Audit & Assurance (1) 2020 (AAA120)

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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AAA120_mainexam_solutions_03.indd; 10 June 2020

Question 1 (20 marks)

Part A (11 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 relevant specific account rather than stating e.g. liabilities.

(a) Risks of material misstatement at assertion level

Any two of the following:

Explanation Key account and key assertion

The allocation of the transaction price determined Contract liability: loyalty credits – Accuracy, Valuation
using the redemption rate between different elements & Allocation
of the customer contract (loyalty credits and photo- OR
book sales) may not be appropriate as there is
Revenue – Accuracy
judgement involved in estimating the redemption rate

There is a risk of overstating revenue as loyalty credits Contract liability: loyalty credits – Classification
may not be initially be recognised as a contract liability OR
in accordance with the requirements of IFRS 15
Revenue – Classification

The liability and equity components of the convertible Convertible note liability – Accuracy, Valuation and
note may not be valued correctly as the fair valuation Allocation
of a convertible instrument requires complex
valuation techniques

(b) Risks of material misstatement at financial statement level

Explanation Mitigating ELC (only one required)

The automated and IT-dependent manual controls
at Cherishables may not be operating effectively
as the systems supporting financial reporting were
compromised due to the successful password hack in
February 2020
The new director, Steris Poh, has relevant expertise
in this area and will be chairing a newly established
IT governance sub-committee that oversees the
company’s IT systems and operations

With the appointment of a new director, there is a The company maintains a register of directors’
risk around the completeness of related parties and interests and outside directorships, which is updated
proper identification and disclosure of related party whenever there is a change in directors
transactions

(c) Evaluation of auditor independence

There is no independence threat regarding Steris’ appointment as a director of Cherishables
despite being a former consulting partner of Decimal as it has been nearly 10 years since Steris
was a partner of Decimal.

Audit & Assurance 120 Main exam solutions Page 1

 Part B (9 marks)
(a) Inherent risk factors supporting and challenging the inherent risk
assessment

•• Apply ISA 315 (Revised) and ISA 540 (Revised) and use the assessing risks flowchart and
table on accounting estimates contained in the CSG to identify inherent risk factors
supporting and challenging the inherent risk assessment.
•• Remember that inherent risks are assessed before considering any related mitigating
controls implemented by management.

The following were possible factors that either supported or challenged the inherent risk
assessment:

(i) Supports low IR assessment (ii) Challenges low IR assessment

•• The estimate is based primarily on observable
inputs and data e.g. executive salary, NZ
government bond rate;
•• The calculation is not complex as there is no need
for specialised skills and techniques nor valuation
concepts and techniques;
•• The spreadsheet model used in the current year is
consistent with the prior year audited model;
•• The estimate is made at the end of the 2nd year of
a 4-year plan;
•• Despite employee retention being an assumption,
historical data indicates most executives have been
with Cherishables since 2016;
•• There is judgement involved in the selection of an
appropriate discount rate;
•• Senior executive retention is an unobservable
assumption and there has been a revision to the
rate used from 60% to 70%;
•• The CFO reviewing calculation is likely included
in the calculation and therefore the calculation is
susceptible to management bias;
•• The key risk for a provision is understatement and is
therefore inherently risky;
•• The prior year inherent risk was assessed as high;

(b) Appropriate audit strategy for LTIP provision

Recall that the audit strategy can either be a controls-based approach or a substantive audit
approach.

A substantive audit approach should be taken in relation to the LTIP provision as the only
control in place is the CFO’s high-level review at the end of the financial year, which is unlikely
to be sufficiently precise to detect and correct material misstatements in the LTIP provision.

(c) Test of details – appropriateness of retention assumption

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.

Obtain a list of senior executives who are included within the LTIP provision and was employed
on or before 1 July 2018 and obtain a list of senior executives who remain employed to the most
recent date of the procedure. Calculate the retention rate from the information received and
compare this to management’s 70% assumption.

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Question 2 (20 marks)

Part A (7 marks)
Apply ISA 330 to the scenario and determine the appropriate auditor’s response.

(a) Reliance on prior year fixed asset controls

Prior year’s controls testing cannot be relied on because:
•• There have been significant changes in operation of controls as a new fixed assets software
replaced the existing software and there was reliance on IT application controls in prior
year; and
•• A significant risk was identified in relation to fixed assets during audit planning.

(b) Further actions on outstanding matters

Use the evaluating tests of controls flowchart and evaluating tests of details flowchart
contained in the CSG to outline further actions required.

Matter Further actions

Matter 1 •• Verify client’s claim that the fixed assets software bug only affects assets with effective life <
3 years;
•• Obtain and audit the client’s manual adjustment at year end;

Matter 2 •• Record the factual error ($158,532) on the summary of misstatements (SoM) as it is above
the clearly trivial threshold;
•• Extend audit testing as part of the investigation of whether the error is an anomaly;

Matter 3 •• The error ($94,254) is below the clearly trivial threshold and therefore no further action is
required

Audit & Assurance 120 Main exam solutions Page 3

 Part B (13 marks)
Intercompany recharge

Follow the steps in performing and evaluating substantive analytical procedures. When
specifying the data required, remember to include both the source and the time period.

(i) Financial and non-financial data

Data required Evaluate reliability

Revenue for all entities within Friendly Films (FF) It is reliable as audit procedures have been performed
Group for the year ended 31 December 2019 on revenue numbers (or profit or loss) numbers with
no exceptions

Allowable expenses (IT expenses and Marketing and It is reliable as audit procedures have been performed
advertising expenses) of the parent for the year ended on expense numbers (or profit or loss) with no
31 December 2019 exceptions

Admission numbers for all entities within the FF group It is reliable as this third-party data is independently
for the year ended 31 December 2019 audited

(ii) Amount to be recharged to each entity

Read the Friendly Films Group Intercompany Charges Agreement and perform the
intercompany charges allocation.

Allowable expenses = $5,145,000 [$2,058,000 (IT expenses) + $3,087,000 (Marketing and

advertising expenses)]
Total amount to be recharged to FF subsidiaries = $4,116,000 (80% × $5,145,000)

Entity Amount allocated Learning reference only (not required for mark)

Friendly Films $1,029,000 20% of allowable expenses allocated to Parent and

(Parent) (20% × $5,145,000) not recharged to subsidiaries

Big Screen $2,469,600 Included subsidiary per definition and is allocated

[(21,432,000/35,720,000) × 4,116,000] recharge based on the relative revenue share

Classy $0 Not an included subsidiary as admission numbers

Cinemas < 100,000

Dreamy $1,646,400 Included subsidiary per definition and is allocated

Movies [(14,288,000/35,720,000) × 4,116,000] recharge based on the relative revenue share

(ii) Determine and explain whether further investigation required

The variance between the calculated expected amount ($4,116,000) and FF’s recorded amount
($2,181,378) is $1,934,622. As the variance exceeds the acceptable variance of $1,672,500 (75% of
overall materiality = $2,230,000), investigation is required.

Page 4 Audit & Assurance 120 Main exam solutions

Question 3 (20 marks)

Part A (9 marks)
(a) Application of professional scepticism

Professional scepticism means an attitude that includes a questioning mind, being alert to
conditions which may indicate possible misstatement due to error or fraud, and a critical
assessment of audit evidence. Standard audit procedures of requesting audit evidence does
not, of itself, demonstrate the application of professional scepticism.

Any two of the following:

•• The audit team has challenged management’s assumptions (discount rate and revenue
forecasts) used in the discounted cash flow projections and the impairment model was
subsequently updated to reflect initial concerns.
•• An alternative calculation has been prepared for Game A with revised assumptions for the
game in order to determine whether the commercial balance is materially misstated.
•• The audit team has engaged a valuation expert in order to challenge management’s
assumptions utilised in the impairment model.

(b) Adequacy of the valuation expert’s work

Apply ISA 620 to the facts to determine the key actions.

Any two of the following:

•• Assess the relevance and reasonableness of the valuation expert’s findings or conclusions
and their consistency with audit evidence the ACA audit team have obtained.
•• Assess the relevance and reasonableness of the significant assumptions (e.g. discount rate,
revenue forecasts, alternative calculations for Game A) and methods used by the valuation
expert.
•• Assess the relevance, completeness, and accuracy of the source data used by the valuation
expert in performing their work (e.g. on Game A).

(c) Commercial software balances

For Commercial software – released:
In accordance with Spigot’s accounting policy, impairment is recognised only when the
carrying amount for each individual game exceeds the value-in-use.
For Game A, the valuation expert has determined a value-in-use range of $750,028 to $901,202.
As Game A’s carrying value ($789,145) is within this range, it is considered reasonable and no
impairment is required.
Games B, C and D are impaired as the carrying amount exceeds the value-in-use. Therefore, the
total impairment that should be recognised is $655,235 ($601,140 + $4,034 + $50,061) which is
above the clearly trivial threshold of $17,500.

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 Since Spigot has recognised $363,845 impairment, the adjusting journal entry that should be
included on the SoM is:

Account Dr Cr
$ $

Impairment Expense 291,390

Commercial software – released 291,390

The commercial software – released balance is materially correct after the adjustment proposed.

For Commercial software – in production:

As there is insufficient audit evidence for commercial software – in production, no conclusion
can be made as to whether the balance is materially correct.

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Part B (11 marks)
(a) Most appropriate audit opinion

Refer to the definition of a qualified opinion in ISA 705 (Revised) and apply the facts in the
scenario.

The most appropriate audit opinion is a qualified opinion, as there is a limitation of scope
(or inability to obtain sufficient appropriate audit evidence) on the commercial software – in
production balance of $521,345. As this balance is above overall materiality of $350,000, it is
material however it is not pervasive as it is confined to commercial software balances in the
financial statements.

(b) Further implications for the auditor’s report

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

(i) Audit opinion

Apply ISA 705 (Revised) to the facts in the scenario.

A ‘Basis of Qualified Opinion’ section would replace the Basis of Opinion section and would
describe the reason for the qualified opinion.

(ii) Work performed by the valuation expert

Apply ISA 620 and ISA 701 to the facts in the scenario.

A ‘Key Audit Matter’ section is required as Spigot is a listed entity. This section should:
•• include reference to the significant audit work performed to obtain sufficient appropriate
audit evidence as to the commercial software – released balance; and
•• exclude reference to commercial software – in production as this is included in the Basis of
Qualified Opinion section.
No reference should be made in the auditor’s report to the work performed by the valuation
expert (unless permission is obtained from the expert). Further, even though the opinion was
modified, the modification was not based on commercial software – released which is the
balance the valuation expert performed work on.

(iii) Letter from the CEO

Apply ISA 720 (Revised) to the facts in the scenario, paying particular attention to the impact
on the section as a result of a qualified opinion arising from a limitation of scope.

An ‘Other Information’ section is required as Spigot is a listed entity and Spigot’s annual report
includes a letter from the CEO. The section should make reference to:
•• the uncorrected material inconsistency which incorrectly states the commercial software –
released balance is $281,716; and
•• the auditor’s inability to consider management’s description of the commercial software – in
production balance in the letter as there was a limitation of scope over this balance.

Audit & Assurance 120 Main exam solutions Page 7

 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 (8 marks)
(a) Materiality
Materiality has not been set appropriately as it has been calculated on the year ended 30 June
2019 results rather than the six-month ended 31 December 2019 results. Further, performance
materiality would not be required to be set for a review engagement as procedures are not
typically tests of details where performance materiality is utilised.

(b) Procedures which are not appropriate

Apply ISRE 2410 and remember that the required procedures for review engagements are
generally enquiry and analytical procedures and any other review procedures as outlined in
the Standard.

The following procedures are not appropriate:

Procedure (P) Justification

P9 Selecting and testing cash payments is a test of details that refers to specific documentation
which is not typical for review procedures

P11 The timing of the enquiry as to whether there are any material events that have occurred is
inappropriate as it is after the date of the signed review report

P16 Obtaining the bank reconciliation and agreeing material amounts and reconciling items to
supporting documentation is a test of details, which is not typical for review procedures

Page 8 Audit & Assurance 120 Main exam solutions

Part B (12 marks)
(a) Corrections required
Any four of the following:
•• The heading should be ‘Independent Auditor’s Review Report’.
•• Reference to opinion should be replaced with conclusion.
•• The reference to work should be replaced with ‘review’ or ‘review, which is not an audit’.
•• The phrase, ‘nothing has come to our attention that causes us to believe that’ should be
added.
•• The reference to year should be replaced with six months.

(b) New engagement request

(i) Identify the relevant Standard and level of assurance
Standard Level of Assurance Explanation

ISAE 3000 (Revised) OR Reasonable As the ERA has greater concerns for the
ASAE3100 OR SAE 3100 wider community, the highest level of
(Revised) assurance would be most appropriate

(ii) Three parties to the engagement

Ensure each party is named specifically – for example, it is not adequate to specify the
responsible party as “the client” or “CoL”.

Role Party

Assurance practitioner Awesum Auditors (AA)

Responsible party CoL’s Directors

Intended user Environmental Regulator Agency (ERA)

(iii) Underlying subject matter and suitable criteria

Understand what the compliance activity actually involves to be able to identify the
underlying subject matter in a compliance engagement.

•• The underlying subject matter is CoL’s compliance activity to ensure work is performed by
personnel approved by ERA in accordance with the Site Rehabilitation Act
•• The suitable criteria is section 600 of the Site Rehabilitation Act.

Audit & Assurance 120 Main exam solutions Page 9