify, from the circumstances outlined above, the factors which indicate low inherent risk in respect of the audit of
Builda Ltd and, for each factor identified, explain why it contributes to low inherent risk.
(8 marks)
(b) Outline the audit work which you would direct the audit staff to undertake in respect of the key
balance sheet and income statement items during the audit of Builda Ltd. (11 marks)
(19 marks)
Saiful Islam Mozumder, Manager Finance & Accounts, Organic Group, mozumder@organic-
crop.com Cell-01711-981920
Builda Ltd
Marking guide
Marks
(a)
Factor indicating low inherent risk Why indicates low inherent risk
The nature of the business. The business is stable with high demand.
There is active involvement by the owner. The MD acts as a control.
The company has no borrowings, there is These factors reduce
no outside interest in the company and the
– Going concern risk
MD‟s attitude is very prudent.
– The risk of manipulation of the figures in
the financial statements.
The MD is the sole signatory. This reduces the risk of
unauthorised payments.
There are no cash transactions.
This reduces the risk of
unrecorded transactions.
The nature of receivables (a receivable This means that recoverability is unlikely
is only created once contracts have to be a problem.
been exchanged).
Revenue/number of houses sold are Reduced risk of inappropriate
easily reconciled (the transactions are revenue recognition.
not complex).
There is no history of VAT problems. Reduced risk of errors or private
(non-business) expenditure.
Saiful Islam Mozumder, Manager Finance & Accounts, Organic Group, mozumder@organic-
crop.com Cell-01711-981920
Use of accountant for bookkeeping/use of Reduced risk of errors.
firm to prepare payroll.
(b) Audit work re key balance sheet and income statement items
Non-current assets
Sample check additions per cash book to invoices and physical inspection.
Inventories
Check year end bank reconciliation, including dates of clearance of outstanding items.
Obtain bank letter.
Direct confirmation of money market balances.
Payables
Inspect unpaid invoices file and suppliers‟ statements for invoices relating to year.
Reconcile deposits to legal correspondence.
Reconcile amounts owed to National Board of Revenue (NBR) with payroll and cash book.
Check after-date payments.
Revenue
Lusco Ltd
Marking guide
Marks
Saiful Islam Mozumder, Manager Finance & Accounts, Organic Group,
mozumder@organic-crop.com Cell-01711-981920
(a) Inherent risk 1
Control risk 1
Detection risk 2½
Reasons for considering risk 2½
Marks available 7
Maximum 4
(b) Factors indicating risk (each) ½
Explanation of why a risk (each) 1
Maximum 10
(c) Controls re completeness of recording and safe custody (each) ½
Maximum 6
Total marks available 20
(a) Risk
Different elements of audit risk
Inherent risk: the risk of material error arising regardless of related internal
controls/risks associated with the nature and characteristics of the business.
Control risk: the risk that internal controls fail to prevent or detect a material error.
Detection risk
The risk that the auditor‟s substantive procedures will fail to detect a material error.
Detection risk is split into sampling and non-sampling risk.
Sampling risk is the risk that the sample is not representative of the population.
Non-sampling risk is the risk that all other work by the auditor fails to detect a material error.
Why auditor needs to consider
Risk assessment
25 Wrapak Ltd
You are responsible for the audit of Wrapak Ltd for the year ended 31 July 20X4. The
principal activity of Wrapak Ltd is the provision of a specialist packaging service for
companies in the cosmetic industry. The majority of Wrapak Ltd‟s customers are blue chip
companies but recently the customer base has broadened to include small and medium sized
companies.
Customers ship their products to Wrapak Ltd, and on arrival warehouse personnel enter details
of each consignment of goods received into Wrapak Ltd‟s computer system. The system is
updated to record the completion of the packaging process and the subsequent despatch of each
consignment to the customer. On confirmation of despatch, the system generates the invoice
which is printed out in the accounts office. All invoices are reviewed and authorised by Anna, the
accountant, prior to mailing to customers. At the end of each week the system generates a list of
consignments which have been completed but not yet despatched.
Anna is also responsible for ledger processing and sending monthly statements to customers.
At the end of each month she tries to find the time to chase slow payers as identified on the
aged receivables analysis. No other credit control procedures are undertaken.
As a result of the increased level of activity, the company moved its operations to larger
freehold premises in May 20X4. The acquisition was funded by a bank loan repayable in
monthly instalments over 10 years. The loan is secured on the premises.
A comparison of the draft accounts for the year ended 31 July 20X4 with the previous
year indicates a significant deterioration in the cash position despite an increase in
(18 marks)
Wrapak Ltd
Marking guide
Marks
(a) Factors which may have contributed to cash flow problems, and policies
and procedures to be implemented to improve cash flow
Factors
Prompt invoicing.
Initial credit checks on new customers.
Imposition of credit limits with regular review thereof.
Checking of age of existing receivable before new work commenced.
Delinquent customers put „on stop‟.
Daily/weekly review of aged receivables analysis with follow-up letters.
Interest on overdue amounts.
Discount for early payment.
Bonus incentive for improvement in cash collection/targets for cash collection.
Referral of overdue debts to debt collection agency.
Use of debt factoring.
(b) Audit procedures to ensure the loan has been properly accounted for
26 Electra Ltd
You are preparing for your audit planning meeting with the finance director of Electra Ltd, whose
principal activity is electrical contracting under fixed-price short-term contracts. You have been
provided with the following information in respect of the years ended 31 March 20X2 and 20X3.
Extracts from the income statement
Draft 20X3 Actual 20X2
CU‟000 CU‟000 CU‟000 CU‟000
Revenue 17,407 15,873
Cost of sales
Opening work in progress 533 499
Materials used 1,788 1,624
Wages and salaries 12,286 9,472
Closing work in progress (832) (533)
–––––– (13,775) –––––– (11,062)
–––––– ––––––
Gross profit 3,632 4,811
Administrative expenses (3,582) (3,175)
–––––– ––––––
Profit from operations 50 1,636
Finance cost (101) (51)
–––––– ––––––
(Loss)/profit before tax (51) 1,585
–––––– ––––––
Extracts from the balance sheet
Draft 20X3 Actual 20X2
ASSETS CU‟000 CU‟000 CU‟000 CU‟000
Non-current assets 1,006 939
Current assets
Work in progress 832 533
Receivables 3,214 1,684
Cash and cash equivalents 264
4,046 2,481
5,052 3,420
Electra Ltd
Marking guide
Mar
ks
(a)
WIP has increased from 17.5 days to 22 This may indicate possible problems/delays
days. with invoicing ultimately impacting on cash
flow.
The trade receivables collection period is This may indicate
up from 38.7 days to 67 days. – Possible bad debts
– An adverse impact on cash flow.
The cash position (cash and cash This indicates a risk of inability to pay debts
equivalents to overdraft) has deteriorated. as they fall due (going concern risk).
There has been a build up of other The delay in payments may be due to
payables. shortage of funds/inability to pay debts.
27 WHAT
Welfare and Help for the Aged Trust (WHAT) is an NGO. It has recently commenced
operating from a community centre in your locality by providing facilities for the well-
being of senior citizens.
WHAT receives income from the following sources.
(1) Donations under deeds of covenant (contractual agreements to donate a
specified amount for a specified number of years) entered into by individuals
(2) Postal donations of cheques and cash
(3) Door-to-door collections by volunteers with boxes, and workplace collections
(4) Other donations (several mini-buses have been given, either new or second hand, by large
businesses)
(5) Grants from local authorities
(6) Sales of refreshments at the community centre
(7) A variety of fund-raising events organised by voluntary helpers.
The directors have appointed your firm as auditors.
Prior to your work on the audit the directors have asked your advice, by way of an
additional engagement, on the internal controls which should be in place over the
company‟s income.
Requirements
(a) Briefly explain how this engagement differs from your engagement as statutory auditor, and set out
the
approach that should be followed for any assurance engagement. (5
marks)
(b) Describe the controls over the above income which you would expect WHAT to operate. For (4)
above you should describe the controls over the donated assets. (15
marks)
(20
marks)
WHAT
Marking guide
Mar
ks
(a) Differences between this engagement and the statutory audit engagement
The statutory audit is carried out under the Companies Act 1994 (CA94) or equivalent legislation.
Under the CA94 the statutory auditor has a duty to carry out whatever work he deems
appropriate in order to reach an opinion on whether the financial statements of a company give a
„true and fair view‟. The auditor‟s opinion is then reported to the shareholders in a predetermined
form of report (as set out in BSA 700).
Here, the auditor has been asked to perform additional work over and above that of the
statutory audit. The scope of this work will be agreed with management and a particular format
of report (addressed to management) will also be agreed.
Approach for assurance engagements
Agree the scope of work to be performed and the basis of the report to be given.
Issue written engagement terms detailing the responsibilities of the parties to the
engagement, the scope of the work and the basis of the report to be presented.
Plan the work to be performed, including
– Assessment of the risks of error and misstatement
– Determination of the quantity of evidence needed to give the report required.
Determine the testing plan to be performed.
Collect and test the detailed evidence.
Review the results of the testing of the evidence and form an overall conclusion on
the engagement.
Prepare and present the assurance report.
The approach to the engagement and all the testing and results must be properly documented in a
set of working papers.
28 Pubgames Ltd
You are a member of the audit team for Pubgames Ltd, a company which manufactures
electronic quiz machines for use in pubs and clubs. The audit manager has informed you
that on the current audit your responsibility will be trade payables. The following
schedule has been prepared by the client.
CU
Trade payables
Overseas suppliers 175,000
Ferganto Ltd 380,000
Others 110,000
GRNI (goods received but not invoiced) 72,000
Having reviewed last year‟s audit files and discussed matters with the client, you have noted the
following.
(1) During the current year the clerk who was responsible for overseas suppliers retired
due to ill health. She was not replaced as the company needs to cut costs, and her
work has been shared out around the rest of the accounts department.
(2) Ferganto Ltd is the sole supplier of high quality sheet steel which is used by Pubgames
Ltd to build the casings for the quiz machines. In the past Ferganto has always refused to
confirm or give a year end balance. In addition, during the current year Ferganto has
Saiful Islam Mozumder, Manager Finance & Accounts, Organic Group,
mozumder@organic-crop.com Cell-01711-981920
introduced a reservation of title clause on all invoices to Pubgames.
(3) „Others‟ relates to around 100-150 small suppliers which produce specialist electrical components.
(4) „GRNI‟ relates to goods received prior to the year end but where no invoices have yet
been entered in the purchase ledger. The figure is considerably higher than last year
because of problems in the computer system, which meant that no purchase invoices
could be processed in the week immediately following the year end.
At the briefing meeting for the audit the manager explained that the client had set a very tight deadline
for audit clearance. This is because it is currently negotiating a merger with one of its competitors, and
the financial statements are needed before final completion.
Requirements
(a) Identify the main audit risks for payables specific to Pubgames Ltd. (4 marks)
(b) Produce an outline audit approach to payables for submission to the manager. (10 marks)
(c) Some audit firms use directional testing as part of their audit approach, with payables being tested
for
understatement. Identify and explain the specific audit techniques which could be used to try to
identify understatement errors in the payables cycle. (3
marks)
(17 marks)
Pubgames Ltd
Marking guide
Mar
ks
Nosh Ltd
Marking guide
Marks
Potential future conflict of Advisory work includes Ensure that existing audit
interest if we are asked to advice on expanding the clients are excluded from
advise on the suitability of business by the acquisition advisory work in respect of
Nosh Ltd acquiring of similar businesses. This acquisitions.
another of our clients. could potentially include
the acquisition of another
audit client.
As we are very involved We may become too Restrict all work to advisory
with the client, there may involved with this client due work only and ensure that no
be the risk of becoming to the other services of tax management decisions are
too familiar with Nosh and advice which we are to made/appear to be made.
Ltd. This could reduce our offer.
Ensure „informed
objectivity.
management‟ is designated by
There is a management Nosh Ltd.
threat implicit in non-audit
Obtain a second partner
services.
review of the audit.
The auditor may become The auditor is to perform Constantly review fee level to
too dependent on the additional work of tax and ensure that it does not
regular fee income of advisory services as well as exceed 15% of gross fee
Nosh Ltd, which may the annual audit. income
impair objectivity and
independence.
Opening balances may be Nosh Ltd is a new audit Check opening balances have
misstated, resulting in client. been brought forward
incorrect closing balances correctly from last year‟s
and comparatives. closing position.
Enquire of management how
opening balances were
calculated.
Review prior period‟s
accounting records and
control procedures to see if
any errors are apparent.
Perform substantive
procedures on opening
balances if other procedures
are unsatisfactory.
Nosh Ltd may not be a Nosh Ltd has a one year Establish what proportion of
going concern if it loses renewable contract with a sales is made to the
the supermarket as its national supermarket chain. supermarket by examining
customer. Financial sales figures for the year in
statements may be the sales day book.
incorrectly drawn up on a Scrutinise correspondence
going concern basis. with supermarket for any
signs of dissatisfaction.
Perform sensitivity analysis on
forecasts to assess impact of
loss of contract.
Ascertain if contract has been
re-signed post year end and
physically inspect a copy of
the contract.
The financial statementsThe managing director has Review purchase day book
may fail to disclose a controlling interest in a and cash payments book for
material related party major supplier. transactions with Plasco Ltd.
transactions.
Check that notes to financial
Purchases may not be on statements disclose the
normal commercial terms. related party transactions.
Compare Plasco Ltd‟s prices
and terms to the industry
average.
Check that the engagement
terms include either auditing
both companies or access to
the auditor of Plasco Ltd.
Obtain a management
representation that all
transactions included are in
the normal course of business
and at arm‟s length.
Revenue and margins mayRevenue and margins have Perform extensive cut-off
be overstated. improved in the year due procedures.
to significant expansion.
Extend procedures for testing
overstatement.
The managing director has successfully negotiated the sale of the entire share capital of Medical
Diagnostics Ltd to a public company in a similar field of business. The key terms of the sale and
purchase agreement, that has been signed, are as follows:
MDL will receive initial cash consideration of CU7 million, with further cash consideration of
CU4 million on 31 January 20X7, providing that the operating profit of Medical Diagnostics Ltd
grows by an average of 5% per annum over the next two years ending 31 October 20X5.
The initial consideration of CU7 million is based on net assets at 31 October 20X3 of CU1.2
million. If the net assets in the final audited accounts for the year ended 31 October 20X3 are less
than CU1.2 million then the initial payment will be reduced by an amount equal to the difference
between the final reported net assets and CU1.2 million. There is no corresponding upward
adjustment.
The audited accounts must be available by 31 December 20X3.
Medical Diagnostics Ltd
Management Accounts
Balance Sheet
Movement 31 October 31 October
in month 20X3 20X3
Actual Actual Budget
CU'000 CU'000 CU'000
Non-current assets (65) 672 720
Marking guide
M
a
r
k
s
Receivable collectability
Adequacy/reasonableness of tax accrual
31 Sporticus Ltd
Your client, Sporticus Ltd, has 40 sports shops and operates 10 leisure
centres around the Midlands. You are the senior in charge of the audit for
the year ending 30 September 20X9.
In previous years substantive procedures have been reduced as a result of
your assessment of control risk as low. This assessment has been supported
by evidence obtained by tests of control.
At the start of the year, in October 20X8, the company established an
internal audit department. The new department is independent of the
accounting function and is responsible directly to David Campbell, the finance
director.
The head of the department, Peter Adams, a chartered accountant, was
promoted from his previous position of assistant chief accountant. An
unqualified accountant with information technology experience was recruited
externally, and the staffing was completed by the internal transfer of a payroll
clerk.
Since its formation the department has evaluated and re-documented the
internal control systems in all areas. It has also performed testing of the
control procedures in the sales and cash handling system throughout the
financial year.
All of the working papers in respect of the work of the department will be
provided to you for the audit. Additionally, before the time the audit is
scheduled to begin in November 20X9, the department is planning to perform
detailed testing of the control procedures in the purchases system during the
whole year.
David Campbell has asked you to explain the extent to which you
will be able to make use of the department‟s work during your
audit for the year ending 30 September 20X9.
Requirements
(a) Write a formal letter to David Campbell setting out
(i) The factors that could limit your ability to use the work of the internal audit department
in your final assessment of control risk (10 marks)
(ii) The effect on your audit and the extent to which you may make use of the work that the
department has carried out, and is planning to perform before the audit. (8 marks)
(b) Set out the advantages to a company of establishing an effective internal audit function. (4 marks)
Sporticus Ltd
Marking guide
Marks
D Campbell Esq
Sporticus Ltd
Maple House
Worthing Street
Cannock
Staffordshire
ST47 2BA 2 October
20X9
Dear David
32 Atlantis Ltd
Atlantis Ltd is a long standing client of the firm. It is a supplier of kitchenware and bathroomware
from a number of outlets which comprise showrooms and stores. All sales are made on credit.
Features of the sales system of the business include the following.
(1) All processing of accounting information is performed centrally at head office from returns
submitted from the branches. The only system maintained at each branch is inventory control
on a personal computer. A full physical count is carried out at each branch at the year end.
(2) Sales orders are supplied from the branch concerned when inventory is available at that
branch. When this is not the case, inventory may be transferred from another branch or
delivered to the customer direct from the other branch. Inventory movement dockets are sent
by the second branch to the originating branch when inventory is transferred between
branches. Sales are accounted for by the branch taking the order.
(3) Due to the competitive nature of the business, branch managers have considerable discretion
to offer discounts from list price, within specified parameters. Part of the remuneration
package of branch managers is dependent on the revenue of their branch.
Atlantis Ltd
Marking guide
M
a
r
k
s
A company website
Company staff
Internal control procedures manual
Company marketing material
Company price lists
Company correspondence (for example, with customers, solicitors, etc)
Procedures to obtain the information
Auditors must carry out a combination of the following procedures to obtain an understanding of the
business:
Analytical procedures
Observation and inspection
Inquiries of client personnel
In addition it is a requirement of BSA 315 that the audit team discuss the client‟s business and the
susceptibility of the financial statements to fraud.
(b)
Potential risks Possible consequences
(4) Invoicing
There is a significant time delay Lengthens the time taken to receive payment,
between delivery and billing. and hence increases working capital
requirements.
There may be up to two weeks‟ accrued Management accounts may be out of date.
income at any point in time
Greater risk of cut-off errors resulting
in understatement of profit.
Trade receivables
Circularise a sample of year end receivables weighted towards the larger balances.
Include copies of customers‟ sales ledger accounts to have best chance of detecting fraud.
Agree after-date cash received and remittance advices to year end receivables.
General
Perform analytical procedures by comparing gross profit margins branch by branch
and to budget and previous years.
Marking guide
Marks
1 Your firm is the auditor of Swanky Cars Garages Ltd, a medium-sized chain of
garages. The following points have arisen from your audit.
(1) Mechanics in two of the garages are known to work at weekends – there is a
possibility that they may be using the company‟s premises to service friends‟
cars.
(2) The garages have been revalued this year resulting in an unrealised surplus of CU45,000.
(3) Some cars taken in part exchange are scrapped immediately. There is no
evidence of any cash being received.
State, for each of the above, whether they should be referred to in the letter to
management or the letter of representation or both. Where you believe they
should be referred to, give reasons.
(3
ma
rks)
1 Letters
Inclusion in letter to management?
(1) Yes – lack of physical control over premises
(2) No
(3) Yes – lack of control over cash receipts
Inclusion in letter of representation?
Saiful Islam Mozumder, Manager Finance & Accounts, Organic Group,
mozumder@organic-crop.com Cell-01711-981920
(1) No
(2) No
(3) Yes – completeness of income
2 The new auditor of a company has concluded that a material amount in the preceding
year‟s financial statements was included within an incorrect current asset heading. The
audit opinion was unqualified.
Explain the auditor‟s responsibilities in relation to the current year‟s audit report. (2
marks)
Misclassific
ation of
expenses
Form
Qualified „except for‟ opinion on income statement
Unqualified opinion on balance sheet and „standard‟ basis of opinion paragraph
Explanation
Matter is material disagreement but not pervasive
Does not affect balance sheet
4 The directors of Howkins Ltd have prepared the financial statements on the going
concern basis, although there is a significant doubt about the company‟s ability to
continue as a going concern. What effects will this situation have on your audit
report if the uncertainty over going concern is
(i) Fully disclosed in the financial statements
(ii) Not disclosed in the financial statements?
(3
ma
rks)
6 You are the auditor of Fenditton Ltd, a listed company with two UK subsidiaries. During your
review of the working papers and draft annual report for the year ended 31 July 20X4 you note
the following matter.
The chairman‟s statement in the annual report indicates that the group‟s profit has trebled in the
year to 31 July 20X4, without explaining that the principal reason for this is the exceptional profit
on the sale of a trade name „Butler‟s Beauties‟ for CU5 million. The name had not previously been
recognised in the financial statements.
State the action that you would take in respect of the above and how your audit report would be
affected if the matter remains unchanged. (4 marks)
Chairman’s
statement Action
Normally no statutory responsibility for auditor to review chairman‟s statement
(CS) for consistency with accounts
If a non-statutory responsibility, auditor needs to consider if CS undermines credibility of
financial statements
Unlikely this will be the case; however, auditor should encourage chairman to revise
contents of his statement
If a statutory responsibility, auditor should encourage client to change CS
If refused, a reference to the non-consistency with the accounts will be required
Impact on audit report
Audit report will not be qualified
Statement referring to the inconsistency should appear after opinion paragraph
immediately above auditor‟s signature
7 As part of the completion stages of an audit, the auditor should carry out a review of the
financial statements.
Saiful Islam Mozumder, Manager Finance & Accounts, Organic Group,
mozumder@organic-crop.com Cell-01711-981920
What conclusions should the auditor be in a position to form as a result of this review? (2
marks)
8 During the year ended 31 August 20X2 Worboys Ltd, an outdoor leisure retailing chain,
switched purchases of tents and waterproof clothing from Leakproof Products Ltd to another
supplier. Two months later, Leakproof Products Ltd went into liquidation.
The liquidators of the company have issued a claim against Worboys Ltd for breach of implied
contract and consequential losses. No amount has yet been put on the claim, but lawyers advise
that it could be substantial and, although they are confident of a successful defence, also advise that
the case could go against Worboys Ltd. This would have a serious effect on the company.
Describe the effects this situation will have on the audit report of Worboys Ltd if the matter is
(i) Fully disclosed in the financial statements
(ii) Not disclosed in the financial statements. (3
marks)
Effect on audit report
(i) Significant uncertainty
Emphasis of matter paragraph
Unqualified
(ii) Disagreement – lack of disclosure
Disclosure given in report
Adverse opinion
Accounts do not give true and fair view
9 During the audit of Morgan Ltd audit tests indicated that company policy requiring purchase
orders to be placed only by the company‟s buying department was not adhered to in 10% of the
transactions examined.
In respect of the above breach in company policy, draft extracts suitable for inclusion in the
auditor‟s
management letter, which set out the possible consequences and the recommendations that you
would make. (4 marks)
Breach in company
policy Consequences
Duplicate orders
Use of unauthorised suppliers
Terms/prices negotiated with unauthorised suppliers generally less favourable
10 Your firm has recently been appointed as auditor to Donner Ltd for the year ending 31
October 20X5. This is the first year of audit for Donner Ltd.
State the matters to be considered in respect of the opening balances of Donner Ltd. (3
marks)
Matters to be considered
Check opening balances correctly brought forward
Review client working papers for prior year
Check appropriateness of accounting policies/accounting policies consistently applied year to year
Any changes appropriately accounted for/disclosed
Substantive work on opening balances (where no alternative available)
State in audit report that comparative figures not audited (BSA 710)
Ensure disclosure of lack of audit in prior year in financial statements
Integrity of accounting system/strength of control environment
11 During your post balance sheet events review of a second division football club, you
found out that the club has just been relegated to the third division. This means that
revenues for the following season are likely to be considerably lower than the current
season.
Explain what additional procedures you would carry out in respect of this matter. (3 marks)
Additional procedures
Discuss with management implications of relegation/management plans
Obtain and review updated cash flow forecasts based on playing in a lower division
Reconsider the going concern basis, e.g. loan covenants, overdraft limits
Assess whether financial statements need amending
Ensure fact that team has been relegated has been adequately disclosed
Review board minutes
Analytical review of forecast revenues with published third division revenues
Further information and why required
(1) Amount of cheque confirms balance outstanding
Cheque received, banked and posted after year end
To confirm as acceptable timing difference in conclusion
(2) Provided for at year end = acceptable timing difference
Not provided for = error in conclusion of test
Whether isolated occurrence or not
For need to extrapolate or not in conclusion
13 The directors of two companies, Fletcher Ltd and Dervish Ltd, have each prevented their
auditors from carrying out procedures considered necessary to verify the amount of
inventories held by third parties of CU250,000.
In the audit of Fletcher Ltd materiality has been set at CU200,000, and in the audit of
Dervish Ltd materiality has been set at CU15,000.
State the effect this matter will have on the audit report of each company. (3 marks)
14. The directors of Denzil Ltd are preparing the financial statements for the year ended
31 May 20X1, and have approached the auditors for advice because they are unsure
whether the company can be considered a going concern.
State the importance of the going concern concept in the preparation of financial
statements, and describe the effect on the financial statements if the company
(i) Is considered a going concern, although there are significant doubts about this
(ii) Is not considered a going concern. (4 marks)
15 Your firm has been engaged to conduct a non-statutory audit of the year end accounts of
the Bangladesh branch of Finch Inc, an American company, and to provide an assurance
report as near to a statutory audit report as you are able.
Set out the main differences between the assurance report you will provide and a statutory
audit report. (2 marks)
16 With regard to auditors‟ communication with those charged with governance, what
matters should auditors communicate according to BSA 260? (3 marks)
Reports to those charged with governance
BSA 260 requires that auditors should communicate matters of governance interest that arise from the
audit to those charged with governance. Auditors are required to take the following steps.
Listed company audit clients (BSA 260 para 11-5)
General approach and scope of audit
Selection and changes in accounting policies
Risk and exposures
Audit adjustments
Material uncertainties
Disagreement with management
Expected modification to the audit report
18 The directors of Pinot Ltd have included the following note in the accounts for the year ended 31
December 20X3.
„The company reached agreement with its lenders, in October 20X3, to extend the maturities of its
debt facilities until September 20X4, waive all existing covenant breaches and reduce interest costs.
All preconditions contained in the facilities agreement have now been satisfied. The company is working
on initiatives to significantly reduce its current debt levels and is to explore opportunities to raise further
funds by September 20X4. Based on progress to date, the directors remain confident that the company
will be successful in achieving its strategy. While there can be no certainty, the directors believe that the
adoption of the going concern basis is appropriate in the preparation of the financial statements.
If adoption of the going concern basis was not appropriate, adjustments would be required to write
down assets to their recoverable value, to reclassify non-current assets as current assets and to
provide for any further liabilities that might arise.‟
Describe, with reasons, the possible effects of this note on the audit report for the year ended
31 December 20X3. (4 marks)
Effect on audit report
Unqualified opinion if note considered adequate
If note inadequate or disagree with basis of preparation – qualified opinion
Modified - emphasis of matter paragraph included in audit report
Drawing users‟ attention to note
Statement that report not qualified in this respect
19 Assurance firms may be engaged to prepare a report on the financial statements and other information
presented by organisations which are required to report under special legislation or regulations.
Give four examples of such organisations, and indicate why they might be subject to such special reports.
(2 marks)
20 You have carried out a receivables circularisation as part of your audit of Trump Ltd for the year ended
31 December 20X2. It was revealed that a customer disagreed with the balance because it had sent a
cheque on 23 December 20X2.
What further information would you require in order to conclude on the result of this test, and why will
you require this information? (1 mark)
21 Siskin Ltd conducts all its sales on a cash basis. The managing director and majority shareholder of
Siskin Ltd has provided a written representation in respect of the completeness of cash sales.
What additional matters would you consider in determining whether or not you would rely on this
representation? (3 marks)
Whether to rely on written representation
Internal controls in place over cash sales/segregation of duties
Whether independent analytical review of GP%/reconciliations
Whether GP% in line with industry sector
Integrity/attitude of MD/well informed
Lifestyle of MD in relation to stated income
Whether audit testing consistent with representations
22 During the audit of Poplar Ltd for the year ended 31 January 20X3 you have been assigned the
responsibility of checking the cash at bank figure in the balance sheet. While checking the bank
reconciliation you discovered that receipts from customers, listed as outstanding lodgements at the
year end, were cleared through the bank on 14 February 20X3.
Explain why this matter should be investigated further. (2 marks)
35 Anagram Ltd
You are the senior in charge of the audit of Anagram Ltd („Anagram‟) for the year ended 30
June 20X5. Anagram is a manufacturer of silicon chips and wafers.
The bulk of the audit fieldwork in respect of this client was completed last week, and the audit
manager has asked you to pull the file together so that she can attend the final clearance
meeting with the client‟s management.
During the course of the audit, particular attention was paid to a major sales contract that
Anagram entered into during the year. The contract is for the supply of a substantial number of
custom-made silicon chips to a Japanese component manufacturer. In order to service this
contract, which has an initial duration of five years, Anagram has invested heavily in new
specialist plant and equipment. This investment has in part been financed by substantial new
bank loans and an extension to the company‟s overdraft facility. The contract also gives the
customer a 60 day credit term on all purchases from Anagram, and this has in turn increased
Anagram‟s working capital requirements.
The sales contract stipulates that the customer is to purchase the product from Anagram in
fixed monthly amounts, referred to in the contract as „call-downs‟. The call-down for March
20X5 went ahead as planned, but the amount of product called-down for April, May, and June
20X5 represented approximately only one-third of the amount originally stipulated in the sales
contract. The lead-time for raw materials purchased by Anagram is two months and therefore
the above shortfall in sales has resulted in a significant increase in the holding of raw materials
and finished goods inventories for Anagram at the year end.
Requirements
(a) List the principal components that you would expect to see in an audit completion memorandum for a
statutory audit conducted under the Companies Acts. (4 marks)
(b) Set out the matters to which you would direct attention during your subsequent events
review in order to reach a satisfactory conclusion on the accounting treatment and
disclosure in respect of the issues raised above. (7 marks)
(c) State with reasons how each of the issues raised above might cause you to modify your audit report in
respect of Anagram. (7 marks)
(18 marks)
Anagram Ltd
Marking guide
Marks
Tutorial note
This answer is the marking plan produced by the examiner. The examiner has confirmed that the
style of this answer is appropriate for use by students in the examination.
36 Garb Ltd
You are the external auditor of Garb Ltd for the year ended 30 September 20X1. Its principal
activity is the design, manufacture and sale of clothing.
The company made a loss in the year ended 30 September 20X1, but the profit forecast
indicates a return to profitability in the year ending 30 September 20X2. The loss was due to
redundancy and restructuring costs following the loss of its major customer, a national retailer,
to whom it supplied clothing under the retailer‟s brand name. The company is now focusing on
its own branded goods which have been sold, historically, at a higher margin. There are plans to
develop its overseas market and to expand the customer base for its recently launched
corporatewear products, and contracts have recently been agreed with several new overseas
customers. The company has also negotiated a new contract with a major supplier, which has
resulted in reduced prices in return for committed monthly purchases.
During the year ended 30 September 20X1 the company suffered severe negative cash flow but
managed to stay within the overdraft facility by delaying payments to trade payables and NBR.
The company has a bank loan which is due for repayment in March 20X2 and is negotiating with
its bankers for a replacement loan required to repay the present loan.
Requirements
(a) Explain what is meant by the going concern concept and why the auditor should consider whether a
company is a going concern. (5 marks)
Garb Ltd
Marking guide
Marks
(a) What is meant by the going concern concept, and why the auditor should consider
whether a company is a going concern
The going concern basis presumes that the entity will continue in operational existence for the
foreseeable future.
Accounting standards require financial statements to be prepared on the going concern basis.
BSA 570 requires auditors to consider the entity‟s ability to continue as a going concern, and
ensure appropriate disclosure in the financial statements.
If the going concern basis is inappropriate, a company may need to ascribe different values to items in
the financial statements (i.e. prepare the financial statements on a break-up basis).
Assets may need to be written down to recoverable amounts or reclassified.
Liabilities may need to be restated to reflect changes in amount or date of maturity.
Additional liabilities for losses/redundancies may arise.
(b) Matters to be considered when reviewing the profit and cash flow forecasts in order to
assess whether the company is a going concern
Profit forecast
Reasonableness of assumptions, particularly in respect of
Saiful Islam Mozumder, Manager Finance & Accounts, Organic Group,
mozumder@organic-crop.com Cell-01711-981920
– Anticipated level of revenue taking into account new contracts/loss of major customer
– Whether margins reflect terms of historical/new sales contracts
– Whether terms of contract agreed with major supplier
– Penalties in respect of late payments to NBR
– Projected exchange rates.
Consider the extent to which forecasts for expired periods are supported by
management accounts/events after the balance sheet date.
Consider profits profile (i.e. quality of profits) – ensure profits are from trading and not
from saleof non-current assets.
Cash flow forecast
Reasonableness of assumptions, in particular
– Expected cash collection performance/status of receivables
– Basis of payment terms to existing suppliers (may indicate tightening by suppliers).
Company‟s ability to meet its debts as they fall due and stay within overdraft limit.
General
Susceptibility of key components to sensitivity analysis.
Any unanticipated costs of closure incurred in the post balance sheet period
have been accounted for.
Competence of preparers of forecasts by reference to previous forecasting.
Accuracy of additions and calculations/consistency between cash flow and profit forecasts.
Whether any of the projections would result in debt covenants being breached.
(c) Implications for the audit report if the negotiations for the replacement loan
are not completed by the time the audit report is signed
This would constitute a material matter re a going concern problem which should be highlighted
in the audit report.
The audit report should be unqualified if there is adequate disclosure in the accounts. The
report should include
37 Plumb Ltd
You are in charge of the audit of Plumb Ltd for the year ended 30 September 20X5. The principal activity is
the provision of plumbing and central heating services under fixed-price short-term contracts. The majority
of the company's business is conducted on a sub-contract basis for construction companies many of which
use Plumb Ltd on a regular basis. It is common practice in this industry sector for construction companies
to pay 95% of the contract value on completion with the 5% balance being retained by the customer for six
months as security against problems with the work undertaken.
Plumb Ltd also has retail outlets through which it sells consumables used in the plumbing trade. However,
management is currently negotiating the sale of the retail operation and plans to use the proceeds to repay a
loan falling due in February 20X6. Following the disposal of the retail operation, Plumb Ltd will continue to buy
consumables used in its contract work from the existing suppliers but in smaller quantities.
Plumb Ltd made an operating loss for the year ended 30 September 20X5. This is mainly due to a
Saiful Islam Mozumder, Manager Finance & Accounts, Organic Group,
mozumder@organic-crop.com Cell-01711-981920
substantial provision for rectification work relating to a contract for Builda Ltd, one of Plumb Ltd's major
customers. The contract was completed in early September 20X5 but failed to meet the customer's
specification. Furthermore, in October 20X5, Plumb Ltd received notification that Builda Ltd had lodged a
claim against the company for substantial compensation for alleged damage to the customer's business. No
provision has been made for this compensation as the directors of Plumb Ltd have instructed the company's
legal advisors to fight the claim.
The company is currently trading at its overdraft limit and the directors have been negotiating with the
company's bankers in order to increase its borrowings. The directors have prepared profit and cash flow
forecasts for the three years ending 30 September 20X8 in support of the request for funding. The
company's bankers require this information to be reviewed by independent accountants and the board of
directors has requested that your firm undertakes this review.
Requirements
(a) In relation to the audit of the financial statements, identify from the information provided above, the
matters which give cause for concern and explain why they give cause for concern. (6 marks)
(b) Identify the different types of audit report modification which may arise from a going concern problem
and state the circumstances in which they are appropriate. (6 marks)
(c) Identify from the information provided above, the specific matters you would consider when reviewing
the assumptions underlying the income and expenditure included in the profit forecast and the
receipts and payments included in the cash flow forecast. (8 marks)
(20 marks)
Plumb Ltd
Marking guide
Marks
Income
– Includes income from retail operations to date of disposal/excludes income from
retail operations following disposal
– Allows for loss of income from major customer
Expenditure
– Allowance made for any loss of bulk discounts due to reduction of purchase of consumables
– Includes legal costs of fighting legal action
– Wages to reflect reduction in operations due to loss of major customer
– Additional overdraft interest but no loan interest following repayment of loan
– Costs of rectification work
– Profit or loss on disposal of retail operations included
– Accounting policies are consistent with historical financial statements
Cash flow
Receipts
– Timing allows for retentions
– Reflects disposal proceeds
Payments
Saiful Islam Mozumder, Manager Finance & Accounts, Organic Group,
mozumder@organic-crop.com Cell-01711-981920
– Loan repayment made in February
– Includes costs of disposal
– Suppliers paid in accordance with their terms of trading
General
– Items in cash flow are consistent with profit forecast
Formal credit limits are set for about 50% of corporate customers with credit accounts,
and audit tests indicated that about 20% of customers with formal credit limits have
exceeded those limits for more than six months.
(2) Property, plant and equipment
Company policy, which was to obtain three quotes for capital expenditure in excess of
CU5,000, was not adhered to on two occasions.
(3) Computer system
File servers holding business-critical data and systems are not sited in secure locations.
The changing of passwords is at the discretion of staff members.
Requirements
(a) Set out, in a manner suitable for inclusion in a report to management, the possible
consequences arising from the weaknesses identified above and the recommendations to
remedy those weaknesses. Your recommendations should clearly describe how the
control procedures should operate.
Note: A covering letter is not required. (18 marks)
(b) When communicating audit matters to those charged with governance, describe the attributes
required for such communication to be effective. (5 marks)
(c) Set out what additional matters are reported to those charged with governance. (3 marks)
(26 marks)
Marking guide
Marks
Bad debts could arise because of sales being made without reference to credit limits.
Working capital may be unnecessarily tied up, with adverse interest implications.
Recommendations
Credit limits should be introduced for all customers with credit accounts.
These limits should be regularly reviewed by head office in conjunction with hotel
managers and credit ratings.
Independent review of aged receivable analysis.
Follow up of slow payers.
(2) Property, plant and equipment
Possible consequences
Property, plant and equipment may not be acquired on the most favourable terms.
Recommendations
Independent review of quotes by estates/property manager who should evidence
review by signature.
Employees involved to be informed in writing in respect of breach of company policy.
(3) Computer
system File
server
Requirements
(a) As the consultant of Bingt & Co undertaking the assignment
(i) Identify the factors, and consequential risks, you would consider when reviewing inventory values
for Salmonoid Ltd (assume that as a firm you have all the technical expertise required)
(ii) State the main features of your final assurance report on inventory values and briefly explain the
significance of each. (14 marks)
(b) Compare the purposes and characteristics (including the levels of assurance provided) of the different
forms of assurance provided by
(i) Audit reports under the Companies Act
(ii) Other reports under legislation or regulation
(iii) Other reports where the scope of the work and of the report to be provided are agreed
between the two parties involved. (8 marks)
(20 marks)
Salmonoid Ltd
Marking guide
Marks
Water is supplied from bore holes. If the water supply runs low or is contaminated
the fish may die.
The fish are susceptible to disease Even a moderate deterioration in water
related to inventory levels. supply may reduce the usable capacity of the
cages below 300,000 fish.
If parasites etc cannot be properly controlled,
the true maximum inventory levels will have
to be reduced if quality is to be maintained.
Poor quality inventories will have a lower
net realisable value.
Inventories held in poor conditions may attract
legal action from animal welfare groups leading
to possible fines and loss of reputation.
Saiful Islam Mozumder, Manager Finance & Accounts, Organic Group, mozumder@organic-
crop.com Cell-01711-981920
(ii) Features of assurance report on inventory values and significance
Feature Significance
Feature Significance
also gives a high, but not absolute, level of assurance about the financial
information. The opinion, and any report to a regulator, may also refer to more
specific matters such as the organisation‟s compliance with rules on accounting
systems and record keeping, or compliance with solvency rules set by the
regulator. The report on these specific matters is a positive assertion about
compliance with these aspects of the rules, and will convey a high level of
assurance to the regulator and other readers of the information.
(iii) Other reports where the scope of the work and of the report to
be provided are agreed between the two parties
„Other reports‟ embraces the many other circumstances where an assurance
firm is engaged by another party to provide a report on a piece of information.
The scope of the engagement is not set down by regulation, so the assurance
firm and the client must agree on the terms of engagement. In particular, the
engagement letter must specify
Marking guide
Marks
Preliminary materiality is established at the planning stage and revisited at the completion stage in the
light of potential adjustments.
Materiality influences
Marks
On a test basis
Auditors do not test every single transaction during an audit, as this would be an inefficient way of
reaching an opinion. Auditors test a sample of transactions and use these results to draw conclusions
about whole populations. This is highlighted in the report to dispel the misconception that the
auditor checks everything.
Reasonable basis
An unqualified audit report is not an absolute guarantee that a set of financial statements is free from
all error. There is always a small audit risk that the wrong opinion has been reached.
It is not possible to be certain that there are no errors, since there are estimates in the financial
statements which involve the use of judgement. In addition, not all transactions have been tested, so it
is possible that some will be recorded incorrectly. However, the auditor will do sufficient work to give
a user reasonable assurance that the financial statements are true and fair.
A true and fair view
There is no formal definition of what „true and fair‟ means. „True‟ implies accurate and „fair‟ implies
free from bias. The financial statements should not be misleading and all disclosures should be
adequate. Preparing financial statements in accordance with generally accepted accounting principles
will imply that they are true and fair. The auditor has a specific duty under the Companies Act to report
as to the truth and fairness of the financial statements.
Chartered Accountants
This demonstrates that the auditor is qualified, skilled and expert on the subject matter as well as a
member of a recognised supervisory body and therefore has the authority to perform an audit.
(b) Objectives of requiring unqualified audit reports to be published in a standard form
To promote the use of common language to assist the user‟s understanding of the meaning of
the report.
To promote comparability between reports so it is easier to recognise when a report is qualified.
To attempt to narrow the expectation gap – the difference between the public‟s perception
of the auditor‟s responsibilities and the legal and professional reality.
To limit scope for litigation.
To convey to the reader the nature and context of the audit opinion.
To indicate the type of assurance concerning the financial statements the auditor feels
is warranted, based on the evidence obtained.
42 CCEP Ltd
Described below are situations that have arisen in three audit clients of your firm.
Chittagong Corporate Engine Parts Ltd (CCEP)
CCEP manufactures engine parts. Revenue for the year ended 31 December 20X3 was
CU200 million, and net profit was CU17 million. NBR has launched an enquiry that is still
underway. It is not possible to ascertain at this stage if a tax liability will arise in this
company. The directors have disclosed the enquiry in a note to the accounts. They have
also indicated a willingness to make any further disclosures that you recommend. A tax
specialist has advised you that the possible range of outcomes in respect of additional tax
CCEP Ltd
Marking guide
Marks
(a) Reasons and benefits of completing a disclosure checklist and carrying out
final analytical procedures when conducting final checks on the financial
statements
The completion of a disclosure checklist ensures that
The financial statements have been prepared using acceptable accounting policies
Disclosures in the financial statements are complete and appropriate
The financial statements are in compliance with statutory requirements and
accounting standards. The checklist also
Provides an efficient method of checking
Provides a quality control procedure
Ensures that information in the directors‟ report is consistent with the financial statements.
By carrying out final analytical procedures the auditor
Ensures the financial statements reflect his knowledge of the business
Looks for any changes in ratios that are unexpected
Checks consistency with the results of his other audit work
Ensures that he has all the information and explanations to allow him to form
an opinion on the financial statements.
Tutorial note
The maximum number of marks available for part (a) in the exam was 4 marks. The above answer reflects 5
marks worth of material.
Tutorial note
The maximum number of marks available for part (b) in the exam was 6 marks. The above answer reflects
11 marks worth of material.
CCEP Ltd
Type of report and reason
The report would be unqualified because
Effect on report
In an additional paragraph before the opinion paragraph state the reason
(disagreement over accrual for freehold property) and amount of CU170,000.
In the opinion paragraph state that the financial statements do not give a true and fair view.
Worldwide Ltd
Type of report and reason
A qualified audit report should be given on the grounds of limitation on scope because
43 Vista Ltd
Described below are situations which have arisen in five audit clients of your firm. The year end in
each case is 30 September 20X2.
Vista Ltd
Vista Ltd, a supplier of retail display equipment, has included in its income statement immediately
below profit after tax, an exceptional loss of CU3.7 million on the sale of a trade investment. This
accounting treatment is not in accordance with accounting standards, which require the loss to be
taken into account in arriving at the profit or loss before taxation.
The pre-tax profit of Vista Ltd for the year ended 30 September 20X2 is CU694,000.
Expo Ltd
Expo Ltd exports a significant amount of its products, and has a major distribution centre in an
overseas country in which there has been a military coup. As a result of travel restrictions imposed by
the military junta, it was not possible for your firm to attend the year end physical inventory count.
The inventories at the overseas distribution centre at 30 September 20X2 represented 75% of Expo
Ltd‟s inventories.
Pharm Ltd
Pharm Ltd, a company engaged in the manufacture of pharmaceutical products, has extensive interests in
an overseas country which requires pharmaceutical products to be registered. The regulatory situation
in that country is undergoing considerable change and Pharm Ltd does not expect to obtain drug
registration as quickly as originally anticipated. However, after carrying out the appropriate review, the
directors have decided that Pharm Ltd has enough resources to continue for the next 12 months.
Additional funding will be required from that point, and the directors believe that this can be achieved
by a further issue of shares within the next 12 months.
The directors have included a note to the accounts explaining the situation.
Mog Ltd
Mog Ltd manufactures light fittings. Certain of its finished inventory lines are out of fashion
and have a net realisable value which is CU35,000 lower than their original cost. However,
the directors have argued that, overall, the net realisable value of the entire inventories
exceeds original cost and that fashions may well change over the next few years such that
the company can ultimately sell these lines above their current net realisable value.
The pre-tax profits of Mog Ltd for the year ended 30 September 20X6 were CU900,000.
Net assets and inventories on 30 September 20X6 totalled CU10 million and CU4 million
respectively.
Hubbard Ltd
Hubbard Ltd is a family company which makes and sells medical syringes. The company‟s
factory is ultra-modern and conforms to the appropriate hygiene standards. All of Hubbard
Ltd‟s syringes are supplied sterilised and individually wrapped. Shortly before its year end the
company‟s solicitors notified the company of an action being brought by a patient who had
contracted gangrene in his right arm following a routine influenza injection. The patient is
claiming that the syringe used by his doctor was contaminated.
This patient will probably have to have his arm amputated. The company‟s solicitors believe
that the case will not come to court for several months, if not years. In addition, they
mention that the patient is also suing the doctor who administered the injection. The patient
concerned is pressing for at least CU500,000 in damages, an amount which is material to the
Saiful Islam Mozumder, Manager Finance & Accounts, Organic Group,
mozumder@organic-crop.com Cell-01711-981920
financial statements. The directors of Hubbard Ltd do not intend to provide for the claim in
this year‟s financial statements. However, a reference to the action will be made in the notes
to the accounts.
Requirements
(a) „The logical extension of audit deregulation would be to allow shareholders in
all companies of whatever size, listed or otherwise, to choose whether to have
an audit.
If the audit were no longer a statutory requirement, shareholders could decide for
themselves what kind of audit suits their company and the commercial terms on
which it is undertaken.
This would solve the problems of value for money, expectation gap and independence at a stroke‟.
Discuss the issues raised by this quotation and consider, reaching a conclusion, the
advantages and disadvantages of there being a legal requirement for an audit. (12
marks)
(b) List the conditions of the Companies Acts which have to be satisfied before an
unmodified audit report on annual financial statements can be issued. (5 marks)
(c) In respect of the situations outlined above, reach a conclusion on whether or not you
would modify each audit report. Give reasons for your conclusions and describe the
potential effects on each audit
report. (20
marks)
(37
marks)
Vista Ltd
Marking guide
Marks
(a) Threshold 1
Expectation gap 4
Independence issues 4
Advantages of legal requirement 4
Disadvantages of legal requirement 4
Conclusion 1
Marks available 18
Maximum 12
(b) Each condition 1
Maximum 5
(c) Vista:
Conclusion ½
Reasons 3
Effect 1
Expo:
Conclusion ½
Reasons 3
Effect 3
Pharm:
Conclusion – disclosure adequate ½
Conclusion – inadequate disclosure ½
Reasons 3
Effect 2
(a) Value of an
audit
Expectation
gap
The audit profession currently defines an audit by reference to BSA 200 Objective and General
Principles Governing an Audit of Financial Statements. An auditor‟s responsibilities are limited to those
expressed by statute or other authority.
The shareholder group and other users of the financial statements have always had a wider
expectation of the audit function. For instance, many people expect auditors to prevent and detect
fraud and all errors. There is also a belief that the auditors should give a guarantee as to the
company‟s ability to continue as a going concern.
Deregulation of the audit would mean that auditors and their clients could reach mutual agreement
on responsibilities, thereby closing the „expectation gap‟.
The APB has indicated that compromise on responsibilities is the most preferable outcome.
However, it would not be appropriate to extend the auditor‟s duties to cover those which are
already the responsibility of management.
The users of financial statements must understand that prevention and detection of errors and
fraud and the ability of the company to continue as a going concern are management
responsibilities. The auditor is an independent expert forming an opinion, not the person
performing the work in the first instance.
Independence
The audit process arose from an independent review of the directors‟ stewardship of companies
in which shareholders had invested. Other users of financial statements have come to regard the
audit opinion as credible because the auditors are separate from the persons responsible for
preparation of the accounts.
The Auditing Practices Board has taken responsibility for ensuring independence through the
issue of ethical standards, including the instruction to firms to rotate the engagement partners of
listed companies every five years.
It is unlikely that deregulating the audit function further will enhance independence. In fact it
could make the situation worse. The auditors would spend even more time with the directors
and thereby familiarity could potentially be increased.
Advantages and disadvantages of a legal audit requirement
Advantages
The existence of a statutory requirement for audit generally reflects the view that there is a
public interest in ensuring proper accountability by those who direct or manage companies.
The current statutory audit requirement („true and fair view‟ and „properly prepared‟) may be
Auditors already provide advice on internal controls and their effectiveness, as part of their
management letter produced after the audit. This is already an important „value added‟ output from
the audit process.
However, within the context of a statutory audit auditors may be inhibited from expressing all of their
concerns, especially those which are more judgemental, such as a view on management, as this could
widen their liability and increase the chances of litigation.
Conclusion
To bring the current statutory requirement to an end would not bring audits in „true and fair‟ and
„properly prepared‟ terms to an end (as many companies would still think them worth having). As
neither the government, the accounting profession, large companies nor shareholders seem likely to
press for total abolition, the most likely scenario for the future scope of audit is a statutory minimum
audit with additional contractual agreements in the form of other assurance engagements.
(b) Companies Acts conditions for an unmodified audit report
The financial statements give a true and fair view/are not materially misstated/are not misleading.
The financial statements have been properly prepared in accordance with the Companies Act 1994.
The directors' report is consistent with the financial statements.
Information in respect of directors‟ remuneration and transactions has been disclosed.
The auditor has received all the information and explanations considered necessary for the audit.
Proper accounting records (including returns from branches) have been maintained.
The accounts are in agreement with the accounting records.
Saiful Islam Mozumder, Manager Finance & Accounts, Organic Group,
mozumder@organic-crop.com Cell-01711-981920
(c) Type of audit reports
Vista Ltd
Qualify on grounds of a material disagreement.
The matter is material as the amount of the loss exceeds the pre-tax profit.
Give an „except for‟ qualification if the matter is not considered pervasive/misleading.
Give an adverse opinion if considered material and pervasive, i.e. the financial statements do
not show a true and fair view.
An additional paragraph, in the opinion section, should include details of the reason for
the qualification and the impact on the financial statements.
Expo Ltd
Qualify on grounds of a material limitation on scope, i.e. evidence reasonably expected to
be available is not available in this instance.
The matter is material as it affects 75% of inventories.
Give an „except for‟ qualification if the matter is not considered pervasive/misleading.
Give a disclaimer (of opinion) if considered pervasive/misleading (i.e. do not express an opinion).
Pharm Ltd
Give an unqualified opinion if disclosure is adequate.
Constitutes a material matter re going concern which should be highlighted as the matter is
likely to have a significant impact on the business.
An emphasis of matter paragraph is required explaining the matter and stating that the opinion
is not qualified in this respect.
If the note to the accounts is inadequate, qualify on the grounds of disagreement.
Mog Ltd
Give an unqualified opinion.
The write-down of inventory to its NRV would reduce profit by 4% and reduce net assets and
inventory by less than 1% each. It is therefore unlikely that the misstatement would be considered
material. The auditor might, however, be put on guard to ensure that CU35,000 is the maximum
misstatement and that all other categories of inventory are correctly valued. Significant departures
from accounting standards are required to be disclosed in the financial statements. Because the
impact on the financial statements of this accounting departure is limited, the auditor is unlikely to
consider it to be significant.
Hubbard Ltd
Give a modified but unqualified report.
The outcome of the legal action is still a long way off. At this stage the case has not come to court
and only limited facts are known.
This matter therefore constitutes a significant uncertainty. A provision will not need to be made in
the accounts but full disclosure should be given.
Providing the auditor is satisfied that the directors‟ disclosure of the action is sufficiently
detailed to highlight all of the circumstances as they are known, no qualification will result
though he should consider modifing his report by adding an emphasis of matter paragraph
drawing attention to the uncertainty.
If, however, the auditor takes the view that the disclosure of the action in the notes to the
accounts is unclear, he should qualify his report „except for‟ on the grounds of a disagreement as
to the extent of disclosure of a material fact.
Saiful Islam Mozumder, Manager Finance & Accounts, Organic Group,
mozumder@organic-crop.com Cell-01711-981920
44 Ironco Ltd
You are preparing for your audit planning meeting with the finance director of Ironco Ltd,
a company whose principal activity is the production of iron castings made to customers‟
specifications. Although the company‟s revenue and assets are below the thresholds for
statutory audit purposes, the company‟s bankers require the annual accounts to be
subjected to a full audit.
The company‟s revenue fell by 10% during the year ended 31 October 20X4 due to the loss
of a major customer, and as a result the company made an operating loss. However, the
directors are forecasting a return to profitability for the year ending 31 October 20X5 as
they are currently negotiating contracts with new customers.
The draft balance sheet as at 31 October 20X4 indicates net assets of CU148,850, but
current liabilities exceeded current assets by CU180,733. Details of current assets and
liabilities as at 31 October 20X4 and 20X3 are set out below.
The company is up to date with VAT payments to NBR but has fallen behind with its payments in respect
of payroll taxes.
Requirements
(a) Set out the benefits, other than the maintenance of its borrowing facility, to the company and its
management of having a full audit. (4 marks)
(b) (i) List ten indicators of going concern problems given in BSA 570.
(ii) Explain the auditors‟ responsibilities in respect of going concern (including reporting
responsibilities). (15 marks)
(c) (i) Identify, from the information provided above, the matters which give cause for concern and
explain why they give cause for concern.
(ii) In respect of the issues raised in (i), identify the matters to which you would direct
your attention during the post balance sheet review.
(iii) Identify the different types of audit report which may arise from the concerns raised above and
state the circumstances in which they are appropriate. (19 marks)
(38 marks)
Ironco Ltd
Saiful Islam Mozumder, Manager Finance & Accounts, Organic Group,
mozumder@organic-crop.com Cell-01711-981920
Marking guide
Marks
(a) Benefits to the company and its management of having a full audit
Enhanced credibility of the financial information/lack of bias.
More reliable information results in more informed decisions.
The audit may act as a deterrent to fraud/stop management abusing assets.
Provides management with assurance that they are complying with statutory
responsibilities/ information filed meets statutory requirements.
By-products of the audit such as
– Identification of weaknesses and recommendations
– Reducing risk and improving performance.
An audit imposes discipline (encourages best practice) which is useful when companies grow.
When audit exemption limits are exceeded, may avoid
– The cost of extra work, and
– Potential future qualification over opening balances.
Where a company has plans to sell the business/offer its shares publicly within the next
few years, audited accounts will assist that process (such an offering may not be possible
without audited accounts for the past three years).