Audit, Assurance and Related Services

Suggested Answer
Certified Finance and Accounting Professional Examination – Summer 2023

A.1 Risks of opening balances and fraudulent financial reporting:

Considering that the audit adjustments were often erroneous in the prior year, it is not
advisable to rely on them to verify opening balances. There poses a risk that the opening
balances may not have been carried forward from the previous year’s financial statements,
especially since this is the first year of audit, or that the opening balances may contain
misstatements.

The disputes with the previous auditor and their removal after only two years of appointment
indicate a fraud risk factor and an intimidating attitude of the management towards the
auditor.

Risk of inadequate disclosure regarding segment reporting:

In previous years, the majority of sales, accounting for 95%, were concentrated in the North
American region therefore it did not qualify to be reported as an operating segment. However,
in the current year, SL has expanded its business to include the Pakistan and Middle East
regions. Furthermore, SL has established a dedicated department to specifically handle clients
located in Pakistan and the Middle East, indicating separate performance measurements.
Therefore, the sales to North America, the Middle East, and Pakistan may qualify to be
reported as operating segments. There is a risk of inadequate disclosure regarding these
segments.

Risks relating to government grant:

SL has recognized the grant of land in its financial statements. However, it remains uncertain
whether SL will be able to generate a business volume of USD 100 million within the next
five years. Consequently, there is a risk that a government grant is recorded when it is not
due. Furthermore, SL may fraudulently misstate its revenue to achieve the sales target.

There is also a risk that the grant is recorded at an incorrect amount as the determination of
fair value needs to be ascertained.

Risk relating to foreign exchange translation:

Since around 85% of the revenue comes from abroad, SL is exposed to numerous transactions
that require translation into PKR. Therefore, there is a risk that the correct exchange rate may
not be applied or that the transactions are not translated on the correct date, resulting in an
incorrect calculation of exchange gain/loss.

Risk of incorrect revaluation of intangible assets:

There is a risk that SL has revalued the intangible assets when it did not qualify to be recorded
under the revaluation model. Generally, there is no market for the sale of software licenses as
these are not salable. Therefore, the fair value of the licenses may not be reliably determined.

Furthermore, whenever an asset is revalued the entire class of asset needs to be revalued.
There is a risk that other intangible assets of the same class may not be revalued. This further
leads to the risk that the management may have tried to fraudulently misstate the financial
statements by not revaluing the entire class of assets. Due to the change in policy SL would
have to take the effect of change in policy retrospectively, there is a risk that it may not be
done and disclosed correctly.

Risk relating to revenue recognition:

There is a risk that during the sale of software, revenue is not correctly apportioned between
the sale of software and future updates. Determining whether license and updates constitute
separate performance obligations requires judgment, as it involves assessing the nature of the
arrangement and the contractual terms.

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 Audit, Assurance and Related Services
Suggested Answer
Certified Finance and Accounting Professional Examination – Summer 2023

The Company’s revenue is derived from various revenue streams, which primarily include
the sale of goods, provision of services as well as end-to-end solutions in the form of long-
term projects, which in most cases lead to revenue being recognized over multiple accounting
periods. There is judgment involved in determining the progress towards satisfaction of
performance obligations which may result in incorrect revenue recognition and its related
contract asset.

Risk relating to the recording of website cost:

A website resulting from development can be recognized as an intangible asset if SL can
demonstrate that it will generate probable future economic benefits. However, if the website
is developed solely or primarily for promoting and advertising its own products and services,
all expenditures on developing such a website shall be recognized as an expense when
incurred, as the probable future economic benefits may not be met. Therefore, there is a risk
that the website is incorrectly recorded as an intangible asset.

Risk relating to data breaches:

SL is gathering clients’ data from its website, which raises concerns regarding data breaches
and cyber-attacks, particularly in the context of IT companies. These breaches can potentially
occur through the website developed by SL or the software it has developed, leading to
potential litigations. Consequently, there is a risk that there may be undisclosed contingencies
or provisions for potential data breaches.

Risk relating to the recording of interest-free employee loans:

There is a risk that SL might have recorded these staff loans at their gross amount without
recording any expense over the period of loan amortization. There is also a risk that SL might
not use an appropriate discount rate for calculating the fair value of loans resulting in incorrect
expense.

A.2 (a) Evaluation of matter (i):

RL has inventory located throughout the country, making it difficult for the auditor to
physically verify the inventory at the year-end. Further, since all orders are first received
at the RL warehouse, inventory owned by retailers may be counted as RL’s inventory.

To address these challenges and ensure accurate inventory reporting, the auditor can
perform the following procedures:
 Obtain a list of inventories held by each supplier and identify locations where
material amounts of inventory are held. Plan inventory counts to be performed by
firm staff at these locations.
 Provide instructions to the audit team on how to identify and include retailer
inventory during the stock count.
 For locations where it is not feasible to conduct inventory counts, arrange for
another auditor to attend the physical counting of inventory performed by third
parties.
 Consider performing inventory counts at interim dates and working them back to
the year-end date if it’s not possible to cover all major locations at year-end.
 Perform tests of controls to assess the adequacy of internal control for ensuring
that inventory is properly counted and adequately safeguarded.
 Inspect documentation related to inventory held by third parties, such as
warehouse receipts.
 Request confirmation from suppliers who hold inventory on behalf of RL.
 Perform a cut-off analysis of orders and inventory received at the warehouse.

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 Audit, Assurance and Related Services
Suggested Answer
Certified Finance and Accounting Professional Examination – Summer 2023

Evaluation of matter (ii):

The reward points offered to customers entitle them to certain cash discounts on future
sales, which results in a provision for settlement of reward points.
To appropriately address the provision for reward points and ensure its accuracy, the
auditor can perform the following procedures:
 Understand and inquire the management process of estimating the provision
required for settlement of reward points.
 Obtain the management’s work or consult with their expert to verify its accuracy
by comparing it with the source data used for its preparation.
 Assess the reasonableness of the management’s assumptions regarding points
redemption and expiration by evaluating the likelihood of customers redeeming
their points based on historical redemption patterns and market conditions.
 Verify the past pattern of redemption made by customers and correlate it with the
working of the current year.
 Obtain management budgets and relate the expected point redemption with them.
 Review any redemptions made subsequent to year-end to assess the
reasonableness of the provision recommended by the management.
 Consider involving auditor’s expert for estimating the provision required for
reward points.

(b) (i) Ensure that RL should have the latest anti-malware and anti-virus programs
installed and apply updates as soon as possible.
(ii) Implement tiered administrative access or utilize one-time passwords/tokens
with procedural guidelines for secure resetting credentials, such as through
password authentication services.
(iii) Establish procedures for securely resetting passwords or other credentials in the
event of compromise, to prevent inadvertent exposure of high-value assets.
(iv) Develop, review, and exercise a system recovery plan as an important risk
mitigation strategy for cybersecurity professionals. Ensure that it enables the
restoration of data as part of a comprehensive disaster recovery strategy.
(v) Remove unwanted or unneeded hardware as much as possible, starting from a
known baseline. Actively manage systems to adapt dynamically in response to
changing threat environments and streamline administrative tasks.
(vi) Utilize a modern operating system that enforces signed software execution
policies for scripts, executables, and device drivers to ensure computer security.
(vii) Form dedicated teams to continuously seek out any evil presences or threat actors
that may have access within the organization. Employ passive detection
mechanisms (like Logs) as an efficient risk mitigation strategy.
(viii) Avoid compromised websites (such as those not using HTML5) and encrypt
network traffic, such as through a VPN.
(ix) Identify malicious traffic to stop DDoS attacks, which may require servers offline
for maintenance.
(x) Enable encryption on the host’s side and provide the option to disable page scripts
to prevent malicious payloads from activating.
(xi) Implement smart firewalls and develop code to identify illegal user inputs.
(xii) Refrain from downloading programs or executables from unrecognized
vendors/retailers or those that attempt to alarm the user with false claims of
serious problems.
(xiii) RL should regularly conduct training and awareness session of its employees on
safeguarding its’s digital assets.
(xiv) Physical security is crucial, and RL should ensure the security of digital assets.
An attacker can easily damage or steal critical IT assets, install malware on
systems, or leave a remote access port on the network.

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 Audit, Assurance and Related Services
Suggested Answer
Certified Finance and Accounting Professional Examination – Summer 2023

A.3 (a) Evaluation of the matter and course of action

Depreciation of the production line should have started once it became available for
use. However, NL’s management has started recording the depreciation from 1 April
2022. As a result, the fixed assets are overstated by Rs. 25 million, and the equity is also
overstated by the same amount excluding any impact from taxation. This misstatement
also affects the corresponding figures in 2022, resulting in a misstatement of both
property plant and equipment and equity.

Further, the misstatement of Rs. 25 million is considered material in the current year
as it represents 11% of profit before tax.

The auditor should ask the management and those charged with governance to restate
the corresponding figures and take the effect of the depreciation from 1 October 2021.

Reporting implication
If the management agrees to make the adjustment retrospectively, an unqualified
opinion will be expressed with an emphasis of matter paragraph giving reasons for the
restatement of figures and a reference to the notes to the financial statements.

However, if the management does not agree to make the adjustment, the auditor’s
report will be qualified due to the misstatement in the current year as well as the
corresponding figures/opening balances. In the Basis for qualified paragraph in the
auditor’s report, the auditor shall refer to both the current period’s figures and the
corresponding figures while describing the matter that give rise to the modification.

(b) Evaluation of the matter and course of action

Expiration of financing arrangements and since the outstanding amounts are payable
on 19 June 2023 this indicates a material uncertainty regarding the entity’s ability to
continue as a going concern which needs to be disclosed in the financial statements.
There is an explicit requirement for management to make a specific assessment of the
entity’s ability to continue as a going concern. It is the auditor’s responsibility to
evaluate management’s assessment in this regard. If management refuses to perform
such an assessment of the entity, it constitutes a scope limitation.

We will ask the management and those charged with governance to make an
assessment of the entity’s ability to continue as a going concern and also disclose it in
the notes to the financial statements.

Reporting implication
If adequate disclosure about a material uncertainty regarding the entity’s ability to
continue as a going concern is not made in the financial statements, the auditor shall
express a qualified opinion or an adverse opinion. In the Basis for Qualified or Adverse
Opinion section of the auditor’s report, the auditor should state that a material
uncertainty exists that may cast significant doubt on the entity’s ability to continue as
a going concern and that the financial statements do not adequately disclose this matter.

If management is not willing to carry out an assessment of an entity’s ability to continue

as a going concern, a qualified opinion or a disclaimer of opinion in the auditor’s report
may be appropriate. This is because the auditor may not be able to obtain sufficient
appropriate audit evidence regarding management’s use of the going concern basis of
accounting in the preparation of the financial statements. In such cases, the auditor
should include in the Basis for Opinion section the reasons for the inability to obtain
sufficient appropriate audit evidence.

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 Audit, Assurance and Related Services
Suggested Answer
Certified Finance and Accounting Professional Examination – Summer 2023

In case the management has performed an assessment of the entity’s ability to continue
as a going concern and has also made appropriate disclosures, then the auditor will
include a paragraph related to material uncertainty related to going concern in our audit
report.

(c) Evaluation of the matter and course of action

Although HAL became aware of the increased warranty claims after the year-end, it
provides evidence of conditions that already existed at the end of the reporting period.
Therefore, it is an adjusting event. Instead of recording warranty provision at 0.2% for
the newly launched vehicle, it should be reassessed based on the recent claims.

It is also necessary to discuss this matter with those charged with governance to reassess
their estimation of the warranty provision.

Reporting implication
If management disagrees with making the above adjustments, auditors will need to
qualify their report. In the basis of opinion section of the report, the auditor should
describe the financial effects of the material misstatement.

A.4 Identification and evaluation of self–review threat

A self-review threat to the fundamental principle of integrity arises since the engagement
partner is unlikely to criticize any elements of the cash flow forecasts and feasibility report
that were not highlighted by him. Since the audit is in the finalization stage, it indicates that
the audit fieldwork might have been completed. It appears that Jibran has not disclosed the
fact to the firm that he was part of the team during the conduct of the feasibility assignment
from Kareem & Company. Consequently, he would have breached the clauses of the ICAP
Code of Ethics and have compromised the fundamental principles of integrity and
professional behavior. The breach has been made by the engagement partner, which is the
most important role among all the team members as he oversees and provides guidance to
the team members.

Course of action
It needs to be evaluated that whether the firm can continue with the engagement and issue an
audit report. Since it is only related to one area of the financial statements, it may be managed
and the firm may continue with the engagement. The firm will have to adopt the following
safeguards:
 using different individuals to conduct an additional review of the affected audit work
 re-perform that work to the extent necessary
 assigning the engagement to another partner
 engaging another firm to review or re-perform the affected audit work to the extent
necessary

The firm also needs to communicate to those charged with governance that a breach of the
code of ethics has been made and discuss with them the following:
 discuss the details of the breach and the firm’s evaluation of the significance of the
breach.
 discuss the firm’s policies and procedures relevant to the breach designed to provide it
with reasonable assurance that independence is maintained.
 inform about any steps that the firm has taken or proposes to take to reduce or avoid
the risk of further breaches occurring.

Consider whether any legal or regulatory requirements apply to the breach and, if so comply
with those requirements.

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 Audit, Assurance and Related Services
Suggested Answer
Certified Finance and Accounting Professional Examination – Summer 2023

Identification and evaluation of intimidation threat to Raja Jibran

There is also a possibility that management may be pressurizing Raja Jibran to capitalize the
loss relating to the new production facility, even if it may not qualify to be capitalized under
IAS 16. Due to this intimidation threat Raja Jibran may not be objective and compromise his
professional judgement.

Course of action
In case Raja Jibran is feeling pressurized he should step away from the engagement and hand
it over to another partner.

Identification and evaluation of intimidation threat to the audit team

Furthermore, Raja Jibran is also intimidating his audit team not to discuss the audit issues
with anyone else. The audit team may also feel pressurized to ignore the audit issues. Due to
this intimidation threat from the partner the audit team may compromise their objectivity.

Course of action
The audit team should promptly communicate the breach in accordance with the firm’s
policies and procedures to other relevant personnel in the firm through:
 escalating the matter within the firm, including when appropriate, explaining any
consequential risks to the firm, for example, with any senior partner or quality control
partner.
 disclosing the matter in line with the firm’s policies, including ethics and
whistleblowing policies, using any established mechanism.

A.5 SEL had purchased land on a 50-year lease. The lease is set to expire in 2030, leaving only 7
years remaining. Therefore, we need to discuss this lease expiration with the management
and consider depreciating the wind turbine over the remaining 7 years unless the lease is
renewable.
Furthermore, since the government requires restoration of the site after the removal of the
wind turbine, a provision for dismantling and restoration needs to be recorded for this asset.
The useful life of the wind turbine will also have an effect on the provision, as it will unwind
over the life of the asset.

To properly evaluate the purchase of the new wind turbines and address these considerations,
the following audit procedures should be performed:
 Obtain the land documents from the management to check whether the lease is
renewable.
 Discuss with SEL’s legal team to ascertain the renewability of the lease of the land.
 Read the minutes of the meeting in which the matter related to the renewal of the lease
was discussed.
 Obtain and verify the invoices for the purchase cost and installation costs of the new
wind turbines.
 Understand and inquire the management process of estimating the provision for
restoration and dismantling costs.
 Obtain and review the management’s assumptions and calculations used to measure
the dismantling and site restoration provision.
 Review the documentation used to support the estimated cost of decommissioning and
restoration.
 Review agreements/regulations with the government pertaining to SEL for installation
and decommissioning of its wind turbines.
 Involve an auditor’s expert to assess the reasonableness of estimates by SEL in its
closure and rehabilitation provisions.
 Review the notes to the draft financial statements to confirm the sufficiency of narrative
and numerical disclosures provided in compliance with IAS 37
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 Audit, Assurance and Related Services
Suggested Answer
Certified Finance and Accounting Professional Examination – Summer 2023

A.6 General/Common Procedures:

(i) Agree to the opening cash position of Rs. 160 million to the cash book and the bank
statement.
(ii) Discuss the key assumptions underlying the preparation of the forecast with
management, which should include the following:
 Inquire about the predicted growth rates in operating cash receipts and payments
of 5% over the year. Also inquire from the management that how both can be at
5% when 15% of customers pay in the month of sale, whereas KDL often pays
within 21 days to avail discounts.
 Discuss the stated collection and payment periods in relation to receivables and
payables.
 Discuss the utilization of running finance facility and dividend payments.
(iii) Analytically review the forecast trends in cash flows comparing them with historical
cash flow statements and other available forecast data for the sector and local economy.
Investigate any significant differences.
(iv) Perform sensitivity analyses on the cash flow forecast by varying the key assumptions,
particularly in relation to growth rates and payment periods. Assess the impact of these
variations on the company’s forecasted cash position.
(v) Since the loan is expected to run until Jun 2027, inquire with the management that the
period covered by the cash flow forecast should extend till 2027.

Revenue:
(vi) Inquire about the discrepancy in the cash flow, where the full-year sale of cheese has
been considered for 2023, even though the facility would only be available from
July 2023.
(vii) Discuss with management the negligible decline in the sales of the corporate brand,
considering that the milk sold to the corporate brand would be reduced and used for
producing cheese.
(viii) Obtain any market study carried out by KDL to assess the possible future sales of cheese
and the potential selling price.

Operating cash payments:

(ix) Verify the settlement discount of 8% terms with suppliers by reviewing contractual
documentation. Confirm that the purchase ledger payments reflect the discounts
taken.
(x) Compare the predicted collection and payment periods to the most recent sales ledgers
and purchase ledgers.
(xi) Verify the salary payments by comparing them to the latest payroll records and cash
book payments to confirm accuracy and completeness. Also check any increase due
to the new cheese business segment, such as additional hiring done by KDL.
(xii) Obtain quotations obtained for the purchase and installation of cheese production set-
up to verify capital expenditure.
(xiii) For a sample of animal feed cost, review supporting documentation such as invoices.
Agree on the amount paid each month with the cash book.

Capital expenditure
(xiv) Discuss possible cost omissions with the preparer of the forecast. For example, inquire
why KDL’s cash flow forecast does not include any capital expenditure other than the
new setup.
(xv) Obtain any quotations obtained for the purchase and installation of the cheese making
equipment.

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 Audit, Assurance and Related Services
Suggested Answer
Certified Finance and Accounting Professional Examination – Summer 2023

Finance cost:
(xvi) Obtain the bank offer document/negotiation from the management regarding the
potential terms of the additional finance being negotiated, in order to confirm the
interest rate.

Taxation:
(xvii) Gain an understanding of the tax laws applicable related to KDL business for checking
the applicable tax rate.
(xviii) Obtain and verify the previous tax returns filed by KDL.

(The End)

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