Audit and Assurance

Suggested Answer
Certificate in Accounting and Finance – Spring 2024

A.1 Fraud Risk Factors:

 Due to challenges such as market saturation and declining profit margins, the
management may be under pressure to engage in fraudulent financial reporting,
potentially through overstating revenues or understating expenses.
 The significant pending transactions related to the sale of shares, coupled with the
potential adverse effects of reporting poor financial results, may pressurize the
management to show better financial results.
 TTL’s high leverage and the rise in interest rates pose a risk of breaching loan
covenants. This situation may exert excessive pressure on management to fraudulently
misstate financial statements to appear compliant with these covenants.
 The reduction of employee wages despite high inflation could result in adverse
relationship between employees and management, providing employees incentive and
rationalization to misappropriate the company’s assets.
 The CEO’s involvement in recommending accounting policy and active engagement
with valuers, particularly in determining the significant estimates, may indicate a
management attitude that favors fraudulent financial reporting. This behavior could be
motivated by a desire to show a better picture of the company to potential buyers and
lenders.
 The decision to enter into a bill and hold agreement at the year-end could be an
opportunity to record the next period’s revenue in the current period. This strategy
introduces complexity in determining the actual completion of performance
obligations.

A.2 (a) Azhar, serving as an independent trustee on the audit committee of the Trust which
owns 3% of PL’s shares, faces self-interest threat to his objectivity and professional
behavior. This threat could lead Azhar to overlook audit issues, negatively affecting
the trust’s shareholding value in the audit client. This threat may result in a
compromise of professional ethics because of bias and conflict of interest, undermining
his objectivity and discrediting the profession.

Furthermore, it needs to be evaluated whether the 3% shareholding is material to the

trust. Considering this shareholding, the trust is unlikely to exert significant influence
over the audit client.

Given Azhar’s role as an independent trustee who contributes to the good governance
and efficient board function without personal benefits from the trust, the threat’s
significance appears low.

(b) The audit team faces familiarity and intimidation threats to their principles of
objectivity and professional behavior. Usman, as the head of HR, may have a close
relationship with the audit team, potentially leading them to over sympathetic towards
his wife’s interests. Therefore, he could intimidate the audit team, given his possible
influence over their salaries and other benefits. This situation could compromise the
audit team’s objectively due to a bias towards Usman or his undue influence over their
employment benefits.

The significance of these threat largely depends on the extent of interaction between
the audit team and Usman, the organization structure of the firm, and level of control
Usman has over audit team’s salary and benefits.

Therefore, considering the above factors, the risk to professional ethics is deemed high.

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 Audit and Assurance
Suggested Answer
Certificate in Accounting and Finance – Spring 2024

(c) The approach taken by the board to remove the auditors is not in accordance with the
correct procedure, as the current auditors cannot be simply removed through a board
resolution during their tenure. Companies Act 2017 outlines the removal process of
auditors, granting the ultimate power to remove an auditor to the shareholders.

Consequently, TFL is required to convene a general meeting to pass a special

resolution for the appointment of a different auditor. Accordingly, a notice must be
issued for a resolution at the company’s general meeting to appoint someone other
than the retiring auditor as the new auditor.

The notice shall also be sent to the current auditor. The auditor will have the right to
represent and make a representation to the shareholders. Given that the auditors are
being removed during their tenure, the board shall appoint auditors with prior approval
of the Commission.

A.3 Evaluation of the scenario:

Since the aviation authorities has notified to phase out Gulfstream-III aircrafts and AL has
only one helicopter for its business, its imperative to ascertain how AL intends to continue
its business after 30 June 2024.

There is therefore a material uncertainty regarding the going concern assumption of AL.
Consequently, AL’s management must assess the going concern of the company and prepare
the financial statements accordingly.

If AL can continue as a going concern, the notification issued by the aviation authority
indicates impairment of the aircrafts. This necessitates testing for impairment and recognition
of any impairment loss in the financial statements.

Audit procedures going concern:

 Discuss and obtain management plans to mitigate these uncertainties if these still
persist as at the balance sheet date.
 Assess how much revenue is generated from the aircraft and helicopter to further assess
the going concern assumption.
 Assess whether AL has sufficient funds or borrowing facilities to purchase new
aircrafts.
 Review the minutes of meeting of the board of directors discussing this issue.
 Review and assess the management assumption regarding the plans and forecast
prepared by the management.
 Review that the disclosures made in the financial statements regarding material
uncertainties as to going concern assumptions and management plans to mitigate those
material uncertainties are adequate.

Audit procedures impairment:

 Obtaining an understanding of management process related to identifying, estimating
and recording impairment for fixed assets to determine whether it is consistent with
the requirement of IAS 36.
 Obtain and review the cash flow forecast prepared by the management for arriving at
the net present value.
 Review and assess adequacy of assumptions like discount rate used by the management
in this regard.
 Obtain the fair valuation report prepared by the management expert to determine the
sale value of the aircrafts.
 Consider involving auditor’s own expert to determine the value of the aircraft.
 Obtain and evaluate the accuracy and completeness of the source data used.
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 Audit and Assurance
Suggested Answer
Certificate in Accounting and Finance – Spring 2024

A.4 As an audit senior tasked with obtaining an understanding of Health Care Limited (HCL)
and its environment, following key areas must be thoroughly considered:

Ownership Structure:
 Investigate the ownership structure to understand the extent of family involvement and
the potential influence of key shareholders on decision-making.
 Determine the distribution of ownership among family members, institutional
investors, and other stakeholders.
 Evaluate any potential conflicts of interest arising from the concentration of ownership
and control within the family.

Governance Structure:
 Analyze the composition and effectiveness of the board of directors, especially
considering the predominance of family members.
 Evaluate the independence of board members and the presence of any governance
mechanisms to mitigate conflicts of interest.
 Assess the roles and responsibilities of family members serving as CEOs and other
positions and their impact on corporate governance practices.

Regulatory Requirements:
 Identify and understand the regulatory environment governing pharmaceutical
companies in Pakistan and any other jurisdictions where HCL operates.
 Ensure compliance with applicable accounting standards, company laws, and
regulations relevant to the pharmaceutical industry.
 Review HCL's history of regulatory compliance and any significant legal or regulatory
issues faced in the past.

Relevant Industry Factors:

 Gain insights into the competitive landscape of the pharmaceutical sector in Pakistan
and abroad.
 Assess the impact of industry dynamics, such as market competition, pricing pressures,
technological advancements, and regulatory changes, on HCL's operations and
financial performance.
 Consider the company's strategies for innovation, research and development, product
diversification, and market expansion.

A.5 (a) If expertise in a field other than accounting or auditing is necessary to obtain sufficient
appropriate audit evidence, the auditor shall determine whether to use the work of an
auditor’s expert. The auditor is not an expert to determine the quantity of coal stored
in piles. Since the inventory of coal has been categorized as a material area, the use of
work of an auditor’s expert will be necessary to obtain sufficient appropriate audit
evidence on inventory.

However, the determination of the value of the coal stock is an area of accounting and
auditing for which an auditor is expected to have expertise and can be verified by
various evidences available, such as subsequent sales to power plants, subsequent
receipts, verifying market prices etc. However for determining the quality of coal
inventory or the quantification of damaged inventory may require the use of auditor
expert if it cannot be reasonably determined by the audit team.

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 Audit and Assurance
Suggested Answer
Certificate in Accounting and Finance – Spring 2024

(b) Identification of related parties

ISA 550 specifically requires to obtain written representation regarding disclosure of
all related parties and their transaction to the auditor and also their disclosure in the
financial statements. However, relying solely on management representation for the
identification of related party transactions may not provide sufficient audit evidence.
While the management representation can provide initial information, it should be
corroborated with additional audit procedures such as review of contracts, inquiries
with external parties, and analysis of transaction data to ensure completeness and
accuracy. Without corroborating evidence, there is a risk of overlooking undisclosed
related party transactions and inaccuracies in the information provided by
management.

Inventory held by third parties

Again, solely relying on management representation for inventories held by third
parties may not be adequate. Audit procedures such as confirmation of inventory held
by third parties, physical count, reliance on report of inventory count performed by
third party auditor, or inspection of inventory movement documents, could be
performed to obtain reliable evidence Relying solely on management representation
could lead to misstatements or errors being overlooked, particularly if there are
discrepancies between what management has recorded and the actual inventory.

A.6 (a) The inventory not verified by the auditor through stock count is 21.4% of the profit and
is therefore material. Audit team needs to obtain evidence either by performing
inventory count at an alternate date and verification of existence of inventory through
other alternate procedures. If the auditor cannot obtain evidence due to non-
performance of the stock count it would be a scope limitation.

Since the effect is confined to a single element. of the financial statement, the effect is
material but not pervasive. Being material and not pervasive in nature auditor will
express a qualified opinion. Auditor will include a basis of qualified opinion paragraph
in which the auditor will discuss the matter giving rise to modification and their
inability to obtain sufficient appropriate audit evidence.

(b) Any transaction with the subsidiary will be a related party transaction. Even though
the management decides not to charge any amount from KL, being a related party
transaction, this arrangement needs to be disclosed in the financial statements. Not
disclosing the related party transaction would be a non-compliance of IAS-24 and will
be a material misstatement.

Being a material misstatement auditor will have to express a qualified opinion. Since
it is a material misstatement of the financial statements that relates to the non-
disclosure of information required to be disclosed, the auditor shall:
 Describe in the basis for opinion section the nature of the omitted information;
and
 Unless prohibited by law or regulation, include the omitted disclosures, provided
it is practicable to do so and the auditor has obtained sufficient appropriate audit
evidence about the omitted information.

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 Audit and Assurance
Suggested Answer
Certificate in Accounting and Finance – Spring 2024

A.7 (a) Discount management

(i) Regularly review and update discount rules in the system to ensure they are
current and accurate.
(ii) Introduce a policy where discounts above a certain threshold require a manual
review or approval from a supervisor. This can catch errors before invoices are
sent out.
(iii) Implement segregation of duties for checking that correct discount has been
applied.
(iv) Implement a system where discount rules are automatically applied based on
predefined criteria (e.g., customer type, order size, promo codes). This reduces
human error in calculating discounts.
(v) Introduce automated checks to verify invoice accuracy against price lists and
discount policies before sending them out to customers.

Order management
(i) Ensure each order is assigned a unique ID so that it could be tracked.
(ii) For every sales order, a despatch note should be produced (manually, or
generated by the system from the order details). Goods should not be despatched
to customers without a despatch note.
(iii) Once a dispatch note is prepared the order should be marked as closed.
(iv) Use an integrated order management system that automatically tracks and
manages orders across all stages of processing. This system can alert staff to
pending orders and ensure none are missed.
(v) Implement a system check to verify if an order ID is already being processed
before allowing it to proceed further.
(vi) Use an order management system that flags duplicate orders based on customer
information, order details, and timestamps.

(b) (i) Comparing the terms of the related party transaction to those of an identical or
similar transaction with one or more unrelated parties.
(ii) Engaging an external expert to determine a market value and to confirm market
terms and conditions for the transaction.
(iii) Comparing the terms of the transaction to known market terms for broadly
similar transactions on an open market.
(iv) Considering the appropriateness of management’s process for supporting the
assertion.
(v) Verifying the source of the internal or external data supporting the assertion, and
testing the data to determine their accuracy, completeness and relevance.
(vi) Evaluating the reasonableness of any significant assumptions on which the
assertion is based.

A.8 (a) (i) Obtain an aged listing of receivables ledger balances at the chosen date.
(ii) If the list is prepared by the client, check the completeness and accuracy of the
list of balances and the total of the balances in the list.
(iii) If the population of receivables ledger balances is not homogeneous, consider
using stratified sampling.
(iv) A suitable sampling method should be chosen. The sample selection process
should as far as possible ensure that the sample is representative of the population
of receivables.
(v) In selecting the sample, certain types of account should be considered for
inclusion, such as overdue accounts, credit balance and nil balance.
(vi) For selected items for circularization, details should be extracted from the
receivables ledger, and letters to the customer should be prepared.
(vii) Obtain management’s authorization to the confirming parties to respond to the
auditor.
(viii) Ensure that the letters should be sent by post directly by the auditor.
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 Audit and Assurance
Suggested Answer
Certificate in Accounting and Finance – Spring 2024

(b) (i) Enhance the quality of the audit.

(ii) Facilitate the effective review and evaluation of the audit evidence obtained and
conclusions reached before finalization of the audit report.
(iii) Assist the audit team in planning and performing the audit.
(iv) Ensure that members of the audit team are accountable for their work.
(v) Maintain a record of matters of continuing significance to future audits.
(vi) Enable an experienced auditor, with no previous connection with that audit, to
conduct quality control reviews or other inspections

(c) (i) Consider the purpose of the audit procedure and the population from which the
sample will be drawn.
(ii) Consider the characteristic of the population from which the sample will be
drawn.
(iii) Consider the nature of the audit evidence sought from the sample.
(iv) Determine a sample size sufficient to reduce sampling risk to an acceptably low
level.
(v) Select items for the sample in such a way that each sampling unit in the
population has an equal chance of selection.

(d) (i) The objective and scope of the audit of the financial statements.
(ii) The responsibilities of the auditor.
(iii) The responsibilities of the management.
(iv) Identification of the applicable financial reporting framework for the preparation
of the financial statements.
(v) Reference to the expected from and content of any reports to be issued by the
auditor.
(vi) A statement that there may be circumstances in which a report may differ from
its expected form and content.

(THE END)

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