Professional Documents
Culture Documents
AUDIT AND
ASSURANCE
QUESTION BANK
Question
P
ICAP
Bank
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C
Contents
Page
Question and Answers Index v
Questions
Section A Multiple choice questions 1
Section B Objective test and long-form questions 17
Answers
Section C Multiple choice answers 71
Section D Objective test and long-form answers 77
I
Index to Objective test and long-form
questions and answers
Question Answer
page page
Question Answer
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Question Answer
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Question Answer
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SECTION
A
Multiple choice questions
6 When an auditor is proposed for removal from office, which one of the following is he
NOT permitted to do?
A Circulate representations to members
B Apply to the court to have the proposal removed
C Speak at the AGM/EGM where the removal is proposed
D Receive notification of the AGM/EGM where the removal is proposed
8 Assuming that it is not the first appointment of the auditor, who is responsible for the
appointment of the auditor?
A The shareholders in a general meeting
B The managing director
C The board of directors in a board meeting
D The audit committee
13 Audit risk is composed of 3 factors. Which of the following is NOT one of those factors?
A Compliance risk
B Detection risk
C Control risk
D Inherent risk
18 Which of the following are you unlikely to see in the current file of auditors working
papers?
A Memorandum & articles of association
B Audit planning memorandum
C Summary of unadjusted errors
D Details of the work done on the inventory count
19 According to ISA 500, the strength of audit evidence is determined by which two
qualities?
A Appropriateness & competence
B Sufficiency & appropriateness
C Reliability & extensiveness
D Objectivity & independence
20 Which of the following is normally the most reliable source of audit evidence?
A Internal audit
B Suppliers statements
C Board minutes
D Analytical review
22 According to ISA 315, which of the following is NOT an element of the control
environment?
A Participation of management
B Information processing
C Commitment to competence
D Human resource policies and practices
31 Which one of the following is NOT an internal control you would expect to see in a
sales system?
A All goods received notes are authorised by the customer
B All orders are checked against credit limits
C All invoices are recorded on pre-numbered sequential documents
D All cash is banked on the same day as it was received
32 Which one of the following is NOT an internal control you would expect to see in a
purchases system?
A Preferred suppliers are used
B All invoices are grid-stamped to create the companys own invoice system
C Employees are only paid for work done
D There is a list of authorised cheque signatories
39 At what stage of the audit do ISAs 315 and 520 require the auditor to use analytical
procedures?
A When tendering for the audit of a new client
B During the planning stage and the review stage
C At the report writing stage
D When deciding whether to rely on the evidence of an expert
44 Which of the following is NOT a substantive test for the audit of non-current assets?
A Reconcile the non-current assets register to the receivables ledger control
account
B Consider the reasonableness of any revaluations
C Physically check a sample of non-current asset additions
D Vouch disposal proceeds to the bank statement
47 Which of the following is NOT a substantive test for the audit of inventories?
A Test the updating of all inventory count differences to inventory records
B Test the accuracy of net realisable value through the review of post year-end
sales
C Have satisfactory explanations been explained for all material inventory count
differences
D Check that all administrative overheads have been correctly accrued for in the
valuation of inventories
49 Which of the following is NOT a substantive test for the audit of receivables?
A Test cash received after the end of the reporting period
B Check adequate provision for doubtful debts
C Check reasons for debit balances (and ensure they are disclosed under
payables)
D Check brought forward balance
52 Which of the following audit procedures is primarily intended to provide audit evidence
as to existence?
A Matching sales invoices to goods despatch notes
B Casting the sales ledger
C Confirming receivables balances with customers
D Checking the dating of outstanding cheques
57 Which of the following statements about the audit of related parties is correct?
A The materiality of related parties is judged by reference to the company being
audited, not the individual related party.
B The main audit concern in relation to related parties is the adequacy of the
disclosures of the related parties that have been identified.
C It is usually considered unnecessary to obtain written representations from
management about related parties.
D A company should disclose both the nature of related party relationships and the
amount of related party transactions.
59 The auditor may work with a specialist. What effect does this have on the auditors
responsibilities?
A The client must take full responsibility for the specialist
B The auditors responsibilities are not diminished in any way
C The auditor and client have joint responsibility for the specialist
D All 3 are equally responsible
61 Which of the following statements about the principal auditor in a group audit is
INCORRECT?
A The principal auditor is responsible for the opinion on the group financial
statements as a whole.
B The principal auditor can demand information and explanations from the
secondary auditor.
C The principal auditor needs to consider the materiality of the portion of the group
audited by him.
D The principal auditor can demand co-terminus year-ends for all group companies.
63 Which of the following items should be communicated by a group auditor to the group
management?
1 material weaknesses in group-wide controls
2 material weaknesses discovered by the group auditor in any component of the
group
3 material weaknesses discovered by any component auditor in any component of
the group
4 Any fraud or suspected fraud
A 1, 2, 3 and 4
B 1 only
C 1 and 4 only
D 1, 2 and 4 only
64 You have been proposed as auditor of a company. What is the first step that you
should take?
A Obtain the clients permission to communicate with the existing auditor
B Obtain the existing auditors working papers
C Obtain a copy of the companys most recent board minutes
D Obtain a copy of the existing auditors letter of engagement
65 Which one of the following may auditors NOT perform for their client?
A Taking management decisions
B Preparation of accounting records
C Preparing tax computations
D Advising on weaknesses in the internal control systems
66 Which of the following are fundamental ethical principles for professional accountants?
1 Competence
2 Compliance
3 Integrity
4 Objectivity
A 1, 2 and 3 only
B 1, 3 and 4 only
C 2, 3 and 4 only
D 1, 2 and 4 only
67 An auditor should not accept a loan on favourable commercial terms from an audit
client because of the threat to his or her independence. The threat would be a:
A Self-interest threat
B Self-review threat
C Advocacy threat
D Familiarity threat
70 Which of the following would you not use as a benchmark for comparison when
undertaking analytical procedures?
A Other audit clients
B Previous years
C Other companies in the same industry
D Budget
A The gap between how the directors of a company perform their duties and how
the shareholders expect them to perform
B The gap between how the directors of a company perform their duties and how
the general public expects them to perform
C The gap between the public perception of the role of company auditors and their
statutory role and responsibilities
D The gap between the auditors own perception of their duties and how they are
set out in the Companies Act
SECTION
B
Objective test and
long-form questions
Required:
(i) Briefly describe each of the fundamental principles of professional ethics.
(7)
(ii) Briefly describe different categories of the threats to compliance with
the fundamental principles. (5)
(b) Mustansar is the audit manager of a team engaged on the audit of a listed
company. During his initial discussion with the chief executive officer (CEO) of
the company, he was informed that depressed economic conditions have badly
affected the company and its liquidity. Due to uncertainty about the future of the
company, certain key employees have left including several staff members of
accounting and finance department. Consequently, the accounting records are in
a bad shape and the management is making efforts to complete the draft
accounts quickly. He therefore requested Mustansir to carry out necessary
accounting work and to help prepare the annual financial statements at a fee to
be agreed mutually.
Required:
Briefly describe the guidelines contained in the ICAPs Code of Ethics and the
extent of support that can be offered by the auditors, in the above situation. (6)
(Total: 18 marks)
2 Levels of assurance
Distinguish between absolute and reasonable assurance. Identify the type of
assurance that is expected in an audit of the financial statements, clearly outlining the
reasons to justify your point of view. (8)
3 Shamsuddin
Shamsuddin a newly qualified chartered accountant has recently established his
practice in the name of Shamsuddin & Co., Chartered Accountants. He is continuously
trying to expand his practice and in this process he came across the following
situations:
(i) One of his friends, who is the owner of an advertising agency, has offered to
provide significant discount for publicity of his new practice.
(ii) Fashion Limited, a private limited company, which has suffered heavily on
account of recent financial turmoil, has informed him that it is willing to appoint
him in the forthcoming annual general meeting (AGM) of the company in place of
the existing auditors, if he can quote a fee below the existing audit fee.
(iii) Design Limited has contacted Shamsuddin and informed him that they are willing
to appoint him as their external auditor in the next AGM at a fee of Rs. 200,000 if
he completes the audit in a month. However, in case of delay in the audit work
the audit fee will be reduced to Rs.150,000.
(iv) Shamsuddin receives an offer of appointment as auditors from Style Enterprises,
a sole proprietorship, who wants to remove the existing auditors before
completion of their term of office.
Required:
Shamsuddin is inclined to accept the above offers. Discuss the options available with
him in each of the above situations. (10)
4 Core concepts
(a) Briefly highlight the managements responsibilities relating to the financial
statements? (7)
(b) During the audit team planning meeting, a member of the audit team passed a
comment that based on past experience with the client, he was confident that the
management of the client was honest and there was no issue as regards
management integrity or risk of fraud in the Company. The audit manager
responded that the auditor should always maintain an attitude of professional
scepticism throughout the audit.
Required:
Briefly describe Audit Scepticism and elaborate on the response of the audit
manager. (8)
(Total: 15 marks)
5 Threats
A chartered accountant is required to comply with five fundamental principles
specified by ICAPs Code of Ethics. However, compliance with the fundamental
principles may potentially be threatened by a broad range of circumstances.
Required:
Briefly describe the categories of threats that may potentially affect
compliance with the fundamental principles. Give two examples for each category.
(10)
8 Audit process
The purpose of an external audit and its role are not well understood. You have been
asked to write some material for inclusion in your firms training materials dealing with
these issues in the audit of large companies.
Required:
(a) Draft an explanation dealing with the purpose of an external audit and its role in
the audit of large companies, for the inclusion in your firms training materials.
(7)
(b) The external audit process for the audit of large entities generally involves two or
more recognisable stages. One stage involves understanding the business and
risk assessment, determining the response to assessed risk, testing of controls
and a limited amount of substantive procedures. This stage is sometimes known
as the interim audit. Another stage involves further tests of controls and
substantive procedures and audit finalisation procedures. This stage is
sometimes known as the final audit.
Describe and explain the main audit procedures and processes that take place
during the interim and final audit of a large entity. (7)
(Total: 14 marks)
10 Fundamental principles
Explain each of the FIVE fundamental principles of ICAPs Code of Ethics (5)
11 Oops
Explain the situations where an auditor may disclose confidential information about a
client. (8)
15 Alpha
The following three entities have approached Alpha & Company, Chartered
Accountants (the firm) for appointment as their statutory auditors. In each case there
are following issues which need to be considered before the firm decides to accept the
assignments.
(i) Client: Safe Bank Limited
Issue: the firm has acquired office equipment from the bank under finance lease
arrangements. In addition, some partners of the firm are also using the banks
credit card facility.
Required:
In each case specify the minimum conditions specified by Companies Ordinance,
1984, which should be fulfilled in order to accept the audit engagement. (9)
17 Shahid Corporation
Azeem and Company have been the auditors of Shahid Corporation Limited, a
listed company, for the past many years. You have been appointed as the audit
engagement manager.
Briefly explain the matters which you would consider while assessing the following:
(a) acceptance and continuance of client relationship. (5)
(b) need to send a new engagement letter. (3)
(Total: 8 marks)
18 Assertions
(a) The auditor shall perform risk assessment procedures to provide a basis
for the identification and assessment of risks of material misstatement at the
financial statement and assertion levels.
(i) Briefly explain what you understand by the risk of material misstatement at
financial statement level. (4)
(ii) List down the risk assessment procedures as referred above. (2)
(b) The auditors assessment of materiality and audit risk may be different at the
time of initially planning the engagement from at the time of evaluating the results
of audit procedures.
Briefly describe the reasons which may lead to such a change in the
auditors assessment. (3)
(c) Briefly describe the assertions used by the auditors in respect of the following:
(i) account balances
(ii) classes of transactions; and
(iii) presentation and disclosures (7)
(Total: 16 marks)
20 ASPL
You are the Audit Manager on the audit of Al-Salam Pakistan Limited (ASPL) for the
year ended June 30, 20X3. ASPL is engaged in the manufacture of a wide range of
plastic products. While reviewing the initial work performed by the audit team, the
following matters have come to your notice:
(i) The quantity of material scrapped during the year is materially different from the
quantity of scrap sold. The companys records show nil balance both at the
beginning and at the close of the year. No reconciliation for the difference has
been provided by the company.
(ii) Sales for the year have increased by 7% over the previous year. However, it
has been noted that sales in the last two weeks of June 2010 have been
exceptionally high and represent 15% of the annual sales. The audit working
papers carry the following observations in respect of the above:
70% of the sales in the last two weeks of June were made to two new
customers whose credit assessment has not been formally documented;
Required:
(a) Analyse each of the above situations and assess whether it represents a fraud or
an error. (6)
(b) What action would you take to deal with the above matters? (9)
(Total: 15 marks)
21 AMF
Al-Madad Foundation (AMF) is a charitable organization. It receives donations which
are utilized to help the destitute persons in accordance with the rules and regulations
prescribed by the AMFs Trust Deed.
The donations are received from the following sources:
(i) Cash collected from the general public through charity boxes placed at
key points in hospitals, airports, superstores etc.,
(ii) cash and cheques received from individuals and institutions at AMFs office; and
(iii) cash from generous individuals who prefer to remain anonymous.
Donations received in case of (ii) and (iii) above, often contain specific instructions for
utilisation of the donated amount for specific purposes e.g. for education of orphan
children.
Required:
(a) Identify the inherent risks in the operations of AMF. (3)
(b) Briefly discuss the effect of each of these risks on the audit of AMF. (3)
(Total: 6 marks)
23 SPL
Strawberry Pakistan Limited (SPL) was incorporated on March 1, 20X3. The directors
of SPL are in the process of appointing the first statutory auditor of the company. They
have requested your firm to submit a proposal for the statutory audit assignment. A
partner of your firm has asked you to draft the proposal after assessing whether the
preconditions for the audit exist.
Required:
(a) Briefly discuss the term preconditions for an audit.
(b) What are the steps that you would perform in order to ensure that preconditions
for the audit exist?
(c) Discuss whether your firm may or may not accept the assignment if one of the
preconditions for the audit is not present.
(Total: 15 marks)
Required:
(i) What do you understand by non-routine transactions and judgmental matters?
(ii) State the reasons on account of which risk of material misstatement is increased
in case of:
Non-routine transactions
Judgmental matters (6)
(Total: 11 marks)
26 Dynamic
In the planning phase of the audit of Dynamic Limited for the year ending 30 June
20X3, you have calculated the following ratios from the management accounts of
the company for the eight months ended 29 February 20X3:
Eight months
Year ended Year ended
period ended
30 June 20X2 30 June 20X1
29 February 20X3
27 Changing terms
An auditor may agree to a change in the terms of engagement provided there is a
reasonable justification for doing so.
Required:
(a) List the circumstances in which the management may request the auditor to
change the terms of an audit engagement.
(b) What factors should be considered by the auditor before accepting a change in
the terms of the engagement?
(c) List the steps that the auditor should consider, if he is unable to agree to a
change in the terms of engagement.
(Total: 9 marks)
28 EL
List the important matters that are required to be included in an audit engagement letter.
(6)
29 Calm Co
ISA 315 Identifying and Assessing the Risks of Material Misstatement Through
Understanding the Entity and its Environment deals with the auditors responsibility to
identify and assess the risks of material misstatement in the financial statements,
through understanding the entity and its environment, including the entitys internal
control.
Required:
(i) Explain the purpose of risk assessment procedures. (3)
(ii) Outline the sources of audit evidence the auditor can use as part of risk
assessment procedures. (3)
(Total: 6 marks)
30 Azam
Azam is a charity whose constitution requires that it raises funds for educational
projects. These projects seek to educate children and support teachers in certain
countries. Charities in the country from which Azam operates have recently become
subject to new audit and accounting regulations.
Charity income consists of cash collections at fund raising events, telephone appeals,
and bequests (money left to the charity by deceased persons). The charity is small and
the trustees do not consider that the charity can afford to employ a qualified
accountant. The charity employs a part time book-keeper and relies on volunteers for
fund raising.
Your firm has been appointed as accountants and auditors to this charity because of
the new regulations. Accounts have been prepared (but not audited) in the past by a
volunteer who is a recently retired Chartered Accountant.
Required:
(a) Describe the risks associated with the audit of Azam under the headings inherent
and control risks and detection risk and explain the implications of these risks for
overall audit risk. (10)
(b) List and explain the audit tests to be performed on income and expenditure from
fund raising events. (10)
Note: In part (a) you may deal with inherent risk and control risk together. You are not
required to deal with the detail of accounting for charities in either part of the question.
(Total: 20 marks)
31 Hurricane
You are the audit manager in charge of the audit of Hurricane, a limited liability
company. The companys year-end is 31 December, and Hurricane has been a client
for seven years. The company purchases and resells fittings for ships including
anchors, compasses, rudders, sails etc. Clients vary in size from small businesses
making yachts to large companies maintaining large luxury cruise ships. No
manufacturing takes place in Hurricane.
32 Zakir Co
(a) With reference to ISA 520 Analytical Procedures explain
(i) what is meant by the term analytical procedures; (2)
(ii) the different types of analytical procedures available to the auditor; and (3)
(iii) the situations in the audit when analytical procedures can be used. (3)
Zakir Co sells garden sheds and furniture from 15 retail outlets. Sales are made to
individuals, with income being in the form of cash and debit cards. All items purchased
are delivered to the customer using Zaks own delivery vans; most sheds are too big for
individuals to transport in their own motor vehicles. The directors of Zak indicate that
the company has had a difficult year, but are pleased to present some acceptable
results to the members.
The income statements for the last two financial years are shown below:
Income statement
31 March 31 March
20X4 20X3
Rs m Rs m
Revenue 7,482 6,364
Cost of sales (3,520) (4,253)
Gross profit 3,962 2,111
Operating expenses
Administration (1,235) (1,320)
Selling and distribution (981) (689)
Interest payable (101) (105)
Investment income 145
Profit/(loss) before tax 1,790 (3)
Required:
(b) As part of your risk assessment procedures for Zakir Co, identify and provide a
possible explanation for unusual changes in the income statement. (9)
(c) Confirmation of the end of year bank balances is an important audit procedure.
Required:
Explain the procedures necessary to obtain a bank confirmation letter from Zakir Co.s
bank. (3)
(Total: 20 marks)
33 Hajira
(a) Explain the term audit risk and the three elements of risk that contribute to total
audit risk. (4)
The Hajira charity was established in 1960. The charitys aim is to provide
support to children from disadvantaged backgrounds who wish to take part in
sports such as tennis, badminton and football.
Hajira has a detailed constitution which explains how the charitys income can be
spent. The constitution also notes that administration expenditure cannot exceed
10% of income in any year.
The charitys income is derived wholly from voluntary donations. Sources of
donations include:
(i) Cash collected by volunteers asking the public for donations in shopping
areas,
(ii) Cheques sent to the charitys head office,
(iii) Donations from generous individuals. Some of these donations have
specific clauses attached to them indicating that the initial amount donated
(capital) cannot be spent and that the income (interest) from the donation
must be spent on specific activities, for example, provision of sports
equipment.
The rules regarding the taxation of charities in the country Hajira is based are
complicated, with only certain expenditure being allowable for taxation purposes
and donations of capital being treated as income in some situations.
Required:
(b) Identify areas of inherent risk in the Hajira charity and explain the effect of each
of these risks on the audit approach. (12)
(c) Explain why the control environment may be weak at the charity Hajira. (4)
(Total: 20 marks)
34 Tahir Co
One of your audit clients is Tahir Co a company providing petrol, aviation fuel and
similar oil based products to the government of the country it is based in. Although the
company is not listed on any stock exchange, it does follow best practice regarding
corporate governance regulations. The audit work for this year is complete, apart from
the matter referred to below.
As part of Tahir Co.s service contract with the government, it is required to hold an
emergency inventory reserve of 6,000 barrels of aviation fuel. The inventory is to be
used if the supply of aviation fuel is interrupted due to unforeseen events such as
natural disaster or terrorist activity.
This fuel has in the past been valued at its cost price of Rs.150 a barrel. The current
value of aviation fuel is Rs.1,200 a barrel. Although the audit work is complete, as
noted above, the directors of Tahir Co have now decided to show the real value of this
closing inventory in the financial statements by valuing closing inventory of fuel at
market value, which does not comply with relevant accounting standards. The draft
financial statements of Tahir Co currently show a profit of approximately Rs.5m with net
assets of Rs.1.7 billion.
Required:
(a) List the audit procedures and actions that you should now take in respect of the
above matter. (6)
(b) For the purposes of this section assume from part (a) that the directors have
agreed to value inventory at Rs.150/barrel.
Having investigated the matter in part (a) above, the directors present you with
an amended set of financial statements showing the emergency reserve stated
not at 6,000 barrels, but reported as 60,000 barrels. The final financial
statements now show a profit following the inclusion of another 54,000 barrels of
oil in inventory. When queried about the change from 6,000 to 60,000 barrels of
inventory, the finance director stated that this change was made to meet
expected amendments to emergency reserve requirements to be published in
about six months time. The inventory will be purchased this year, and no liability
will be shown in the financial statements for this future purchase. The finance
director also pointed out that part of Tahir Co.s contract with the government
requires Tahir Co to disclose an annual profit and that a review of bank loans is
due in three months. Finally the finance director stated that if your audit firm
qualifies the financial statements in respect of the increase in inventory, they will
not be recommended for re-appointment at the annual general meeting. The
finance director refuses to amend the financial statements to remove this
fictitious inventory.
Required:
(i) State the external auditors responsibilities regarding the detection of fraud;
(4)
(ii) Discuss to which groups the auditors of Tahir Co could report the fictitious
aviation fuel inventory; (6)
(iii) Discuss the safeguards that the auditors of Tahir Co can use in an attempt
to overcome the intimidation threat from the directors of Tahir Co. (4)
(Total: 20 marks)
INTERNAL CONTROL
35 Controls
(a) If the auditor plans to rely on controls that have not changed since they were last
tested, the auditor should test the operating effectiveness of such controls at
least once in every third audit. Identify the situations in which the auditor may
decide to test the controls again, in the very next audit. (4)
(Total: 14 marks)
36 Shahzad
(a) Briefly explain the components of internal control as referred to in the
International Standards on Auditing. (9)
(b) Your firm is the auditor of Shahzad Limited (SL), a listed company, which is a
wholesaler of consumable products. SL records its sale on delivery of goods and
maintains up to date computerised inventory records.
A full inventory count was conducted at the year end. The senior who attended
the physical stocktaking at the central warehouse has observed the following
matters:
(i) The inventory count took place on January 1, 20X3 under the supervision
of the Inventory Controller. No movement of inventory took place on that
day.
(ii) Four counting teams were formed. Each team comprised of two
persons. The floor area was allocated by the teams among themselves.
(iii) Each team was instructed by the Inventory Controller to remember
which inventory had been counted.
(iv) Pre-numbered count sheets were provided to the staff involved in the
inventory count. The count sheets showed the inventory ledger balances,
to facilitate reconciliation.
(v) Old, slow-moving or already sold inventories were highlighted on the
count sheets at the time of counting.
(vi) Items not located on the pre-numbered inventory sheets were
recorded on separate sheets which were numbered by the staff.
(vii) At the end of the count, all inventories against which advances from
customers had been received were removed from the physical inventory
on the instruction of the Inventory Controller.
Required:
Identify the weaknesses in the system of inventory count. Give appropriate
explanations to support your point of view. (9)
(Total: 18 marks)
37 Waheed Engineering
Your firm is the external auditor of Waheed Engineering, a listed company, which has
revenue of Rs100 million. The head office site includes the manufacturing unit, the
accounting functions and main administration. There are a number of sales offices in
different parts of the country. Waheed Engineering does not have an internal audit
department.
At the interim audit you have been assigned to the audit of the wages system. This will
involve obtaining an understanding of the wages system, testing the controls and
performing substantive procedures in order to verify wages transactions.
The wages records are maintained on a computer and all the wages information is
processed at the head office. Some of the employees in the manufacturing unit are
paid in cash, and all other employees have their wages paid directly into their bank
account.
Manufacturing employees are paid their wages a week in arrears. All other employees
are paid at the end of each week or month.
38 Danish
Your firm has recently been appointed as auditor to Danish, a private company that
runs a chain of small supermarkets selling fresh and frozen food, and canned and dry
food. Danish has very few controls over inventory because the company trusts local
managers to make good decisions regarding the purchase, sale and control of
inventory, all of which is done locally. Pricing is generally performed on a cost-plus
basis.
Each supermarket has a stand-alone computer system on which monthly accounts are
prepared. These accounts are mailed to head office every quarter. There is no
integrated inventory control, sale or purchasing system and no regular system for
inventory counting. Management accounts are produced twice a year.
Trade at the supermarkets has increased in recent years and the number of
supermarkets has increased. However, the quality of staff that has been recruited has
fallen. Senior management at Danish are now prepared to invest in more up-to-date
systems.
Required:
(a) Describe the problems that you might expect to find at Danish resulting from poor
internal controls. (8)
(b) Make FOUR recommendations to the senior management of Danish for the
improvement of internal controls, and explain the advantages and disadvantages
of each recommendation. (12)
(Total: 20 marks)
39 Roses Anytime
(a) ISAs identify a number of key procedures which auditors should perform if they
wish to rely on internal controls and reduce the level of substantive testing they
perform. These include:
(i) documentation of accounting and internal control systems;
(ii) walk-through tests;
(iii) audit sampling;
(iv) testing internal controls;
(v) dealing with deviations from the application of control procedures.
Required:
Briefly explain each of the procedures listed above. (10)
(b) Roses Anytime sells Roses wholesale. Customers telephone the company and
their orders are taken by clerks who take details of the Roses to be delivered, the
address to which they are to be delivered, and account details of the customer.
The clerks input these details into the company's computer system (whilst the
order is being taken) which is integrated with the company's inventory control
system. The company's standard credit terms are payment one month from the
order (all orders are despatched within 48 hours) and most customers pay by
bank transfer, An accounts receivable ledger is maintained and statements are
sent to customers once a month. Credit limits are set by the credit controller
according to a standard formula and are automatically applied by the computer
system, as are the prices of Roses.
Required:
Describe and explain the purpose of the internal controls you might expect to see
in the sales system at Roses Anytime over the:
(i) receipt, processing and recording of orders; (6)
(ii) collection of cash. (4)
(Total: 20 marks)
40 Trade Receivables
There are many reasons for maintaining internal control systems. These include the
need to ensure that:
(i) transactions are properly authorised;
(ii) transactions are promptly and accurately recorded;
(iii) access to assets and records is properly authorised;
(iv) recorded assets represent actual assets.
In the absence of internal controls, errors, omissions and misappropriation of assets
are likely and external and internal auditors pay particular attention to both the design
and operation of internal control systems.
Receivables is an area in which most organisations expect internal controls to be
operating effectively.
Required:
(a) In the context of receivables, list and describe the types of error, omission and
misappropriation of assets that can occur in practice where internal controls are
weak or non-existent. (8)
(b) Explain why even a good system of internal control will not necessarily prevent or
detect errors, omissions and the misappropriation of assets in a receivables
system, and explain why a good system of internal control is important to
auditors. (4)
(c) List the main internal controls that you would expect to be in operation in the
receivables system at a small manufacturing company with a computerised
accounting system. (7)
(d) Explain why external auditors seek to rely on the proper operation of internal
controls wherever possible. (5)
(Total: 24 marks)
41 Granger
Granger is a privately owned incorporated business that operates a garage which
repairs and services motor vehicles. Most customers are required to pay by cash or
cheque on collecting their vehicle. Credit accounts are available to business
customers, These customers sign the invoice on collection of the vehicle and their
business is billed monthly. Separate series of pre-numbered invoices are drawn up by
the foreman for cash sales and for credit sales. All customer accounts are maintained
by the receptionist. His duties include the following:
Cash sales
Collect cash or cheques from customers on collecting their vehicle.
At the end of the day, check the numerical sequence of cash sales invoices, add the
sales total and agree the total to the amount of cash and cheques received.
Record the total cash sales in the cash receipts book.
Credit sales
Obtain the customer's signature on the copy invoice of business account customers.
Enter the invoices in numerical sequence in the sales journal and post the customer's
account in the accounts receivable ledger.
Send monthly statements to credit account customers and follow up overdue accounts.
List the balances on the accounts receivable ledger at the end of the month and
reconcile the total with the control account in the general ledger.
Write off uncollectible balances to bad debts.
Cash receipts
Open the mail, extract cheques from credit account customers, record them in the cash
receipts book and post the accounts receivable ledger,
Make up the day's banking of cash (and cheques) from both cash and credit sales,
prepare the deposit slip and bank the cash (and cheques).
All other accounting duties are the responsibility of two further accounts clerks and all
are subject to supervision by the garage manager.
Required:
(a) (i) Explain why the functions assigned to the receptionist result in an
inadequate segregation of duties. Your explanation should identify
misstatements that could occur and indicate how those duties could be
reassigned to other staff members. (8)
(ii) Identify other control procedures you would consider necessary to ensure
the completeness of the recorded cash receipts and accounts receivable.
(4)
(b) As a member of the audit staff of the company's external auditors, you visit the
garage and make a count of cash on hand. You subsequently compare details of
unbanked cash receipts that you counted with the entry in the cash receipts
boots for that date. Although the total in the cash receipts book is the same, the
amount of banknotes and coins is less and there is a cheque from a business
customer that you did not record.
Required:
(i) Explain the procedures to be followed in making a cash-count for audit
purposes. (4)
(ii) Explain the irregularity that the discrepancy between the cash count and
cash receipts book might lead you to suspect, and describe how you would
investigate the discrepancy. (4)
(Total: 20 marks)
AUDIT EVIDENCE
42 Nobel
You are the manager on the audit of Nobel Limited, a listed company, which
manufactures automotive parts and air-conditioners for motor vehicle assemblers.
Annual sale of the Company is Rs. 850 million and profit before tax is Rs. 60 million.
Your review of the audit working paper file has disclosed the following outstanding
issues:
(i) The company is facing a potential legal claim from Mehran Motors Limited
(MML) in respect of defective air conditioners supplied to them. A claim for Rs.
25 million being the cost of replacement of air conditioners and lost production
time has been lodged with the Company by MML. The management is of the
view that the claim is not justified, as the air conditioners were properly
functioning and had been tested for quality and that the defects have arisen
because of the negligence of MML and its technicians. However, a provision of
Rs. 2 million has been made in the financial statements in this respect.
(ii) Depreciation on certain equipment has been charged at 10% per annum on
reducing balance method. This rate is consistent with prior years and the same
rate is being used by most other companies, in the automobile industry.
However, significant losses have recently been recorded on the disposal of
similar equipment.
Management has provided written representations in respect of the above matters.
Required:
What audit evidence will you gather to address the above issues? (6)
43 Masoom Limited
As the manger on the audit of Masoom Limited you want the management to appoint
experts to assist you on certain matters.
Explain the circumstances where auditor may use the work of an expert and the
auditors responsibilities in this regard. (7)
44 Sky blue
Mr Mubarak is the audit senior on the audit of Sky Blue Limited. While comparing the
draft financial statements with the previous year, he noted many unusual fluctuations.
Briefly explain the procedure he should follow, in the above situation. (6)
45 Direct confirmations 1
Direct confirmations from third parties provide independent audit evidence that
certain account balances and items in the financial statements are properly recorded
and disclosed.
Required:
(a) Distinguish between positive and negative confirmations. (2)
(b) Briefly describe the risks associated with each of the above type of confirmation
and the steps that an auditor usually takes to avert such risks. (5)
(c) Explain why and under what circumstances an auditor may decide to use
negative confirmation requests. Also, identify the circumstances where the
auditor may use a combination of positive and negative confirmations. (6)
(Total: 13 marks)
46 Chill
You are the engagement manager on the audit of Chill Limited. During the course of
audit, you have been provided an Actuarial Valuation Report on the Companys
Employees Retirement Benefits Scheme. You have noted that the report has
been prepared by M/s Saleem and Company which is not well known to you.
Required:
Briefly describe the matters that you would consider before using the report prepared
by Saleem and Company. (5)
47 Sales sampling
(a) You are the audit manager on a client where an annual sale is Rs. 640 million.
During the course of annual audit the following table was developed by an
audit team member, to categorize the annual sales:
Rs.
Category A 50 sales transactions to different customers 300 million
Category B 100 transactions to different customers 200 million
Category C 500 transactions to different customers 140 million
Total 640 million
Sohail, a team member, is of the view that if verification of all the transactions in
category A is carried out, there is no need to perform further procedures.
However, other team members do not agree and consider that proper sampling
should be carried out from the total population and categorization should be
ignored.
Required:
As an audit manager of the job, you are required to:
(i) Explain how audit efficiency could be improved by using the above table.
(ii) List other ways in which the sales population may be categorized and what
precaution should be taken while carrying out such categorization.
(iii) Give your opinion on the views expressed by:
x Sohail
x Other audit team members. (11)
(b) Describe the circumstances in which an auditor may decide to examine entire
population of items that make up an account balance. (3)
(Total: 14 marks)
48 PQR
During the audit of PQR Limited you have been assigned the task of evaluating the
work performed by the internal audit department of the company on certain specific
areas.
Required:
(a) Describe how you would evaluate the work performed, in order to determine the
extent of reliance that may be placed thereon. (6)
(b) List the important differences between internal and external audit with respect
to the following:
Independence
Objectives
Reporting (8)
(Total: 14 marks)
50 Related parties
Describe the procedures that the auditor may perform, in order to ensure the
completeness of the information provided by the management, about related parties.
(6)
51 Direct confirmations 2
Direct confirmations of balances due from customers are obtained to satisfy the
objective of ensuring that the customer exists and owes the specified amount to the
company at a certain date.
Required:
(a) State the circumstances in which an auditor may decide not to circulate the
requests for direct confirmation. (5)
(b) What are the factors that an auditor considers while designing the requests for
direct confirmation? (5)
(c) Describe the alternative audit procedures which may be conducted if the
customer does not reply to a request for confirmation. (6)
(Total: 16 marks)
52 Working papers
The preparation of working papers is an integral part of the auditors responsibilities.
Identify the factors that the auditor should consider while determining the form, content
and extent of audit working papers. (7)
53 Al-Shams
Al-Shams Limited is an unquoted public company. A large part of its business is
carried out with persons / organisations related to the management or the
shareholders.
Required:
(a) State any eight procedures which an auditor may perform for determining the
existence of related parties or related party transactions. (8)
(b) Give four examples of situations that may be indicative of dominant influence
exerted by a related party. (4)
(Total: 12 marks)
54 Auditors expert
When expertise in a field other than accounting or auditing is necessary to
obtain sufficient appropriate audit evidence, the auditor has to determine whether to
use the work of an auditors expert.
Required:
List down the sources from where the auditor may get the information regarding
the experts competence, capabilities and objectivity. (6)
55 ADL
(a) Differentiate between the following:
(i) Statistical and non-statistical sampling
(ii) Sampling and non-sampling risk (5)
(b) You are the audit manager on Apple Distribution Limited (ADL). While reviewing
the audit planning documentation, you found that the audit team has selected
100 out of a total of 2,550 debtors for balance confirmation. The details are as
follows:
50 largest debtors constitute approximately 40% of total debtors. Out of
these, 10 have been selected.
90 other debtors were selected through haphazard sampling.
All debtors below Rs. 5,000 were ignored as immaterial.
Balances due from government and some of the related parties were
ignored as prior years working papers showed that they never responded to
requests for confirmation.
Required:
(i) Comment on the sampling approach adopted by the audit team.
(ii) Suggest alternative means of selecting the sample in which the material
balances have a greater probability of selection. (8)
(Total: 13 marks)
56 Guava & Co
You are the training manager at Guava & Co., Chartered Accountants. Some
trainees in the firm have requested you to clarify the following issues:
(a) Can the auditor discard any audit document, forming part of his opinion, after
the issuance of the auditors report?
(b) The changes that can be incorporated during the final file assembly process
citing three such examples.
(c) The circumstances under which it becomes necessary to modify the existing audit
documents or add new audit documents after the issuance of the auditors report
and the matters that should be documented in such a situation.
Required:
Offer appropriate explanations for each of the above issues. (11)
57 RP planning
As the auditor of a listed company with a number of related parties, what steps
would you consider as part of your audit planning to ensure that all related party
relationships and transactions are identified and disclosed in the financial statements.
(13)
58 Manufacturing inventories
List the substantive procedures that may be performed by the auditor to verify the
amount of inventories as appearing in the financial statements of a manufacturing
concern. (15)
59 Wedge & Co
(a) You are the audit manager of W edge & Co, a firm of Chartered Accountants.
The audit seniors on various jobs have sought your advice in respect of the
following independent situations:
(i) The expected rate of deviation based on the auditors understanding of
controls has increased to an extent which is unacceptably high.
(ii) Number of debtors has increased from 4,500 to 5,000 and the amount of
debtors as a percentage of total assets has also increased.
(iii) The expected amount of misstatement has decreased from Rs. 300,000
to Rs. 200,000 whereas the monetary amount in respect of which an
appropriate level of assurance is required has increased by Rs. 50,000.
Required:
State with reasons, the effect of each of the above issues on the sample size of:
(i) Tests of controls; and
(ii) substantive procedures. (7)
(b) While determining the sample size for tests of controls, the auditor takes into
account the expected rate of deviation. State the factors that are relevant to the
auditors consideration of the expected rate of deviation. (4)
(c) Differentiate between the following:
(i) Fair presentation framework and compliance framework
(ii) Tolerable misstatement and performance materiality (9)
(Total: 20 marks)
60 MWL
You are currently in the planning phase of the audit of Mineral Water Limited (MWL) for
the year ended 30 June 2012. The following information is available to you:
Customer No. of Balance 10 10-20 21-30 31-90 > 90
Segment Customers outstanding days days days days days
Rs. in thousand
Super 12 20,014 8,125 5,053 6,396 311 129
markets
Wholesalers 65 14,910 5,078 6,019 3,150 454 209
Retailers 553 4,743 1,756 1,798 724 278 187
Five star 7 7,694 2,805 2,793 1,784 201 111
hotels
47,361 17,764 15,663 12,054 1,244 636
50% provision for doubtful debts has been made by MWL against balances
outstanding for more than 30 days whereas the balances outstanding for more than 90
days have been fully provided.
Required:
(a) Indicate what would be the basis for selecting debtors for circularising positive
and negative requests for confirmations. (6)
(b) Briefly explain as to how you would deal with a situation where a debtor confirms
a balance which is different from the amount appearing in the confirmation
request. (8)
(Total: 14 marks)
61 BPR
List the substantive procedures that may be performed by an auditor to verify the
following:
(a) Bank reconciliation statements (6)
(b) Payroll (8)
(c) Raw material purchases (6)
(Total: 20 marks)
62 Taskeen Co
(a) (i) In the context of ISA 530 Audit sampling, explain and provide examples of
the terms sampling risk and non-sampling risk. (4)
(ii) Briefly explain how sampling and non-sampling risk can be controlled by
the audit firm. (2)
(b) Taskeen Co is owned and managed by two brothers with equal shareholdings.
The company specialises in the sale of expensive motor vehicles. Annual
revenue is in the region of Rs70,000,000 and the company requires an audit
under local legislation. About 500 cars are sold each year, with an average value
of Rs140,000, although the range of values is from Rs130,000 to Rs160,000.
Invoices are completed manually with one director signing all invoices to confirm
the sales value is correct. All accounting and financial statement preparation is
carried out by the directors. A recent expansion of the companys showroom was
financed by a bank loan, repayable over the next five years.
The audit manager is starting to plan the audit of Taskeen Co. The audit senior
and audit junior assigned to the audit are helping the manager as a training
exercise.
Comments are being made about how to select a sample of sales invoices for
testing. Audit procedures are needed to ensure that the managing director has
signed them and then to trace details into the sales day book and sales ledger.
We should check all invoices suggests the audit manager.
How about selecting a sample using statistical sampling techniques, adds the
audit senior.
Why waste time obtaining a sample? asks the audit junior. He adds taking a
random sample of invoices by reviewing the invoice file and manually choosing a
few important invoices will be much quicker.
Required:
Briefly explain each of the sample selection methods suggested by the audit
manager, audit senior and audit junior, and discuss whether or not they are
appropriate for obtaining a representative sample of sales invoices. (9)
(c) Define materiality and explain why the auditors of Taskeen Co must form an
opinion on whether the financial statements are free from material misstatement.
(5)
(Total: 20 marks)
63 Wings
Wings is an airline. The company owns some of its fleet of aircraft. Other aircraft are
leased from third parties. Wings has an internal audit function that has recently
expanded. Your firm is the external auditor to Wings. Your firm has been asked to
investigate the extent of which it may be able to rely on the work of internal audit in the
following areas:
Sales and ticketing;
Fleet acquisition and maintenance;
Trade payables and long-term debt financing (borrowings).
The company outsources its in-flight catering and payroll functions to different service
organisations.
Required:
(a) Explain why the work of internal auditors, in the three areas noted above, is likely
to be useful to you as the external auditor. (9)
(b) Explain how the quality of the internal audit function is likely to influence the
extent of your reliance on internal audit work. (5)
(c) Describe the audit evidence you will seek relating to internal controls over the
out-sourced functions (in-flight catering and payroll). (6)
(Total: 20 marks)
64 Glasses2Go
ISA 230 Audit Documentation establishes standards and provides guidance regarding
documentation in the context of the audit of financial statements.
Required:
(a) List the purposes of audit working papers. (3)
(b) You have recently been promoted to audit manager in the audit firm of Sadia &
Co. As part of your new responsibilities, you have been placed in charge of the
audit of Glasses2Go, a long established audit client of Sadia & Co. Glasses2Go
sells spectacles; the company owns 42 stores where customers can have their
eyes tested and choose from a range of frames.
Required:
List the documentation that should be of assistance to you in familiarising
yourself with Glasses2Go. Describe the information you should expect to obtain
from each document. (8)
(c) The time is now towards the end of the audit, and you are reviewing working
papers produced by the audit team. An example of a working paper you have just
reviewed is shown below.
Client name: Glasses2Go
Year end: 30 April 20X3
Working paper: Payables transaction testing
Audit assertion: To make sure that the purchases day book is correct.
Method: Select a sample of 15 purchase orders recorded in the purchase
order system. Trace details to the goods received note (GRN), purchase
invoice (PI) and the purchase day book (PDB) ensuring that the quantities
and prices recorded on the purchase order match those on the GRN, PI
and PDB.
Test details: In accordance with audit risk, a sample of purchase orders
were selected from a numerically sequenced purchase order system and
details traced as stated in the method. Details of items tested can be found
on another working paper.
Results: Details of purchase orders were normally correctly recorded
through the system. Five purchase orders did not have any associated
GRN, PI and were not recorded in the PDB. Further investigation showed
that these orders had been cancelled due to a change in spectacle
specification. However, this does not appear to be a system weakness as
the internal controls do not allow for changes in specification.
Conclusion: Purchase orders are completely recorded in the purchase day
book.
Required:
Explain why the working paper shown above does not meet the standards
normally expected of a working paper.
Note: You are not required to reproduce the working paper. (9)
(Total: 20 marks)
65 ISA 620
ISA 620 Using the work of an auditors expert contains guidance where the auditor uses
the work of an expert to provide knowledge relevant to the audit, which the audit firm itself
does not possess. Before the firm can rely on the work of the expert, ISA 620 requires the
firm to assess that work.
Required:
(i) Set out FOUR examples of financial statement areas where the audit firm might
be likely to rely upon the work of an expert employed by the audit firm. (2)
(ii) Set out the main procedures an audit firm should apply before relying on the work
of such an expert. (4)
(Total: 6 marks)
66 Cuddly World
You are the auditor of Cuddly World, a company which manufactures and sells small
cuddly toys by mail order. The company is managed by Mr Kabir and two assistants.
Mr Kabir authorises important transactions such as wages and large orders, one
assistant maintains the payables ledger and orders inventory and pays suppliers, and
the other assistant receives customer orders and despatches cuddly toys. Due to other
business commitments Mr Kabir only visits the office once a week.
At any time, about 100 different types of cuddly toys are available for sale. All sales are
made cash with order there are no receivables. Customers pay using credit cards
and occasionally by sending cash. Revenue is over Rs 5.2 million.
You are planning the audit of Cuddly World and are considering using some of the
procedures for gathering audit evidence recommended by ISA 500 as follows:
(1) analytical procedures;
(2) inquiry;
(3) inspection;
(4) observation;
(5) recalculation.
Required:
(a) For each of the above procedures:
(i) explain its use in gathering audit evidence; (5)
(ii) describe one example for the audit of Cuddly World. (5)
(b) Discuss the suitability of each procedure for Cuddly World, explaining the
limitations of each. (10)
(Total: 20 marks)
67 Analytical procedures and materiality
(a) Analytical procedures are an important and powerful tool for auditors in
explaining the performance of a business. ISAs 315 and 320 require the auditor
to apply analytical procedures at the planning and overall review stages of the
audit.
Required:
Explain the possible reasons for the following changes in accounting ratios found
at the planning stage of the audit:
(i) an increase in the current ratio;
(ii) a decrease in the gross profit margin; and
(iii) an increase in the inventory holding period; (6)
Note: No marks will be awarded for showing the calculation of the ratio, all parts
carry equal marks.
(b) The concept of materiality is fundamental to the work of auditors and is covered
by ISA 320 Materiality in planning and performing an audit. Matters that are
immaterial are not reported in financial statements.
Required:
Explain the concept of materiality and describe how materiality affects the audit
work performed by auditors. (4)
(Total: 10 marks)
68 Tahira Transporters
You are the external auditor of Tahira Transporters, a public limited company (TT). The
company's year-end is 11 March. You have been the auditor since the company was
formed 24 years ago to take advantage of the increase in goods being transported by
road. Many companies needed to transport their products but did not always have
sufficient vehicles to move them. TT therefore purchased ten vehicles and hired these
to haulage companies for amounts of time ranging from three days to six months.
The business has grown in size and profitability and now has over 550 vehicles on hire
to many different companies. At any one time, between five and 20 vehicles are
located at the company premises where they are being repaired; the rest could be
anywhere on the extensive road network of the country it operates in. Full details of all
vehicles are maintained in a non-current asset register.
Bookings for hire of vehicles are received either over the telephone or via e-mail in TT's
offices. A booking clerk checks the customer's credit status on the receivables ledger
and then the availability of vehicles using the Vehicle Management System (VMS)
software on TT's computer network. E-mails are filed electronically by customer name
in the e-mail program used by TT. If the customer's credit rating is acceptable and a
vehicle is available, the booking is entered into the VMS and confirmed to the customer
using the telephone or e-mail. Booking information is then transferred within the
network from the VMS to the receivables ledger programme, where a sales invoice is
raised. Standard rental amounts are allocated to each booking depending on the
amount of time the vehicle is being hired for. Hard copy invoices are sent in the post for
telephone orders or via e-mail for e-mail orders.
The main class of asset on TT's statement of financial position is the vehicles. The net
book value of the vehicles is Rs6 million out of total shareholders' funds of Rs15 million
as at 31 March 20X3.
Required:
(a) List and explain the reason for the audit tests you should perform to check the
completeness and accuracy of the sales figure in TT's financial statements.
(10)
(b) List and describe the audit work you should perform on the statement of financial
position figure for vehicles in TT's financial statements for the year ended 31
March 20X3. (10)
(Total: 20 marks)
69 Willow
As a staff member of R and A Chartered Certified Accountants you are assigned to the
audit of tangible non-current assets of Willow for the year ended 31 March 20X3. R and
A have been the auditors of Willow for many years. You obtain the following schedule
of movements on property, plant and equipment and analysis of additions from the
companys accountant.
Property Plant and machinery Total
Rs m Rs m Rs m
Cost or valuation
1 April 20X2 340 275 615
Additions 123 123
Disposals (72) (72)
Revaluations 120 120
31 March 20X3 460 326 786
Accumulated depreciation
1 April 20X2 24 213 237
Provision 5 30 35
Written back on disposal (65) (65)
Adjustment on revaluation (24) (24)
31 March 20X3 5 178 183
Carrying amount
31 March 20X3 455 148 603
31 March 20X2 316 62 378
Schedule of additions (plant and machinery)
Supplier Description Cost
Rs m
New Models Milling machine Model 38 55
Drill Suppliers Power drill Type 45C 34
Hoist Co Electric hoist no 722 18
Sundry below Rs 1m 16
123
The companys accountant also advises you that the property was revalued following a
valuation by the companys property manager who is a professionally qualified valuer.
During your verification of depreciation you discover that most plant and machinery is
fully depreciated. Moreover you discover that, due to oversight, depreciation has
continued to be provided on fully depreciated items. As at the beginning of the year the
amount of overstatement was Rs 43m. The accountant suggests the correction be
made by reducing the current years charge for depreciation.
Required:
(a) State, with reasons, the initial audit procedures you would perform on the
schedules provided by the companys accountant. (3)
(b) Outline the substantive audit procedures you would apply in verifying additions to
plant and machinery. Your answer should identify procedures applicable to each
of the financial statement assertions. (8)
(c) Describe the audit procedures applicable to verifying the revaluation of property.
(5)
(d) With respect to the correction to accumulated depreciation, and assuming the
amount to be material, discuss the accountants proposed treatment. If you
disagree with the accountants proposal, state, with reasons, the correct
accounting treatment. (4)
(Total: 20 marks)
70 Sparkle Forever
You are the audit manager in the firm of Dandy & Co, an audit firm with ten national
offices. One of your clients, Sparkle Forever, purchases diamond jewellery from three
manufacturers. The jewellery is then sold from Sparkle Forevers four shops. This is the
only client your firm has in the diamond industry.
You are planning to attend the physical inventory count for Sparkle Forever. Inventory
is the largest account on the statement of financial position with each of the four shops
holding material amounts. Due to the high value of the inventory, all shops will be
visited and test counts performed.
With the permission of the directors of Sparkle Forever, you have employed JJ, a firm
of specialist diamond valuers who will also be in attendance. JJ will verify that the
jewellery is, in fact, made from diamonds and that the jewellery is saleable with respect
to current trends in fashion. JJ will also suggest, on a sample basis, the value of
specific items of jewellery. Counting will be carried out by shop staff in teams of two
using pre-numbered count sheets.
Required:
(a) List and explain the reason for the audit procedures used in obtaining evidence in
relation to the inventory count of inventory held in the shops. (10)
(b) Explain the factors you should consider when placing reliance on the work of UJ.
(5)
(c) Describe the audit procedures you should perform to ensure that jewellery
inventory is valued correctly. (5)
(Total: 20 marks)
71 Bubbles
Bubbles manufactures and distributes soft drinks. Its inventories are controlled using a
real-time system which provides accurate records of quantities and costs of inventories
held at any point in time. This system is known within the company as the 'Stockpop'
system and it is integrated with the purchases and sales system. Bubbles has an
internal audit department whose activities encompass inventories.
No year-end inventory count takes place Inventories are held in several large
warehouses where non-stop production takes place.
Your firm is the external auditor to Bubbles and you have been asked to perform the
audit of inventories, Inventories include finished goods and raw materials (water, sugar,
sweeteners, carbonating materials, flavourings, cans, bottles, bottle tops, fastenings
and packaging materials).
Your firm, which has several offices, wishes to rely on the 'Stockpop' system to provide
the basis of the figure to be included in the financial statements 'for inventories. Your
firm does not wish to ask the company to conduct a year-end inventory count.
Required:
(a) Describe the audit tests that you would perform on the `Stockpop' system during
the year in order to determine whether to rely on it as a basis for the raw
materials and finished goods figures to be included in the financial statements.
(11)
Note: You are not required to deal with work in progress.
(b) Describe the audit tests you would perform on the records held by Bubbles at the
year end to ensure that raw materials and finished goods are fairly stated in the
financial statements. (9)
(Total: 20 marks)
72 ISA 500
ISA 500 Audit evidence identifies seven main testing procedures. One of these is
external confirmation.
Required:
(a) List FOUR examples of external confirmations. (2)
(b) For EACH of the examples in (a) above explain:
ONE audit assertion that the external confirmation supports, and
ONE audit assertion that the external confirmation does NOT support. (8)
(Total: 10 marks)
73 Javeria Co
Javeria Co has a significant number of cash transactions and recent non-current asset
purchases have been financed by a bank loan. This loan is repayable in equal annual
instalments for the next five years.
Required:
(a) Explain the procedures to obtain a bank report for audit purposes from Javeria
Co.s bank and the substantive procedures that should be carried out on that
report. (5)
(b) List the further substantive procedures that should be carried out on the bank
balances in Javeria Co.s financial statements. (5)
(Total: 10 marks)
74 Porridge
Porridge is a small manufacturing company of which your firm of Chartered Certified
Accountants is the external auditor. You have been assigned to the audit of trade
payables.
The audit file indicates that control risk for purchases and payments transactions is
assessed as slightly less than high because of limitations in the extent of segregation
of duties due to the small number of accounts personnel. There are no other identified
control problems or prior year audit problems.
Narrative notes on the accounting system contain the following descriptions.
Purchases are requisitioned by the user department and ordered, using
prenumbered order forms, by the purchasing manager.
Raw materials and manufacturing supplies are delivered to the receiving
department of the factory where the receiver issues prenumbered goods inward
notes (GINs).
Purchases of other goods and services are delivered directly to the requisitioning
department and no GINs are issued.
The accounts department checks suppliers' invoices with purchase orders, and
x for production department purchases, with GINs
x for other purchases, sends the invoices to the requisitioning department
manager who initials the invoice to indicate that it is appropriate to pay.
Invoices are then processed to the accounting records using proprietary
software.
All suppliers are paid at the end of the month following the month of receipt of the
invoice.
Payables at 31 October 20X3 therefore represent goods and services invoiced in
October. In addition, invoices received between 1 and 15 November were divided into
those relating to goods received or services provided before and after 31 October, the
former being recorded in the accounting records before the October trial balance was
produced. On 15 November, any unmatched GINs relating to deliveries before 31
October were posted to the accounts as at 31 October at the estimated amounts of the
invoices.
Suppliers' invoices are filed alphabetically with supporting documentation, all of which
is cancelled with the date of payment when the cheque is issued. Suppliers' monthly
statements are also filed with the invoices. These are scrutinised by the accounts
department for unusual items, such as overdue invoices, but are not regularly
reconciled with the company's own records.
Required:
(a) In your audit of trade payables in the 31 October 20X3 financial statements
explain which of the financial statement assertions you would regard as
presenting the greatest inherent risk. (4)
(b) Discuss the reasons for undertaking or not undertaking a payables
circularisation. (4)
(c) Outline substantive procedures you would apply in your audit of trade payables
relating to production department purchases. (6)
(d) Explain additional procedures you would perform in verifying the completeness of
non-production department payables. (6)
(Total: 20 marks)
75 Trembridge Engineering
Your firm is the auditor of Trembridge Engineering, and you have been asked to
suggest the audit work you will carry out in verifying accounts payable and purchase
accruals at the company's year end of 30 September 20X3. You attended the inventory
count at the year end.
The company operates from a single site and all raw materials for production are
received by the goods inwards department. When the materials are received they are
checked for quantity and quality to the delivery note and purchase order, and a multi-
part goods received note is made out and signed by the storekeeper. If there are any
problems with the raw materials, a discrepancy note is raised which gives details of the
problems (e.g. incorrect quantities or faulty materials).
The purchase accounting department receive the purchase invoices, check them to the
purchase order and goods received note and post them to the purchase ledger. At the
end of each month, payments are made to suppliers. The purchase ledger is
maintained on a PC.
The main sundry payables and accruals at the year end include:
(i) wages accruals and associated taxes payable;
(ii) sales taxes payable;
(iii)time dependent accruals, such as interest on loans and overdrafts, telephone,
heat and light, and other expenses paid in arrears.
Most employees' wages are paid weekly in arrears.
Required:
Describe in detail the audit work you will carry out to:
(a) check suppliers' statements to the balances on the purchase ledger; (8)
(b) verify that purchases cut-off has been correctly carried out at the year end; (5)
(c) ensure that sundry payables and accruals are correctly stated. (7)
(Total: 20 marks)
77 Heidi Co
Following a competitive tender, your audit firm Cal & Co has just gained a new audit
client Heidi Co. You are the manager in charge of planning the audit work. Heidi Co.s
year end is 30 June 20X3 with a scheduled date to complete the audit of 15 August
20X3. The date now is 3 June 20X3.
Heidi Co provides repair services to motor vehicles from 25 different locations. All
inventory, sales and purchasing systems are computerised, with each location
maintaining its own computer system. The software in each location is the same
because the programs were written specifically for Heidi Co by a reputable software
house. Data from each location is amalgamated on a monthly basis at Heidi Co.s head
office to produce management and financial accounts.
You are currently planning your audit approach for Heidi Co. One option being
considered is to re-write Cal & Co.s audit software to interrogate the computerised
inventory systems in each location of Heidi Co (except for head office) as part of
inventory valuation testing. However, you have also been informed that any computer
testing will have to be on a live basis and you are aware that July is a major holiday
period for your audit firm.
Required:
(a) (i) Explain the benefits of using audit software in the audit of Heidi Co; (4)
(ii) Explain the problems that may be encountered in the audit of Heidi Co and
for each problem, explain how that problem could be overcome. (10)
(b) Following a discussion with the management at Heidi Co you now understand
that the internal audit department are prepared to assist with the statutory audit.
Specifically, the chief internal auditor is prepared to provide you with
documentation on the computerised inventory systems at Heidi Co. The
documentation provides details of the software and shows diagrammatically how
transactions are processed through the inventory system. This documentation
can be used to significantly decrease the time needed to understand the
computer systems and enable audit software to be written for this years audit.
Required:
Explain how you will evaluate the computer systems documentation produced by
the internal audit department in order to place reliance on it during your audit. (6)
(Total: 20 marks)
SCENARIOS
78 Zeedin Co
Zeedin Co assembles fridges, microwaves, washing machines and other similar
domestic appliances from parts procured from a large number of suppliers. As part of
the interim audit work two weeks prior to the company year-end, you are testing the
procurement and purchases systems and attending the inventory count.
Procurement and purchases system
Parts inventory is monitored by the stores manager. When the quantity of a particular
part falls below re-order level, an e-mail is sent to the procurement department
detailing the part required and the quantity to order. A copy of the e-mail is filed on the
store managers computer.
Staff in the procurement department check the e-mail, allocate the order to an
authorised supplier and send the order to that supplier using Electronic Data
Interchange (EDI). A copy of the EDI order is filed in the order database by the
computer system. The order is identified by a unique order number.
When goods are received at Zeedin, the stores clerk confirms that the inventory agrees
to the delivery note and checks the order database to ensure that the inventory were in
fact ordered by Zeedin. (Delivery is refused where goods do not have a delivery note.)
The order in the order database is updated to confirm receipt of goods, and the
perpetual inventory system updated to show the receipt of inventory. The physical
goods are added to the parts store and the paper delivery note is stamped with the
order number and is filed in the goods inwards department.
The supplier sends a purchase invoice to Zeedin using EDI; invoices are automatically
routed to the accounts department. On receipt of the invoice, the accounts clerk checks
the order database, matches the invoice details with the database and updates the
database to confirm receipt of invoice. The invoice is added to the purchases database,
where the purchase day book (PDB) and suppliers individual account in the payables
ledger are automatically updated.
Required:
(a) List SIX audit procedures that an auditor would normally carry out on the
purchases system at Zeedin Co, explaining the reason for each procedure. (12)
(b) List FOUR audit procedures that an auditor will normally perform prior to
attending the clients premises on the day of the inventory count. (2)
(c) (i) State the aim of a test of control and the aim of a substantive procedure. (5)
(ii) In respect of your attendance at Zeedin Co.s inventory count, state one
test of control and one substantive procedure that you should perform. (4)
(d) On the day of the inventory count, you attended depot nine at Zeedin. You
observed the following activities:
1. Pre-numbered count sheets were being issued to clients staff carrying out
the count. The count sheets showed the inventory ledger balances for
checking against physical inventory.
2. All count staff were drawn from the inventory warehouse and were counting
in teams of two.
3. Three counting teams were allocated to each area of the stores to count,
although the teams were allowed to decide which pair of staff counted
which inventory within each area. Staff were warned that they had to
remember which inventory had been counted.
4. Information was recorded on the count sheets in pencil so amendments
could be made easily as required.
5. Any inventory not located on the pre-numbered inventory sheets was
recorded on separate inventory sheets which were numbered by staff as
they were used.
6. At the end of the count, all count sheets were collected and the numeric
sequence of the sheets checked; the sheets were not signed.
Required:
(i) List the weaknesses in the control system for counting inventory at depot
nine. (3)
(ii) For each weakness, explain why it is a weakness and state how that
weakness can be overcome. (9)
(Total: 35 marks)
79 Sahito Co
Introduction audit firm
You are an audit senior in Bachani & Co, a firm providing audit and assurance
services. At the request of an audit partner, you are preparing the audit programme for
the income and receivables systems of Sahito Co.
Audit documentation is available from the previous years audit, including internal
control questionnaires and audit programmes for the despatch and sales system. The
audit approach last year did not involve the use of computer assisted audit techniques
(CAATs); the same approach will be taken this year. As far as you are aware, Sahitos
system of internal control has not changed in the last year.
Client background sales system
Sahito Co is a wholesaler of electrical goods such as kettles, televisions, MP3 players,
etc. The company maintains one large warehouse in a major city. The customers of
Sahito are always owners of small retail shops, where electrical goods are sold to
members of the public. Sahito only sells to authorised customers; following appropriate
credit checks, each customer is given a Sahito identification card to confirm their
status. The card must be used to obtain goods from the warehouse.
Despatch and sales system
The despatch and sales system operates as follows:
1. Customers visit Sahitos warehouse and load the goods they require into their
vans after showing their Sahito identification card to the despatch staff.
2. A pre-numbered goods despatch note (GDN) is produced and signed by the
customer and a member of Sahitos despatch staff confirming goods taken.
3. One copy of the GDN is sent to the accounts department, the second copy is
retained in the despatch department.
4. Accounts staff enter goods despatch information onto the computerised sales
system. The GDN is signed.
5. The computer system produces the sales invoice, with reference to the inventory
master file for product details and prices, maintains the sales day book and also
the receivables ledger. The receivables control account is balanced by the
computer.
6. Invoices are printed out and sent to each customer in the post with paper copies
maintained in the accounts department. Invoices are compared to GDNs by
accounts staff and signed.
7. Paper copies of the receivables ledger control account and list of aged
receivables are also available.
8. Error reports are produced showing breaks in the GDN sequence.
Information on receivables
The chief accountant has informed you that receivables days have increased from 45
to 60 days over the last year.
80 Bashir Co
Introduction
Bashir Co assembles specialist motor vehicles such as lorries, buses and trucks. The
company owns four assembly plants to which parts are delivered and assembled into
the motor vehicles.
The motor vehicles are assembled using a mix of robot and manual production lines.
The human workers normally work a standard eight hour day, although this is
supplemented by overtime on a regular basis as Bashir has a full order book. There is
one shift per day; mass production and around the clock working are not possible due
to the specialist nature of the motor vehicles being assembled.
Wages system shift workers
Shift-workers arrive for work at about 7.00 am and clock in using an electronic
identification card. The card is scanned by the time recording system and each
production shift-workers identification number is read from their card by the scanner.
The worker is then logged in as being at work. Shift-workers are paid from the time of
logging in. The logging in process is not monitored as it is assumed that shift-workers
would not work without first logging in on the time recording system.
Shift-workers are split into groups of about 25 employees, with each group under the
supervision of a shift foreman. Each day, each group of shift-workers is allocated a
specific vehicle to manufacture. At least 400 vehicles have to be manufactured each
day by each work group. If necessary, overtime is worked to complete the days quota
of vehicles. The shift foreman is not required to monitor the extent of any overtime
working although the foreman does ensure workers are not taking unnecessary or
prolonged breaks which would automatically increase the amount of overtime worked.
Shift-workers log off at the end of each shift by re-scanning their identification card.
Payment of wages
Details of hours worked each week are sent electronically to the payroll department,
where hours worked are allocated by the computerised wages system to each
employees wages records. Staff in the payroll department compare hours worked from
the time recording system to the computerised wages system, and enter a code word
to confirm the accuracy of transfer. The code word also acts as authorisation to
calculate net wages. The code word is the name of a domestic cat belonging to the
department head and is therefore generally known around the department.
Each week the computerised wages system calculates:
(i) gross wages, using the standard rate and overtime rates per hour for each
employee,
(ii) statutory deductions from wages, and
(iii) net pay.
The list of net pay for each employee is sent over Bashirs internal network to the
accounts department. In the accounts department, an accounts clerk ensures that
employee bank details are on file. The clerk then authorises and makes payment to
those employees using Bashirs online banking systems. Every few weeks the financial
accountant reviews the total amount of wages made to ensure that the management
accounts are accurate.
Termination of employees
Occasionally, employees leave Bashir. When this happens, the personnel department
sends an e-mail to the payroll department detailing the employees termination date
and any unclaimed holiday pay. The receipt of the e-mail by the payroll department is
not monitored by the personnel department.
Salaries system shift managers
All shift managers are paid an annual salary; there are no overtime payments.
Salaries were increased in July by 3% and an annual bonus of 5% of salary was paid in
November.
Required:
(a) List FOUR control objectives of a wages system. (2)
(b) As the external auditors of Bashir Co, write a management letter to the directors
in respect of the shift-workers wages recording and payment systems which:
(i) Identifies and explains FOUR weaknesses in that system;
(ii) Explains the possible effect of each weakness;
(iii) Provides a recommendation to alleviate each weakness. (14)
(c) List THREE substantive analytical procedures you should perform on the shift
managers salary system. For each procedure, state your expectation of the
result of that procedure. (6)
(d) Audit evidence can be obtained using various audit procedures, such as
inspection.
APART FROM THIS PROCEDURE, in respect of testing the accuracy of the time
recording system at Bashir Co, explain FOUR procedures used in collecting audit
evidence and discuss whether the auditor will benefit from using each procedure.
(8)
(Total: 30 marks)
COMPLETION
81 Analytical procedures
(a) Analytical procedures are an important part of the audit process and a tool
which the auditor uses during the various phases of an audit.
Required:
(i) Describe the nature and purpose of analytical procedures used during an
audit. (6)
(ii) Describe the factors that the auditor needs to consider while designing
and performing analytical procedures as substantive procedures.
(4)
(iii) Describe the objectives which an auditor expects to achieve while applying
analytical procedures at the overall review stage of an audit. (4)
82 Auditor responsibility
The auditor is required to issue an audit report at the end of the audit, which sets out
his opinion on the financial statements. An important element of the audit report is
the statement of auditors responsibility.
Required:
Narrate the matters that should be contained in the statement of auditors responsibility
as included in an audit report issued under ISA-700 The Independent Auditors Report
on a Complete Set of General Purpose Financial Statements. (8)
83 Al-Badr
Al-Badr & Company, Chartered Accountants, have conducted the statutory audit of the
financial statements of Al-Qasim Limited, a listed company, for the year ended June
30, 20X3 under the requirements of the Companies Ordinance, 1984. The job in
charge has drafted the following audit report:
Auditors Report to the Directors
We have audited the annexed balance sheet of Al-Qasim Limited as at June 30, 20X3
and the related profit and loss account and statement of changes in equity together
with the notes forming part thereof, for the year then ended and we state that we have
obtained all the information and explanations which, to the best of our knowledge and
belief, were necessary for the purposes of our audit.
We conducted our audit in accordance with the auditing standards. These standards
require that we plan and perform the audit to obtain reasonable assurance about
whether the above said statements are free of any material misstatement. An audit
includes examining evidence supporting the amounts and disclosures in the above said
statements. An audit also includes assessing the accounting policies and all estimates
made by management, as well as, evaluating the overall presentation of the above said
statements. We believe that our audit provides a reasonable basis for our opinion and,
after due verification, we report that:
disclosures in the above said statements. An audit also includes assessing the
accounting policies and significant estimates made by management, as well as,
evaluating the overall presentation of the above said statements. We believe that our
audit provides a reasonable basis for our opinion and, after due verification, we report
that:
(a) in our opinion, proper books of accounts have been kept by the company.
(b) in our opinion:
(i) the balance sheet and profit and loss account together with the notes
thereon have been drawn up in conformity with the Companies Ordinance
1984, and are in agreement with the books of account and are further in
accordance with accounting policies consistently applied;
(ii) the expenditure incurred during the year was in accordance with the objects
of the Company; and
(iii) the business conducted, investments made and the expenditure incurred
during the year were for the purpose of the Companys business;
(c) in our opinion and to the best of our information and according to the
explanations given to us, the balance sheet, profit and loss account, statement of
comprehensive income, cash flow statement and statement of changes in equity
together with the notes forming part thereof, on form with the approved
accounting standards as applicable in Pakistan and give the information required
by the Companies Ordinance, 1984, in the manner so required and respectively
give a true and fair view of the state of the Companys affairs as at 30 June 2012;
and
(d) in our opinion, no zakat was deductible at source under the Zakat and Ushr
Ordinance, 1980.
Chartered Accountants
Date: 01 September 2012
Required:
Identify the errors in the above report vis--vis a standard statutory audit report
(Note: You are not required to redraft the report.) (Total: 15 marks)
The directors have refused to make a provision against the debt on the grounds
that the liquidator was appointed after the balance sheet date. They have also
refused to make any provision in respect of the work in process as they are
planning to sell the machinery being manufactured to another customer for Rs. 15.7
million.
The profit after tax of MIL is Rs. 85 million. The materiality level is 10% of profit
after tax. (06)
(c) Swat Limited has invested Rs. 150 million in a business which is not mentioned in
the object clause of its Memorandum of Association. However, the object clause
was amended a week before the signing of the audit report. (05)
Required:
In the light of the relevant requirements, discuss how should the auditor deal with the
above situations and describe the impact thereof on the audit report. (Total: 15 marks)
88 Hafiz Limited
You are the manager responsible for the audit of Hafiz Limited (HL), a listed company,
whose fieldwork in respect of the statutory audit is in progress. You are reviewing the
following issues which were brought to your attention by the audit team:
(i) HLs parent company is registered in a foreign country and has asked your firm to
also provide an audit report on a separate set of financial statements which have
been prepared under the accounting framework prevalent in that country. (05)
(ii) HL has paid a substantial amount of consultancy fee to a firm in another foreign
country. The management of HL is unable to provide a convincing explanation for
such a payment. An employee of HL has unofficially informed the audit senior that
the amount was paid to avoid paying a fine. However, the management has
denied this allegation. (05)
Required:
Discuss how would you deal with each of the above issues and what may be the
implications thereof on your audit report. (Total: 10 marks)
91 Ranjha Limited
Ranjha Limited (RL), a listed company, is engaged in the manufacture of fast moving
consumer goods.
The draft financial statements for the year ended March 31, 2011 show a profit before
taxation of Rs. 12 million and total assets of Rs. 300 million.
As the audit manager, you are reviewing the following issues which were brought to
your notice by the audit team:
(i) On June 1, 2010 RL acquired a plant at a cost of Rs. 50 million. The plant has a
useful life of 10 years with no residual value. RL follows the policy to depreciate
the plant on the straight line method. On January 1, 2011 the plant suffered
physical damage due to a fire in the factory. The technician from the
manufacturer has inspected the plant and reported that the damage has
affected its production capacity which has now been reduced by 30%.
(ii) During the year a petition has been filed against RL by one of its customers for
recovery of Rs. 20 million, along with mark-up, damages and compensation, on
the ground that materials supplied by RL were defective. RL has filed a written
statement in the Court denying the allegations.
RLs legal advisor is of the view that the final liability of the company may range
from 0% to 50%.
However, at this point of time, it is not possible to determine the amount with
reasonable degree of accuracy. No provision in this regard has been made in the draft
financial statements.
(iii) In April 2007, RL acquired a high-tech production management software for Rs.
10 million. The useful life of the software is 10 years. During the year it was
discovered that in the past the software was erroneously amortised assuming a
useful life of 20 years.
The management has decided to adjust the amount short provided, over the
remaining useful life of the software.
Required:
Discuss the matters that may be of significance to you as an auditor in respect of each
of the above issues. Also explain their implication on the audit report. (12 marks)
92 Pervasive effects
(a) Briefly explain the term pervasive effects on the financial statements. (04 marks)
(b) As the engagement partner, you have reviewed the audit working papers of
Apricot Engineering Limited (AEL). The audit team has highlighted the following
matters in the working papers.
(i) The company has issued a bank guarantee to one of its related parties
after the balance sheet date. No disclosure in this regard has been made in
the draft financial statements.
(ii) AEL has paid a dividend after many years. Zakat has been appropriately
deducted and deposited in the Central Zakat Fund.
(iii) Subsequent to the year end, a major debtor has declared bankruptcy. The
company expects to recover only 20% of the outstanding amount. The
management has refused to make a provision but is ready to disclose the
fact by way of a note.
(iv) With effect from January 1, 2010, AEL has:
x changed the method of charging depreciation on its fixed assets from
the straight line to the diminishing balance; and
x revised its estimate of useful lives of vehicles from 6 years to 4 years.
Required:
Discuss the impact of each of the above matters on your audit report. (10 marks)
97 Written representations
One of the objectives of obtaining a written representation from management is to
ensure that the management knows and acknowledges its responsibility for the
preparation of the financial statements and for the completeness of the information
provided to the auditor.
Required:
Specify the situations which may create doubts as to the reliability of written
representations. What course of action would the auditor take in such a situation? (7)
98 Shahrukh and Co
Shahrukh and Company, Chartered Accountants, have conducted the statutory
audit of the financial statements of Karim Limited, a listed company, for the year
ended 30 June 20X3 under the Companies Ordinance, 1984. The job in charge has
drafted the following audit report:
Auditors Report to the Members
We have audited the annexed balance sheet of Karim Limited (the Company) as at 30
June 20X3, and the related Income and Expenditure Account, Statement of
Comprehensive Income, Cash Flow Statement and Statement of Changes in Equity
together with the notes forming part thereof, for the year then ended and we state that
we have obtained all the information and explanations which were necessary for the
purposes of our audit.
It is the responsibility of the companys management to establish and maintain a
system of internal control and prepare and present the above said statements in
conformity with the approved auditing standards and the requirements of the fourth
schedule to the Companies Ordinance, 1984. Our responsibility is to audit these
statements.
We conducted our audit in accordance with the auditing standards as applicable in
Pakistan. These standards require that we plan and perform the audit to obtain
reasonable and limited assurance about whether the above statements are free of any
misstatement. An audit includes examining evidence supporting the amounts and
disclosures in the above said statements. An audit also includes assessing the
accounting policies and significant estimates made by management, as well as,
evaluating the overall presentation of the above said statements. We believe that our
audit provides a reasonable basis for our opinion and, after due verification, we report
that:
(a) in our opinion, proper books of accounts have been kept by the company.
(b) in our opinion:
(i) the balance sheet and profit and loss account together with the notes
thereon have been drawn up in conformity with the Companies Ordinance
1984, and are in agreement with the books of account and are further in
accordance with accounting policies consistently applied;
(ii) the expenditure incurred during the year was in accordance with the objects
of the Company; and
(iii) the business conducted, investments made and the expenditure incurred
during the year were for the purpose of the Companys business;
(c) in our opinion and to the best of our information and according to the
explanations given to us, the balance sheet, profit and loss account, statement of
comprehensive income, cash flow statement and statement of changes in equity
together with the notes forming part thereof, conform with the approved
accounting standards as applicable in Pakistan and give the information required
99 Kazmi-Wassan
You are the manager in charge of the audit of Kazmi-Wassan, a listed company which
manufactures specialist cars and other motor vehicles for use in films. Audited revenue
is Rs 140 million with profit before tax of Rs 7.5 million.
All audit work up to, but not including, the obtaining of written representations has been
completed. A review of the audit file disclosed the following outstanding points:
Tigers Purr
The company is facing a potential legal claim from the Tigers Purr company in respect
of a defective vehicle that was supplied for one of their films. Tigers Purr maintains that
the vehicle was not built strongly enough while the directors of Kazmi-Wassan argue
that the specification was not sufficiently detailed. Dropping a vehicle 50 metres into
the river and expecting it to continue to remain in working condition would be unusual,
but this is what Tigers Purr expected. Solicitors are unable to determine liability at the
present time. A claim for Rs 4 million being the cost of a replacement vehicle and lost
production time has been received by Kazmi-Wassan from Tigers Purr. The directors
opinion is that the claim is not justified.
Depreciation
Depreciation of specialist production equipment has been included in the financial
statements at the amount of 10% pa based on reducing balance. However, the
treatment is consistent with prior accounting periods (which received an unmodified
auditors report) and the companies in the same industry and sales of old equipment
show negligible profit or loss on sale. The audit senior, who is new to the audit, feels
that depreciation is being undercharged in the financial statements.
Required:
(a) Explain the purpose of a written representation letter. (5)
(b) For each of the above matters:
(i) discuss whether or not a paragraph is required in the representation letter;
and
(ii) if appropriate, draft the paragraph for inclusion in the representation letter.
(10)
(c) A suggested format for the letter of representation has been sent by the auditors
to the directors of Kazmi-Wassan. The directors have stated that they will not
sign the letter of representation this year on the grounds that they believe the
additional evidence that it provides is not required by the auditor.
Required:
Discuss the actions the auditor may take as a result of the decision made by the
directors not to sign the letter of representation. (5)
(Total: 20 marks)
100 RK Resourcing
You are the auditor of RK Resourcing, a limited liability company which extracts,
refines and sells oil and petroleum related products.
The audit of RK Resourcing for the year ended 30 June 20X3 had the following events:
Date (20X3) Event
15 August Bankruptcy of major customer representing 11% of the trade
receivables on the statement of financial position.
21 September Financial statements approved by directors.
22 September Audit work completed and auditors report signed.
1 November Accidental release of toxic chemicals into the sea from the
companys oil refinery resulting in severe damage to the
environment. Management had amended and made adequate
disclosure of the event in the financial statements.
23 November Financial statements issued to members of RK Resourcing.
30 November A fire at one of the companys oil wells completely destroys the well.
Drilling a new well will take ten months with a consequent loss in oil
production during this time.
Required:
(a) International Standard on Auditing 560 Subsequent Events explains the audit
work required in connection with subsequent events.
List the audit procedures that can be used prior to the auditors report being
signed to identify events that may require adjustment or disclosure in the financial
statements. (5)
(b) For each of the following three dates:
15 August 20X3
1 November 20X3, and
30 November 20X3:
(i) State whether the events occurring on those dates are adjusting or non-
adjusting according to IAS 10 Events After the Reporting Period, giving
reasons for your decision. (6)
(ii) Explain the auditors responsibility and the audit procedures that should be
carried out. (9)
Note: Marks are allocated evenly across the three dates.
(Total: 20 marks)
REVIEW ENGAGEMENTS
102 ISRE 2400
(a) Explain the meaning of assurance and give two examples of types of assurance
which can be provided, distinguishing between the two in terms of the level of
assurance offered by each of them. (4)
(b) ISRE 2400 Engagements to review financial information sets out the objective,
general principles and procedures to be applied to a review engagement.
Required:
Set out the main types of procedures which an accountant should perform when
carrying out a review engagement. (4)
(Total: 8 marks)
103 Karim
Karim & Company, Chartered Accountants are engaged in the review of interim
financial information of Babar Textiles Mills Limited for the half year ended June 30,
20X3. The increase in oil and energy prices and current inflationary trend prevailing in
the country has resulted in substantial losses and the Companys outlook is negative.
Moreover, in view of recessionary pressures being faced by the US and many of the
EU economies, some of the large customers in those countries have not renewed their
orders and many others are expected to follow. Consequently, the company has
decided to lay off 40 percent of its workforce gradually, over the next few months.
Required:
Describe how the auditor should address the above issue and the implications it may
have on the review report of interim financial information. (9)
104 IFI
The auditor should have an understanding of the entity and its environment to enable
him to plan the engagement and select the inquiries, analytical and other review
procedures.
Required:
State the procedures which an auditor may perform, to update his understanding of the
entity and its environment, while carrying out an engagement to review interim financial
information. (10)
SECTION
C
Multiple choice answers
2 C
3 C
4 A
5 C
7 A
8 A
9 D
10 C
12 D
13 A
14 D
15 B
17 B
18 A
19 B
20 B
22 B
23 C
24 C
25 D
27 B
28 D
29 A
30 C
32 C
33 B
34 B
35 D
37 D
38 B
39 B
40 C
42 B
43 D
44 A
45 A
47 D
48 D
49 C
50 B
52 A
53 A
54 A
55 A
57 D
58 C
60 D
61 D
62 A
63 D
65 A
66 B
67 A
68 A
70 A
71 C
72 C
73 B
75 A
76 D
77 D
SECTION
D
Objective test and
long-form answers
Objectivity:
A chartered accountant should not allow bias, conflict of interest or undue
influence of others to override professional or business judgments.
Professional competence and due care:
A chartered accountant has a continuing duty to maintain the required
professional knowledge and skill to ensure that a client or employer
receives competent professional service based on current developments
in practice, legislation and techniques. A chartered Accountant should act
diligently and in accordance with applicable technical and professional
standards when providing professional services.
Confidentiality:
Confidential information acquired as a result of professional and business
relationships should not be disclosed to third parties without proper and
specific authority unless there is a legal or professional right or duty to
disclose. Confidential information acquired as a result of professional and
business relationships should not be used for personal advantage of the
chartered accountant or third parties.
Professional Behaviour:
A chartered accountant should comply with relevant laws and regulations
and should avoid any action that discredits the profession.
(ii) The threats to compliance with the fundamental principles may be
categorized as follows:
Self-interest threats:
These may occur as a result of the financial or other interests of a
chartered accountant or of an immediate or close family member.
Self-review threats:
These may occur when a current assignment requires re-evaluation of
the opinion previously expressed by the same chartered accountant.
Advocacy threats:
These may occur when a chartered accountant promotes a position or
opinion to the point that subsequent objectivity may be compromised.
Familiarity threats:
These may occur when, because of a close relationship, a chartered
accountant becomes too sympathetic to the interests of others.
Intimidation threats:
These may occur when a chartered accountant may be deterred from
acting objectively by threats, actual or perceived.
(b) Assisting financial statement audit client in matters such as preparing accounting
records or financial statements may create a self-review threat when the financial
statements are subsequently audited by the firm.
It is the clients management responsibility to ensure that accounting records are
kept and financial statements are prepared.
In the above case, the firm can provide assistance provided it does not involve
taking management decisions. Such management decisions include:
Determining or changing journal entries, or the classifications for accounts or
transaction or other accounting records without obtaining the approval of the
audit client;
Authorizing or approving transactions; and
Preparing source documents or originating data (including decisions on
valuation assumptions), or making changes to such documents or data.
2 Levels of assurance
Reasonable assurance is a concept relating to the accumulation of the audit
evidence necessary for the auditor to conclude that there are no material
misstatements in the financial statements taken as a whole.
Whereas absolute assurance provides a guarantee that the financial statements are
free from material misstatements.
An auditor cannot obtain absolute assurance because there are inherent limitations in
an audit that affect the auditors ability to detect material misstatements. These
limitations result from factors such as:
(ii) The inherent limitations of any accounting and internal controls system (for
example, the possibility of collusion);
(iii) The fact that most audit evidence is persuasive rather than conclusive.
3 Shamsuddin
(i) As per the Code of Ethics for Chartered Accountants issued by ICAP, the
practicing chartered accountants are not allowed to publicize their services in
a manner as is done by other normal businesses.
(ii) The Code of Ethics for Chartered Accountants issued by ICAP states that:
(iii) As per the Code of Ethics for Chartered Accountants, issued by ICAP, the
professional fees should not be contingent upon the findings or results of
such services.
(iv) Being a sole proprietorship the existing and proposed auditors should
immediately communicate the fact to ICAP and the proposed auditor should
not accept the offer without clearance from ICAP and the existing auditor.
4 Core concepts
(a) The managements responsibilities in relation to the financial statements
include the following:
The overall responsibility for the preparation and presentation of the
financial statements.
Identifying the financial reporting framework to be used in the preparation
and presentation of the financial statements.
Designing, implementing and maintaining internal controls relevant to the
preparation and presentation of financial statements that are free from
material misstatement whether due to fraud or error.
Selecting and applying appropriate accounting policies.
Making accounting estimates that are reasonable in the circumstances.
(b) Audit Scepticism
Audit scepticism is an attitude of professional scepticism which means that the
auditor should recognize the fact that circumstances may exist that may cause
the financial statements to be materially misstated. Consequently, he should
make a critical assessment with a questioning mind of the validity of audit
evidence obtained. He should remain alert to audit evidence that contradicts or
brings into question the reliability of documents and responses to inquiries and
the reliability of other information obtained from management and those
charged with governance.
Elaboration on the response of the audit manager that auditor should always
maintain an attitude of professional scepticism throughout the audit:
Although the auditor cannot be expected to disregard past experience of the
honesty and integrity of the entitys management and those charged with
governance, the auditors attitude of professional scepticism is particularly
important in considering the risks of material misstatement on account of
changes in circumstances.
5 Threats
Following are the categories of threats that may potentially affect the fundamental
principles:
(i) Self-interest threats
This may occur as a result of the financial or other interests of a chartered
accountant or of an immediate or close family member.
A financial interest in a client or jointly holding a financial interest with a
client.
Undue dependence on total fees from a client.
Having a close business relationship with a client.
Concern about the possibility of losing a client.
Potential employment with a client.
Contingent fees relating to an assurance engagement.
A loan to or from an assurance client or any of its directors or officers.
(ii) Self-review threat
This may occur when a previous judgment needs to be re-evaluated by the
chartered accountant responsible for that judgment.
The discovery of a significant error during a re-evaluation of the work of the
chartered accountant in practice.
Reporting on the operation of financial systems after being involved in their
design or implementation.
Having prepared the original data used to generate records that are the
subject matter of the engagement.
A member of the assurance team being, or having recently been, a director
or officer of that client.
A member of the assurance team being, or having recently been, employed
by the client in a position to exert direct and significant influence over the
subject matter of the engagement.
Performing a service for a client that directly affects the subject matter of the
assurance engagement.
Threats
(ii) A self-interest threat may be created if the loan amount is material to the
firm/ partner.
Safeguards:
Threats:
Safeguards:
(iii) Involve an additional chartered accountant who was not a member of the
assurance team to review the work or advise as necessary; or
(v) Ensuring that the individual concerned is not entitled to any benefits or
payments from the firm unless these are made in accordance with fixed
pre-determined arrangements. In addition, any amount owed to the
individual should not be of such significance to threaten the firms
independence.
(vi) Ensuring that the individual does not continue to participate or appear to
participate in the firms business or professional activities.
(b) Bilal and Company, Chartered Accountants are eligible to act as the
auditor of IJK Limited.
IJK Limited is not an associated company of LMN Limited as LMN
Limited holds 15.4% shares of IJK Limited. Therefore the wife of the
partner is not required to dispose of the shares in LMN Limited.
Holding of non-voting shares is not relevant in determining the status of
the company.
8 Audit process
(a) Training materials: purpose of external audit and its role
(i) The external audit has a long history that derives largely from the
separation of the ownership and management of assets. Those who own
assets wish to ensure that those to whom they have entrusted control are
using those assets wisely. This is known as the 'stewardship' function.
(ii) The requirement for an independent audit helps to ensure that financial
statements are free of bias and manipulation for the benefit of users of
financial information.
(iii) Companies are owned by shareholders but they are managed by directors
(in very small companies, owners and managers are the same, but many
such companies are not subject to statutory audit requirements).
(iv) The requirement for a statutory audit is a public interest issue: the public is
invited to invest in enterprises, it is in the interests of the capital markets
(and society as a whole) that those investing do so in the knowledge that
they will be provided with 'true and fair' information about the enterprise,
This should result in the efficient allocation of capital as investors are able
to make rational decisions on the basis of transparent financial information.
(v) The requirement for an audit can help prevent investors from being
defrauded, although there is no guarantee of this because the external
audit has inherent limitations. Reducing the possibility of false information
being provided by managers to owners is achieved by the requirement for
external auditors to be independent of the managers upon whose financial
statements they are reporting.
(vi) The purpose of the external audit under International Standards on Auditing
is for the auditor to obtain sufficient appropriate audit evidence on which to
base the audit opinion. This opinion is to the effect that the financial
statements give a 'true and fair view' (or 'present fairly in all material
respects') of the position, performance (and cash flows) of the entity. This
opinion is prepared for the benefit of shareholders.
(b) Main audit procedures and processes: interim and final audit
Interim
(i) The interim audit generally involves risk assessment, the testing of internal
controls, and certain analytical and other substantive procedures. Many of
these procedures are often performed concurrently.
(ii) Risk assessment involves gathering information about the business,
inquiries, analytical procedures and determining the response to assessed
risk. In practice it also involves the determination of materiality and
tolerable error.
(iii) Risk assessment also involves evaluating the design of internal controls
and determining whether they have been implemented.
Final
(iv) Final audit procedures involve further tests of controls, substantive
procedures and audit finalisation procedures.
(v) Further tests of controls are designed to test transactions occurring
between the date of the interim audit and the period-end. This is to
ascertain whether the conclusions from controls testing during interim work
remain valid for the full period.
(vi) Substantive procedures may involve a blend of substantive analytical
procedures plus tests of detail. The tests of detail typically involve selecting
a sample from a source, for example a collection of purchase transactions,
and tracing the transactions through to originating evidence, for example
purchase invoices. Tests of detail are also carried out in the opposite
direction by selecting from the external source (e.g. supplier invoices) then
tracing entries through to the books and records
(vii) Audit finalisation procedures involve a review of the financial statements as
a whole to ensure that they are internally consistent and presented in
accordance with the relevant financial reporting framework (and the
auditor's knowledge of the business). This phase includes the Partners
review of significant matters raised by the audit team during the audit.
(ii) Fraud
Currently the responsibility within a company for the prevention and
detection of fraud rests with management. The auditor is not responsible for
preventing fraud but audit procedures should be designed to give the
auditor a reasonable expectation of detecting any material misstatements,
whether intentional or unintentional, in a companys financial statements.
(iii) Non-audit services
There is no objection in principle to a practice providing non-audit services
but care must be taken not to perform management functions or make
management decisions. The key factor is that there is no conflict of interest
between audit and the other services provided.
Accountancy work, however, should not be performed for a public company
except in emergency situations. The scale and nature of such work should
be regularly reviewed.
In all cases in which a practice is concerned in the preparation of
accounting records for an audit client, the following safeguards should be
observed:
the client should accept responsibility for the records as its own;
the practice should not assume the role of management conducting
the operations of an enterprise;
the practice should make appropriate audit tests even where it has
processed or maintained certain records.
Other types of non-audit work such as valuation services and internal audit
services are prohibited where the management threat or self-review threats
are too great.
Local legisalation will also usually provide that an auditor may not be an
officer or employee of a client company. Thus it is necessary for the auditor
to ensure that he does not make executive decisions.
(iv) Duration of appointment
Local legislation usually provides that a company shall at each general
meeting appoint an auditor to hold office from the conclusion of that
meeting until the conclusion of the next general meeting at which accounts
are laid. Although the ICAP Code does not specifically deal with the length
of audit appointments it recognises that using the same senior personal on
an engagement over a long period of time may create a familiarity threat.
Safeguards might include rotating senior staff or review by an independent
party.
(b) Reasons for criticism in the above areas
(i) Auditing standards
ISAs are set by the IAASB whose members are mainly drawn from the
members of the auditing profession. The local disciplinary procedures
applied against an auditor for non-compliance with an auditing standard are
enforced by the professional bodies of accountants. Thus politicians have
criticised this self-regulatory procedure believing it to be open to abuse and
lacking independence. The argument put forward is that auditing standards
should be set by an independent body.
(ii) Fraud
It is quite apparent from the press and audit research that the public believe
that the auditor should and in fact does search for fraud during the conduct
of an audit. In view of the scandals over the years, the public expectation of
the extent of an audit has increased. The public finds it difficult to accept
that an auditor has no responsibility for the detection and reporting of fraud,
especially when one sees the high social cost of recent scandals.
(iii) Non-audit services
Audit firms do not act exclusively in the capacity of auditors for their clients.
Audit work is in some cases, not the main business of audit firms. Auditors
provide many other services to their clients including tax advice, brand
name valuation and recruitment advice. Audit firms are dependent upon the
fees earned from non-audit services, and this dependency can affect the
auditors attitude to the audit. If an audit firm loses the audit, the financial
loss to the auditors can be significantly more than just the audit fee if he
provides other services to the client.
(iv) Duration of appointment
It has been argued that the long-term nature of the company audit
engagement can lead to a loss in auditor independence due to an
increasing familiarity with the companys management. In many countries
the audit appointment has to be terminated after a fixed number of years. If
the audit appointment was for a fixed maximum period, then auditors would
not be under the same pressure to maintain their client base if they know
that their relationship with the company was for a limited period, and that
audit appointments would be rotated.
10 Fundamental principles
Fundamental principles
Integrity. A professional accountant should be honest and straightforward in performing
professional services.
Objectivity. A professional accountant should be fair and not allow personal bias,
conflict of interest or influence of others to override objectivity.
Professional competence and due care. When performing professional services, a
professional accountant should show competence and duty of care by keeping up-to-
date with developments in practice, legislation and techniques.
Confidentiality. A professional accountant should respect the confidentiality of
information acquired during the course of providing professional services and should
not use or disclose such information without obtaining client permission.
Professional behaviour. A professional accountant should act in a manner consistent
with the good reputation of the profession and refrain from any conduct which might
bring discredit to the profession.
11 Oops
Confidential information
General rules
Information obtained during an audit is normally held to be confidential; that is it will not
be disclosed to a third party.
(ii) The lawyers refuse to provide anything other than informal evidence and
this will almost certainly not be sufficient to form an audit opinion.
(iii) Unless audit evidence can be obtained elsewhere a qualified opinion may
be needed for both companies as the amounts involved are material.
(iv) It may be possible for the auditors to suggest to the companies that it would
be very helpful for the lawyers to provide some indication as to their view of
the likely outcome and the amounts involved, in order to avoid a modified
opinion.
(v) The auditors should also take note of the progress of any legal proceedings
and any proceedings that may be instigated by the public health authorities
as such authorities might impose significant fines, and they might even
close the businesses down, which has implications for the going concern
status of both.
(vi) The auditors may also seek written representation under ISA 580 from the
management about the likely outcome of the case to be obtained.
14 Saad Co
(a) Ethical threat (b) Mitigation of threat
Mr Sher, the engagement partner has Mr Sher should be rotated from being
been involved with the client for the last engagement partner. He can still contact
nine years. the client but should not be in the
This means he may be too familiar with position of signing the audit report.
the client to be able to make objective
decisions due to this long association.
There is no ethical rule which stops Mr To show complete independence, Zhura
Sher recommending Zhura for the audit, should not be part of the audit team.
or letting Zhura take part in the audit, However, if Mr Sher is no longer the
providing Zhura has the appropriate engagement partner then this removes
skills. If she does not have the the ethical threat and Zhura could be
appropriate skills then there could be a included in the audit team so long as she
breach of the need for an audit team to possesses the appropriate skills.
demonstrate professional competence
and due care.
There may also be the impression of lack
of independence as Zhura is related to
the engagement partner. Zhura could be
tempted not to identify errors in case this
prejudiced her fathers relationship with
the client.
As long as Mr Faisal paid a full fee on To show independence from the client,
normal commercial terms to Saad Co for Mr Faisal could be asked not to use the
the investment advice, then there is no services of Saad Co again unless this is
ethical threat. This would be a normal first agreed with the engagement
commercial transaction and Mr Faisal partner.
would not gain any benefit.
However, continued use of client
services could imply a lack of
independence especially if Mr Faisal is
not paying a full fee and therefore
receiving a benefit from the client.
15 Alpha
(i) The firm is not qualified for appointment as auditor of Safe Bank because it is
indebted to the bank.
The firm may accept appointment by terminating the lease agreement and
reducing the credit card balance to Rs 500,000.
(ii) The firm is not qualified for appointment as auditor of PCL as one of the firms
partners had been a director of PCL during the past three years.
There is no way for the firm to accept the appointment except that the partner
resigns from the firm.
(iii) The firm is not qualified for appointment as auditor of Gama Limited, as a
partner of the firm holds shares in Beta Limited, the associated company of GL.
Firm can accept appointment if the partner disposes off the shares of Beta
Limited within ninety days of appointment.
17 Shahid Corporation
(a) Acceptance and continuance of client relationships and specific audit
engagements include considering:
The integrity of the principal owners, key management and those charged
with governance of the entity;
Whether the engagement team is competent to perform the audit
engagement and has the necessary time and resources; and
Whether the firm and the engagement team can comply with ethical
requirements
Deciding whether to continue a client relationship includes consideration of
significant matters that have arisen during the current or previous audit
engagement, and their implications for continuing the relationship.
For example, a client may have started to expand its business operation into an
area where the firm does not possess the necessary knowledge or expertise.
(b) The auditor may decide not to send a new engagement letter for each period.
However, under the following situation it may be appropriate to send a new
engagement letter:
Any indication that the client misunderstands the objective and scope of
the audit
Any revised or special terms of the engagement
A recent change of senior management or those charged with governance.
A significant change in nature or size of the clients business
A significant change in ownership
Legal or regulatory requirements.
18 Assertions
(a) (i) Risks of material misstatement at the financial statement level refer
to risks that relate pervasively to the financial statements as a whole
and potentially affect a number of assertions.
They are not necessarily identifiable with specific assertions at the
class of transactions, account balance, or disclosure level. Rather,
they represent circumstances that may increase the risks of material
misstatement at the assertion level. For example, through
management override of internal control.
Financial statement level risks mostly relate to situations arising
from fraud.
Risks at the financial statement level may derive in particular from a
weak control environment. For example, weaknesses such as
managements lack of competence.
(ii) The risk assessment procedures related to the risk of material
misstatement at the financial statement/assertion level are as follows:
Inquiries of management and of others within the entity who in the
auditors judgment may have information that is likely to assist in
identifying risks of material misstatement due to fraud or error.
Analytical procedures.
Observation and inspection.
(b) The auditors assessment of materiality and audit risk at the planning stage may
change later i.e. at the time of evaluating the results of audit procedures, on
account of the following:
change in circumstances
change in auditors knowledge as a result of performing audit procedures
because the auditor may have intentionally set the materiality at a lower
level, to reduce the likelihood of undiscovered misstatement and hence
provide a margin of safety.
(c) (i) Assertions about account balances at the period end:
Existence assets, liabilities and equity interest exist.
Rights and Obligations - The entity holds or controls the rights to
assets, and liabilities are the obligation of the entity.
Completeness all assets, liabilities and equity interest that should
have been recorded have been recorded.
Valuation and allocation assets, liabilities and equity interests are
included in the financial statements at appropriate amounts.
(ii) Assertions about classes of transactions:
Occurrence transactions and events that have been recorded
have occurred and pertain to the entity.
Completeness all transactions and events that should have been
recorded have been recorded.
Accuracy amounts and other data relating to recorded
transactions and events have been recorded appropriately.
Cut-off transactions and events have been recorded in the correct
accounting period.
Classification transactions and events have been recorded in the
proper accounts.
(iii) Assertions about presentation and disclosure:
Occurrence and rights and obligations disclosed events,
transactions and other matters have occurred and pertain to the
entity.
Completeness all disclosures that should have been included in
the financial statements have been included.
Classification and understandability financial information is
appropriately presented and described.
Accuracy and valuation financial and other information are
disclosed fairly and at appropriate amounts.
20 ASPL
(a) (i) In the absence of any valid explanations from the management, it would be
considered as misappropriation of assets i.e. fraud as it seems to involve
the theft of an entity's assets.
(ii) It is a case of fraudulent financial reporting as it seems that management
has tried to inflate the sales in order to deceive financial statement users.
An apparent intention behind this action is the management bonuses which
are linked to the operating performance of the company.
(iii) It is an error on the part of accountant. The underlying records such as the
invoice etc. have not been altered and even the voucher has been prepared
with the correct amount which shows that it is an unintentional
misstatement.
(b) (i) If we have identified a fraud or has obtained information that indicate that a
fraud may exist, we should communicate these matters on a timely basis to
the appropriate level of management. This is so even if the matter might be
considered immaterial.
We should consider whether there are matters related to fraud to be
discussed with those charged with governance of the entity. Matters may
include:
Concerns about the nature, extent and frequency of management's
assessments of the controls in place to prevent and detect fraud and
of the risk that the financial statements may be misstated.
21 AMF
(a) Areas of Inherent Risk
(i) Donations
Donations may fall, especially where donors own income is limited or
declining, or there is a change in the circumstances.
No control over the completeness of donations (especially over the cash
donations).
(ii) Expenses
Donations are spent outside the aims and objectives of AMF.
Donations are not spent in accordance with donors instructions.
(b) Effect on the audit approach
(i) It is difficult to estimate that income in the future will be sufficient to meet the
expenditure of the AMF. Audit of the going concern concept (as in ensuring
that the AMF can still operate) will therefore be quite difficult.
(ii) Audit tests are unlikely to be effective to meet the assertion of completeness.
The audit report may need to be modified and qualified to explain the lack of
evidence stating that completeness of income cannot be confirmed.
(iii) Careful review of expenditure will be necessary to ensure that expenditure is
not ultra vires the objectives of the AMF. The auditor will need to review the
trust deed and other documents of the AMF carefully in this respect.
(iv) The use of donations received for specific purposes would have to be
checked to ensure that instruction of donors has been followed.
23 SPL
(a) Preconditions for an audit are as follows:
(ii) the management and, where appropriate, those charged with governance
agreed on the premise on which the audit is to be conducted.
(b) In order to establish whether the preconditions for an audit are present, we will:
to provide us with
(c) If a precondition for an audit is not present, the matter would be discussed with
the management. Unless required by law or regulation to do so, we will not
accept the proposed audit engagement, if the pre-conditions are not met.
Our opinion on the financial statements will not include such phrases
as "present fairly, in all material respects," or "give a true and fair
view" unless it is expressively required to be stated under the law or
regulation.
If the above conditions are not present and still we are required by law or
regulation to undertake the audit engagement, we shall:
(i) evaluate the effect of the misleading nature of the financial statements on
report; and
(ii) include appropriate reference to this matter in the terms of the audit
engagement.
(ii) The firm would not be deemed indebted to the company as the amount of
debt is not exceeding Rs. 500,000.
(b) (i) The Appointment of Apricot and Company, Chartered Accountants will be in
order.
(ii) Banana Limited and Water Melon Limited are not associated companies as
the common director is a Government nominee.
(c) (i) Mr Zaheer can be appointed as the Auditor of Lychee (Private) Limited
(iii) The fact that 40% of the shareholding is owned by Blue Black Limited does
not disqualify Mr Zaheer as the auditor of LPL.
(d) Before accepting the offer Walnut and Company, Chartered Accountants, apart
from obtaining professional clearance from the existing auditor is also required to
inform the ICAP (Institute) and obtain prior clearance from the Institute.
(e) (i) Since the three year period has not been lapsed,
(iii) The fact that Mr Sadiq was serving on the board as a Government
nominee does not make any difference, in this case.
26 Dynamic
The prospective audit risks are as follows:
Overstatement of Debtors:
Average period for outstanding debtors has reached to four months which is
indicative of a risk of inadequate provision against doubtful debts.
Overstatement/ Understatement of Inventories:
The inventories turnover rate has decreased to 3 times per year from 5 times in 20X1.
It is indicative of the following types of risks:
(a) Obsolescence of inventories.
(b) Improper valuation of inventories.
Overstating of income as well as understating of expenses:
The income position has weakened and the company has suffered losses as the
interest coverage has moved below 1.0. In such a situation there is a risk that the
management may like to overstate its revenue, and understate its expenses.
Liquidity Problems:
The company is experiencing liquidity problems as are evidenced from the decline in
current ratio and quick asset ratio.
Decline in Gross Profit %:
The decline in GP % needs to be justified. The absence of an appropriate explanation
may be indicative of:
(a) Improper pricing and discounting policies
(b) Improper purchasing policies
27 Changing terms
(a) Circumstances in which the management can request the auditor to
change the terms of audit engagement:
(i) Change in circumstances affecting the need for the service.
(ii) A misunderstanding as to the nature of an audit as originally requested.
(iii) A restriction on the scope of an audit engagement, whether caused by
management or caused by other circumstances.
(b) Factors that are to be considered by the auditor before accepting the
change in terms of engagement:
(i) Justification provided for changing the terms of engagement.
(ii) The information in respect of which the change is requested by the
management.
(iii) Legal or contractual implications of the change.
(c) Steps that the auditor can take, if he is unable to agree to a change in
terms of engagement:
If the auditor is unable to agree to a change in the terms of the audit
engagement and is not permitted by management to continue the original
engagement, the auditor shall:
(i) Withdraw from the audit engagement where possible under applicable law
or regulation; and
(ii) Determine whether there is any obligation, either contractual or otherwise,
to report the circumstances to other parties, such as those charged with
governance, owners or regulators.
28 EL
Key Components of Audit engagement letter:
The objective and scope of the audit of financial statements;
The responsibilities of the auditor;
The responsibilities of management;
Identification of the applicable financial reporting framework for the preparation
of the financial statements;
Reference to the expected form and content of any reports to be issued by the
auditor and;
A statement that there may be circumstances in which a report may differ from
its expected form and content.
29 Calm Co
Risk assessment procedures
(i) Purpose
The main purpose of risk assessment procedures is to help the auditor
obtain an understanding of the audit client.
The procedures will provide audit evidence relating to the auditors risk
assessment of a material misstatement in the clients financial statements.
The auditor will also obtain initial evidence regarding the classes of
transactions at the client and the operating effectiveness of the clients
internal controls.
Finally, the auditor may identify risks in other areas such as being
associated with a particular client or not being able to follow ethical
guidelines of ICAP.
(ii) Sources of audit evidence
The auditor may obtain evidence from:
Enquiries of management and others connected with the entity such
as external legal counsel or valuation experts
Analytical procedures including ratio analysis to obtain high level data
on the client
Observation of entity activities and inspection of documents, etc.
30 Azam
(a) Risks and implications for audit risk
Inherent and control risks
(i) Charities such as Azam can be viewed as inherently risky because they are
often managed by non-professionals and susceptible to fraud. In Azams
case inherent risk is likely to be high as there is no full-time accountant and
volunteers are used to raise funds.
(ii) As Azam is staffed mainly by volunteers the inherent risk also increases
that transactions are not properly recorded. Volunteers are often more
enthusiastic as to what they typically perceive as the value add and
making a difference activities and hence paperwork can be overlooked.
(iii) Azams small size also reduces the opportunity for segregation of duties
and thus increases control risk and susceptibility to fraud.
(iv) Azam may be at risk of being in violation of its constitutions which is
important where funds are raised from public or private donors who may
well object strongly if funds are not applied in the manner expected. The
question states that funds are required for educational projects so this
could be a problem if funds have been used for other purposes.
(v) Azam is likely to have a high level of control risk because formal internal
controls are expensive and unlikely to be in place. This means that
donations are susceptible to misappropriation and Azam will have had to
rely heavily on the trustworthiness of volunteers.
(vi) Inherent risk is also increased due to the fact that Azam has not been
audited previously which could lead to a greater risk of misstatement of
opening balances.
Detection risk
(vii) Detection risk comprises sampling risk and non-sampling risk. It is possible
with Azam that all transactions will be tested and therefore sampling risk
(the risk that samples are unrepresentative of the populations from which
they are drawn) eliminated.
(viii) Non-sampling risk is the risk that auditors will draw incorrect conclusions
because, for example, mistakes are made, or errors of judgement are made
in interpreting results, or because the auditors are unfamiliar with the client.
As this is Azams first audit non-sampling risk is increased.
Audit risk
(ix) Audit risk is the product of inherent risk, control risk and detection risk that
the auditors will issue an inappropriate audit opinion. This risk can be
managed by decreasing detection risk by altering the nature, timing and
extent of audit procedures applied. As inherent risk is high and controls
likely weak (as is likely to be the case with Azam) more audit work will be
performed in appropriate areas in order to reduce audit risk to an
acceptable level by reducing detection risk.
(b) Audit tests fund raising events
(i) Attend fund raising events and observe the procedures employed in
collecting, counting, banking and recording the cash. This will help provide
audit evidence that funds have not been misappropriated and that all
income from such events has been recorded. Sealed boxes or tins that are
opened in the presence of two volunteers are often used for these
purposes.
(ii) Perform cash counts at the events to provide evidence that cash has been
counted correctly and that there is no collusion between volunteers to
misappropriate funds.
(iii) Examine bank paying in slips, bank statements and bank reconciliations
and ensure that these agree with records made at events. This also
provides evidence as to the completeness of income.
(iv) Examine the records of expenditure for fund raising events (hire of
equipment, entertainers, purchase of refreshments etc.) and ensure that
these have been properly authorised (where appropriate) and that receipts
have been obtained for all expenditure. This provides evidence as to the
completeness and accuracy of expenditure.
(v) Review the income and expenditure of fund raising events against any
budgets that have been prepared and investigate any significant
discrepancies.
(vi) Ensure that all the necessary licenses (such as public entertainment
licences) have been obtained by the trustees for such events in order to
ensure that no action is likely to be taken against the charity or volunteers.
(vii) Obtain representations from the trustees to the effect that there are no
outstanding unrecorded liabilities for such events again for completeness
of expenditure and liabilities.
31 Hurricane
(a) Importance of audit planning
According to ISA 300, the auditor should plan the audit work so that the
engagement will be performed in an effective manner. Specifically, planning is
required for the following reasons:
To develop a general strategy and detailed approach for the specific
nature, timing and extent of the audit work. This will help to ensure that the
audit is carried out in an efficient and timely manner.
So that attention is devoted to the important areas of the audit. Planning will
also help to identify problem areas so they can be addressed in a timely
fashion.
To determine the amount of work to be carried out and therefore assist in
determining the number of staff required to perform the audit work.
To provide a document as a reference for an initial discussion of the
approach to the audit with the companys audit committee. The plan will
also help ensure that audit work is co-ordinated with client staff: e.g. for
production of specific documentation to assist the auditor.
To act as a basis for the production of the audit program.
(b) Audit strategy
Client: Hurricane
Year ended: 31 December 20X4
Prepared by: A Manager
Characteristics of entity
Hurricane requires a normal statutory audit there are no audit or filing
exemptions available.
The financial reporting framework is the International Accounting Standards and
there are no industry specific reporting requirements.
Hurricane buys and then resells all types of fixtures and fittings for ships from
yachts through to large cruise ships. The company has ten warehouses, seven of
which are located near to branches of our audit firm.
Key dates
Key dates in the audit timetable are:
Interim audit
Final audit
Meeting with audit committee
Financial statements approved by management
Specific dates are to be confirmed.
Overview of audit approach
The shipping supply industry has grown by 7% during the last year. Hurricanes
sales increase is 12% indicating that the company continues to perform well
within the industry.
There have been no changes to the accounting policies of Hurricane during the
year.
This is the first year that International Standards on Auditing (ISAs) are relevant
to this company. A detailed check will be required to ensure that no changes are
required to the audit plan.
The overall audit approach will be to use tests of control where possible.
However, the fall in gross profit indicates that sales may be understated or cost of
sales (COS) overstated, so additional substantive procedures may be required in
this area.
Materiality determination
Materiality will initially be set at to 1% of revenue as this figure appears to be
more accurate than gross profit.
Materiality on the statement of financial position will be based on net asset
values.
Performance materiality will be set for specific areas.
Identification of risk areas with a higher risk of misstatement
A review of the draft financial statements for the company shows the following
risks:
Sales have increased by 12% but COS by 19%. There is a risk of COS
being overstated.
Inventory on the statement of financial position is down significantly on last
year indicating that there may be valuation or quantity errors.
Trade receivables have increased by about 50%, significantly more than
the increase in sales. This indicates that the company may have debt
collection problems. Additional testing may be required on after date cash
collections to check for bad debts.
Non-current assets have fallen by Rs. 900m, which is significant given that
most non-current assets are land and buildings. The reason for sale must
be ascertained.
Non-current liabilities have also fallen by Rs1 billion. While not necessarily
linked to the fall in non-current assets, there is a possibility that non-current
assets have been sold to pay off the liabilities.
Audit approach extent of controls testing
Audit testing will focus on the use of tests of controls where possible. However,
changes have been made to the inventory system during the year, limiting the
extent of testing of controls. Client systems have changed in the year with a new
computerised inventory control system. Unfortunately, the change was not
identified until audit planning started. Three actions are necessary in respect of
this system:
Audit initial installation of the system including transfer of balances. One of
the reasons for the low inventory value could be omission of inventory
balances on transfer.
Test count inventory at the year end and agree to the computerised
inventory records (and vice versa) to test their accuracy. Note that the client
will not be counting inventory at the year end but relying on the
computerised system.
Test check bookings into and out of inventory from the purchases and sales
systems.
32 Zakir Co
(a) (i) Explanation of analytical procedures
Analytical procedures are used in obtaining an understanding of an entity
and its environment and in the overall review at the end of the audit.
Analytical procedures actually means the evaluation of financial and other
information, and the review of plausible relationships in that information.
The review also includes identifying fluctuations and relationships that do
not appear consistent with other relevant information or results.
(ii) Types of analytical procedures
Analytical procedures can be used as:
Comparison of comparable information to prior periods to identify
unusual changes or fluctuations in amounts.
Comparison of actual or anticipated results of the entity with budgets
and/or forecasts, or the expectations of the auditor in order to
determine the potential accuracy of those results.
Comparison to industry information either for the industry as a whole
or by comparison to entities of similar size to the client to determine
whether receivable days, for example, are reasonable.
(iii) Use of analytical procedures
Risk assessment procedures
Analytical procedures are used at the beginning of the audit to help the
auditor obtain an understanding of the entity and assess the risk of material
misstatement. Audit procedures can then be directed to these risky areas.
Analytical procedures as substantive procedures
Analytical procedures can be used as substantive procedures in
determining the risk of material misstatement at the assertion level during
work on the income statement and statement of financial position (balance
sheet).
Analytical procedures in the overall review at the end of the audit
Analytical procedures help the auditor at the end of the audit in forming an
overall conclusion as to whether the financial statements as a whole are
consistent with the auditors understanding of the entity.
33 Hajira
(a) Audit risk
Audit risk is the risk that an auditor gives an inappropriate opinion on the financial
statements being audited.
Inherent risk is the susceptibility of an assertion to a misstatement that could be
material individually or when aggregated with misstatements, assuming that there
are no related controls. The risk of such misstatement is greater for some
assertions and related classes of transactions, account balances, and
disclosures than for others.
Control risk is the risk that a material error could occur in an assertion that could
be material, individually or when aggregated with other misstatements, will not be
prevented or detected on a timely basis by the companys internal control
systems.
Detection risk is the risk that the auditors procedures will not detect a
misstatement that exists in an assertion that could be material, individually or
when aggregated with other misstatements.
(b) Inherent risks in charity
Taxation rules relevant to charities. The auditor will need to ensure that
There is a risk that the rules will be staff familiar with the taxation rules
broken due to lack of correct analysis affecting the charity are on the audit
of income/expenditure. team.
34 Tahir Co
(a) Valuation of aviation inventory
Review GAAP to ensure that there are no exceptions for aviation fuel or
inventory held for emergency purposes which would suggest a market
valuation should be used.
Calculate the difference in valuation. The error in inventory valuation is
Rs.1,050 * 6,000 barrels or Rs.6.3m, which is a material amount compared
to profit.
Review prior year working papers to determine whether a similar situation
occurred last year and ascertain the outcome at that stage.
Discuss the matter with the directors to obtain reasons why they believe
that market value should be used for the inventory this year.
Warn the directors that in your opinion, aviation fuel should be valued at the
lower of cost or net realisable value (that is Rs.150/barrel) and that using
market value will result in a modification to the audit report.
If the directors now amend the financial statements to show inventory
valued at cost, then consider mentioning the issue in the weakness letter
and do not modify the audit report in respect of this matter.
If the directors will not amend the financial statements, quantify the effect of
the disagreement in the valuation method the sum of Rs.6.3m is material
to the financial statements as Tahir Co.s income statement figure is
converted from a profit to a loss of Rs.1.3m although net assets decrease
by only about 03%.
Obtain a written representation letter from the directors of Tahir Co
confirming that market value is to be used for the emergency inventory of
aviation fuel.
If the directors will not amend the financial statements, draft the relevant
sections of the audit report, showing a qualification on the grounds of
disagreement with the accounting policy for valuation of inventory.
(b) (i) External auditor responsibilities regarding detection of fraud
Overall responsibility of auditor
The external auditor is primarily responsible for the audit opinion on the
financial statements following the international auditing standards (ISAs).
ISA 240 (Redrafted) The Auditors Responsibilities Relating to Fraud in an
Audit of Financial Statements is relevant to audit work regarding fraud.
The main focus of audit work is therefore to ensure that the financial
statements show a true and fair view. The detection of fraud is therefore not
the main focus of the external auditors work. An auditor is responsible for
obtaining reasonable assurance that the financial statements as a whole
are free from material misstatement, whether caused by fraud or error.
The auditor is responsible for maintaining an attitude of professional
scepticism throughout the audit, considering the potential for management
override of controls and recognising the fact that audit procedures that are
effective for detecting error may not be effective for detecting fraud.
Materiality
ISA 240 states that the auditor should reduce audit risk to an acceptably
low level.
Therefore, in reaching the audit opinion and performing audit work, the
external auditor takes into account the concept of materiality. In other
words, the external auditor is not responsible for checking all the
transactions. Audit procedures are planned to have a reasonable likelihood
of identifying material fraud.
Discussion among the audit team
A discussion is required among the engagement team placing particular
emphasis on how and where the entitys financial statements may be
susceptible to material misstatement due to fraud, including how fraud
might occur.
Identification of fraud
In situations where the external auditor does detect fraud, then the auditor
will need to consider the implications for the entire audit. In other words, the
external auditor has a responsibility to extend testing into other areas
because the risk of providing an incorrect audit opinion will have increased.
(ii) Groups to report fraud to
Report to audit committee
Disclose the situation to the audit committee as they are charged with
maintaining a high standard of governance in the company.
The committee should be able to discuss the situation with the directors
and recommend that they take appropriate action e.g. amend the financial
statements.
Report to government
As Tahir Co is acting under a government contract, and the over-statement
of inventory will mean Tahir Co breaches that contract (the reported profit
becoming a loss), then the auditor may have to report the situation directly
to the government. The auditor of Tahir Co needs to review the contract to
confirm the reporting required under that contract.
Report to members
If the financial statements do not show a true and fair view then the auditor
needs to report this fact to the members of Tahir Co. The audit report will
be qualified with an except for or adverse opinion (depending on
materiality) and information concerning the reason for the disagreement
given. In this case the auditor is likely to state factually the problem of
inventory quantities being incorrect, rather than stating or implying that the
directors are involved in fraud.
Report to professional body
If the auditor is uncertain as to the correct course of action, advice may be
obtained from the auditors professional body. Depending on the advice
received, the auditor may simply report to the members in the audit report,
although resignation and the convening of a general meeting is another
reporting option.
(iii) Intimidation threat safeguards
In response to the implied threat of dismissal if the audit report is modified
regarding the potential fraud/error, the following safeguards are available to
the auditor.
35 Controls
(a) On account of the following factors, the auditor may decide, not to rely on
audit evidence obtained in prior audits:
A weak control environment.
Weak monitoring of controls.
A significant manual element to the relevant controls.
Changes in the personnel that significantly affect the application of the
controls.
Change in circumstances that indicate the need for changes in the
control.
(b) The components of internal controls are as follows:
(i) Control Environment:
The control environment includes the attitudes, awareness and actions
of management and those charged with governance concerning the
entitys internal control and their importance in the entity.
(ii) Entitys Risk assessment process:
The entitys risk assessment process includes how management
identifies risks relevant to the preparation of financial statements to
ensure that it gives a true and fair view in accordance with the entitys
applicable financial reporting framework, estimates their significance,
assesses the likelihood of their occurrence, and decides upon action to
manage them.
(iii) Information System, Including the related business processes,
relevant to financial reporting, and communication:
An information system consists of infrastructure (physical and hardware
components). Software, people, procedures, and data.
36 Shahzad
(a) The components of internal controls are as follows:
(i) Control environment:
These are the policies and procedures that help ensure that managements
directives are carried out.
(b) Following weaknesses in inventory count are identified from audit seniors
observations:
The person responsible for counting may try to match the numbers provided
instead of carrying out an independent count.
If the separate sheets are numbered as they are used, there is no means of
identifying that all sheets issued have been returned and the last count
sheet(s) may go unnoticed.
37 Waheed Engineering
(a) Control Purpose
Payroll data is approved by a senior To prevent any unauthorised
official. inaccurate deductions being made.
Payroll transactions should be The correct amount is paid over to
recalculated. employees or the relevant authorities.
Official notification of starters and To prevent employees being paid after
leavers i.e. tax documentation. they have left or before they have
started.
All hours worked are authorised. To prevent the company paying for
work not done.
All employees to collect their wages in To prevent loss/theft.
person.
(b) Verifying that employees are not paid prior to commencing work
(i) Two payrolls should be selected from different periods in the year.
(ii) Employees not listed on the second payroll should have left during the year
and employees not listed on the first payroll should have started during the
period.
(iii) This can then be verified by examining the permanent payroll information
where there should be a copy of each employees contract of employment.
(iv) Also tax authority official forms should confirm departure and start dates.
The main reason for carrying out this exercise is to ensure that all
employees are bona fide i.e. payments are being made to authorised
employees.
(iv) All unclaimed wages should be listed; the payroll date, name and amount
noted.
(v) The unclaimed wages should then be stored in the safe until collected.
38 Danish
(a) Problems expected at Danish resulting from poor internal control
(i) I would expect the company to experience some level of over-ordering,
leading to reduced profitability as a result of inventory going past its best
before date.
(ii) Inventory that is not well-controlled in a supermarket may result in a breach
of health and safety regulations which may result in fines or even closure of
the supermarkets.
(iii) I would expect there to be stock-outs leading to the potential loss of
business to other supermarkets.
(iv) I would expect there to be inefficiencies as a result of a lack of central
ordering system resulting from quality discounts not being obtained.
(v) All of the problems noted above are likely to be exacerbated where local
managers or staff are either inexperienced or possibly dishonest the
question states that poorer quality staff have been recruited recently.
(iv) Recommendation 4: that sales price decisions are made by head office.
Advantages
This would enable the company to experiment with the use of loss leaders,
for example, and to impose a degree of consistency across supermarkets
to prevent inappropriate pricing decisions being taken by local managers.
Disadvantages
Again, loss of control at a local level is likely to result in resentment and the
possible loss of good staff. What sells well in one supermarket may not do
so in another. To the extent that head office have less experience of local
conditions than local staff, it is possible that inappropriate pricing decisions
may be made by head office.
39 Roses Anytime
(a) Key procedures
(i) Documentation of accounting and internal control systems
Auditors document accounting and internal control systems in order to
evaluate them for their adequacy as a basis for the preparation of the
financial statements and to make a preliminary risk assessment of internal
controls.
In very simple systems with few internal controls where auditors do not
intend to perform tests of internal controls, it is not necessary to document
the internal control system in detail. It is always necessary, however, to
have sufficient knowledge of the business to perform an effective audit.
For large entities, where the client has already documented the system, it is
not necessary for the auditors to repeat the process if they can satisfy
themselves that the clients documentation is adequate.
(ii) Walk-through tests
The purpose of walk-through tests is for the auditors to establish that their
recording of the accounting and internal control system is adequate.
Auditors trace a number of transactions from source to destination in the
system, and vice versa. For example, customer orders can be traced from
the initial documentation recording the order, through to the related entries
in the daybooks and ledgers.
It is common for walk-through tests to be performed at the same time as
tests of controls, where auditors are reasonably confident that systems are
recorded adequately.
(iii) Audit sampling
Auditors perform tests of controls and tests of detail on a sample basis in
order to form conclusions on the populations from which the samples are
drawn.
It is not possible in anything but the very smallest of entities to take any
other approach, as testing 100% of a population may be impractical, not
cost effective and not accurate because populations are too large and
because of human error.
From time to time, there should be a check to ensure that the credit
limits within the system are being properly calculated and properly
applied to individual transactions. Similar considerations apply to
prices maintained within the system.
The computer system should also reject any order for which there are
no Roses available so that orders cannot be taken for Roses that
cannot be delivered.
All invoices should be posted to the sales daybook, the accounts
receivable ledger and the accounts receivable control account
automatically by the system and the accounts receivable ledger and
that accounts receivable control account should be reconciled each
month in order for sales and receivables records to be kept up to
date.
There should be controls in place to deal with credit notes and other
discrepancies involving the price, type or quality of Roses delivered in
order to maintain the accuracy of records and customer goodwill.
(ii) Collection of cash
At the end of each period, the system should produce a list of
overdue receivables. There should be procedures for chasing these
customers and for putting a stop on accounts where amounts are
significant in order to control bad debts.
When bank transfers are received from customers, they should be
input into the system and matched with individual transactions and
controls should ensure that the correct amounts are allocated to the
correct customers and transactions.
An exception report should be produced for any unallocated bank
transfers. Exceptions should be promptly investigated. This will
ensure that receivables information is accurate and up to date and
that customers are not chased for amounts that have been paid.
A bank reconciliation should be performed on a monthly basis in
order to ensure that the companys cash records are complete,
accurate and up to date.
40 Trade Receivables
(a) Types of error, omission and misappropriation receivables
(i) Where internal controls are weak, the errors that occur may include the
issue of invoices and credit notes for the wrong amounts, the issue of
invoices and credit notes to the wrong customers, the incorrect recording of
invoices, credit notes, cash and contras in the ledgers and daybooks, and
the incorrect setting of credit limits.
(ii) Where internal controls are weak, invoices, credit notes cash and contras
may simple go unrecorded.
(iii) The effect of this will be that receivables may be under or over-stated in the
records and that the company will not receive that money that is due to it,
or that goodwill with customers is damaged.
(iv) The assets that may be misappropriated include cash and inventory. If
records are poor, it will be easy to hide the misappropriation of cash that is
41 Granger
(a) (i) Inadequate segregation of duties and proposed reassignment
A basic principle of segregation of duties is that an individual employee
should not be able to make errors and be in a position to conceal the fact.
Proper segregation means that, if an error or misstatement is made, it will
be detected by another employee in the ordinary course of his or her
duties. A general rule of segregation is that the funtions of processing
transactions, recording transactions and maintaining records over the
subsequent assets or liabilities, should be performed by different
individuals.
The receptionists duties should be restricted to processing cash receipts
transactions. All other functions should be assigned to other staff
members.
Function to be Possible Reassignment
reassigned misstatement
Checking the The receptionist could This should be
numerical continuity of deliberately understate assigned to Clerk 1.
invoices, determining the total in order to (See additional
the total cash sales misappropriate the procoedure 1.)
and entering the cash cash or conceal a
receipts journal. shortage of cash.
Posting the accounts An invoice could be Clerk 1 should post the
receivable ledger. deliberately omitted accounts receivable
and the subsequent ledger from credit
cash receipt sales invoices whose
misapprpriated if done numerical sequence is
by the same person. checked.
Errors, such as
transaction errors,
made in entering the
sales journal are likely
to be repeated in
entering the accounts
receivable ledger.
Cash receipts could be
temporarily
misappropriated and
the shortgage
42 Nobel
The audit evidences which may be gathered in the cases referred to in the question
are as follows:
(i) x Legal Opinion.
x The terms and conditions of the contract related to defective material and
liability thereof.
x Quality Control procedures prevalent in the company.
x Documentation of response of other customers, to whom similar items
have been supplied.
x Opinion of independent experts.
x Documentation of the Evaluation of the basis of provision.
(ii) x Industry standards.
x Opinion of independent experts (regarding useful life, pattern of wear tear
etc.)
x The environment (production load, maintenance policies etc.) under which
the company is operating and its comparison with other firms in the
industry.
x The reasons for sale of equipment (normal case or otherwise)
43 Masoom Limited
Using the work of an expert
An auditor may need the opinion of an expert on matters which require professional
expertise, other than accounting and audit.
Example of such circumstances are:
Valuation of assets such as plants, work of art etc.;
Determination of quantities such as stockpile, underground mineral etc.;
Determination of amount using specialized methods like actuarial valuation;
Measurement of work completed;
Legal opinions.
Auditors Responsibility while using the work of expert
Evaluate the professional competence of the expert;
Evaluate the objectivity of the expert;
Obtain sufficient appropriate audit evidence that the scope of the experts work
is adequate;
Evaluate the appropriateness of experts work regarding the assertion being
confirmed;
Resolve the inconsistency, if any, between results of the expert and other audit
evidence.
44 Sky blue
The investigation of unusual fluctuations and relationships ordinarily begins with
inquiries of management, followed by:
(a) Corroboration of managements responses, for example, by comparing them
with the auditors understanding of the entity and other audit evidence obtained
during the course of the audit; and
(b) Consideration of the need to apply other audit procedures, if management is
unable to provide adequate explanation.
45 Direct confirmations 1
(a) A positive external confirmation request asks the respondent to reply to the
auditor in all cases, whether he agrees with the information provided in the
confirmation request or not.
A negative external confirmation request asks the respondent to reply only in
the event of disagreement with the information provided in the request.
(b) Associated risks and necessary steps to be taken by the auditor.
Positive External Confirmation
The risk associated with such type of confirmation is that the respondent may
reply to the confirmation request without verifying that the information is correct.
The auditor is not ordinarily able to detect whether this has occurred.
The auditor may reduce this risk, by using positive confirmation requests that
do not state the amount (or other information) on the confirmation request, but
asks the respondent to fill in the amount or furnish other information.
Negative External Confirmation
Risk associated is that when no response is received, there is no explicit audit
evidence that intended third parties have received the confirmation requests
and verified that the information contained therein is correct.
Accordingly, the use of negative confirmation requests ordinarily provides less
reliable audit evidence than the use of positive confirmation requests.
The auditor considers performing other substantive procedures to supplement
the use of negative confirmations.
(c) Negative confirmation requests may be used under one or more of the
following circumstances:
(i) The assessed risk of material misstatement is lower;
(ii) A large number of small balances is involved;
(iii) Substantial number of errors are not expected; and
(iv) The auditor has no reason to believe that respondents will disregard
their requests.
A combination of positive and negative external confirmations may be
used, for example, where the accounts receivables comprise a small number of
large balances and a large number of small balances.
The auditor may then decide that it is appropriate to confirm all or a sample of
the large balances with positive confirmation requests and a sample of the
small balances using negative confirmation requests.
46 Chill
When planning to use the report the auditor should evaluate the professional
competence of the expert.
This will involve considering the experts:
Professional certification or licensing by, or membership in, an appropriate
professional body; and
Experience and reputation in the field in which the auditor is seeking audit
evidence.
The auditor should also evaluate the objectivity of the expert. The risk that the
experts objectivity will be impaired increases when the expert is in some way
related to or dependent on the entity.
47 Sales sampling
(a) (i) Audit efficiency may be improved as the auditor has stratified a population
by dividing it into discrete sub-populations which have an identifying
characteristic. The stratification reduces the variability of items within each
stratum and therefore allows the sample size to be reduced without a
proportional increase in sampling risk
(ii) Other ways by which sales population may be stratified are as under:
By product
By customers or category of customers
Geographically
Terms of sales such as credit, cash, advance etc.
Precaution: sub-categorization/sub-populations need to be carefully defined
such that any sampling unit can only belong to one stratum.
Their view that proper sampling should be carried out from the total
population of 640 million and categorization should be ignored altogether is
not correct because stratification helps in improving the efficiency of the
audit.
The auditor may decide to examine the entire population in the following
circumstances:
when there is a significant risk and other means do not provide sufficient
appropriate audit evidence; or
when the repetitive nature of a calculation or other process performed
automatically by an information system makes a 100% examination cost
effective.
48 PQR
(a) For the purpose of determining the extent of reliance that may be placed on the
work of internal auditor in specified areas, it may be evaluated by:
(i) Inspecting the adequacy of the scope of the work and related programs.
(ii) Determining by means of inspection whether the preliminary assessment of
Internal audit function remains appropriate.
(iii) Obtain evidence that:
The work is performed by staff having adequate technical training and
proficiency as internal auditors and the work of assistants are properly
supervised, reviewed and documented.
Sufficient appropriate audit evidence was obtained to serve as a
reasonable basis for conclusions reached.
Conclusions reached are appropriate in the circumstances and any
reports prepared are consistent with the results of work performed.
Any exceptions/unusual matters disclosed by internal audit are properly
resolved.
(b) Important differences between Internal Audit and the External Audit
Independence
Since internal audit is a part of the entity, no matter how autonomous and
objective it is., it cannot reach the level of independence enjoyed by the external
auditors.
Objectives
The objectives of internal audit function vary according to managements
requirements. Whereas, the primary objective of external auditor is to ascertain
whether or not the financial statements are free of material misstatements.
Reporting
Report of external auditor is addressed to the members (shareholders) /
owners / those charged with the governance of the entity.
50 Related parties
Procedure to identify Related Parties
The auditor may perform the following audit procedures to ensure the completeness of
the information provided by management about related parties:
(i) Review prior year working papers for names of known related parties;
(ii) Review the entitys procedures for identification of related parties;
(iii) Inquire as to the affiliation of those charged with governance and officers with
other entities;
(iv) Review shareholder records to determine the names of principal shareholders
or, if appropriate, obtain a listing of principal share-holders from the share
register;
(v) Review minutes of the meetings of shareholders and those charged with
governance and other relevant statutory records such as the register of
directors interests;
(vi) Inquire of other auditors currently involved in the audit, or predecessor auditors,
as to their knowledge of additional related parties; and
(vii) Review the entitys income tax returns and other information supplied to
regulatory agencies.
51 Direct confirmations 2
(a) The auditor may consider not to circulate the direct confirmation to the
customers where:
(i) accounts receivables are immaterial to the financial statements; or
(ii) the response rate is not expected to be adequate; or
(iii) the responses are not expected to be reliable; or
(iv) inherent and control risk in aggregate are assessed at low level.
(v) audit evidence expected to be gathered through other substantive
procedures (e.g. analytical procedures) is sufficient to reduce the audit
risk to an acceptable level.
vi) management requests not to send the confirmation and auditor after
satisfying himself from the reason and explanation given by the
management.
(b) While designing the confirmation request, the auditor considers the following
factors:
(i) Assertions being addressed through the direct confirmation.
(ii) Form of the external confirmation requests (i.e. positive or negative or
combination of both)
(iii) Prior experience on the audit of similar engagements.
(iv) The nature of the information being confirmed.
(v) The intended respondent.
(vi) Type of information respondents will be able to confirm readily.
(c) The auditor may perform one or more of the following steps:
(i) Check receipt from customers after balance sheet date.
(ii) When there is no receipt from customers after balance sheet date, the
auditor should consider the following audit procedures:
Verify validity of purchase orders, if any.
Verify goods dispatched note other documents duly acknowledged
by the customers.
(iii) Obtain explanations for invoices remaining unpaid, if any, after
subsequent one have been paid.
(iv) Examine sales near the period end to provide audit evidence about cut-
off assertion.
52 Working papers
The auditor should consider the following factors while determining the form, content
and extent of audit working papers.
(i) The nature of the audit procedures to be performed;
(iii) The extent of judgment required in performing the work and evaluating the
results;
(iv) The significance of the audit evidence obtained;
(vi) The need to document a conclusion or the basis for a conclusion not readily
determinable from the documentation of the work performed or audit evidence
obtained; and
(vii) The audit methodology and tools used.
53 Al-Shams
(a) (i) Evaluate the companys procedures for identifying and for properly
accounting for related-party transactions.
(iv) Identify all employee benefit plans and the names of the officers and
trustees thereof.
(viii) Review significant contracts re-negotiated by the entity during the period.
(ix) Review significant contracts and agreements not in the entitys ordinary
course of business.
(i) Significant transactions are referred to the related party for final approval.
(ii) There is little or no debate among management and those charged with
governance regarding business proposals initiated by the related party.
(iii) Transactions involving the related party (or a close family member of the
related party) are rarely independently reviewed and approved.
(iv) The related party has vetoed significant business decisions taken by
management or those charged with governance.
54 Auditors expert
Information regarding the competence, capabilities and objectivity of an auditors
expert may come from a variety of sources, such as:
- Personal experience with previous work of that expert.
- Discussions with that expert.
- Discussions with other auditors or others who are familiar with that
experts work.
- Knowledge of the experts qualifications, membership of a professional
body or industry association, license to practice or other forms of
external recognition.
- Published papers or books written by that expert.
- The auditors firms quality control policies and procedures.
55 ADL
(a) (i) Statistical and non-statistical sampling
An approach to sampling that has the following characteristics is called
statistical sampling:
Random selection of the sample items; and
The use of probability theory to evaluate sample results, including
measurement of sampling risk.
A sampling approach that does not have above characteristics is
considered non-statistical sampling.
(ii) Sampling and non-sampling risk
Sampling risk is the risk that the auditors conclusion based on a sample
may be different from the conclusion if the entire population were subjected
to the same audit procedure.
Non sampling risk is the risk that the auditor may reach an erroneous
conclusion for any reason not related to sampling risk.
(b) (i) The following shortcomings have been observed in the approach adopted
by the Audit Team:
By ignoring less than Rs. 5,000 debtors, the government debtors and
some of the related parties, for the purpose of sampling, the following
important principles have not been complied with.
x That the auditor should consider the risk of material misstatement
on the entire population.
x That the auditor should attempt to ensure that all items in the
population have a chance of selection.
In stratification, the audit efforts are directed towards larger value items.
However, the audit planning documentation should explain why the only
10 debtors out of 50 largest debtors were selected.
(ii) Alternative means of sampling material balances are as follows:
Stratification
This would involve dividing the sample into discrete sub-populations
(stratum) which have an identifying characteristic. In our case, the
population may be stratified by monetary value. For example, following
strata may be created:
Above Rs. 1,000,000
Between Rs. 500,000 and Rs. 1,000,000
Below Rs. 500,000
The sample may be made from each strata allowing effort to be directed to
the larger value items.
Value weighted selection (Monetary unit sampling)
When performing test of details, it may be efficient to identify sampling as
the individual monetary units that make up the population. In this method,
each monetary unit in a population has an equal chance of being selected
for testing. Audit effort is directed to the larger value items because they
have a greater chance of selection, and can result in smaller sample sizes.
56 Guava & Co
(a) After the assembly of the final audit file has been completed, the auditor shall
not delete or discard audit documentation of any nature before the end of the
retention period.
The firm should establish its own policies and procedures for the retention of
engagement documentation. The retention period for audit engagement
ordinarily is no shorter than five years from the date of auditors report.
(b) Changes in the audit documentation during the final file assembly process may
only be made if they are administrative in nature. Examples of such changes
include:
(i) Deleting or discarding superseded documentation;
(iv) Documenting audit evidence that the auditor has obtained, discussed
and agreed with the relevant members of the engagement team before
the date of the auditors report.
(c) The auditor must respond appropriately to facts that become known to the
auditor after the date of the auditors report, that, had they been known to the
auditor at that date, may have caused the auditor to amend the auditors report.
Examples might include:
- Evidence as to the valuation of assets e.g. the agreement of a sale price
significantly lower than previously recorded for the disposal of a large
property portfolio.
- Evidence that brings into question the appropriateness of the going
concern assumption, for example the non-renewal of financing.
- The resolution of a legal case for an amount that is materially different
from the expected liability recorded in the financial statements.
- The bankruptcy of a major client.
In this relation the auditor should document:
(i) The circumstances encountered.
57 RP planning
The steps that I as an auditor would consider as part of the audit planning to ensure
that all related party relationships and transactions are identified and disclosed in the
financial statements are as follows:
(a) Obtaining an understanding of the controls, if any, that management has
established to identify, account for, and disclose related party relationships and
transactions in accordance with the applicable financial reporting framework.
(b) Inquiring of the management regarding:
(i) The identity of the entitys related parties, including changes from the prior
period;
(ii) The nature of relationships between the entity and these related parties; and
(iii) Whether the entity entered into any transactions with these related parties
during the period and, if so, the type and purpose of the transactions.
(c) Inspecting the following documents for indications of the existence of related party
relationships or transactions that management has not previously identified or
disclosed:
(i) Bank and legal confirmations
(ii) Minutes of meetings of shareholders and of those charged with governance;
and
(iii) Any other records or documents as the auditor considers necessary (e.g.
Form A, Form 29, Register of members etc.).
(d) Reviewing the extent and nature of business transacted with major customers,
suppliers, borrowers and lenders for indications of previously undisclosed
relationships.
(e) Reviewing the significant transactions outside the normal course of business,
paying particular attention to the transaction recognized at or near end of the
reporting period and inquire of management:
The nature of these transactions
Whether related parties are involved in these transactions
(f) Once related parties have been identified, the client should provide the details of
transactions with such parties. I as auditor would ensure that these transactions
are disclosed appropriately in the financial statements as per applicable financial
reporting framework.
58 Manufacturing inventories
Substantive Procedures
Physical verification:
(i) Evaluate the clients physical inventory taking instructions and procedures
to their staff.
(ii) Attend physical inventory count to observe the inventory count procedures.
(iii) Ascertain whether the staff members are carrying out the physical
inventory count as per approved instructions issued to them.
(iv) Perform test counts to ensure the efficiency and effectiveness of the
physical count procedures.
(v) Observe the physical inventory count and identify the matters for
appropriate follow-up during the audit. These matters may include the
following:
Excess/ Shortages found in test count performed by the auditors.
Items of inventory identified as obsolete, slow moving, damaged or
defective.
Details of instances where the approved inventory count procedures
are not followed by the staff members of the client.
Instances where the stock records (bin cards, stock and stores ledger
etc.) do not contain adequate details relating to balance of inventory in
hand, minimum level, maximum level, ordering level, specification of
inventory and location of inventory etc.
Cut-off procedures and adherence thereto.
(vi) Check that the adjustments arising out of the physical count have been
made in the stock count sheets.
(vii) Check final stock sheets for quantity, pricing, extensions, casting,
summarization, and signatures of the stock taking staff.
Finished Goods:
(i) Obtain a list of items (schedule) shown as finished goods, with full
particulars, quantity and value
(ii) Compare the list with physical count sheet balances and with stock ledger
balances
(iii) On test basis check the items and quantities in the stock ledger with the
bin card.
(iv) With regard to cut-off procedures performed during the attendance at the
physical inventory count, check the goods outward book or delivery
outwards book for the last few days of the year, and early few days of the
succeeding financial year.
(v) If goods are sold on consignment, check the closing stock with the
consignment account.
Work in Process:
(i) Obtain a list of items shown as work in progress, with full particulars,
quantity and value.
(ii) Compare the list with physical count sheet balances and with stock ledger
balances
(iii) Check the quantity and items included in the list with the production reports
and job cards etc.
(iv) Check records showing the work in progress opening balances, raw
material and other material issued and labour and overheads charged to
production and closing balance of work in process.
(v) Where it is not possible to quantify or value the work in process for
technical reasons, the auditor should consider to use an expert.
Raw material:
(i) Obtain a list of items shown as Raw material, with full particulars, quantity
and value.
(ii) Compare the list with physical count sheet balances and with stock ledger
balances.
(iii) Verify the cost of raw material appearing in the financial statements by
matching with them with the purchase invoices etc.
Valuation of Inventories:
(i) Ensure that stock has been valued in accordance with the valuation policy.
(ii) Ensure that inventories have been valued at the lower of cost and net
realizable value.
(iii) Ensure that the cost of inventories comprise of purchase price, cost of
conversion and other costs incurred in bringing the inventories to their
present location and condition.
(iv) Check that the following costs have not been included in the cost of
inventories:
Abnormal wastes in labour, material or other production overheads.
Storage costs unless considered necessary for the production process/
inventory.
Administrative overheads
Selling and distribution costs
Financial charges
(v) Examine and perform test checks to verify the proper allocation of
overheads is in accordance with the requirements of IAS 2.
(vi) Where the inventories are valued at net realizable value, check that
valuation is correct and is based on the most reliable evidence.
(vii) Check that the cost of obsolete and damaged items is properly written
down.
(viii) Test arithmetical accuracy of the calculation of the stock sheets.
Disclosure:
Ensure that inventories have been disclosed in accordance with the requirements
of International Financial Reporting Standards and the Companies Ordinance,
1984.
General:
(i) Trace opening balance from last years working papers.
(ii) Agree closing balance appearing in the financial statements with books of
accounts.
(iii) Ensure that inventories have been appropriately classified.
(iv) Obtain direct confirmation for stocks held by third parties.
(v) Check reconciliations of opening and closing balances with production/ sale
records, wherever possible.
59 Wedge & Co
(a) Effect on sample size of Effect on sample size
Factor
Tests of controls of tests of details
60 MWL
(a) Selection of Accounts Receivable for circulation at year-end
(i) The debtors listing will be stratified in accordance with the different market
segments (Super markets, whole sellers, retailers and five star hotels)
All twelve super markets, as well as the seven five star hotels will be
purposely selected (59% of the total debtors balance will be covered in
this manner).
Debtors with nil and credit balances, as well as overdue debtors should
also be selected.
(b) Situation where a debtor confirms a balance which is different from the
amount appearing in the confirmation request:
(ii) Misstatement
In case of timing differences, the auditor will need to reconcile the amount
confirmed by the confirming party and the amount sent for confirmation.
In either case, the auditor will consider whether he needs to revise his risk
assessment and audit procedures.
61 BPR
(a) Substantive Procedures for verification of Bank reconciliation statements:
Trace and agree balances per books of accounts (ledger or bank book) as
appearing in the bank reconciliation statement with the general ledger/
bank book.
Trace and agree balances per bank statement as appearing in the bank
reconciliation statement with the bank statements.
Trace reconciling items appearing in the previous months bank
reconciliation into current months ledger/ bank statement/ bank
reconciliation statement.
Check subsequent clearance of current months reconciling items.
Review and discuss long outstanding items appearing in the bank
reconciliation statement.
Ensure that all outstanding items requiring adjustments are properly
accounted for in the books of accounts.
Check arithmetical accuracy of reconciliation statements.
(b) Substantive Procedures for Payroll:
From the payroll record:
x Select a sample of newly appointed staff and check their salaries with
the appointment letter.
x Select a sample of other staff (appointed in previous years) and check
their salaries with the increment letter.
x In both the above cases check that allowances and deductions are in
accordance with the companys policies or the relevant legal
requirements.
Select a sample of payroll summaries and:
x Check that payroll summary has been approved by an appropriate
authority.
62 Taskeen Co
(a) Sampling risk
Sampling risk is the possibility that the auditors conclusion, based on a sample,
may be different from the conclusion reached if the entire population were
subjected to the audit procedure.
The auditor may conclude from the results of testing that either material
misstatements exist, when they do not, or that material misstatements do not
exist when in fact they do.
Sampling risk is controlled by the audit firm ensuring that it is using a valid
method of selecting items from a population and/or increasing the sample size.
Non-sampling risk
Non-sampling risk arises from any factor that causes an auditor to reach an
incorrect conclusion that is not related to the size of the sample.
Examples of non-sampling risk include the use of inappropriate procedures,
misinterpretation of evidence or the auditor simply missing an error.
Non-sampling risk is controlled by providing appropriate training for staff so they
know which audit techniques to use and will recognise an error when one occurs.
(b) Sample selection methods
The audit manager suggests checking all invoices, effectively ignoring any
statistical sampling; in other words this is not statistical sampling. Audit tests will
be applied to all of the sales invoices. This approach may be appropriate for the
audit of Tam because:
The population is relatively small and it is likely to be quicker to test all the
items than spend time constructing a sample.
All the transactions are not large but could be considered material in their
own right, e.g. compared to project. As all the transactions are material,
then they all need to be tested.
The audit senior suggests using statistical sampling. This will mean selecting a
limited number of sales invoices from the population using probability theory
ensuring a random selection of the sample and then applying audit tests to those
invoices only. This approach may be appropriate because:
The population consists of similar items (i.e. it is homogeneous) and there
are no indications of the control system failing or changing during the year.
There is the query about how long it will take to determine and produce a
sample, which may make statistical sampling inappropriate in this situation.
The audit junior suggests using random sampling, which the junior auditor
appears to understand as manually choosing which invoices to look at. The
approach therefore involves an element of bias and is not statistical or true
random sampling.
While this approach appears to save time, it is not appropriate because:
The sample selected will not be chosen randomly but on the whim of the
auditor. Human nature will tend to avoid difficult items for testing.
Also, as invoices will not have been chosen using statistical sampling, no
valid conclusion can be drawn from the results of the test. If an error is
found it will be difficult extrapolating that error on to the population.
(c) Materiality
Information is material if its omission or misstatement could influence the
economic decisions of users taken on the basis of the financial statements.
Materiality depends on the size of the item or error judged in the particular
circumstances of its omission or misstatement.
It is important that the auditors of Tam ensure that the financial statements are
free from material error for the following reasons:
63 Wings
(a) Use of the work of the internal auditors by external auditors
Sales and ticketing
(i) The sales function is likely to be integrated with the accounting and internal
control system used to produce the figure in the financial statements for
revenue, on which the external auditor reports.
(ii) The internal auditors' work on the ticketing system is less likely to be useful
because it relates to an operational area which does not have a direct
impact on the financial statements. There are, however, regulatory matters
that may need to be considered by the external auditor. Ticketing may also
have an indirect effect, because it is likely to be integrated with the sales
system and there is likely to be some crossover between the controls over
ticketing and controls over sales generally. The work of the internal auditors
is therefore likely to be of some use to the external auditor.
Fleet acquisition and maintenance
(iii) The internal auditors' work on the fleet acquisition system is likely to be
very relevant to the external auditors because owned aircraft and leased
aircraft will constitute a substantial element of statement of financial
position assets and liabilities, and depreciation and finance charges in the
income statement,
(iv) Much of the internal auditors' work is likely to relate to ensuring that
company policy has been complied with. Policy will relate to the
authorisation for and acquisition of aircraft, and accounting for aircraft in
terms of the correct classification of leases (operating or financing) and
depreciation policy, for example. Company policy is likely to be extensive
and detailed for such material items and external auditors will be concerned
to ensure that it is both appropriate and has been complied with.
(v) It is also possible that the internal auditors' work may involve some
verification of the income statement/statement of comprehensive income
and statement of financial position entries at the year-end. Given the likely
materiality of the amounts involved, this work will also be of interest to the
external auditors.
(vi) It is possible that the internal auditors' work may also relate to the quality of
aircraft, and other operational aspects of fleet management. These issues
may also be relevant to the external auditors, at least insofar as they relate
to compliance with laws and regulations.
(vii) In relation to maintenance, the internal auditors' work is likely to relate to
the authorisation and correct accounting for maintenance expenditure
(capitalisation or expensing), and on the operational side, to the quality
thereof, as for fleet acquisition (above). Maintenance expenditure in the
income statement/statement of comprehensive income may well be
material and the work of the internal auditors is therefore of interest to
external auditors.
Trade payables and long-term debt financing
(viii) The extent of the external auditor's interest in the internal auditors' work on
trade payables and long-term financing will depend on the materiality of the
amounts involved. Trade payables (for certain types of routine
maintenance, and payables due to the service organisations, for example)
may be material. Long-term debt financing is very likely to be material as
many airlines have substantial debt financing.
(ix) Internal audit work on trade payables is likely to involve ensuring that
routine internal controls are properly designed and are operating. The
external auditors may well be interested in the internal auditors' work in this
area.
(x) There are substantial financial statement disclosures required for debt
financing. The internal auditors' assistance with ensuring that disclosures
are properly made, as well as with ensuring that any covenants have been
complied with and that the accounting for the financing is appropriate, may
also be helpful to the external auditors.
(b) Quality of internal audit function: extent of reliance
(i) The quality of the internal audit function will have a significant effect on the
extent of the external auditor's reliance. If the quality of work is not
adequate, reliance will not be possible, regardless of the extent and
relevance of the work performed.
(ii) The firm will seek to ensure that there is an appropriate structure within the
department itself, with appropriate reporting lines outside the department,
preferably reporting to the audit committee.
(iii) The internal audit function has recently been expanded and there are likely
to be changes in the way that it is organised. The function should have
operational independence within the organisation and formal terms of
reference that encompass the recent changes made.
(iv) The function should have a clearly defined set of operating procedures, as
well as a work program. Proper documentation of all work performed is
essential.
(v) Staff should be appropriately trained, experienced and qualified. The head
of such an important department should preferably be professionally
qualified.
(c) Audit evidence: outsourced functions
(i) Internal controls exercised by the company over in-flight catering and
payroll must be properly designed and operated. The firm will seek to
review documentation of controls and internal audit reports. It will seek to
obtain evidence that controls have been applied.
64 Glasses2Go
(a) Purposes of audit working papers
The purposes of audit working papers include:
To assist with the planning and performance of the audit.
To assist in the supervision and review of audit work, and
To record the audit evidence resulting from the audit work performed to
support the auditors opinion.
(b) Documentation Information obtained
Memorandum and articles of Details of the objectives of Specs4You, its
association permitted capital structure and the internal
constitution of the company.
Most recent published financial Provide detail on the size of the company,
statements profitability, etc. as well as any unusual
factors such as loans due for repayment
Most recent management Determine the current status of the
accounts/budgets/ cash flow company including ongoing profitability,
information ability to meet budget, etc. as well as
identifying any potential going concern
problems.
Organisation chart of Spec4You To identify the key managers and
employees in the company and other
people to contact during the audit.
Industry data on spectacles To find out how Specs4You is performing
sales compared to the industry standards. This
will help to highlight any areas of concern
for example, higher than expected cost of
sales, for investigation on the audit.
65 ISA 620
Reliance on the work of an auditors expert
(i) Likely areas of reliance
Legal opinions, for example, the experts view on the likely outcome of an
ongoing court case.
Specialist valuation areas, such as property.
Determination of stage of completion of complex work-in-progress in the
audit of inventories.
Determination of likely realisable value of assets, such as plant which is
possibly obsolete, to see if a write-down is needed.
(ii) Assessing the work of an expert
The audit firm should carry out the following procedures.
Assess the competence, capabilities and objectivity of the expert.
Obtain an understanding of the experts field of expertise. This must be
sufficient to allow the auditor to determine the nature, scope and objectives
of the experts work and evaluate the adequacy of that work.
Agree the terms of engagement with the expert, including:
- the nature, scope and objectives of the experts work
- the respective responsibilities of the expert and the auditor
- the form of the experts report
- confidentiality requirements
Evaluate the adequacy of the experts work, including the:
- reasonableness of the experts conclusions
- consistency of those conclusions with other audit evidence
- reasonableness of significant assumptions and methods used
- relevance, completeness and accuracy of source data.
66 Cuddly World
(a) Procedures
(i) Use in gathering audit evidence
Analytical procedures consist of evaluations of financial information made
by a study of plausible relationships among both financial and non-financial
data.
Inquiry means to seek relevant information from sources, both financial
and non-financial, either inside or outside the company being audited.
Evidence may be obtained orally or in writing.
Inspection is the physical review or examination of records, documents
and tangible assets. It may include examination of records for evidence of
controls in the form of a compliance test.
All of the changes noted below may also be due to simple accounting errors or, in
some cases, misappropriation of inventory or cash.
A decrease in the gross profit margin may indicate that the cost of raw
materials or bought-in goods has increased, or that discounts or selling
prices have decreased. This may not be a bad thing if the reason for this is
an overall increase in revenue.
The inventory holding period indicates the number of days the company
could continue to trade if supplies were to cease. The longer the period,
the higher the level of inventory held. Inventory holding involves
expenditure. Generally, the lower the figure the better provided that the
company does not run out of inventory. An increase can indicate that the
company is unable to sell its inventory. An increase can also indicate that
the company is expecting additional sales, or simply that the business is
expanding. Many businesses are cyclical and increases and decreases are
to be expected.
(b) Materiality
Concept
Materiality is related to risk and used in the calculation of sample sizes and
tolerable misstatement, and in the performance of analytical procedures. Less
work is performed in immaterial areas than in material areas, although some work
is always performed because an area that may appear to be immaterial may,
when tested, provide to be material.
68 Tahira Transporters
(a)
Audit test Reason for test
Discuss with booking clerk how orders The main problem with the sales
are recorded from the customer. system in TT is the lack of evidence for
the receipt of the telephone order.
checks are therefore required to ensure
that orders are completely and
accurately recorded in the VMS where
no input document is available.
Discuss with the directors the To check on the personnel controls in
recruitment and training of booking TT which will be designed to minimise
clerks. loss of customer orders.
To ensure that staff have appropriate
skill and training to operate the ordering
system without losing customer orders.
With clients permission, attempt to To confirm the completeness and
enter orders into the VMS from an accuracy of recording of orders by the
input terminal. computer system.
For the sample of confirmed e-mail To check for accuracy of transfer of
orders held in the e-mail programme, information from the e-mail to the VMS.
trace details onto the VMS ensuring The method of filling of the e-mails
that details of vehicle hire regarding means that completeness of e-mail
time and dates are accurately orders cannot easily be determined.
recorded. Audit software may be able to re-sort
the orders.
Review hard copy customer complaint To check for evidence of orders being
files and e-mail files on computer for sent by customers but not entered into
evidence of unfilled orders. TTs sales system.
For a sample of bookings in the VMS, To check for completeness of transfer
trace details to the list of sales invoices of information between the two
raised maintained in the receivables programmes. The test can be carried
ledger programme. out manually or using test data. Manual
testing may be difficult where there is
no obvious audit trail between the two
systems.
For a sample of sales invoices in the To check for accuracy of charging for
VMS, trace details to the list of sales each individual vehicle hire. Evidence
invoices raised maintained in the of undercharge would indicate that
receivables ledger programme. sales are understated.
Cast the list of invoices in the To ensure that the total sales for that
receivables ledger programme for one month are accurate. Transfer of data to
month. Trace total sales to the general the nominal ledger ensures that the
ledger programme. total sales amount is recorded correctly
in the ledger.
Cast the monthly sales figures in the The final cast and checking ensures
general ledger and agree to the that the financial accounts figure is
financial statements. Investigage any accurate.
discrepancies. Casting tests can be carried out
manually or using computer audit
software.
69 Willow
(a) Initial audit procedures
Clerical accuracy
This schedule has been prepared by the companys accountant. If I am to use
the schedule as the basis for planning and performing my audit. I must first
ensure that it is correct in accordance with the companys books and records. I
would, therefore:
verify the schedule to and from accounts recorded in the nominal ledger
and with the draft financial statements;
check the correctness of additions and other calculations on the schedule.
The basis for this procedure is that of professional scepticism which requires
making no presumption as to the accuracy of information provided by
management.
Opening balances
I would check that the opening balances are in agreement with the balances in
the previous years audit file. This is for two reasons:
To ensure that any amendments to the previous years closing balance
agreed at audit had been properly recorded in the companys books and
records.
With plant and equipment most audit procedures are applied to
transactions that change the balance. Reliance is placed on audit
procedures performed in previous years in verifying assets brought forward
at the beginning of the year.
(b) Audit procedures additions
Existence
Vouch additions to suppliers invoices.
Examine goods inward notes or evidence confirming delivery of the items
prior to the year end.
Examine purchase orders, requisitions and other evidence, such as Board
approval, that the purchase had been properly authorised.
Physically examine some of the items confirming description and serial
numbers to the invoice.
Completeness
Analyse repairs and maintenance to ensure that no items charged to this
account should not have been capitalised.
Scrutinise the companys capital budget and capital commitments recorded
in the previous years financial statements for details of proposed additions
and enquire as to why any such items are not recorded as additions.
Rights and obligations
Ensure that the purchase documentation assigns ownership rights to the
company.
Valuation
Ensure that the amount recorded as additions is in accordance with the
cost on the purchase invoice including all matters properly included, such
as delivery, but excluding amounts that should not be capitalised, such as
the cost of removal of plant being replaced. Where other costs are
capitalised, such as own labour for assembly and testing, I would verify the
amounts as appropriate.
Presentation and disclosure
Ensure that the items properly meet the definition of plant and equipment
and are properly recorded as such.
(c) Revaluation
Competence and objectivity of the valuer
My prime concern would be that the valuer is an employee of the entity.
Nevertheless, I may be prepared to accept the valuation although I would need to
be satisfied that the valuation has been performed with sufficient objectivity that it
represents sufficient, appropriate audit evidence. This depends on factors such
as the materiality of the amounts involved and the available of corroboratory
evidence. The revaluation is certainly substantial representing a gain of Rs 144m
on property, plant and equipment having a written down value of Rs.603m.
It is a common practice for interim valuations to be undertaken by valuers
employed by the entity providing they are confirmed by less frequent independent
valuations, such as every five years. If this is the practice I would examine the
record of past valuations to see if the employees valuations tended to be
confirmed by the independent valuations.
I would also enquire into the professional qualifications and experience of the
valuer to ensure that he or she is both suitably qualified to perform valuations and
sufficiently experienced in valuations of the type undertaken.
Scope of work
I would obtain a copy of the valuers report and:
check that the valuation given in the report is consistent with the valuation
recorded in the financial statements;
check that the basis of valuation is consistent with an acceptable basis of
financial statement valuations, such as open market value and, in
particular, that it relates to the property as it is and does not anticipate
future uncertain events such as rezoning for planning, new roads etc. and
form a view as to how thoroughly the valuer has undertaken his or her
work.
Although the valuer was an employee of the company I would need to ensure
that no undue restriction was placed on the valuers access to relevant
information having a bearing on the valuation.
Assessing the work of the valuer
When reviewing the work of the valuer I would expect to see the basis of the
valuation explained and justified in the report. Where practicable I could confirm
any data used such as recent transactions involving similar property. I could also
consider the reasonableness of any assumptions made concerning which I have
some knowledge, such as the effect of recent changes in legislation or in the
economic climate.
Conclusion
If I find that:
the valuer is professionally qualified, and sufficiently experienced,
the scope of the work is adequate; and
other evidence corroborates the reliability of the valuation
I would probably be prepared to accept the work of the valuer as an expert
providing sufficient appropriate evidence as to the valuation of the property. My
confidence in the valuation would be enhanced if it were an interim valuation
subject to periodic confirmation by independent valuers.
(d) Accumulated depreciation
According to IAS 8 the correction of errors which are the natural result of
estimates inherent in the accounting process are normally dealt with in the
income statement in the period in which they are identified. This would appear to
be the accountants argument.
An alternative view is that this is a fundamental error and the cumulative
adjustments applicable to prior periods have no bearing on the results of the
current period. In this case, as a prior period adjustment, the benchmark
treatment required by IAS 8 is to adjust the opening balance of retained earnings
of retained earnings and to amend the comparative figures for the previous
accounting period. However, the accountants proposed treatment is consistent
with the allowed alternative treatment providing it is accompanied by additional
pro forma information as required by the benchmark treatment.
70 Sparkle Forever
(a) Audit procedures and reasons in relation to inventory count
Audit procedure Reason
Perform an overall review with client To check that clients physical count
staff to ensure that they are following instructions are being followed as this
the clients physical count instructions. will help to ensure that the count is
Specifically ensure that: complete and accurate.
Inventory is divided into To ensure there is a clear layout of
appropriate sections for recording inventory, ensuring items are not
perhaps by type of jewellery missed.
Staff are counting in pairs with Prevents collusion and provides a
one person checking the inventory check over security of inventory
and another recording. (jewellery is high value) and that the
count sheets are not falsified.
Appropriate checks are in place to To ensure that inventory is not double-
ensure that each item of jewellery counted
is only counted once.
The shop is closed during the To ensure that there is no confusion
count. regarding which items are sold.
Count sheets are pre-numbered. To ensure that no count sheets are
lost.
Obtain a sample of inventory items To ensure that the inventory recorded
already recorded on the count sheets on the count sheets actually exists.
and agree to the jewellery inventory.
71 Bubbles
(a) Audit tests on Stockpop system during the year
(i) There are two main aspects to the audit of the Stockpop system; those
relating to quantities and those relating to costs, in order to rely on the
system as a basis for the figure in the financial statements I would need to
ensure that management had a system for ensuring that:
the system was accurate and up-to-date;
errors were investigated and corrected on a regular basis; and
each item of inventory was counted at least once a year (in practice
items are likely to be counted more often that this as such systems
are often relied on to produce figures for management accounts).
(ii) I would ask management about the procedures for inventory counting and
review the related documentation, including inventory counting instructions,
and form a view as to whether the system was adequate in principle. I
would also review the results of any internal audit work on the system
design (assuming that I considered the internal audit function to be
adequate).
(iii) I would need to obtain evidence relating to the three items noted in (i)
above. I would therefore visit the warehouses during the year, possibly on
a rotational basis, to ensure that the system was being operated in the
manner prescribed.
(iv) I would perform certain preliminary analytical procedures to establish which
warehouses to visit (such as those where the records indicated that large
volumes of inventories were held, warehouses that were experiencing
problems or had experienced problems in the past, or warehouses that
were considered high risk or other reasons). I might use different offices of
my own firm for these purposes, and/or I would enlist the help of internal
audit. I would review the results of the work already performed by internal
audit.
(v) I would ask local staff about the procedures performed, especially about
any variations from the procedures prescribed. I would observe procedures
being performed.
(vi) I would test check records of goods received and goods despatched and
trace them through the Stockpop system to ensure that records were
accurate and input on a timely basis. I would ensure that the correct
corresponding entries for costs had been made in the purchases and sales
systems.
(vii) I would perform my own test checks of inventory and trace my counts
through the Stockpop, sales and purchases systems.
(viii) I would consider using CAATs (computer assisted audit techniques),
including test data and audit software to establish whether, for example, the
system is rejecting entries outside certain pre-determined parameters (cost
per unit for example), and that the system highlights any old inventory, or
any exceptions such as negative inventory quantities.
(ix) I would review all exception reports produced by the system to see if there
were any recurring or old items and to ensure that all errors and exceptions
were being dealt with on a timely basis.
(b) Audit tests on records at year end
(i) I would analytically review the year-end records to establish the overall
quantities and costs of inventories and the quantities and costs of raw
materials and finished goods.
(ii) I would ask management about any problems experienced with the system
at, or close to, the period-end and about how they had been dealt with to
ensure that they had been appropriately resolved.
(iii) I would also ask management about the likely level of write-down of either
raw materials or finished goods (inventory being of inadequate quality or
spoiled, for example). I would compare this with prior years and form an
opinion as to its appropriateness. I would check the calculation of the
allowance for damaged inventory and review exception reports close to the
period-end.
(iv) I would obtain schedules of the costs and quantities to be included in the
financial statements and trace these back to the output of the Stockpop
system noting and substantiating any significant adjustments.
(v) I would enquire as to how accurate cut-off had been achieved. I would
perform cut-off tests on the records by tracing samples of goods received
and despatch notes just before and just after the year-end to the Stockpop,
sales and purchases systems in order to ensure that costs had been
correctly allocated to the correct accounting period. I would also perform
this test in reverse, from the Stockpop, sales and purchases systems
through to goods received and despatch notes.
(vi) I would ensure that the valuation method used by Bubbles was in
accordance with IAS 2 Inventories and that, for example, the system was
adequate to ensure that finished goods included an appropriate element of
labour and overhead costs.
72 ISA 500
(a) Four examples of external confirmations
Four examples of external confirmations are:
Accounts receivable letter
Solicitor letter
Bank report letter
Inventory held by third parties.
(b) Assertions achieved and not achieved by each example (only one example of
each required).
Accounts receivable letter
This letter provides evidence of the existence of the receivable when a reply is
returned from that receivable direct to the auditor.
The letter provides evidence on cut-off because sales or cash receipts recorded
in the incorrect accounting period will have to be reconciled to the balance
provided by the receivable.
The letter does not provide evidence of completeness of the receivables balance
because receivables may not query balances which are understated.
The letter does not provide evidence of the valuation of the receivables balance
because the receivable cannot be expected to list all outstanding balances and
external confirmation of the debt does not mean it will be paid.
Solicitor letter
A solicitor letter provides evidence as to the existence of claims at the period end
as the solicitor will confirm specific claims.
However, the letter does not necessarily confirm the valuation of claims due to
uncertainty about the future or the completeness of any legal claims as solicitors
do not normally provide a list of all claims they prefer to comment only on
claims they are actually asked about.
Bank report letter
A bank confirmation letter provides good evidence on the existence of the
companys bank accounts as the bank has confirmed this information in writing.
A bank letter cannot necessarily be relied on to provide complete or accurate
information. Most banks place a disclaimer on the letter of errors and omissions
excepted indicating that the auditor must review this evidence against other cash
and bank evidence obtained.
Inventory held by third parties
A letter from the third party holding the inventory will provide evidence of the
existence of that inventory because the third party has confirmed this in writing.
However, the letter does not provide evidence regarding the valuation of the
inventory; confirming something exists does not necessarily mean it is in good
condition.
73 Javeria Co
(a) Procedure for obtaining a bank letter
The auditor should consider if a bank letter is required. For the audit of Javeria
Co the letter is required as the company has significant cash transactions and a
loan from the bank.
The auditor will produce an external confirmation letter in accordance with local
audit regulations and practices.
The letter will be sent to the client to sign and authorise disclosure and then it will
be forwarded on to Javerias bank.
Alternatively, the client may already have provided a standard authority for the
bank to respond to a bank letter each year. In this case separate authority would
not be required.
Ideally the letter should be sent before the end of the accounting period to enable
the bank to complete it on a timely basis e.g. at the year-end.
The bank will complete the letter and send it back directly to the auditor.
Audit procedures on the bank letter include:
Agree the balances for each bank account to the relevant bank
reconciliation and the year-end balance in the financial statements.
Agree total interest charges on the letter to the interest expense account in
the general ledger.
For any details of loans, ensure repayment terms are correctly disclosed in
the financial statements between current and non-current liabilities.
(b) Substantive procedures for the audit of bank balances
(1) Obtain a copy of the year-end trial balance.
Agree the bank balance on the trial balance to
the year-end bank balance on the computer system, and
the balance on the financial statements.
(2) Obtain a copy of Javeria Co.s bank reconciliation.
Cast the reconciliation
Agree the bank balance to the trial balance.
Agree the bank statement balance to the year-end bank statement.
Agree any unpresented lodgements to the bank statement after the
end of the year
Agree any unpresented cheques or similar expenses to the cash
book before the end of the year and the bank statements after the
end of the year.
74 Porridge
(a) Inherent risk trade payables
In my audit of trade payables I would regard completeness as presenting the
greatest level of inherent risk for the following reasons:
(i) Management has an incentive to understate purchases and thus payables
in order to improve profits. This applies not only to senior management but
to line managers who are close to budgetary limits on certain expenditures
and are under pressure to withhold recording of suppliers invoices until
after the year end.
(ii) Senior management may be under pressure to understate payables in
order to improve the companys apparent liquidity. This would be the case if
the company were seeking to raise additional finance or to renew existing
borrowing agreements. The more liquid the statement of financial position
shows the company to be the more favourable the terms are likely to be.
(iii) Principal control procedures placed in operation by the company relate to
the occurrence assertion in order to prevent improper purchasing by
employees or overpayments to suppliers.
(iv) The primary source of information initiating recognition of a liability is the
suppliers invoice. During the year the company has no incentive to
accelerate the receipt of suppliers invoices. This means that, as at the end
of the reporting period, there could be outstanding claims not yet invoiced
by suppliers which the entity has no formalised procedures for identifying
promptly.
(v) Valuation is rarely a problem except in complex contractual situations
where the amount due is contingent upon some future event such as a
volume discount dependent on total purchases at some future date
exceeding some agreed amount.
(b) Accounts payable circularisation
In my audit of Porridge I would not normally undertake a payables circularisation
for the following reasons.
(i) For payables, much of the documentary evidence available is in the form of
third party sourced suppliers invoices and statements, in contrast to
accounts receivable for which most of the available documentation is entity
prepared.
(ii) Examination of documentary evidence is usually a cheaper form of
substantive evidence than external confirmation.
(iii) Although examination of third party sourced documentary evidence is less
reliable than external confirmations received directly by the auditor, it
usually provides sufficient evidence.
I would, however, consider an accounts payable circularisation in the following
situations.
(iv) A substantial proportion of the companys suppliers does not issue monthly
statements.
(v) Statements from suppliers with whom the company does substantial
business are unexpectedly unavailable for the last month of the year.
(vi) Only fax or photocopies of statements are available whose authenticity is
doubtful.
(vii) I have reasons to suspect that the company, or a member of the companys
staff, may be deliberately understating liabilities and there is a possibility
that some of the suppliers statements may be forgeries given the ease of
replicating documents with modern scanning and desk top publishing
technology. Assessment of control risk as slightly less than high, the limited
segregation of duties, and the failure to routinely reconcile all statements
with the accounts payable ledger mean that this is not necessarily a remote
possibility.
(c) Substantive procedures applicable to production payables
Initial procedures
(i) Obtain a list of such accounts payable and test its accuracy by testing it to
and from the computer records and adding it and agreeing it to the control
account. (If production payables are not segregated from other payables
this procedure will apply to all payables.)
Analytical procedures
(ii) Perform analytical procedures on accounts payable and compare the
results with expectations:
compare current years balance with previous years;
compare the average age of payables with previous years;
compare gross profit with previous year and industry average.
Tests of details of transactions
(iii) Ascertain cut-off data for goods received notes (GRNs) (probably obtained
during attendance at the physical inventory count).
(iv) Check cut-off by obtaining GRNs for two weeks prior to the year end and:
checking their numerical continuity;
tracing GRNs to the purchases recorded before 31 October or the
accrual journal entry.
(v) For a smaller sample I would verify the existence of recorded purchases
prior to the year end by vouching a sample of purchases and purchase
accruals to GRNs in the sequence issued prior to the year end.
(vi) For a sample of the closing accruals I would verify the amount of the
accrual by vouching the amount to a subsequently received suppliers
invoice.
Tests of details of balances
(vii) Select a sample of accounts payable using criteria such as:
all suppliers from whom the entity bought more than 1% of its
purchases during the year;
a random sample of all other suppliers including nil and credit
balances;
(viii) For each supplier in the sample I would compare the balance with the
suppliers statement and investigate differences.
(ix) If any suppliers statements were unavailable I would consider confirming
the balance directly with the supplier.
75 Trembridge Engineering
(a) Checking suppliers' statements to the balances on the purchase ledger
(i) Assess the system of control in the purchases system and its reliability. If
discrepancies are found in the audit tests, increase the sample of items
checked.
If the company's staff regularly perform checks on the supplier's statements
then perform fewer checks and instead rely on their work as evidence.
(ii) Generally, check a larger proportion of suppliers where the balances are
large, or where there are a large number of transactions. If no statements
are available from a particular supplier then consider telephoning to confirm
the balance instead.
(iii) If the balance on the supplier's statement agrees to the balance on the
purchase ledger then no further work needs to be carried out.
(iv) If differences arise they will be due to a number of occurrences, such as:
goods in transit;
cash in transit; and
other differences such as incorrect treatment of discounts.
(v) Goods in transit are invoices on the supplier's statement which are not on
the customer's purchase ledger. If these differences have been included in
purchase accruals no further checks are necessary. However, for large
value items, check the goods received note (GRN) to ensure they were
received before the year-end.
(vi) Cash in transit may be verified by checking against the following month's
suppliers statement.
(vii) Other differences, such as discounts, need only be investigated if they are
material.
(b) Verification of purchases cut-off
In order to complete an adequate cut-off test for purchases and goods inwards
the ideal starting point is the population of goods received notes.
A sample should be selected that includes items from both before and after the
year end.
For each item, it will be ensured that the date included in inventory, the purchase
invoice date and the date posted to the purchase ledger all correspond. For
example a goods received note dated before the year end means the following.
(i) the items should be in inventory;
(ii) the purchase invoice should be included in the income statement/statement
of comprehensive income and dated before the year end;
(iii) the purchase ledger should include the purchase invoice before the year
end.
A cut-off error will exist if the items are not recognised in the correct accounting
period.
(c) Audit work on sundry payables and accruals
(i) Compare to the previous year's figures and identify any material
fluctuations.
(ii) Net wages accruals and tax/social insurance payables can be verified by
referring to the monthly payroll. Normally it would be expected that one
month of each may be outstanding.
(iii) The sales tax payable is verified by agreeing the amount to the tax return
and then agreeing the tax return calculation by checking input tax to the
purchase day book, output tax to the sales day book and any sundry
amounts to either cash book or petty cash book
(iv) Accrued interest on the bank loan and overdraft will be checked to the bank
letter.
(v) Other accruals will be checked to invoices received after the year-end (or if
no invoices have been received after the year end, then invoices received
before the year end will be used).
(vi) Consider whether there are any circumstances which have arisen in the
year which may result in new accruals, and check if these accruals have
been included.
77 Heidi Co
(a) (i) Benefits of using audit software
Standard systems at client
The same computerised systems and programs as used in all 25 branches
of Heidi Co. This means that the same audit software can be used in each
location providing significant time savings compared to the situation where
client systems are different in each location.
Use actual computer files not copies or printouts
Use of audit software means that the Heidi Co.s actual inventory files can
be tested rather than having to rely on printouts or screen images. The
latter could be incorrect, by accident or by deliberate mistake. The audit
firm will have more confidence that the real files have been tested.
Test more items
Use of software will mean that more inventory records can be tested it is
possible that all product lines could be tested for obsolescence rather than
a sample using manual techniques. The auditor will therefore gain more
evidence and have greater confidence that inventory is valued correctly.
Cost
The relative cost of using audit software decreases the more years that
software is used. Any cost overruns this year could be offset against the
audit fees in future years when the actual expense will be less.
(ii) Problems on the audit of Heidi
Timescale six week reporting deadline audit planning
The audit report is due to be signed six weeks after the year end. This means
that there will be considerable pressure on the auditor to complete audit work
without compromising standards by rushing procedures.
This problem can be overcome by careful planning of the audit, use of
experienced staff and ensuring other staff such as second partner reviews are
booked well in advance.
Timescale six week reporting deadline software issues
The audit report is due to be signed about six weeks after the year end. This
means that there is little time to write and test audit software, let alone use the
software and evaluate the results of testing.
This problem can be alleviated by careful planning. Access to Heidi Co.s
software and data files must be obtained as soon as possible and work
commenced on tailoring Cal & Co.s software following this. Specialist computer
audit staff should be booked as soon as possible to perform this work.
First year audit costs
The relative costs of an audit in the first year at a client tend to be greater due to
the additional work of ascertaining client systems. This means that Cal & Co may
have a limited budget to document systems including computer systems.
This problem can be alleviated to some extent again by good audit planning. The
manager must also monitor the audit process carefully, ensuring that any
additional work caused by the client not providing access to systems information
including computer systems is identified and added to the total billing cost of the
audit.
Staff holidays
Most of the audit work will be carried out in July, which is also the month when
many of Cal & Co staff take their annual holiday. This means that there will be a
shortage of audit staff, particularly as audit work for Heidi Co is being booked
with little notice.
The problem can be alleviated by booking staff as soon as possible and then
identifying any shortages. Where necessary, staff may be borrowed from other
offices or even different countries on a secondment basis where shortages are
acute.
Non-standard systems
Heidi Co.s computer software is non-standard, having been written specifically
for the organisation. This means that more time will be necessary to understand
the system than if standard systems were used.
This problem can be alleviated either by obtaining documentation from the client
or by approaching the software house (with Heidi Co.s permission) to see if they
can assist with provision of information on data structures for the inventory
systems. Provision of this information will decrease the time taken to tailor audit
software for use in Heidi Co.
Issues of live testing
Cal & Co has been informed that inventory systems must be tested on a live
basis. This increases the risk of accidental amendment or deletion of client data
systems compared to testing copy files.
To limit the possibility of damage to client systems, Cal & Co can consider
performing inventory testing on days when Heidi Co is not operating e.g.
weekends. At the worst, backups of data files taken from the previous day can be
re-installed when Cal & Co.s testing is complete.
Computer systems
The client has 25 locations, with each location maintaining its own computer
system. It is possible that computer systems are not common across the client
due to amendments made at the branch level.
This problem can be overcome to some extent by asking staff at each branch
whether systems have been amended and focusing audit work on material
branches.
Usefulness of audit software
The use of audit software at Heidi Co does appear to have significant problems
this year. This means that even if the audit software is ready, there may still be
some risk of incorrect conclusions being derived due to lack of testing, etc.
This problem can be alleviated by seriously considering the possibility of using a
manual audit this year. The manager may need to investigate whether a manual
audit is feasible and if so whether it could be completed within the necessary
timescale with minimal audit risk.
(b) Reliance on internal audit documentation
There are two issues to consider; the ability of internal audit to produce the
documentation and the actual accuracy of the documentation itself.
The ability of the internal audit department to produce the documentation can be
determined by:
Ensuring that the department has staff who have appropriate qualifications.
Provision of a relevant qualification e.g. membership of a computer related
institute would be appropriate.
78 Zeedin Co
(a) Audit procedures procurement and purchases system
Procedure Reason for procedure
Obtain a sample of e-mails from the Ensure that all orders are recorded and
store managers computer. Trace that the order details are correct.
details to the order database.
Obtain a sample of orders in the To confirm that all goods ordered were
order database, record details of the received.
order and trace to the paper delivery
note filed in the goods inwards
department.
For the sample of orders above, To confirm that goods received were
agree to the inventory database. completely and accurately recorded in the
inventory database.
Obtain a sample of paper delivery To confirm that inventory received has
notes and agree to the order been recorded in Zeedins accounting
database and inventory database. system and that liabilities are therefore not
understated.
Within the purchase database, obtain To confirm that purchase invoice details
a sample of invoices recorded in the have been correctly recorded in the
purchase day book, agree details of payables database.
price and supplier to the purchase
invoice record in the database.
For a sample of purchase invoices in To confirm that the purchase liability has
the purchase day book, agree details been recorded only for goods actually
to the delivery notes for items on that received.
invoice.
For the sample of purchase invoices To confirm that the liability has been
above, agree details to the individual recorded in the correct payables account.
payables account in the payables
database.
Select increases in the purchase To ensure that invoiced goods have been
daybook and vouch to the order ordered, confirming the occurrence
database. assertion.
Using computer-assisted audit To confirm the completeness and accuracy
techniques, cast the purchase day of the liability recorded in the general
book and agree total of liability ledger.
incurred to the general ledger.
79 Sahito Co
(a) Prior year internal control questionnaires
Obtain the audit file from last years audit. Ensure that the documentation on
the sales system is complete. Review the audit file for indications of
weaknesses in the sales system and note these for investigation this year.
Obtain system documentation from the client. Review this to identify any
changes made in the last 12 months.
Interview client staff to ascertain whether systems have changed this year
and to ensure that the internal control questionnaires produced last year are
correct.
Perform walk-through checks. Trace a few transactions through the sales
system to ensure that the internal control questionnaires on the audit file are
accurate and can be relied upon to produce the audit programmes for this
year.
During walk-through checks, ensure that the controls documented in the
system notes are actually working, for example, verifying that documents are
signed as indicated in the notes.
(b) Tests of control
Test of control Reason for test
Review a sample of goods despatch Ensures that the goods despatched
notes (GDN) for signatures of the are correctly recorded on the GDNs.
goods despatch staff and customer.
Ensures that the GDN details have
Review a sample of GDNs for
been entered onto the computer
signature of the accounts staff.
system.
Observe despatch system ensuring Ensures that goods are only
Sahito staff have seen the customers despatched to authorised customers.
identification card prior to goods being
loaded into customers vans.
80 Bashir Co
(a) Control Objectives wages system
Employees are only paid for work that they have done
Gross pay has been calculated correctly
Gross pay has been authorised
Net pay has been calculated correctly
Gross and net pay have been recorded accurately in the general ledger
Only genuine employees are paid
Correct amounts are paid to taxation authorities.
(b) The Directors
Bashir Co
1701 Any Street
Big Town 12345
Pakistan
3 December 20X3
Dear Sirs
Management letter
We write to bring to your attention weaknesses in your companys internal control
systems and provide recommendations to alleviate those weaknesses.
(i) Weakness: (ii) Possible effect: (iii) Recommendation:
The logging in Employees could bring The shift manager should
process for cards for absent reconcile the number of
employees is not employees to the workers physically present
monitored. assembly plant and scan on the production line with
that card for the employee; the computerised record of
If you require any further information on the above, please do not hesitate to
contact us.
Yours faithfully
Global Audit Co.
(d)
Audit procedure Benefit to auditor in testing
accuracy of time recording system
Confirmation
Confirmation is the process of Obtaining information from a third
obtaining a representation of party will be difficult. The
information or of an existing condition manufacturer of the time recording
directly from a third party. system could be approached to
discuss known errors with the system;
however, information provided may be
limited by the need to protect the
manufacturers integrity.
It is therefore unlikely that the auditor
will benefit from this procedure.
Observation
This procedure involves watching a Testing will be limited to ensuring all
procedure being performed by others shift-workers actually clock in and out
in this case watching shift-workers when they arrive to and depart from
using the time recording system. work. The procedure has limited use
as it only confirms it worked when
shift-workers were observed. It also
cannot confirm that hours have been
recorded accurately.
Inquiry
Inquiry involves obtaining information Inquiry only confirms that shift-
from client staff or external sources. workers confirm they clock-in or out. It
does not directly confirm the action
actually happened or the accuracy of
the recording of hours worked.
Recalculation
Recalculation means re-checking the Recalculation can confirm the hours
arithmetical accuracy of the clients worked are correctly calculated as the
records; in this case the hours worked difference between the clocking in and
by the time-recording system. out times in the time recording
system. When used with
reperformance evidence this will
confirm the overall accuracy of the
time recording system.
Reperformance
This is the auditors independent If the auditor notes the time of clocking
execution of procedures or controls in and out, then these times can be
that were originally performed as part agreed to the time recording system
of the entitys internal control. confirming the accuracy of recording
(or confirm that client staff actually
perform this control). Reperformance
is therefore a good source of audit
evidence.
Analytical procedures
Analytical procedures involve This procedure will be useful for the
comparing financial or non-financial auditor as the total time recorded for
data for plausible relationships. each employee should be standard
hours plus any estimate of the
overtime worked.
81 Analytical procedures
(a) (i) Analytical procedures include the consideration of comparisons of the
entitys financial information with, for example:
82 Auditor responsibility
The statement of responsibility should state the following:
the auditor plans and performs the audit to obtain reasonable assurance
whether the financial statements are free from material misstatement.
(iv) That an audit involves performing procedures to obtain audit evidence about the
amounts and disclosures in the financial statements.
(v) That while selecting the procedures to be performed the auditor exercises
judgment, including the assessment of risks of material misstatements and
whether due to fraud or error.
(vi) In making the risk assessment the auditor considers internal controls relevant to
fair presentation of financial statements in order to design audit procedures that
are appropriate in the circumstances but not for the purpose of expressing an
opinion on the effectiveness of the entitys internal control.
(viii) The auditor believes that the audit evidence the auditor has obtained is sufficient
and appropriate to provide a basis for the auditors opinion.
83 Al-Badr
(i) Audit report should be addressed to the members of the company instead of
directors.
(ii) In the introductory paragraph and opinion paragraph, the word cash flow
statement has been omitted.
(iii) In the opinion paragraph, the words its cash flows have been omitted.
(iv) The paragraph explaining the responsibilities of management and auditors has
been omitted. This paragraph should come after the introductory paragraph.
(v) After the statement We conducted our audit in accordance with the auditing
standards in the audit responsibility paragraph, the words as applicable in
Pakistan have been omitted.
(vi) In the auditors responsibility paragraph, the words on test basis have been
omitted.
(vii) In the auditors responsibility paragraph, the word all estimates.... should be
replaced with the words significant estimates.
(viii) The opinion paragraph whether proper books of account have been kept by the
company as required under the Companies Ordinance, 1984, has been omitted.
(ix) In paragraph (b) of the opinion, the financial statements have incorrectly been
referred to have been drawn up in accordance with International Financial
Reporting Standards instead of the requirement i.e. approved accounting
standards as applicable in Pakistan.
(x) Name of the engagement partner has not been mentioned.
88 Hafiz Limited
(i) In this case of reporting on more than one set of financial statements,the auditor
will need to determine that whether the reporting requirements of other
framework are acceptable to the auditor in the prevailing circumstances.
Impact on Audit Report
If the framework is acceptable then the auditor will include an other matter
paragraph in the auditors report, which will include a reference that he has also
issued an audit report on another set financial statements which has been
prepared as per the reporting requirements of a different accounting framework.
(ii) Evaluate the reasons provided by the management for making this
payment, to assess whether the amount paid in the circumstances was
reasonable.
If the management is unable to provide satisfactory explanation it may be
indicative of the following:
x That the amount paid was not for the purposes of the companys
business.
x There was a non-compliance with a law as has been unofficially
claimed by an employee.
In either case, the auditor should consider the impact thereof on his initial
risk assessment and to revise the audit procedures accordingly.
The indication of non-compliance with laws and regulations may require the
auditor to consider the potential financial consequences of the non-
compliance, on the financial statements including, the imposition of fines
and penalties and the impact thereof on the companys ability to carry out its
business.
The auditor may discuss his findings with those charged with governance if
the auditor considers that they will be able to provide with additional audit
evidence in relation to the transaction.
If management or those charged with governance do not provide sufficient
appropriate audit information to the auditor, the auditor may consider it
appropriate to consult with the entitys legal counsel or auditors own legal
counsel if the auditor is not satisfied with the entitys legal counsel.
The auditor may also consider whether it is necessary for him under the
relevant laws and regulations to report the matter to the concerned
authorities.
Impact on Audit Report
If the auditor concludes that the non compliance has a material effect on the financial
statements which has not been adequately reflected therein, the auditor shall express
a qualified opinion or an adverse opinion.
If the auditor concludes that the expenditure incurred is not for the purpose of the
business, the auditor shall express a qualified opinion or an adverse opinion
depending upon the materiality of the transaction.
If the auditor is precluded by management or those charged with governance from
obtaining sufficient appropriate audit evidence to evaluate whether non-compliance
that may be material to the financial statements has, or is likely to have occurred, the
auditor shall express a qualified opinion or disclaim an opinion on account of scope
limitation.
(i) In accordance with IAS 16, Property, Plant and Equipment, if a policy of
revaluation is to be applied, it should be applied to all the non current assets
in a particular class of assets.
(ii) Since compliance with (i) above is not possible, the auditor should advise
the client to not to change the accounting policy and state the values of the
property at cost.
(iii) In case of disagreement the auditor may consider issuing a qualified report.
91 Ranjha Limited
(a) (i) Significant matter
92 Pervasive effects
(a) Pervasive is a term used to describe the effects of misstatement on the financial
statements or the possible effects thereon if any misstatement remains
undetected due to the auditors inability to obtain sufficient appropriate audit
evidence.
Pervasive effects on the financial statements are those that, in the auditors
judgments:
(i) are not confined to specific elements, account or items of the financial
statements,
(b) (i) Issuance of bank guarantee after the year end does not require any
adjustment or disclosure. Therefore, there will be no effect on the audit
report on this issue.
(ii) The audit report shall state that Zakat deductible at source under the
Zakat & Ushr Ordinance, 1980, was deducted and deposited in the
Central Zakat Fund established under section 7 of that Ordinance.
(iii) The auditor should consider the materiality of the amount. If the amount is
material, the auditor should express a qualified or adverse opinion.
(iv) The audit report shall mention the exception to the consistent
application of accounting policies and whether the auditor concurs
with it or not.
The financial statements shall be adjusted accordingly and the effect
of change in estimate shall be disclosed in the notes to the financial
statements unless the differences are material and auditor has
reasons to differ with the reviewed estimate. There would be no
impact on the audit report on this issue.
97 Written representations
Under the following situations, the auditor would have doubt as to the reliability of written
representation:
(a) When the auditor has concerns about the competence, integrity, ethical values or
diligence of management, or about its commitment to or enforcement of these.
(b) When written representations are inconsistent with other audit evidence obtained.
Course of action in situation (a)
(i) The auditor shall determine the effect that such concerns may have on the
reliability of representations and audit evidence in general.
(ii) If the auditor concludes that the risks related to management representations on
the financial statements is such that an audit cannot be conducted, the auditor may
consider withdrawing from the engagement
Course of action in situation (b)
(i) The auditor may consider whether the risk assessment remains appropriate and, if
not, revise the risk assessment and determine the nature, timing and extent of
further audit procedures to respond to the assessed risks.
(ii) If the matter remains unresolved, the auditor shall reconsider the assessment of
the competence, integrity, ethical values or diligence of management, or of its
commitment to or enforcement of these, and shall determine the effect that this
may have on the reliability of other representations and audit evidence in general.
(iii) If the auditor concludes that the written representations are not reliable, the auditor
shall take appropriate actions, including determining the possible effect on the
opinion in the auditors report.
98 Shahrukh and Co
(i) In the introductory paragraph the word Income and expenditure account
should be replaced with profit and loss account".
(ii) In the introductory paragraph the phrase to the best of our knowledge and
belief is to be inserted before the phrase were necessary for the purpose of
an audit.
(iii) In the responsibility paragraph the word auditing standard is to be replaced
with accounting standard.
(iv) In the responsibility paragraph the phrase of the fourth schedule is to be
omitted.
(v) At the end of responsibility paragraph the phrase; Our responsibility is to audit
these statements is to be replaced with the phrase Our responsibility is to
express an opinion on these statements based on our audit.
(vi) In the scope paragraph the phrase and limited is incorrect and be omitted.
(vii) In the scope paragraph the word material be added before the word
misstatement.
(viii) In the scope paragraph the phrase on a test basis should be added before
the phrase evidence supporting the amounts and disclosures in the above
said statements.
(ix) In point (a) the phrase as required by the Companies Ordinance 1984 be
added.
(x) In para (b) point (ii) the phrase was in accordance with the objects of the
Company be replaced with was for the purpose of the Companys business
(xi) In para (b) point (iii) the phrase was for the purpose of the Companys
business be replaced with were in accordance with the objects of the
Company
(xii) In para (c) the phrase of the profit or loss, its cash flows and changes in equity
for the year then ended; be added at the end.
(xiii) The place of signing of accounts is to be mentioned after the signature of the
firm
(xiv) Name of the engagement partner has not been mentioned.
99 Kazmi-Wassan
(a) Purpose of a written representation letter
Written representations are a form of audit evidence. They are usually contained
in a letter, written by the companys directors and sent to the auditor, just prior to
the completion of audit work and before the audit report is signed.
Representations are required for two reasons:
firstly, so the directors can acknowledge their collective responsibility for
the preparation of the financial statements and to confirm that they have
approved those statements;
secondly, to confirm any matters, which are material to the financial
statements where representations are crucial to obtaining sufficient and
appropriate audit evidence.
In the latter situation, other forms of audit evidence are normally unavailable
because knowledge of the facts is confined to management and the matter is one
of judgement or opinion.
Obtaining representations does not mean that other evidence does not have to
be obtained. Audit evidence will still be collected and the representation will
support that evidence. Any contradiction between sources of evidence should,
as always, be investigated.
(b) Matters
(i) Tigers Purr
The amount of the claim is material being 50% of profit before taxation.
There is also a lack of definite supporting evidence for the claim. The two
main pieces of evidence available are the claim from Tigers Purr itself and
the legal advice from Kazmi-Wassans solicitors. However, any claim
amount cannot be accurately determined because the dispute has not been
settled.
The directors have stated that they believe the claim not to be justified,
which is one possible outcome of the dispute. However, in order to obtain
sufficient evidence to show how the treatment of the potential claim was
decided for the financial statements, the auditor must obtain this opinion in
writing. Reference must therefore be made to the claim in the
representation letter.
Paragraph for inclusion in representation letter.
A legal claim against Kazmi-Wassan by Tigers Purr has been estimated at
Rs 4 million by Tigers Purr. However, the directors are of the opinion that
the claim is not justified on the grounds of breach of product specification.
No provision has been made in the financial statements, although
disclosure of the situation is adequate. No similar claims have been
received or are expected to be received.
(ii) Depreciation
This matter is unlikely to be included in the letter of representation because
the auditor appears to have obtained sufficient evidence to confirm the
accounting treatment. The lack of profit or loss on sale confirms that the
depreciation charge is appropriate large profits would indicate over-
depreciation and large losses, under-depreciation. The amount also meets
industry standards confirming the Kazmi-Wassans accounting policy is
acceptable. Including the point in the representation letter is inappropriate
because the matter is not crucial and does not appear to be based on
judgment or opinion. The only opinion here appears to be that of the auditor
unless the feelings can be turned into some appropriate audit evidence,
the matter should be closed.
(c) Lack of representation letter
The auditor may take the following actions:
(i) Discuss the situation with the directors to try and resolve the issue that the
directors have raised. The auditor will need to explain the need for the
representation letter again (and note that the signing of the letter was
mentioned in the engagement letter).
(ii) Ascertain exact reasons why the directors will not sign the letter. Consider
whether amendments can be made to the letter to incorporate the directors
concerns that will still provide the auditor with appropriate and sufficient
audit evidence.
(iii) The discussion must clearly explain the fact that if the auditor does not
receive sufficient and appropriate audit evidence, then the audit report will
have to be qualified.
The reason for the audit qualification will be uncertainty regarding the
amounts and disclosures in the financial statements.
(iv) Even if the letter is subsequently signed, the auditor must still evaluate the
reliability of the evidence. If, in the auditors opinion, the letter no longer
provides sufficient or reliable evidence, then a qualification may still be
required.
100 RK Resourcing
(a) Audit procedures to be used prior to the audit report being signed
Reviewing procedures established by management to try and ensure that
subsequent events are identified.
Reading minutes of the meetings of directors, the audit committee and
shareholders and enquiring into unusual items.
Obtaining and reading the companys latest interim accounts as well as any
budgets and cash flow forecasts.
Obtaining additional evidence if possible from the companys lawyers
concerning litigation and claims.
Asking management as to whether any subsequent events have occurred
such as
x New borrowing commitments
x Significant sales of assets
x New shares or debentures issued
x Assets being destroyed by flood, fire etc. or impounded by the
government
x Unusual accounting adjustments made or being contemplated
Checking whether any events have occurred that could call into question
the validity of the going concern assumption.
(b) The three dates
15 August 20X3
(i) Adjusting or non-adjusting?
The bankruptcy of a major customer provides additional evidence of
conditions existing at the end of the reporting period. The customer will not
be able to pay debts due, therefore receivables are overstated and the bad
debt expense in the profit and loss account is understated. An adjustment
for the amount of the receivable should be made in the financial
statements.
(iv) Stating that time was a factor in obtaining information and explanations for
the audit is not correct as this implies some factor which could have been
avoided and that the audit may therefore be incomplete. The auditor has to
plan the audit carefully and ensure that all the information and explanations
considered necessary are obtained to form an opinion, not simply stop work
when time runs out.
(v) The auditor does not confirm that the financial statements are free from
material misstatement as this implies a degree of accuracy that the auditor
simply cannot provide. Making the statement could also leave the auditor
liable to claims from members or third parties should errors be found in the
financial statements later. Rather than make such a categorical statement,
the correct wording from ISA 700 states that the auditor provides
reasonable assurance that the financial statements are free from material
misstatement, which clearly implies that audit techniques are limited.
(vi) The disclaimer regarding errors appears to be useful in that it limits the
auditor's liability. However, it does not belong in the auditors responsibility
paragraph as it appears to severely limit the auditor's responsibilities stating
that the directors are responsible for all errors. Managements responsibility
is also clearly outlined in another section of the report, and this statement
also appears to extend those responsibilities making the audit report overall
less clear. This could also imply that the auditor has done little or no work.
103 Karim
In the above situation the auditor should carry out the following procedures:
(i) He should inquire whether the management has changed its assessment of the
entitys ability to continue as a going concern.
(ii) If on account of the above inquiry or on account of his own assessment of the
situation the auditor concludes that the conditions cast significant doubts about
the entitys ability to continue as a going concern, he should:
Inquire the management about its future plans, the feasibility of these
plans and whether management believes that the outcome of such plans
will improve the situation.
Consider the adequacy of the disclosure of such matters in the financial
information
(iii) The auditor should consider whether the note given by the management
adequately discloses the uncertainty as regards the entitys ability to continue
as a going concern.
(iv) If he assesses that the note is adequate, the auditor should give an emphasis
of the matter paragraph.
(v) If adequate disclosure is not made in the interim financial information, the
auditor should express a qualified or adverse opinion, as appropriate. The
report should include specific reference to the fact that there is such a material
uncertainty.
104 IFI
Procedures which an auditor may perform to update the understanding of the entity
and its environment for an engagement to review interim financial information
includes the following:
(a) Reading the documentation, to the extent necessary, of the preceding years
audit and reviews of prior interim period(s) of the current year and corresponding
interim period(s) of the prior year, to enable the auditor to identify matters that
may affect the current-period interim financial information.
(b) Considering any significant risks, including the risk of management override of
controls that were identified in the audit of the prior years financial statements.
(c) Reading the most recent annual and comparable prior period interim financial
information.
(d) Considering materiality with reference to the applicable financial reporting
framework as it relates to interim financial information to assist in determining
the nature and extent of the procedures to be performed and evaluating the
effect of misstatements.
(e) Considering the nature of any corrected material misstatements and any
identified uncorrected immaterial misstatements in the prior years financial
statements.
(f) Considering significant financial accounting and reporting matters that may be of
continuing significance such as material weaknesses in internal control.
(g) Considering the results of any audit procedures performed with respect to the
current years financial statements.
(h) Considering the results of any internal audit performed and the subsequent
actions taken by management.
(i) Inquiring of management about the results of managements assessment of the
risk that the interim financial information may be materially misstated as a result
of fraud.
(j) Inquiring of management about the effect of changes in the entitys business
activities.
(k) Inquiring of management about any significant changes in internal control and
the potential effect of any such changes on the preparation of interim financial
information.
(l) Inquiring of management of the process by which the interim financial
information has been prepared and the reliability of the underlying accounting
records to which the interim financial information is agreed or reconciled.
2015
AUDIT AND
ASSURANCE
QUESTION BANK