No, 1

Jecha Motor Cars Co (Jecha) manufactures a range of motor cars and its year end is
31 January 2015. You are the audit supervisor of Zororo & Co and are currently
preparing the audit programmes for the year-end audit of Jecha. You have had a
meeting with your audit manager and he has notified you of a number of issues
identified during the audit risk assessment process.

Land and buildings

Jecha have a policy of revaluing land and buildings, this is undertaken on a rolling
basis over a five-year period. During the year Jecha requested an external valuer to
revalue a number of properties, including a warehouse purchased in May 2014.
Depreciation is charged on a pro rata basis.
Work in progress
Jecha undertakes continuous production of cars, 24 hours a day, seven days a week.
An inventory count is to be undertaken at the year end and Zororo & Co will attend.
You are responsible for the audit of work in progress (WIP) and will be part of the
team attending the count as well as the final audit. WIP constitutes the partly
assembled cars at the year end and this balance is likely to be material. Jackson
values WIP according to percentage of completion, and standard costs are then
applied to these percentages.

Required:
(a) Explain the factors Zororo & Co should consider when placing reliance on
the work of the independent valuer.

(b) Describe the substantive procedures the auditor should perform to obtain
sufficient and appropriate audit evidence in relation to:
(i) The revaluation of land and buildings and the recently purchased
warehouse; and

(ii) The valuation of work in progress.

(c) During the audit, your team has identified an error in the valuation of work
in progress, as a number of the assumptions contain out of date information.
The directors of Jackson have indicated that they do not wish to amend the
financial statements.
 Required:
Explain the steps Zororo & Co should now take and the impact on the
audit report in relation to the directors refusal to amend the financial
statements.

No 2

P. Ltd is a Mutare based company which designs and builds saw mill
machines. It also has a new branch in Durban, South Africa, which it acquired
recently. More than 90% of the saw mills are designed to customer
specifications. Recently the economy has been poorly performing and P. Ltd
had resorted to designing and building saw mill machines without orders.
This is in anticipation that the economy can improvement very soon and the
machines will get buyers. Most of the companys output is exported to South
Africa and its prices are quoted in the South African Rand.

You are asked to act as the senior in charge of the audit. The companys
yearend is 31 August. The companys previous audit file shows that internal
controls are very weak.

The companys management is new and is currently amending saw mill

designs in line with new technology. A considerable amount has been
invested in this. The company is also heavily indebted. Its major financier is
considering reviewing the bank overdraft facility in October 2015 and the
CEO wishes to ensure the continuing availability of the facility.

In line with international standards, the Zimbabwean Government in March

2015 has made certain disclosures mandatory. It has also set minimum
standards for all machinery produced and sold.

Required

I. Explain the term audit planning

II. Identify and explain circumstances particular to P. Ltd that need to be
considered when planning the audit.
No, 3

Explain the following letters of communication, clearly explaining their

purposes

a. Engagement Letter
b. Management Letter
c. Letter of Representation
d. Letter of weakness

No, 4 a.

You are the Chief Internal Auditor of A.C Holdings Ltd. The CEO was asked by
the Board of Directors (BODs) to justify the existence of the Internal Audit
Department. The BODs says that every year there is an external audit as a
result the Internal Audit Department is an unnecessary cost as it duplicates
the external auditors effort.

The CEO writes a memorandum to you, asking for assistance in the

preparation of a response to be presented to the BODs. The CEO wants you
to cover the following areas:

I. Explain the term auditing.

II. Differences between an Internal Auditor and an External Auditor
(duties, responsibilities, reports etc).

No, 4 b.

III. Discuss the importance of the Internal Audit Department.

IV. How can the effectiveness of the Internal Auditing Department be
enhanced?

No, 5

Farai Plc is a local Zimbabwean company which designs and builds sophisticated
racing boats. It has a small yard 400km away which it purchased recently. Most of the
boats are built to customer specifications. However as trade has been slack recently,
the company is building some boats without orders in the hope of obtaining buyers
when the market picks up. Most of the companys output is for export and it quotes
its prices in South African Rand (Foreign currency) which has been recently unstable.
You have been asked to act as senior in charge of the audit. The company has a year
end of September 30. It is apparent from the previous years audit file that the
company has always had weak internal controls, management turnover was high and
the auditor was not comfortable working with an expert employed by the Farai Plc.
The company had a third expert over a period of two years.

Farai Plc remunerates management based on level of production. During the year the
company acquired a significant shareholding in Zambezi Ltd. Zambezi Ltd is into oil
mining and refinery. The previous year audit report was qualified on the basis of
failure to prove the existence of some inventory items (boats) as well as not obliging
to the regional and national oil mining regulations.

The company is currently amending boat designs to take advantage of new technology
and has invested a significant amount of time and money in this. Consequently it is
heavily indebted to the bank. The bank overdraft facility is to be reviewed in
November and the bank manager has requested that the latest audited accounts be
available for that review.

The new CEO has asked you to complete the audit by 31 October as he wishes to
ensure the continuing availability of the overdraft facility before attending a major
trade fair in late November.

Required

a) Describe the matters you would consider when planning the audit of Farai Plc.
b) Explain the procedures you would go through when auditing the Motor
Vehicles for Farai Plc.

No, 6

Gathering audit evidence is an essential part of the audit process.

 a. Explain the importance of gathering audit evidence.
b. Discuss factors influencing the sufficiency of audit evidence.
c. Comment on the factors affecting the appropriateness of audit
evidence.

No, 7

Companies should maintain internal controls that provide reasonable

assurance that fraudulent financial reporting will be prevented or subject to
early detection.

a. Explain what is meant by Internal Control.

b. List and explain any four types of internal controls.
c.

No, 8

Clearly illustrating the reasons, suggest comprehensive internal controls

you would set to safeguard:

i) a fleet of company vehicles.

ii) Firms creditors
iii) Computer hardware and software

No, 9

a. Explain the terms interim and a final audit clearly distinguish them
b. In certain circumstances Auditors are asked to assess forecasted Financial
Statements and or balances.
(i) Explain the Auditors responsibility with respect to giving an assurance
of forecasted Financial Statements and or balances.
(ii) Which possible responses can Auditors have when asked to give an
assurance of forecasted Financial Statements?

No, 10
List and explain types of audit opinions and the circumstances under which
such opinions are given.

No, 11

At the beginning of the annual audit of Christys plc, wholesale distributor consumer durables located in
Tenenure,
Dublin. Bob Roberts, CPA and Registered Auditor, was given a copy of Christys financial statements as
prepared
by the companys accountant. On reviewing these statements, Bob notes the following unusual
conditions:
1. The accounts receivable outstanding at the year-end represent an unusually high number of average
days
credit sales.
2. The inventories on hand at the year-end represent an unusually high proportion of the current assets.
3. The working capital ratio of the company is almost twice that of the previous year.
4. The percentage of gross profit on net sales is considerably in excess of that of previous years.
5. The rate of turnover of inventory is unusually low in comparison with previous years.
REQUIRED:
Taking all the above conditions together, what irregularities might Bob suspect regarding sales and
inventories?
Give reasons for your answer (10 marks)

Suggested Solution No, 11

[Generally one mark for identifying issue; 1 or 2 marks for explanation.]

Including fictitious 3
Manipulating inventory upwards 3
Inconsistencies or errors in cut-off 2
Change in basis of valuing inventories 2
Other 2

Qn No 12

AUDITOR INDEPENDENCE AND PROFESSIONAL ETHICS

It is important that an auditors independence is beyond question and that he should behave with integrity
and objectivity in all professional and business situations. The following are a series of questions which
were asked by auditors at a recent update seminar on professional ethics.

REQUIRED:

Can you explain how you would deal with each of the following Questions:
(a) Can I audit my brothers company?
(b) Sango and Co, the previous auditors, will not give my firm professional clearance or the usual
handover information because they are owed fees. Should I accept the clients offer of appointment?
(c) Can I prepare the financial statements of a public company and still remain as its auditor?
(d) My Client has threatened to sue the firm of negligence. Can I still continue to act as auditor?
(e) I am an articled clerk of the Institute of Chartered Accountants of Zimbabwe. Am I bound by the ethical
guidelines of the institute?

Qn No 13

The Auditors may from time to time require the services of an expert i.e. someone more qualified than
the auditor in certain areas. Accordingly in such circumstances the auditor will need to apply relevant
procedures to the experts work.

REQUIRED:
What are the requirements of International Standards of Auditing with respect to using the work of an
expert?

Qn No 14

Acceptance of professional appointments Sepia

Bless is an audit manager in Sepia, a firm of Chartered Certified Accountants. His specific responsibilities
include advising the senior audit partner on the acceptance of new assignments. The following matters
have arisen in connection with three prospective client companies:

(a) The firm has been nominated to act as an auditor to Squid, a private limited company. It has been
waiting for a response to its letter of professional enquiry to Squids auditor, Krill & Co, for several weeks.
Blesss recent attempts to call the current engagement partner, Anton Fargues, in Krill & Co, have been
met with the response from Antons personal assistant that Mr Fargues is not available.

(b) Sepia has been approached by the management of Hatchet, a company listed on a recognised stock
exchange, to advise on a take-over bid which they propose to make. The target company, Vitronella, is an
audit client of Sepia. However, Hatchet is not.

(c) A former colleague in Sepia, Edwin Stenuit, is now employed by another audit firm, Keratin. Sepia and
Keratin and three other firms have recently tendered for the audit of Benthos, a limited liability company.
Benthos is expected to announce the successful firm next week. Yesterday, at a social gathering, Edwin
confided to Bless that Keratin lowballed on their tender for the audit as they expect to be able to provide
Benthos with lucrative other services.

Required:
Comment on the professional issues raised by each of the above matters and the steps, if any, that Sepia
should now take.

Suggested Solution to Qn No 14

The question requires you to:

Comment on professional issues and
Discuss the steps to be taken by Sepia in each of the given situations
This type of practice management question is likely to come up in the exam and you should be
prepared to answer at least one such question in the exam.
While answering each situation, you should break your answer into two parts according to the
requirement of the question (i.e. comments and steps taken).

(a) Reply to professional enquiry letter

Professional issues
Sepia has communicated with Krill & Co in respect of Squids new audit, which is in accordance with the
ethical guidance for accepting new professional assignments. However, Krill also has a professional
duty of confidentiality to its client, Squid. There may be two reasons for Krills unresponsiveness to
Sepias professional enquiry letter:
Squid may not have permitted Krill to part with any of its information. In this case, Sepia should not
accept the appointment.

Krill has casually ignored the professional enquiry letter. In this case, Krill is liable for professional
misconduct. Instead of simply ignoring the letter, Anton Fargues should:
Notify Squids management about the communication received from Sepia.
Write to Sepia stating that it cannot give any information according to the clients request.

In any case, Krill should not have simply failed to respond. It is Krills duty to communicate with Sepia
and make the firm aware of any serious issues that might have an implication on Sepias independence
and that might help in safeguarding the fundamental principles of the profession.

If there are any contentious issues (e.g. suspicion about some unlawful act by Squid which is not backed
by proof) which Anton Fargues does not wish to convey in writing, he should attempt to have an oral
discussion with Sepia rather than ignoring the letter. This would help Sepia in deciding whether to accept
the nomination or not.

Steps to be taken by Sepia

Approach Squids management: Sepia should discuss the matter with Squids management and try to
obtain a written representation stating that Krill & Co has been permitted to communicate with Sepia in
view of its professional duties.
Refuse nomination: if it is found that Squid has not permitted Krill & Co to respond to Sepias
communication, Sepia should try to determine the reason behind this and preferably refuse accepting the
nomination unless Sepia is convinced that permission has been refused for genuine reasons.
Re-approach Krill & Co: Sepia should send a final letter to Anton Fargues through registered post (i.e.
requiring acknowledgement of receipt)) stating that a reply is awaited until a fixed time (e.g. seven days)
after which, in the absence of a reply Sepia would assume that there are no issues for discussion and it
would consider accepting the nomination.
Word of caution: Sepia should, without fail, mention in its final letter to Krill, stating that if the reply is
not received other than for a genuine reason, a written complaint will be made to the relevant professional
body.
Action against Krill & Co: in order to render Anton Fargues liable for his unprofessional behaviour,
Sepia should make a written complaint to the disciplinary committee of the professional body which he is
a member of.

(b) Cross client decisions

Professional issues
In the given scenario, the auditor is approached by a new client (Hatchet) to advise on certain decisions
which relate to a transaction with the auditors existing client (Vitronella). This immediately raises two
prime issues i.e. integrity and confidentiality.

Confidentiality:
Sepia has a professional duty of confidentiality towards its existing client, Vitronella. Sepia should take
all reasonable steps to avoid conflicts of interest arising from new engagements and the possession
of confidential information.

If Vitronella approaches Sepia for financial advice on Hatchets take-over bid, it would fall within the ambit
of their client-auditor relationship and is therefore normal.
Generally, it is normal for a client to approach its existing auditors for technical advice on certain
matters.

Therefore, the fact that Hatchet has approached Sepia (instead of its current auditor) should raise a
doubt for Sepia. It is likely that Hatchet knows Vitronellas auditors and therefore has approached them
for advice on the take-over bid so that some confidential information about Vitronella could be obtained.
Hatchets intentions should be determined.

Integrity: the ACCAs Rules of Professional Conduct considers that it is not improper for an audit firm
to audit two clients which are contesting a take-over. Refusing services to such clients could damage
the clients as well as the auditors interests. However, the given situation is different as Sepia is not
Hatchets auditor. Sepia cannot resign from Vitronella in order to undertake the advisory role for
Hatchet, even if Hatchets engagement is more lucrative.

Steps to be taken by Sepia

Decline Hatchets request: there seems to be a clear conflict of interest in accepting Hatchets
engagement. This is because Sepia is not Hatchets auditor. Therefore, Sepia should decline Hatchets
request to advise on the take-over bid.

Inform Vitronella: in order to maintain good client-auditor relationship, Sepia should advise Vitronellas
management regarding declining Hatchets request.

(c) Lowballing
Professional issues
Lowballing refers to setting initial audit fees at a lower level in order to win a client in the hope that
additional work can be obtained from that client in the future. It is often referred to as the loss-leading
practice in which auditors compete for clients by reducing their fees for statutory audits. It is called loss-
leading because lowballing is believed to hamper the quality of an audit, as the fees quoted are on the
lower side.

The objective of setting lower audit fees is to obtain more lucrative non-audit work (e.g. consultancy and
tax advice) from the same client in future and therefore to compensate for a lower paying assignment with
higher paying ones.
In the given situation, two issues have arisen, i.e. ethical issues with respect to lowballing, and
confidentiality.

Ethical issues
According to the general Code of Ethics and Conduct, the fact that one audit firm has quoted a lower fee
than another audit firm does not in itself constitute a professional misconduct and is not considered
improper provided that the prospective client is not misled about:
the precise range of services that the quoted fee is intended to cover, and
the likely level of fees for any other work undertaken.
Therefore, if Benthos is not misled about the range of services to be offered by Keratin within the fees
quoted or the level of fees for any other work, Keratin is not liable for professional misconduct.
Although an admission to lowballing may sound improper, it does not breach the current ethical guidance,
provided Benthos understands the situation. Keratin could also offer Benthos free services for a
period of time, perhaps for the first year. However, Benthos should then be aware of and understand what
the cost of future audits would be.

If lowballing results in:

lower quality service (e.g. Keratin cuts corners to keep within budget),
negligence or fraud (e.g. falsification of audit working papers),
compromising integrity ( e.g. Keratin resorts to inappropriate practices to manage its work within lower
fees),
conflicts between Benthos and Keratin (if non-audit work does not materialise), then Keratin would be
liable for incompetence and professional misconduct.

If Keratin tries to increase the audit fees (instead of providing a lower quality service) there might be
disputes with Benthos which may refuse to pay higher fees. In this case, it might be difficult for Keratin
to take the matter to arbitration if Benthos was misled.

Begin your answer with the meaning of lowballing (even if this is not asked for), as it is a technical term.

Confidentiality: Edwin Stenuit has disclosed what seems to be confidential information regarding his
firm, Keratin. The fact that he was a former colleague in Sepia does not reduce his responsibility to
protect confidential information in relation to his firms affairs. Edwin is therefore likely to be in breach of a
duty of confidentiality towards his employer. If an action is taken by Keratin against Edwin, he might be
liable for professional misconduct.

Steps to be taken by Sepia

No action: Sepia need not take any steps against lowballing or Edwin as it would not affect Sepia directly.
Sepia cannot take any steps to prevent Benthos from awarding the tender to whichever firm it chooses.

Action against Edwin: complaining about Edwins breach of confidentiality might be unnecessary.
Instead, Sepia should consider conducting cold reviews of the audits on which Edwin has worked
previously, as his integrity is now doubtful.

Pricing policy: if Keratin is selected by Benthos, Sepia can consider reviewing its pricing policy for future
tendering bids.

No, 15
You are an audit senior of Salt & Co and are in the process of reviewing the systems
testing completed on the payroll cycle of Bronze Industries Co (Bronze), as well as
preparing the audit programmes for the final audit.

Bronze operate several chemical processing factories across the country, it

manufactures 24 hours a day, seven days a week and employees work a standard shift
of eight hours and are paid for hours worked at an hourly rate. Factory employees
are paid weekly, with approximately 80% being paid by bank transfer and 20% in
cash; the different payment methods are due to employee preferences and Bronze
has no plans to change these methods. The administration and sales teams are paid
monthly by bank transfer.

Factory staff are each issued a sequentially numbered clock card which details their
employee number and name. Employees swipe their cards at the beginning and end
of the eight-hour shift and this process is not supervised. During the shift employees
are entitled to a 30-minute paid break and employees do not need to clock out to
access the dining area. Clock card data links into the payroll system, which
automatically calculates gross and net pay along with any statutory deductions. The
payroll supervisor for each payment run checks on a sample basis some of these
calculations to ensure the system is operating effectively.

Bronze has a human resources department which is responsible for setting up new
permanent employees and leavers. Appointments of temporary staff are made by
factory production supervisors. Occasionally overtime is required of factory staff,
usually to fill gaps caused by staff holidays. Overtime reports which detail the
amount of overtime worked are sent out quarterly by the payroll department to
production supervisors for their review.

To encourage staff to attend work on time for all shifts Bronze pays a discretionary
bonus every six months to factory staff; the production supervisors determine the
amounts to be paid. This is communicated in writing by the production supervisors to
the payroll department and the bonus is input by a clerk into the system.

For employees paid by bank transfer, the payroll manager reviews the list of the
payments and agrees to the payroll records prior to authorising the bank payment. If
any changes are required, the payroll manager amends the records. For employees
paid in cash, the pay packets are prepared in the payroll department and a clerk
distributes them to employees; as she knows most of these individuals she does not
require proof of identity.

Required:

(a) Identify and explain FIVE internal control STRENGTHS in Bezel Industries Cos
payroll system.
 (b) Identify and explain FIVE internal control DEFICIENCIES in Bezel
Industries Cos payroll system and provide a RECOMMENDATION to address each
of these deficiencies.

Qn 16

You are an audit manager in Ross & Co, a firm of Chartered Certified Accountants. The principal activity
of one of your audit clients, Murray Co, is the manufacture and retail sale of women's fashions and
menswear throughout the capital cities of Western Europe.

The following financial information has been extracted from Murray's most recent consolidated financial
statements:

Year ended 31 March 20Y0 20X9

$000 $000
Revenue 36,367 27,141
Gross Profit 22,368 16,624
Profit before tax 5,307 4,405
Intangible Assets
Goodwill 85 85
Trademarks 52 37
Property, plant and equipment 7,577 4,898
Current Assets 13,803 9,737
Total assets 21,517 14,757
Equity 13,226 10,285
Non-current liabilities - provisions 201 87
Current liabilities - trade and other payables 8,090 4,385
Total equity and liabilities 21,517 14,757

In May 20Y0 Murray purchased 100% of the shareholding of Di Rollo Co. Di Rollo manufactures fashion
accessories (for example, jewellery, scarves and bags) in South America that are sold throughout the
world by mail order. Murray's management is now planning that clothes manufacture will expand into
South America and sold into Di Rollo's mail order market. Additionally, Di Rollo's accessories will be
added to the retail stores' product range.

Murray is a member of an ethical trade initiative that aims to improve the employment conditions of all
workers involved in the manufacture of its products. Last week Di Rollo's chief executive was dismissed
following allegations that he contravened Di Rollo's policy relating to the environmentally-friendly disposal
of waste products. The former chief executive is now suing Di Rollo for six months' salary in lieu of notice
and a currently undisclosed sum for damages.
Ross & Co has recently been invited to accept nomination as auditor to Di Rollo. Murray's management
has indicated that the audit fee for the enlarged Murray group should not exceed 120% of the fee for the
year ended 31 March 20Y0. You have been provided with the following information relating to the
acquisition of Di Rollo:
Carrying Fair value Fair value
amount adjustment to the group
$000 $000 $000
Di Rollo brand name 600
Plant and equipment 95 419 514
Current assets 400 400
Current liabilities (648) (648)
Net assets at date of acquisition (153) 419 866
Goodwill arising on acquisition 859
Cash consideration 1,725

Required:
(a) Using the information provided, explain the matters that should be considered before accepting the
engagement to audit the financial statements of Di Rollo Co for the year ending 31 March 20Y1.

(b) Explain what effect the acquisition of Di Rollo Co will have on the planning of your audit of the
consolidated financial statements of Murray Co for the year ending 31 March 20Y1.

You have been making preliminary inquiries regarding matters arising from the previous year's audit of Di
Rollo.

It has been revealed that no action has been taken in response to the management letter prepared by the
previous auditors. Di Rollo's management has explained that this was because it was 'poorly prepared'
and 'unhelpful'.

Required:
(c) Briefly describe various criteria against which the effectiveness of a management letter may be
assessed.

Suggested Solution to Qn 16 - Murray

In Part (a), you need to explain the matters that should be considered before accepting the engagement
to audit the financial statements You require to use the following information from the scenario for this
answer:

Murray is an existing client

The business of Di Rocco is not of a specialised nature
Staff from Ross & Co may have been involved in the due diligence of the acquisition
The principal auditor is generally appointed as the component auditor
Ross can face an intimidation threat on account of the proposed fee
In Part (b), you need to explain what effect the acquisition of Di Rollo Co will have on the planning of your
audit of the consolidated financial statements of Murray Co for the year ending 31 March 20Y1.If you
have understood Study Guide D2, you can get easy marks by applying the general issues relating to
group audit (like goodwill, fair values of net assets acquired, consistent accounting policies/year ends,
inter-company balances and transactions) in your answer.

In Part (c), you need to briefly describe various criteria against which the effectiveness of a management
letter may be assessed. This is a knowledge based question. Read the requirement carefully and do not
just describe is contents, however assess its effectiveness.

(a) Matters to be considered before accepting the engagement to audit the financial statements of Di
Rollo Co for the year ending 31 March 20Y1
1. Materiality

Di Rollo is material to the Murray group. This is evident from the following table:
Details Fair values Carrying value of Ratio of Di Rollo as
of Di Rollos Murray (20X7) compared to Murray

$ $ $
Non-current assets 514 7,577 6.8
Current assets 400 13,803 2.8
Current liabilities 648 8,090 8
1.5 marks

2. New audit
When professional accountants in public practice are asked to replace other professional accountants,
the accountant faces a threat of accepting an assignment wherein the fundamental principles (integrity,
objectivity and professional competence and due care) may not be adhered to.
From the scenario it does not appear that Ross will have issues which will affect its professional
competence and due care as:

Ross has the experience of auditing Murray which is larger than Di Rollo, and
Rosss business is not associated with industries like banking or insurance, all of which will require
specialised auditing skills

The main factors which could affect professional competence and due care are:

(i) If Ross does not have enough staff in South America (like associates) to carry out the engagement
(ii) If Ross cannot conduct the audit of Di Rollo promptly so that the consolidated financial statements of
Murray are not audited within the allotted time.
(iii) If Ross does not have the knowledge of South American legal and taxation regulations.

If the staff of Ross involved in the due diligence is also included as a team member of the audit team for
Di Rollo, a self-review threat could occur. In order to ensure that Rosss objectivity in forming an opinion
on the financial statements of Di Rollo is not impaired, it is advisable not to include the same team
members for the audit.

Generally auditors of the parent company are appointed as the auditors of the subsidiaries. Therefore
replacing the present auditor of Di Rocco with that of Ross is a normal practice. However Ross needs to:
ascertain whether circumstances existed which threatened the compliance with the fundamental
principles
obtain an undertaking from the owners / officials charged with governance of the prospective client of
their commitment to improve internal controls or corporate governance practices.
To understand these factors Ross must obtain permission from Murray to communicate with the existing
auditor of Di Rollo.

3. Disclaimer of opinion
During the communication with the previous auditors or with the management of the company, if it comes
to light that the entity would not be able to provide sufficient audit evidence on certain matters which are
material to the financial statements, the auditor can decline the nomination as it would result in the audit
report including a disclaimer of opinion.

4. Lowballing
The proposed fees may result in lowballing. Lowballing refers to the practice of quoting fees at rates
which are lower than the market rates charged by the predecessor firm. Such a practice leads to a self-
interest threat as the auditor may sacrifice the quality of the audit to retain / accept clients. In order to
avoid this conflict of interest there is a 20% increase in the fees that will cover the cost of auditing
Murrays financial statements.
Furthermore it must be at par with the general fees charged for such an audit.
Maximum marks 8
Following are examples of invalid points which must be avoided in your answer:
Matters relating to independence issues, like Ross holding shares in Di Rollo as it a 100% subsidiary of
Murray
Debating on why the current auditor is not being retained. This is inappropriate as it is natural to appoint
the principal auditor as the component auditor
Including irrelevant points like:
the fee itself was so great as to threaten independence
Ross & Co must need experts to deal with mail order and/or fashion jewellery and/or consolidated
financial statements.
Identifying business risks in Di Rollo (and/or Murray)
Describing how they might audit the subsidiary.
Suggesting that a conflict of interest must arise if both subsidiary and parent were audited by the same
firm.
(b) Effect of the acquisition on planning the audit of Murrays consolidated financial statements for the
year ending 31 March 20Y1

1. Group structure
Ross will specifically look for the following information:
The legal and reporting structure of the group: to ensure it looks legitimate and understand the size and
scope of work involved.
Identification of the groups significant components as well as information about the economic, political
and social environment within which they operate: to ensure that relevant information can be gained when
needed.
Therefore the primary information which must be collected would be to identify all entities that should be
consolidated into the Murray groups financial statements for the year ending 31 March 20Y1.

2. Materiality
While planning the audit, the auditor needs to decide the amount and level of work to be carried out. For
this he needs to decide the levels of materiality. This will involve judgement of the following factors:
identification of the components financial information with regard to the group
materiality of the component and its financial statements with regard to the group as a whole
the amounts lower than the materiality level for a particular class of transactions
the threshold below which misstatements cannot be regarded as trivial to the firm and a list of those
uncorrected misstatements that are above the threshold limit

The materiality levels (in monetary terms) for the financial statements of the group as a whole will have to
be set at higher levels than in the prior year.
Furthermore the materiality of each subsidiary should be re-calculated, with reference to the extended
group. It may happen that a subsidiary that was material for the year ended 31 March 20Y0 may not be
material to the group. The results of the recalculation will enable the auditor to identify those entities
which the auditor needs to visit and those for which substantive analytical procedures alone may be
carried out.
Di Rollos assets are material to the group (as discussed in answer to part a). Furthermore Di Rollos post
acquisition results are also expected to be material as it was acquired within two months of the financial
year.
Therefore an inspection of the South American operations is necessary. During the visit the auditor must
hold a meeting with the previous auditors to review the prior years working papers and also to discuss
about any matters which would affect specific account balances where there could be problems at the
time of consolidation.
3 marks
3. Goodwill
The consolidated financial statements will require:
combining of assets and liabilities (of Di Rollo, with Murray as on 31 March 20Y1) on a line by line
basis.
recognition of goodwill arising on acquisition
Di Rollos assets like brand name and plant and equipment will be recognised at fair values. The audit
plan must therefore include conducting a review of the work of the expert (i.e. the brand valuation expert
and the plant valuer). This will include a review of the working papers (to determine whether the
assumptions used by the expert are reasonable) and an evaluation of the experts qualifications,
experience, independence, etc.
The auditor needs to review the depreciation policies of the entity. This is because the fair value
adjustment on plant and equipment is 441% of the carrying amount, which is quite substantial. This may
indicate that Di Rollos depreciation policies are not based on the useful life of the asset.
The amount of goodwill is 50% of the cash consideration. This figure is significant to the financial
statements.
The financial statements carry the risk of overstatement of goodwill to the extent of non- recognition of
specific assets (for example franchises which are acquired are recognised as goodwill instead of
intangible assets. This will imply that the intangible assets are incorrectly impaired rather than being
amortised).

4. Subsequent impairment
The allegations against Di Roccos former chief executive indicate the possibility of impairment of Di
Roccos brand name as well as goodwill. The auditor should look into this matter while carrying out the
audit.

5. Liabilities relating to legal suit

The status of suit filed by the former CEO needs to be reviewed with the clients legal counsel. The review
process will include enquiries relating to the probability of Di Rocco defending the suit successfully. If the
matter is not resolved and the amount involved is material, the consolidated financial statements as at 31
March 20Y1 will have to include a disclosure relating to contingent liabilities. Furthermore a provision for
legal fees will also have to be made.

6. Group (related party) transactions and balances

Under the provisions of IRFS 3, Business Combinations all intra-group transactions and balances and
unrealised profits and losses on transactions with associates need to be identified and eliminated while
consolidating the financial statements.
To determine whether the consolidated financial statements have met with the provisions mentioned
above, the auditor must:

identify the list of all the companies in the group (including any associates).
review the transfer pricing policies of the company.
identify the inter-company transactions from the accounting systems.
confirm that all companies and that inter-company balances are regularly reconciled.

This list is not exhaustive.

You can add some more important tasks!
The verb in the question is assess. Therefore we have included the importance of each of the elements
in the answer!

7. Accounting policies
IAS 27 requires that consolidated financial statements shall be prepared using uniform accounting
policies for like transactions and other events in similar circumstances. If all the entities in the group do
not follow uniform accounting policies, then the consolidated financial statements will not reflect a correct
picture of the financial status of the group.
Hence, Ross needs to confirm that uniform and consistent accounting policies for like transactions and
other events are followed by each component in the group. If this requirement is not fulfilled, then Ross
has to confirm that the necessary adjustments (relating to material accounting policies which are not
uniform) are made to bring consistency in the group accounts.

8. Work schedule
Ross and Murray must mutually agree on the dates when the various activities relating to audit of the
consolidated financial statements takes place. For this the following important activities need to be
scheduled:
Date of preparation of consolidated financial statements
Date of reconciliations relating to inter-company balances and transactions
Date of completion of basic audit
Subsequent events review
Date of finalisation of subsidiary accounts
Auditors final completion of audit

Maximum marks 10
1 to 3 marks are allotted for each valid point with explanation. Therefore to score maximum marks, your
answer can include 4 valid points.

Following are examples of invalid points which must be avoided in your answer:

referring to the amortisation of goodwill instead of the prescribed accounting treatment to test it annually
for impairment.

mentioning that Di Rollo brand name could not be capitalised because it was internally generated.
Here it is important to understand that it had been acquired in a business combination and so was a
purchased asset.

mentioning that there is a requirement for an active market to capitalise or initially recognise an
intangible asset. Here you must remember that this is a valid requirement under the revaluation model
and not cost model.
repeating points made in part (a),

(c) Management letter effectiveness criteria

The management letter must be assessed using the following criteria:

1. Timing
Management letters contain important matters like the auditors approach to internal control relevant to
the audit, application of materiality, the extent to which the auditor uses the work of the internal audit, the
effect of significant accounting policies in controversial or emerging areas, significant audit findings, etc.
This letter therefore provides a very good base for an entity to make improvements to its existing internal
controls.
Therefore the letter must be issued as soon at the audit is completed.

2. Clarity
The management letter needs to make it clear that matters identified in the letter are important, and have
come to the attention of the auditor as a result of the audit. The letter must very clearly explain the impact
of each weakness in terms of the risk of financial loss. Such wording will ensure that the management
takes prompt action to overcome the weakness. The wordings must be from the clients perspective
rather than the audit perspective like increased audit risk.

3. Evidence needs to be factual

While referring to any particular issues in the management letter, the auditor should make specific
comments which are supported by evidence. This is because errors in the audits observations will not
just show the auditors in poor light but may also lead to liabilities for the auditors. Furthermore, the auditor
needs to be very careful while commenting on the entitys personnel. Instead of making any negative
comments it is advised to phrase any concerns about personnel in a diplomatic way.

4. Identification of the user

Management letters should clearly identify the intended user as the letter will contain confidential
information.

5. Obtaining feedback
The auditor should try to resolve the issues arising from the audit before issuing an opinion. The
management letter, therefore, must provoke a timely response. It should specify the consequences of
failure to resolve the matters in time. This might serve as a red flag for management. Furthermore (for
matters where irregularities were noticed), the letter must also include the responses from the line
managers or senior managers regarding how they have decided to make improvements in future.

6. Subject matter
Only significant matters that have come to the auditors attention as a result of the audit need to be
included.
These matters may or may not have an effect on the financial statements. The letter should indicate the
implications of the matters raised and, where necessary, use specific examples identified during the audit
to illustrate the matter raised and assist the users understanding.

7. Internal control
The auditors report should point out that the related control on financial systems was considered.
However, his findings were neither directed towards assessing the effectiveness of internal controls and
identifying weakness in the same nor expressing any assurance on the same.

8. Discuss with line managers and staff

Furthermore it is critical that the letter is first discussed with line managers and then is promptly sent to
the appropriate level of management. Also, if a particular group of management fails to respond within a
reasonable time, the next level of management should be consulted.
However care needs to be taken to ensure that the recommendations for improvements (suggested by
the auditor) must be practical and realistic.

9. Disclaimer about scope of audit

Management letters need to make it clear that matters identified in the letter are significant and have
come to the auditors attention as a result of the audit. The auditor has not undertaken any additional
procedures to identify other matters e.g. an investigation of fraud is not the subject matter and will only be
investigated if the auditor comes across evidence to indicate an occurrence of fraud. Non-detection of
such factors by the auditor does not mean that financial statements are free from fraud.
Qn 17

Elisha Co manufactures chemical products using a flow production process. Its year
ends on 31 July 2016 and the draft profit before tax is $13 600. You are the Audit
Team Leader and the year-end audit is to start shortly. The following issues have been
brought to your attention:

(i) Revaluation of plant and equipment

In August 2015, management reviewed Elisha Cos non-current asset
valuations and decided to update the carrying value of all plant and equipment.
The CEO, Tarisai Zororai, contacted his brother, Chido, a valuer and
requested Chidos firm to do the valuation.

(ii) Inventory valuation

Your firm attended the year-end inventory count for Elisha Co. It found that the
process for recording work in progress (WIP) and finished goods was
acceptable. Both WIP and finished goods are material to the financial
statements and the quantity and stage of completion of all ongoing
production was recorded accurately during the count.
During the inventory count, the count supervisor noted that a consignment
of finished goods, compound Z172E valued at $720,000 was defective. The
chemical mix was incorrect. The finance director believes that compound
Z172E can still be sold at a discounted sum of $400,000.

(iii) Bank loan

Elisha Co got a bank loan of $2 600 on 1 October 2014. Repayments of $200
are due quarterly, with a lump sum of $800 due for repayment in January
2017. The company met all loan payments in 2015 on time, but was late in
paying the April and July 2016 repayments.

Required:
(a) Describe substantive procedures you should perform to obtain sufficient,
appropriate audit evidence in relation to the above three matters.
(The mark allocation is shown against each of the three matters above.)

(b) Describe the procedures which the auditor of Elisha Co should perform in
assessing whether or not the company is a going concern.
Qn 18

ISA 300 Planning an Audit of Financial Statements provides guidance to assist auditors
in planning an audit.

Required:
Explain the benefits of audit planning.

You are an audit supervisor of Cheshungu & Co and are planning the audit of your
client, Shungudzashe Co which manufactures cleaning products. Its year end was 31
July 2016 and the draft profit before tax is $336 million. You are supervising a large
audit team for the first time and will have specific responsibility for supervising and
reviewing the work of the audit assistants in your team.
Shungudzashe Co purchases most of its raw materials from suppliers in Africa and
these goods are shipped directly to the companys warehouse and the goods are
usually in transit for up to three weeks. The company has incurred $13 million of
expenditure on developing a new range of cleaning products which are due to be
launched into the market place in November 2016. In September 2015, Shungudzashe
Co also invested $09 million in a complex piece of plant and machinery as part of
the development process. The full amount has been capitalised and this cost includes
the purchase price, installation costs and training costs.
This year, the bonus scheme for senior management and directors has been changed
so that rather than focusing on profits, it is instead based on the value of year-end
total assets. In previous years an allowance for receivables, made up of specific
balances, which equalled almost 1% of trade receivables was maintained. However,
the finance director feels that this is excessive and unnecessary and has therefore
not included it for 20X6 and has credited the opening balance to the profit or loss
account.
A new general ledger system was introduced in May 2016; the finance director has
stated that the data was transferred and the old and new systems were run in
parallel until the end of August 2016. As a result of the additional workload on the
finance team, a number of control account reconciliations were not completed as at
31 July 2016, including the bank reconciliation. The finance director is comfortable
with this as these reconciliations were completed successfully for both June and
August 2016. In addition, the year-end close down of the purchase ledger was
undertaken on 8 August 2016.

Required:
(b) Describe SIX audit risks, and explain the auditors response to each risk,
 in planning the audit of Shungudzashe Co.
Note: Prepare your answer using two columns headed Audit risk and
Auditors response respectively.

(c) Describe the audit supervisors responsibilities in relation to supervising

and reviewing the audit assistants work during the audit of
Shungudzashe Co.

QN 19

The Auditors may from time to time require the services of an expert. In such
circumstances the auditor will need to apply relevant procedures to the experts work
as well as in selecting an appropriate expert.

Required

a. Giving relevant examples, explain the term EXPERT distinguishing it from an

Accountant / Auditor.

b. Explain factors considered in selecting an expert and how such information

may be collected?

c. Giving examples, explain the responsibilities of an Auditor with respect to

the use of an experts work and the experts obligation in an audit
assignment.