Audit & Assurance (3) 2020 (AAA320)

Main exam solutions

Please note these indicate the minimum coverage of issues the examiner was looking for and are not
representative of all possible solutions that were awarded marks. They are provided as a guideline to the types
of answers that would most often be awarded marks.

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Question 1 (20 marks)

Part A (12 marks)

• Apply ISA 315 (Revised) to explain the risks of material misstatement at the assertion
level and the financial statement level.
• Ensure you identify the key specific account (rather than stating e.g. liabilities) and the
key assertion.

(a) Risk of material misstatement at financial statement level

There is a going concern risk impacting the financial statements due to two factors:
1. The debt covenant is close to being breached (0.39 per November actuals) so there is a risk
that borrowings will be called immediately and Loo EG will be unable to pay debts as and
when they fall due.
2. There are significant cash flow issues due to the impact of the pandemic, resulting in slower
sales during the year, slower receipt of debtor balances and an anticipation of slow sales in
December.

(b) Risks of material misstatement at assertion level

Any three of the following:

(i) Explanation of risk of material misstatement (ii) Key account and key assertion

There is a fraud risk as there is incentive for staff to push sales Sales revenue – Completeness
into next year as no bonus is expected to be paid this year and
the revenue target has been lowered for next year

Despite communication to staff that no bonuses will be Bonus provision – Existence

paid due to the decrease in sales, there is a bonus provision OR
recorded
Employee expense – Occurrence

Struggling customers are requesting an extension of payment Accounts receivable – Accuracy, Valuation
terms and there are significant outstanding balances and and Allocation
the loss of major customer, which all indicate a risk that the OR
impairment of accounts receivable is not calculated accurately
Allowance for impairment of receivables –
Accuracy, Valuation and Allocation

If the debt covenant is breached, there is a risk that borrowings Borrowings – Classification
will become a current liability and will not be classified or
presented in the financial statements correctly

The loss of a major customer combined with expected poor Inventory – Accuracy, Valuation and
December sales could result in a risk of inventory obsolescence Allocation
OR
Provision for stock obsolescence – Accuracy,
Valuation and Allocation

Audit & Assurance 320 Main exam solutions Page 1

 Part B (8 marks)
(a) Inappropriate planning decisions
• Budget – As the audit risk for Loo EG’s 31 December 2020 audit is assessed as high, it is
inappropriate to reduce partner hours as the lack of proper supervision and review has a
detrimental impact on audit quality.
• Debtor confirmation – Changing debtor confirmations from positive to negative
confirmations is inappropriate as this provides less persuasive evidence given debtors have
a history of not responding to confirmations.

(b) Independence matter

Communication Key actions
recipient

Within the audit Any one of the following:

team 1. Address the breach by removing the employee from the audit team OR use different
individuals to conduct an additional review of the affected work or re-perform that
work to the extent necessary
2. Communicate with the audit partner and those responsible in the firm for policies/
procedures in relation to independence
3. Document the breach and actions taken

With the client Inform those charged with governance about the breach, discuss the significance, how it
occurred and the action taken to resolve it

(c) Determine overall materiality

• Remember to apply a lower percentage for a higher risk assessment.

• Extrapolate the revenue figure provided in the facts to 12 months.

Revenue would be an appropriate benchmark because Loo EG’s profit before tax is volatile as
its 11-month results are showing a loss. The lowest end of the threshold should be used as the
audit risk for the Loo EG 31 December 2020 audit engagement has been assessed as high.
Overall materiality = $4,394,000/11 × 12 × 0.5% = $23,967

Page 2 Audit & Assurance 320 Main exam solutions

Question 2 (10 marks)

(a) Cash controls testing and impact on audit approach and other special audit
consideration

• Use the flowchart in the CSG to evaluate the control testing results.
• Consider the impact of the audit findings on other areas of the audit.

Transactions #7165 and #7389 are both deviations as these cash disbursements were not
approved by the appropriate signatories. Therefore, the actual deviation rate is 2 ÷ 25 = 8%.
As the actual deviation rate is more than the tolerable deviation rate of 5%, the cash payments
control is not operating effectively.
(i) Therefore PA cannot continue with a controls-based approach for cash as initially planned
and increased substantive procedures will need to be performed for cash.
(ii) There is a need to address the increased risk of fraud at Layebela given the unauthorised
nature of the payments.

(b) Review points on the audit work performed on the cash account

Apply the concept of sufficient appropriate audit evidence to the facts in the scenario.

Any six of the following:

1. Obtain a copy of the bank confirmation provided directly from the bank to PA as auditors.
2. Agree the balance per the bank statement for the general operating and interest-bearing
account to the bank statement.
3. Review the bank statement subsequent to 30 June 2020 to ensure the deposit in transit was
included in bank statement or vouch to source documentation (e.g. remittance advice,
deposit slip).
4. Review the bank statement subsequent to 30 June 2020 to ensure that each cheque was
presented in bank statement or vouch to source documentation (e.g. cheque stub).
5. Obtain an understanding of the reconciling items to determine what comprises the amount
shown as $1,155.
6. Perform further work to understand the $500 account that appears on the bank
confirmation.
7. Review whether there are any other balances on the bank confirmation that have not been
considered.

Audit & Assurance 320 Main exam solutions Page 3

 Question 3 (20 marks)

Part A (9 marks)
(a) Key assertion

Use ISA 315 (Revised) to determine the appropriate assertion.

The key assertion tested by this audit procedure is completeness. The audit procedure tests
whether the physical inventory has been recorded in the financial records (i.e. the inventory
subsidiary ledger).

(b) Changes required to the summary of misstatements

Product Code Explanation

B051 While there is no difference in the stock quantity, as these are unsaleable damaged bikes they
need to be written off and recorded on the SoM

B099 The inventory sub-ledger is correct as the sale of these bikes occurred prior to year end
(29 June 2020) and therefore should not form part of inventory. No amount needs to be
recorded on the SoM

B143 As this is an input error into the system during the stocktake and subsequently confirmed by
the client, this should be included on the SoM

B180 As the 160 bikes are held on consignment at a third party’s premises, this is not necessarily a
variance and further work is required before considering whether to include on the SoM

B256 As the client has provided count sheets that agree to the inventory sub-ledger, and as the
theft occurred after year end, the inventory sub-ledger is not misstated as at 30 June 2020 and
no amount should be included on the SoM

(c) Audit procedure

A relevant audit procedure addresses the risk of material misstatement. A robust procedure
is specific as to the nature, timing and extent of the procedure to be performed.

Send a third party confirmation to the third party storage facility requesting confirmation of
the quantity and condition of BykesGalore product B180 as at 30 June 2020 and compare to the
inventory sub-ledger. Investigate any differences.

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Part B (11 marks)
(a) Summary of misstatements

• Consider the clearly trivial threshold when determining misstatements to include on

the SoM.
• Prepare the summary of misstatements with journal entries including reference to
specific accounts.
• Aggregate the misstatements by the following elements of the financial statements:
profit or loss, assets, liabilities and equity.

Item Journal Profit or Loss Assets Liabilities Equity

$ $ $ $

2 Dr Impairment loss – R&D 31,400

  Cr Capitalised R&D (31,400)
  (40% × $78,500)

3 Dr Inventory in-transit 53,225

  Cr Accounts payable (53,225)

4 Dr Goods received uninvoiced 28,750

  Cr Inventory (28,750)

Total 31,400 (6,925) (24,475)

The financial statements are not materially misstated as all misstatements are immaterial, both
individually and in aggregate, as they are less than overall materiality of $110,000.

(b) Audit opinion and auditor’s report

Refer to additional paragraphs in the auditor’s report section in the CSG and apply to the
facts in the scenario.

The most appropriate audit opinion is an unmodified opinion, as the uncorrected misstatements
are immaterial and sufficient appropriate audit evidence has been obtained.
An ‘Other Matter’ paragraph is required as this is a first-year audit of BykesGalore for AAP.

(c) Communicate deficiency in process level controls

Apply your understanding of process level controls to the scenario.

The control over the GRU liability account is not operating effectively as there are purchases
remaining in this account even after the invoice has been paid and therefore liabilities and
inventory are overstated.

Audit & Assurance 320 Main exam solutions Page 5

 Question 4 (20 marks)

Choose one set of standards (international, Australian or New Zealand) and apply them
consistently throughout your study and in the exam.

Part A (10 marks)

(a) Identify applicable standard

Use the flowchart contained in the CSG to identify the relevant standard applicable to each
work request.

Work request Applicable standard Justification

1 ISRE 2400 (Revised)/ASRE 2400/ AA (Wellington) has been asked to perform a review and is
ISRE (NZ) 2400 not the auditor of LUL (Wellington) yet as the tender for the
group audit is still in progress

2 ISA 600/ASA 600/ISA (NZ) 600 AA (Wellington) is asked to perform work as part of a group
audit engagement

3 ISA 805 (Revised)/ASA 805/ The requested work is an audit of a specific element of a
ISA (NZ) 805 (Revised) financial statement (revenue)

(b) Procedures which are not appropriate

Apply ISRE 2400 (Revised) to the facts in the scenario.

Procedure Justification

P12 As AA Wellington was not the auditor in the prior year, its responsibility is to obtain an
understanding of the entity and its environment, including the accounting policies. Reading
the prior year audited financial statements/financial information alone is not sufficient and
therefore not appropriate

P16 Rather than focusing on whether the assessment of the entity has changed, the inquiries
should include the basis for management’s assessment of the entity’s ability to continue as
a going concern, including whether there are events or conditions that appear to cast doubt
on the entity’s ability to continue as a going concern

Page 6 Audit & Assurance 320 Main exam solutions

Part B (10 marks)
(a) Identify applicable standard and level of assurance

Use the flowchart contained in the CSG to identify the relevant standard applicable for each
work request.

Entity Standard   Explanation  Level of Assurance 

LUL (Wellington) ISAE 3400/ASAE 3450/ The engagement is to provide Moderate (or Limited)
ISAE (NZ) 3000 (Revised) assurance over projections in
prospective financial information

LUL (Italy) ISRS 4400/ASRS 4400/ Specific agreed upon procedures have None
APS‑1 (Revised) been requested by the client to be
reported as factual findings

(b) Errors within the draft report extracts

Use your knowledge of engagements involving prospective financial information and

agreed upon procedures to identify and outline the errors in each of the draft reports.

Report for: Errors  

LUL (Wellington) • Reference to ’reasonably expected to occur’ is not correct. It should be: ‘not necessarily
expected to occur’
• Reference to ‘not materially misstated’ is not correct. Given the types of evidence
available in assessing the assumptions on which the prospective financial information
is based, it may be difficult for the auditor to obtain a level of satisfaction sufficient
to provide a positive expression of opinion that the assumptions are free of material
misstatement

LUL (Italy) • Reference to ‘designed by AA (Italy)’ is not correct. This is an agreed upon procedures
engagement and the procedures should be agreed with management
• Reference to ‘materially correct’ is not correct. The assurance practitioner provides
a report of factual findings for an agreed upon procedures engagement and therefore
provides no assurance

Audit & Assurance 320 Main exam solutions Page 7