The Professionals’ Academy of Commerce

Exam Focused Topic-wise Test for CFAP

21st September, 2023
2 Hours – 60 Marks
Suggested Answers Test-04

Audit, Assurance & Related Services

Answer.1 (Total Marks 20, 1 Marks for each point)
(a) Audit risks
i. There is a risk that sufficient and appropriate audit evidence may not be obtained from the
component auditors, which will impact the opinion on group financial statements.
ii. As this significant component is audited by another firm, there is a risk that insufficient audit
evidence is available as we would be relying on the work of another firm. Consideration must be
given to how sufficient evidence can be gathered as relying on a questionnaire only may be
inadequate due to this being a new subsidiary with relative significance.
iii. There are errors and omissions from the goodwill calculation which results in the risk that the
individual and group financial statements are not prepared in accordance with relevant financial
reporting standards.
iv. Non-controlling interest has been valued at fair value which is an acceptable accounting policy
choice but the calculation does not show how this amount is calculated. As MG’ shares are not
publicly traded, the fair value of the shares are required by IFRS 3 to be measured using a valuation
technique.
v. Another error is the inclusion of the acquisition costs as part of the cost of the investment as IFRS 3
requires these costs to be expensed. This would reduce the profit of the parent company and the
group.
vi. The consideration to acquire MG includes the potential to make an additional payment if the
contract with a new client is agreed by 1 March 2020. If there is a high probability of payout and
given the level of judgment required this is a risky area.
vii. The group needs not only estimate fair value but also ensure that they include all assets and
liabilities that are not already recognised in MG’ financial statements. The research undertaken by
MG is an example of this.
viii. The only fair value adjustment relates to property and it is likely that there could be other
adjustments. The group need to ascertain the fair value of the contingent liability based on the facts
and circumstances that existed at the acquisition date, which may differ from Rs. 250 million.
ix. There is a re-measurement period of 12 months from acquisition that allows the group time to
obtain information necessary to measure the fair value based on conditions that existed at the
acquisition date. If the conditions that changed the court case from possible to probable arose in the
post-acquisition period, then they are not allowed to adjust the goodwill calculation, but the change
must be recognised as an expense in the post- acquisition period. This could potentially mean that
the group’s profit could be reduced by Rs. 500 million. The actual adjustment could be significantly
less depending on the fair value of the contingent liability at acquisition.
x. Investment property may have been valued on the incorrect basis and concerns over the
independence and experience of the valuer which will impact WEL and the group financial
statements.
xi. The key risk with the investment property is the fair value determined by the valuers at the year-
end; the 25% increase in property value over a short period of time indicates over valuation.
xii. IFRS 13 states that the fair value of non-financial assets should be determined based on the highest
and best use of asset provided that highest and best use needs to be physically possible, legally
permissible and financially feasible.
xiii. The lease liability has not been measured in line with IFRS 16 which will impact WEL and the
group financial statements.
xiv. WEL has entered into a lease with a variable lease payment that depends on rate of inflation. IFRS
16 says that such variable payments should be included in the initial measurement of the lease
liability but are measured at the prevailing rate at the commencement date of the lease. As such,
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there is no adjustment for future inflation when the lease is initially measured. The lease liability
should then be re-measured when the payments change as a result of inflation. This re-measurement
will increase the right of use asset and the lease liability.
xv. This means that the right-of-use asset and the lease liability have been overstated and the
depreciation and finance cost for the year will also be overstated. It is not possible to assess the
materiality of the issue but as the leases are significant this could be a key audit risk and will have
an impact on the individual and group financial statements.

(b) (Total Marks 6, 1 Marks for each point)

i. The auditor should review its existing conclusion on the IT control environment over FT and
consider any necessary revision.
ii. As auditors we must obtain an understanding of any non-compliance with laws and regulations in
line with ISA 250. The possible cyberattack outcome may mean that FT is not complying with the
relevant laws and regulations.
iii. The impact on the financial statements would arise from any potential financial penalties.
iv. The potential breach is more complicated as the audit team overheard this information which could
easily have been misheard or may be factually incorrect. However this fact does not mean that we
can ignore the issue.
v. The potential breach should be discussed with management and our audit approach should be
carefully reviewed in light of this. While management are responsible for compliance with laws and
regulations, the auditor is responsible for designing audit procedures to help identify instances of
non-compliance.
vi. Depending on the results of additional testing and discussions we may also need to consider our
duties in reporting the issue to the relevant regulatory and enforcement authorities. Although
confidentiality is an issue, we may have to consider whether we have a statutory or public interest
duty to disclose this.
Whilst the potential cyberattack is yet to be audited it does lead to concern over this highly important area.
Once this area has been audited, we need to consider the integrity of management.
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Answer.2
(a)
General (awarded in any section but only once)
New finance director.
Lack of familiarity with CPL / no experience of board members.
Management override may indicate disregard for internal controls.
Raises doubts about management integrity.

Land and buildings

Justification
There is a risk of overstatement.
There is a 50% increase in the value of land despite a partial disposal.
The revaluation involves judgement and might not be appropriate, especially as:
- the finance director’s wife is a partner at Beecher Associates, which carried out the valuation
- consequently the valuation may be biased.
The year-end revaluation adjustments may not have been accounted for correctly.
The calculation of the cost of the portion of land sold may be incorrect.

Procedures
With respect to the valuation performed by Beecher:
- ascertain who performed the valuation / if Olivia was involved.
- inspect the terms of reference/scope of work agreed.
- consider Beecher’s reputation, competence and qualifications
- inspect the valuation report
- consider the appropriateness of the basis of valuation and the reasonableness of any assumptions.
Inspect the accounting records to ensure the valuation has been correctly reflected therein.
Reperform calculations of the revaluation adjustments.
Ascertain the value of other similar properties in the area.
Consider appointing an auditor’s expert to perform an independent valuation.
Physically inspect the land and buildings.
Inspect the title deeds / land registry records.
Inspect management’s calculations of the portion of land sold to Navas:
- agree this to the surveyor’s report / sales documents / contract
- reperform any calculations.
Ensure the portion of land sold has been removed from the non-current asset register.

Plant and machinery

Justification
There is a risk of overstatement of cost.
There has been a 26.9% increase in cost / 42.6% increase in the carrying amount.
Additions represent 28% of cost at 1 September 2018.
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Labour costs and components may not represent enhancements and hence may not meet the relevant
criteria to be capitalised.
Some components are purchased in euro and there is a risk of translation errors.
Scrapped components may not have been removed from the non-current asset register.
There is a risk of understatement of depreciation.
The depreciation charge has fallen by 20%.
The depreciation charge for the year represents 7% of cost at 31 August 2019 which is below the
policy of 10%.
The expected charge for the year is Rs. 271,000.
There is increased complexity because different components are likely to have different useful lives.
An estimated useful life of 10 years (10%) may not be appropriate because:
- the new products may still be subject to the EU ban in 2021
- consequently machinery may only have a remaining useful life of 2 years
- machinery may therefore have suffered an impairment.

Procedures
Obtain a schedule of additions in the year:
- vouch component costs to invoice
- obtain exchange rates from an independent source and reperform the translation
- vouch labour costs to timesheets/payroll records
- ascertain whether component/labour costs relate to enhancements/improvements of plant and
machinery
- ensure the additions meet the relevant capitalisation criteria.
Obtain a schedule of scrapped components:
- inspect the non-current asset register to ensure that cost/accumulated depreciation has been correctly
removed.
Ascertain and evaluate the controls over the recording of additions and disposals.
Physically inspect a sample of plant and machinery.
Ascertain from management the basis for depreciation / determining useful lives and consider if this is
reasonable.
Obtain a schedule of the depreciation calculation and reperform the calculation.
Inspect evidence of management’s impairment review.
Ascertain the reasons why the directors believe the new products will not fall under the EU ban.
Inspect any announcements/documents by the EU on this matter.

Related party transactions

Justification
CPL has a new owner and a new board consequently, the firm may not be aware of all related parties.
The sale of land to Navas and the engagement of Beecher both represent related party transactions.
There is a risk that these transactions have not been (properly) disclosed in the financial statements.
Internal control deficiencies were identified by MPL’ internal audit team which may indicate the
presence of transactions with related parties / transactions not on an arm’s length basis, for example:
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- offering contracts on preferential terms

- transacting with non-approved suppliers.
Transactions may be deliberately concealed from the auditor if management is reluctant to disclose
them.

Procedures
Request a list of related parties from CPL’s directors.
Inspect MPL’ register of shareholders.
Review the list of related parties supplied by the group audito.
Inspect accounting records for transactions with related parties or use data analytics routines to
scrutinise the records for transactions with known related parties.
Read the board minutes for evidence of related party transactions.
Ascertain the internal control procedures in place to:
- identify related parties
- record related party transactions in the accounting system.
Evaluate and test these controls.
Inspect the invoice from Beechers.
Inspect the contract for the sale of land to Navas.
Inspect the related party disclosures in the financial statements.
Obtain a written representation from management that related party disclosures are complete.

(b)
(i) Contracts negotiated in 2019 with terms of trade which are more favourable to the customer than
CPL’s standard terms
- May result in reduced profitability
- Extended payment periods will result in a negative impact on cash flow
- CPL may continue to supply customers who are no longer solvent
- Resulting in irrecoverable receivables
- Loss of goodwill if customers discover they do not benefit from preferential terms
(ii) Management override of the approval process for purchases of plant and machinery, including
transactions with suppliers not on CPL’s list of approved suppliers
- Management override may indicate a general disregard for internal controls which may result in
errors in the financial statements
- CPL may not be getting the best price for purchases
- Loss of any preferential terms / bulk purchase discounts negotiated with approved suppliers
- Components purchased may not be of sufficient quality which could result in:
- breakdowns/faults
- increased repair costs
- delays in production
- Negative impact on profit/cash flow
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Answer.3
The following are the risks that may result in material misstatement in the financial statements and the
procedures that may be performed to mitigate those risks:

Audit procedures to
Risk Implication mitigate risks
Although, the sales have decreased
from Rs. 6,700 million in 2017 to
Rs. 4,300 million in 2018, resulting Noting of last document
in a net decrease of Rs. 2,400 as on 30 June 2018 such
Overstatement of sales / million, still there is a significant as invoices, gate passes,
(i) Sales cut off may not be risk that even this sales may have delivery challans etc.
proper. been overstated because, the
Company was facing earning Sales cut off procedures
pressure and physical inventory should be performed.
observation has been delayed by 15
days.(correlate with point iv)
Detailed test of
transaction should be
During the year, PPE has almost
performed on additions
doubled to Rs. 2,325 million. There
of PPE. This may
Revenue expenses may is a significant risk that revenue
(ii) include vouching and
have been capitalized. expenses may have been capitalized
verification of source
with the cost of PPE for new
documents and physical
product “Cherry”.
verification of PPE
acquired during the year.
Impairment of items of With the introduction of new Identify items of PPE
property, plant and product, impairment of PPE items acquired for “merry” in
equipment that belong to the old product may prior years from Fixed
not have been provided for. Asset Register, ascertain
their carrying values and
assesses the amount of
unrecorded impairment
loss if any.
Trade debts have more than
doubled in spite of the decrease in
sales. There is a risk that these Circularization of
Existence/ validity of receivables may have been independent
(iii)
trade receivable. overstated as of the balance sheet confirmation requests to
date. The sales relating to next year the debtors.
may have been recorded in the year
under audit.
Analysis of Debtors
aging schedule,
In spite of lower sales, trade Company’s credit policy
receivables have increased and provision for
Indication of doubtful/ significantly by Rs. 130 million. doubtful debts.
uncollectable accounts. There might be old outstanding
debts. Scrutinize the amount of
sales recorded in the last
week to identify undue
increase if any.
Understatement of This year, the management has At the time of stock
inventory/ Inventory cut requested to carry out physical take, roll back working
(iv) off may not be verification of inventories 15 days should be prepared and
proper/Inventory after the balance sheet date. verified and cross
valuation may not be matched with the cut off
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correct. There is a risk of understatement of
inventory and overstatement of
sales as the Company might have
tried to recognize sales of
subsequent period in the period
under audit.
The Company has abandoned the
product “merry”. The intangible
Impairment of intangible assets might include unamortized
(v)
assets cost of intangibles related to
“merry” which should have been
charged off.
documents to ensure that
inventory movements
are recorded in correct
accounting period.
Cut off procedures
should be performed.
NRV of the old product
“Merry” need to be
considered.
Detailed verification of
intangible assets to
identify those costs from
which future economic
benefits are no more
expected to flow to the
Company.