Audit and Assurance (Int) - SQB

ACCA
PAPER F8
AUDIT AND ASSURANCE

(INTERNATIONAL)
STUDY QUESTION BANK
For Examinations to June 2015
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STUDY QUESTION BANK AUDIT AND ASSURANCE (F8)
CONTENTS
Question Page Answer Marks Date worked
EXTERNAL AUDIT
1 International auditing 1 1001 16

2 ISA 200 1 1002 20
CORPORATE GOVERNANCE
3 Audit committee 1 1003 20
PROFESSIONAL CODES OF ETHICS AND CONDUCT
4 Eastfield Distributors 2 1007 20

5 Abel & Co (ACCA D00) 3 1010 20
6 Professional ethics (ACCA PP01) 3 1012 20
AUDIT APPOINTMENT
7 Viswa (ACCA J04) 4 1014 20

8 Carling 5 1016 15
DOCUMENTATION
9 Working papers 5 1019 20
AUDIT PLANNING
10 Planning documentation 6 1023 20
UNDERSTANDING THE ENTITY
11 Norbert 6 1025 20
12 Audit risk 7 1028 20
13 Hivex (ACCA J03) 7 1032 20
FRAUD, LAWS AND REGULATIONS
14 Fraud and error (ACCA D04) 8 1034 20
TESTS OF CONTROL
15 Knits 9 1037 20
16 Ibson 10 1041 20
17 Eastwood engineering (ACCA J98) 11 1043 20
18 SHW (ACCA J10) 12 1045 20
AUDIT EVIDENCE
19 Sources of audit evidence 13 1047 15
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AUDIT AND ASSURANCE (F8) STUDY QUESTION BANK
ANALYTICAL PROCEDURES
20 Delta 13 1050 20
21 Zak Co (ACCA J08) 14 1053 20
ACCOUNTING ESTIMATES
22 Accounting estimates 15 1055 15

23 Estimates 15 1057 20
WRITTEN REPRESENTATIONS
24 Letter of representation (ACCA J02) 16 1059 20
COMPUTER-ASSISTED AUDIT TECHNIQUES
25 Methods of evidence gathering (ACCA J04) 16 1061 20

26 Porthos (ACCA D05) 17 1064 20
NON-CURRENT ASSETS
27 Insurance Brokers (ACCA J95) 17 1066 20
INVENTORY
28 Basis of valuation 18 1068 20

29 Rocks Forever (ACCA J08) 19 1071 20
30 Redburn (ACCA D09) 19 1073 30
EXTERNAL CONFIRMATIONS, RECEIVABLES AND SALES
31 Spondon (ACCA D95) 20 1078 20

32 Cambridge 21 1080 14
33 Tracey Transporters (ACCA J05) 21 1082 20
34 B-Star (ACCA J09) 22 1084 30
LOANS, BANK AND CASH
35 Cromwell 23 1087 20
LIABILITIES, PROVISIONS AND CONTINGENCIES
36 Company A (ACCA D02) 24 1090 20
SMALL BUSINESS AND NOT-FOR-PROFIT ORGANISATIONS
37 Welfare Help for the Aged Trust (WHAT) 24 1092 20

38 Audit of small businesses 25 1095 20
AUDIT FINALISATION
39 Calva (ACCA D03) 25 1097 20

40 OilRakers (ACCA D05) 26 1099 20
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THE AUDITORS REPORT ON FINANCIAL STATEMENTS
41 Audit scope 27 1102 20

42 Theta 27 1104 16
43 Hood Enterprises (ACCA J05) 28 1106 20
GOING CONCERN
44 Mowbray Computers (ACCA J94) 29 1108 20

45 Green Co (ACCA J07) 29 1110 20
INTERNAL AUDIT
46 MonteHodge Co (ACCA J08) 30 1113 20
USING THE WORK OF INTERNAL AUDIT
47 Brampton Co (ACCA D09) 31 1115 20
POINT DEVELOPMENT EXERCISES
48 Quick questions 31 1118 15

49 Jasper, Ruby, Garnet & Emerald 32 1120 12
50 Burton Housing 34 1122 20
FURTHER PRACTICE QUESTIONS
51 Documentation and engagement letters (ACCA J11) 37 1123 10

52 Components and elements (ACCA D11) 37 1124 10
53 Parker (ACCA J05) Audit planning 38 1126 20
54 Smoothbrush (ACCA J10) 39 1128 30
55 Chuck Industries Co (ACCA D11) 40 1133 30
56 BearsWorld (ACCA J05) Audit evidence 42 1137 20
57 Reddy (ACCA D00) Audit finalisation 42 1139 20
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Question 1 INTERNATIONAL AUDITING
The International Audit and Assurance Standards Board (IAASB) is authorised to issue International
Standards on Auditing (ISAs).
Required:
(a) Define an audit. (2 marks)

(b) Briefly explain the five Fundamental Principles to be followed by professional
accountants. (5 marks)
(c) State the general principles of an audit of historic financial statements. (4 marks)
(d) Describe the authority of International Standards on Auditing. (5 marks)
(16 marks)
Question 2 ISA 200
ISA 200 Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance
with International Standards on Auditing deals with, amongst other matters, the responsibility for
financial statements and the concept of reasonable assurance.
In general, ISA 200 considers that an audit in accordance with ISAs is designed to provide reasonable
assurance that the financial statements taken as a whole are free from material misstatement.
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.
Reasonable assurance relates to the whole audit process.
However, there are inherent limitations in an audit that affect the auditors ability to detect material
misstatements. In addition, the work undertaken by the auditor to form an opinion is, in many areas,
determined by the judgement of the auditor.
Required:
(a) State the respective responsibilities for financial statements of the management of the
entity and of its external auditors. (6 marks)
(b) Describe the inherent limitations facing auditors in undertaking their work. (6 marks)
(c) Describe the significant types of judgements made by auditors:
(i) in gathering evidence; (4 marks)
(ii) in arriving at an opinion on the financial statements. (4 marks)
(20 marks)
Question 3 AUDIT COMMITTEE
The objective of a system of corporate governance is to secure the effective, sound and efficient
operation of companies. This objective transcends any legislation or voluntary code. Good corporate
governance embraces not only making the company prosper but also doing business in a legal and
ethical manner.
A key element of corporate governance is the audit committee. In many countries the audit committee
is a committee of a single board of directors and is of a voluntary nature regulated by voluntary codes.
In other countries there are committees which are of a supervisory nature and these are regulated by
statute. For example in Germany all large public companies must have a supervisory board which
contains non-executive directors who elect the board.
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Required:
(a) Explain how an audit committee could improve the effectiveness of the external
auditors work. (10 marks)
(b) Discuss the problems of ensuring the independence of the members of the audit
committee where the membership is regulated by a voluntary code of practice. (5 marks)
(c) Discuss the view that the role of the audit committee should not be left to voluntary
codes of practice but should be regulated by the law in all countries. (5 marks)
(20 marks)
Question 4 EASTFIELD DISTRIBUTORS
Your firm is the external auditor of Eastfield Distributors, a listed company, which has sales of $25
million and a profit before tax of $17 million. The company operates from a head office at Eastfield
and has sales outlets and warehouses around the country. The directors have decided the company has
reached a size when it needs an internal audit department. As is becoming increasingly common, the
directors have asked your firm to provide this service to the company as well as being the statutory
auditor of the companys annual financial statements. In answering the question, you should consider:
(i) the effects of the Association of Chartered Certified Accountants Code of Ethics and
Conduct in relation to providing an internal audit service to Eastfield Distributors;
(ii) the extent to which your audit firm can rely on the internal audit work when carrying out the
statutory audit of Eastfield Distributors;
(iii) the arrangements over control of the work and reporting of the internal audit staff:
the extent to which the internal audit staff should be responsible to Eastfield
Distributors, and who should control their work;
the extent to which the internal audit staff should be responsible to a manager or
partner of the external audit firm, and whether the same manager and partner should
be responsible for both the internal audit staff of Eastfield Distributors and the
external audit.
Required:
(a) Describe the matters you should consider and the action you will take to ensure your
firm remains independent as external auditor of the annual financial statements.
(8 marks)
(b) Describe the advantages and disadvantages to Eastfield Distributors of your firm
providing an internal audit service. (7 marks)
(c) Describe the advantages and disadvantages to your audit firm of providing an internal
audit service to Eastfield Distributors. (5 marks)
(20 marks)
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Question 5 ABEL & CO
Abel & Co, Chartered Certified Accountants, recently held a staff training session on quality control.
The session concluded with staff being invited to raise matters from their experience relating to the
ethical rules on independence. Some of these matters are given below.
(a) Shortly before commencing the final audit of a large listed company, a junior staff member on
the audit team inherited a number of shares in that company. No action was taken because,
although representing a large investment for the staff member concerned, the number of
shares was totally immaterial with respect to the company. Moreover, the partner knew that,
when the companys results were announced, the share price would rise and he did not think it
was fair to require the staff member to sell them now. (5 marks)
(b) The management accountant of another listed company client had an accident and was away
from work for three months. At the time of the accident the audit senior was winding up the
prior years audit and, because of his familiarity with the companys management accounting
system, it was agreed that he would take over as management accountant for the three months.
(5 marks)
(c) In its management letter to another audit client, Abel & Co warned the company that their
computer system lacked essential controls. The company decided to install a totally new
computer system and Abel & Cos management consultancy department was appointed to
design the new system. (5 marks)
(d) Abel & Co was recently approached by a large company that was not, then, an audit client,
for a second opinion. The company was in dispute with its existing auditors who were
proposing to issue a modified auditors report because of disagreement over inventory
valuation. Abel & Cos technical partner reviewed the evidence provided by the company
and advised the company that its accounting treatment was in order. Shortly afterwards Abel
& Co was invited to accept nomination as auditors. The reply to the letter of enquiry to the
existing auditors made it clear that the inventory valuation dispute was not as straightforward
as the company had made it out to be. (5 marks)
Required:
Discuss the possibility that Abel & Co had impaired their independence or otherwise acted
unprofessionally in each of the situations described.
(20 marks)
Question 6 PROFESSIONAL ETHICS
You work for a medium-sized firm of Chartered Certified Accountants with seven offices and 150
employees. Your firm has been asked to tender for the provision of statutory audit and other services to
Billington Travel, a private company providing discounted package holiday services in the
Mediterranean. The company is growing fast and would represent a substantial amount of fee income
for your firm. The finance director has explained to you that the company would like the successful
firm to provide a number of different services. These include the statutory audit and assistance with the
preparation of the financial statements. The company is also struggling with a new computer system
and the finance director considers that a systems review by your firm may be helpful. Your firm does
not have much experience in the travel sector.
Required:
(a) Explain why it is necessary for external auditors to be and be seen to be independent of
their audit clients. (3 marks)

(b) With reference to the ACCAs Code of Ethics and Conduct, describe the ethical matters
that should be considered in deciding on whether your firm should tender for:
(i) the statutory audit of Billington Travel; (4 marks)

(ii) the provision of other services to Billington Travel. (4 marks)
(c) You are a student Chartered Certified Accountant and you are one of four assistant internal
auditors in a large manufacturing company. You report to the chief internal auditor. You
have been working on the review of the payables system and you have discovered what you
consider to be several serious deficiencies in the structure and operation of the system. You
have reported these matters in writing to the chief internal auditor but you are aware that none
of these matters have been covered in his final report on the system which is due to be
presented to management.
Required:
(i) List the actions you might take in these circumstances. (6 marks)
(ii) Explain the dangers of doing nothing in these circumstances. (3 marks)
(20 marks)
Question 7 VISWA
Viswa is a company that provides call centre services for a variety of organisations. It operates in a
medium sized city and your firm is the largest audit firm in the city. Viswa is owned and run by two
entrepreneurs with experience in this sector and has been in existence for five years. It is expanding
rapidly in terms of its client base, the number of staff it employs and its profits. It is now 15 June 2014
and you have been approached to perform the audit for the year ending 30 June 2014. Your firm has
not audited this company before. Viswa has had three different firms of auditors since its
incorporation.
Viswas directors have indicated to you informally that the reason they wish to change auditors is
because of a disagreement about certain disclosures in the financial statements in the previous year.
The directors consider that the disagreement is a trivial matter and have indicated that the company
accountant will be able to provide you with the details once the audit has commenced. Your firm has
explained that before accepting the appointment, there are various matters to be considered within the
firm and other procedures to be undertaken, some of which will require the co-operation of the
directors. Your firm has other clients that operate call centres. The directors have asked your firm to
commence the audit immediately because audited accounts are needed by the bank by 30 July 2014.
Your firm is very busy at this time of year.
Required:
(a) Describe the practical and ethical matters to consider within your firm and procedures
that must be undertaken before accepting the appointment as auditor to Viswa.
(10 marks)
(b) Explain why it would be inappropriate to commence the audit before consideration of
the matters and the procedures referred to in (a) above have been completed. (5 marks)
(c) Explain the purpose of an engagement letter and list its contents. (5 marks)
(20 marks)

Question 8 CARLING
Your firm has been invited by Mr Thorburn, managing director and majority shareholder of Carling
Ltd, to accept appointment as auditor of the company. The present firm of auditors will not be
reappointed when its term of office expires as Mr Thorburn is dissatisfied with its services.
In addition Mr Thorburn has requested that:
(i) an employee of your firm assumes responsibility for preparing the monthly management
accounts to a tight deadline. The continuation of the overdraft facility is dependent on receipt
of these accounts within ten days of each month end; and
(ii) the audit partner attends the monthly board meetings, mainly to explain the management
accounts to the other directors.
Required:
(a) Describe the matters that you would consider in deciding whether or not to accept
appointment as auditor and provide the additional services requested. (8 marks)
(b) List the actions you would take before reaching a decision whether or not you should
undertake any assignments for Carling. (5 marks)
(c) Assuming that there are no professional reasons why the audit appointment should not
be accepted, reach a conclusion on whether on whether or not you should provide the
additional services requested. (2 marks)
(15 marks)
Question 9 WORKING PAPERS
According to ISA 230 Audit Documentation, the auditor is required to document evidence that the
audit was planned and performed in accordance with ISAs and applicable legal and regulatory
requirements.
Required:
(a) Describe the working papers which would be of particular assistance to you as a newly
appointed senior in charge of a recurring audit at the final audit stage (the previous
senior having left the firm after the interim audit):
(i) in familiarising yourself with the client company;

(ii) when you are planning the current years final audit. (12 marks)
(b) Identify and explain the criteria which you would use to judge the quality of working
papers. (8 marks)
(20 marks)

Question 10 PLANNING DOCUMENTATION
The auditor should document the overall audit strategy . to record the key decisions considered
necessary to properly plan . and the audit plan . setting out the planned nature, timing and extent of
risk assessment procedures .
Required:
(a) Distinguish between the overall audit strategy and audit plan (6 marks)
(b) Discuss the advantages and disadvantages of using standardised audit programmes.
(6 marks)
(c) Viewco is a manufacturer of TVs and video recorders. It carries out a full physical inventory
count at its central warehouse every year on 31 December, its financial year end. Inventories
of finished goods are normally of the order of $3 million, with inventories of components and
work in progress normally approximately $1 million.
You are the audit senior responsible for the audit of Viewco for the year ending 31 December.
Together with a junior member of staff, you will be attending Viewcos physical inventory
count.
Required:
State, with reasons, what information the working papers relating to this attendance
should contain. (8 marks)
(20 marks)
Question 11 NORBERT
Norbert is a local company which designs and builds racing yachts. It has a small yard 400 kilometres
away which it purchased recently. Most of the yachts are built to customer specification. However, as
trade has been slack recently, the company is building some yachts without orders in the hope of
obtaining buyers when the market picks up. Most of the companys output is for export and it quotes
its prices in Euros1.
You have been asked to act as senior in charge of the audit. The company has a year end of
30 September. It is apparent from the previous years audit file that the company has always had weak
internal controls.
The company is currently amending its designs to take advantage of new technology and has invested a
considerable amount of time and money in this. Consequently it is heavily indebted to the bank. The
bank overdraft facility is to be reviewed in November and the bank manager has requested that the
latest audited accounts be available for that review.
The chief executive has asked you to complete the audit by 31 October as he wishes to ensure the
continuing availability of the overdraft facility before attending a major trade fair in late November.
Required:
(a) Describe the matters that you should consider when planning the audit of Norbert.
(10 marks)
1
You are to assume that this is not the local currency.

(b) Explain why each matter must be taken into account and how it may be dealt with in the
audit plan. (10 marks)
(20 marks)
Question 12 AUDIT RISK
It is important for an auditor to consider audit and business risk when planning, carrying out and
coming to an opinion on the financial statements of a company. Risks that a business will not be able to
achieve its objectives mostly translate into a risk that a material error or misstatement will be in the
financial statements.
The auditor should plan and perform the audit to reduce audit risk to an acceptably low level. Whilst
there are many audit risk models used by auditors, ISA 200 Overall Objectives of the Independent
Auditor and the Conduct of an Audit in Accordance with International Standards on Auditing has
categorised audit risk into:
(1) inherent risk;

(2) control risk; and
(3) detection risk.
Required:
(a) Define the following terms:
(i) audit risk;

(ii) inherent risk;
(iii) control risk;
(iv) detection risk. (4 marks)
(b) Explain the factors which affect inherent risk in an audit. (6 marks)
(c) Describe the work you will carry out to quantify the control risk in a purchases system.
(5 marks)
(d) In relation to detection risk:
(i) explain the effect on the detection risk of the inherent risk and control risk if
the auditor requires a particular level of audit risk;
(ii) briefly describe the audit checks you will perform in verifying trade payables
and accruals, and how these tests are affected by the value of the detection risk.
(5 marks)
(20 marks)
Question 13 HIVEX
You have been presented with the following draft financial information about Hivex, a very successful
company that develops and licences specialist computer software and hardware. Its non-current assets
mainly consist of property, computer hardware and investments, and there have been additions to these
during the year. The company is experiencing increasing competition from rival companies, most of
which specialise in hardware or software, but not both. There is pressure to advertise and to cut prices.

You are the audit manager. You are planning the audit and are conducting a preliminary analytical
review and associated risk analysis for this client for the year ended 31 May 2014. You have been
provided with a summarised draft statement of comprehensive income which has been produced very
quickly and certain accounting ratios and percentages. You have been informed that the company
accounts for research and development costs in accordance with IAS 38 Intangible Assets.
Statement of comprehensive income Year ended 31 May

2014 2013
$000 $000
Revenue 15,206 13,524
Cost of sales 3,009 3,007

Gross profit 12,197 10,517
Distribution costs 3,006 1,996
Administrative expenses 994 1,768
Selling expenses 3,002 274

Operating profit 5,195 6,479
Net interest receivable 995 395
Income tax expense 3,104 1,452

Profit 3,086 5,422

Retained profits 1,617 3,983

Dividends paid $1,469 $1,439
Accounting ratios and percentages

Earnings per share 043 104
Gross margin 080 078
Expenses as a percentage of revenue:
Distribution costs 020 015
Administrative expenses 007 013
Selling expenses 020 002
Operating profit 034 048
Required:
(a) Using the information above, comment briefly on the performance of the company for
the two years. (8 marks)
(b) Use your answer to part (a) to identify the areas that are subject to increased audit risk
and describe the further audit work you would perform in response to those risks.
(12 marks)
(20 marks)
Question 14 FRAUD AND ERROR
Fraud and error present risks to an entity. Both internal and external auditors are required to deal with
risks to the entity. However, the responsibilities of internal and external auditors in relation to the risk
of fraud and error differ.

Required:
(a) Explain how the internal audit function helps an entity deal with the risk of fraud and
error. (7 marks)
(b) Explain the responsibilities of external auditors in respect of the risk of fraud and error
in an audit of financial statements. (7 marks)
(c) Stone Holidays is an independent travel agency. It does not operate holidays itself. It takes
commission on holidays sold to customers through its chain of high street shops. Staff are
partly paid on a commission basis.
Well-established tour operators run the holidays that Stone Holidays sells. The networked
reservations system through which holidays are booked and the computerised accounting
system are both well-established systems used by many independent travel agencies.
Payments by customers, including deposits, are accepted in cash and by debit and credit card.
Stone Holidays is legally required to pay an amount of money (based on its total sales for the
year) into a central fund maintained to compensate customers if the agency should cease
operations.
Describe the nature of the risks to which Stone Holidays is subject arising from fraud
and error. (6 marks)
(20 marks)
Question 15 KNITS
Knits is a small company which manufactures and sells high quality knitwear. Its customers are mainly
fashion boutiques.
Knits has two directors, one of whom is non-executive. The other is involved in the day-to-day
administration of the company. There are forty other employees. Most of these work in the factory,
two work in the warehouse, four are sales representatives and two are accounts staff. The accounts staff
are Miss Jones, who is responsible for processing sales and accounts receivable, and Mrs Singh, who is
the purchases and wages clerk. Mrs Singh works part-time, five mornings a week.
Each of the sales representatives visit shops throughout a region; taking orders from customers which
are recorded on pre-numbered two-part order forms. Completed forms are passed to the accounts
department. Miss Jones files one copy of the order form in numerical sequence and passes the other to
the warehouse.
The completed order is despatched from the warehouse by carrier, accompanied by one copy of a
despatch note. The other copy is sent to Miss Jones, who prepares an invoice based on the information
it contains and on the companys price list. She sends one copy of the invoice to the customer, and a
second copy of the invoice is retained.
Each Friday, Miss Jones inputs the weeks invoices to the computerised sales ledger. She then files the
invoices alphabetically by customer name. Despatch notes are not retained because filing space is
limited.
Miss Jones opens the post daily and lists remittances received from customers. Every Friday, she
inputs the information listed to the sales ledger. Cheques received are banked daily by the executive
director.

Miss Jones reviews the sales ledger balances every month and writes to customers who have not paid
within 90 days of receiving goods. The sales ledger is printed out annually for year-end purposes.
Otherwise no hard copy is printed and Miss Jones reviews the sales ledger on the VDU screen.
The companys computer package includes the facility to produce a sales day book and sales ledger
control account. These are not used because Miss Jones considers that the low volume of transactions
(50 75 invoices per week) makes them unnecessary.
Required:
(a) State, with reasons, what you consider to be the potential weaknesses in Knits present
system of accounting for sales and receivables. (12 marks)
(b) Describe controls that a small firm such as Knits could feasibly adopt to overcome the
weaknesses you have identified. (8 marks)
Note: You are NOT required to consider the system for dealing with returns and credit notes.
(20 marks)
Question 16 IBSON
You work in the newly established internal audit department of Ibson which supplies frozen seafood to
supermarkets. The accountant has provided you with the following information about the purchases
system. Your enquiries about the system indicate that there are no relevant procedures other than those
described.
Requisition and ordering
Salesmen raise 2-part purchase requisitions (PRs). The buying department raises three-part, pre-
numbered purchase orders (POs). These are authorised by the buyer. The first copy is sent to the
supplier, the second to stores and the third is filed in the buying department.
Receiving
On receipt of goods the quality and quantity is checked immediately and, if unacceptable, the whole
consignment is refused. If accepted, a two-part goods received note (GRN) is raised. If the goods
received match the PO, the top copy of the GRN is filed in numerical sequence with the PO attached.
The bottom copy is sent to the accounts department and filed pending receipt of invoice. In the event of
a part-consignment the GRN (both parts) is kept with the PO until the order has been fulfilled.
Recording
All invoices received for goods are matched against GRNs before recording details in the purchase day
book. The invoices, with GRNs attached, are kept in a pending payment file, until the month end, in
alphabetical order.
Payment
Every month end, a bought ledger clerk prepares a payment requisition (PR) for each supplier. The
invoices and GRNs are stapled to the PRs which are then authorised for payment by the buyer. A
payment listing including suppliers bank details is prepared by the clerk, checked by the buyer, and
given to the chief finance office for signature and delivery to Ibsons bank.

Required:
(a) List the procedures which should be in operation in the purchases system to exercise
control over:
(i) the purchase and receipt of goods; and
(ii) the recording and settlement of liabilities. (10 marks)
(b) Comment on specific weaknesses which might exist in Ibsons purchases system and give
recommendations for improvement. (10 marks)
(20 marks)
Question 17 EASTWOOD ENGINEERING
Your firm is the external auditor of Eastwood Engineering, a listed company, which has annual sales of
$100 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. Eastwood
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.
There is a personnel department which is independent of the wages department. The personnel
department maintain records of the employees, including their starting date, grade, current wage rate
and leaving date (if appropriate).
Previous years audits have revealed frauds by wages department staff which have been facilitated by
weaknesses in controls in the wages system. These frauds have included:
(i) paying employees after appointment but before they commenced work;
(ii) paying employees after they have left; and
(iii) paying fictitious employees.
A check of current controls in the wages system has revealed that the company has failed to instigate
controls to prevent these types of fraud recurring. So, the audit programme requires extensive
substantive procedures to be carried out to ensure that recorded wages transactions have not been mis-
stated by similar frauds taking place in the current year.
The existence of employees at the head office site can be verified by physical inspection. From a cost
effectiveness point of view, only a small sample of sales offices will be visited. The audit manager has
asked you to consider the audit procedures you would carry out to obtain sufficient appropriate
evidence of the existence of employees at sales offices not visited by the audit staff.

The audit manager has explained that unclaimed wages arise when manufacturing employees are not
present to collect their wages when they are paid out. The unclaimed wage packets are given to the
cashier who records their details in the unclaimed wages book and is responsible for their custody. Any
employee who has not received his wage package at the pay-out can obtain it from the cashier. You
have ascertained that there is no system of checking the operation of the unclaimed wages system by a
person independent of the cashier and the wages department.
Required:
(a) Explain how you would verify that employees are not paid before they commenced
employment or after they have left (a starters and leavers test). (5 marks)
(b) Describe the audit procedures you would carry out in connection with attending a pay-
out of wages in cash to manufacturing employees. (5 marks)
(c) Describe the substantive checks of transactions you would carry out on the unclaimed
wages system. (5 marks)
(d) Describe the evidence you would obtain to verify the existence of employees whose wages
are paid directly into their bank account, including those at sales offices. (5 marks)
(20 marks)
Question 18 SHW
(a) (i) Define a test of control and a substantive procedure; (2 marks)
(ii) State ONE test of control and ONE substantive procedure in relation to sales
invoicing. (2 marks)
(b) Shiny Happy Windows Co (SHW) is a window cleaning company. Customers windows are
cleaned monthly, the window cleaner then posts a stamped addressed envelope for payment
through the customers front door.
SHW has a large number of receivable balances and these customers pay by cheque or cash,
which is received in the stamped addressed envelopes in the post. The following procedures
are applied to the cash received cycle:
1. A junior clerk from the accounts department opens the post and if any cheques or
cash have been sent, she records the receipts in the cash received log and then
places all the monies into the locked small cash box.
2. The contents of the cash box are counted each day and every few days these sums
are banked by which ever member of the finance team is available.
3. The cashier records the details of the cash received log into the cash receipts day
book and also updates the sales ledger.
4. Usually on a monthly basis the cashier performs a bank reconciliation, which he

then files, if he misses a month then he catches this up in the following months
reconciliation.

Required:
For the cash cycle of SHW:
(i) Identify and explain THREE deficiencies in the system; (3 marks)
(ii) Suggest controls to address each of these deficiencies; and (3 marks)
(iii) List tests of controls the auditor of SHW would perform to assess if the
controls are operating effectively. (3 marks)
(c) Describe substantive procedures an auditor would perform in verifying a companys

bank balance. (7 marks)
(20 marks)
Question 19 SOURCES OF AUDIT EVIDENCE
The auditor should obtain sufficient appropriate audit evidence to be able to draw reasonable
conclusions on which to base the audit opinion.
Sufficiency is the measure of the quantity of audit evidence; appropriateness is the measure of the
quality of audit evidence and its relevance to a particular assertion and its reliability.
ISA 500 Audit Evidence
Required:
Discuss the extent to which each of the following sources of audit evidence is appropriate and
sufficient:
(i) oral management representations in respect of the completeness of sales where the
majority of transactions are conducted on a cash basis;
(ii) flowcharts of the accounting and control system prepared by a companys internal audit
department;
(iii) year-end suppliers statements;
(iv) physical inspection of a tangible non-current asset by an auditor;
(v) comparison of items of income and expenditure for the current period with
corresponding information for prior periods.
(15 marks)
Question 20 DELTA
Delta operates a chain of 30 shops throughout the country, dealing in car and van spare parts. It has
150 employees, of whom 30 work at its headquarters and central warehouse and the remainder at its
shops. At its year end, 31 May, inventory of spare parts totalled $2.2m, of which $1.4m were held at
the individual shops and the remainder at the warehouse. Inventory represented 75% of Deltas net
assets.
Deltas sales are almost entirely for cash or cheques. It has few trade receivables.

Delta operates a computerised information system. The reports which this system produces each month
include a detailed statement of comprehensive income and statement of financial position for each shop,
and a detailed analysis of the age and type of inventories held at each location including the warehouse.
Physical inventory counts are carried out twice a year, on 30 November and 31 May, at all locations,
and discrepancies between book and physical inventories are investigated.
Required:
Describe what analytical procedures might be used in the audit of Delta:

(i) at the planning stage; (8 marks)
(ii) as substantive procedures; (8 marks)
(iii) at the overall review stage. (4 marks)
Your answer should include the purpose of each procedure you identify and how it would be used
in the audit.
(20 marks)
Question 21 ZAK CO
(a) With reference to ISA 520 Analytical Procedures explain:
(i) what is meant by the term analytical procedures; (2 marks)
(ii) the different types of analytical procedures available to the auditor; and
(3 marks)
(iii) the situations in the audit when analytical procedures can be used. (3 marks)
(b) Zak 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 statements of profit or loss for the last two financial years are shown below:
2014 2013
$000 $000
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)

Statement of financial position extract
Cash and bank 253 (950)


Required:
As part of your risk assessment procedures for Zak Co, identify and provide a possible
explanation for unusual changes in the statement of profit or loss. (9 marks)
(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 Zak Cos
bank. (3 marks)
(20 marks)
Question 22 ACCOUNTING ESTIMATES
The audit of accounting estimates is often problematic. Many estimates are material to the financial
statements and involve the application of a high degree of subjective judgement. It is important that
accounting estimates are adequately disclosed in the financial statements. There have been a number of
cases in which auditors were accused of issuing unmodified reports on financial statements with
inadequate disclosure of such estimates.
ISA 540 Auditing Accounting Estimates, including Fair Value Estimates and Related Disclosures states
that the determination of an accounting estimate may be simple or complex, depending on the nature of
the item.
Required:
(a) Give examples of accounting estimates and explain why they are important to the
financial statement audit. (4 marks)
(b) Describe the approach to the audit of accounting estimates and explain the problems in
applying the approach. (7 marks)
(c) Describe the extent to which auditors may seek to rely on management representations
during the course of their audit of accounting estimates in accordance with ISA 580
Written Representations (4 marks)
(15 marks)
Question 23 ESTIMATES
An accounting estimate is defined by International Standards on Auditing as an approximation of the

amount of an item in the absence of a precise means of measurement.
Required:
(a) State the matters you would consider and describe the audit work you would perform in
order to ascertain whether the following are fairly stated in the financial statements:
(i) provision to meet warranty claims, made by a company which assembles a

range of powered garden tools from bought-in components; (8 marks)
(ii) estimate for annual depreciation charge on a compressed air system purchased
by the company during the year for its assembly department. (8 marks)

(b) Explain why the audit of accounting estimates is a difficult area for the auditor.
(4 marks)
(20 marks)
Question 24 LETTER OF REPRESENTATION
Towards the end of an audit, it is common for the external auditor to seek a letter of representation
(written representations) from the management of the client company.
Required:
(a) Explain why auditors seek letters of representation. (5 marks)
(b) List the matters commonly included in the letter of representation. (6 marks)
(c) Explain why it is important to discuss the content of the letter of representation at an
early stage during the audit. (3 marks)
(d) Explain why management is sometimes unwilling to sign a letter of representation and
describe the actions an external auditor can take if management refuses to sign a letter
of representation. (6 marks)
(20 marks)
Question 25 METHODS OF EVIDENCE GATHERING
There are a number of different methods of obtaining audit evidence. Methods include:
(i) analytical procedures;

(ii) audit sampling;
(iii) tests of controls;
(iv) detailed testing of transactions and balances;
(v) computer-assisted audit techniques (CAATs).
These methods overlap and may be used for different purposes during an audit of financial statements.
Required:
(a) Explain the advantages and disadvantages of each of the five methods of evidence
gathering listed above. (15 marks)
Note: You are NOT required to describe the methods listed above.
(b) Describe the relationship between the five methods of evidence gathering described
above. (5 marks)
(20 marks)

Question 26 PORTHOS
(a) Computer-Assisted Audit Techniques (CAATs) are used to assist an auditor in the collection
of audit evidence from computerised systems.
Required:
List and briefly explain four advantages of CAATs. (4 marks)
(b) Porthos is a retailer of sports equipment, specialising in racquet sports such as tennis, squash
and badminton. The company purchases equipment from a variety of different suppliers and
then resells this using the Internet as the only selling media. The company has over 150
different types of racquets available in inventory, each identified via a unique product code.
Customers place their orders directly on the Internet site. Most orders are for one or two
racquets only. The ordering/sales software automatically verifies the order details, customer
address and credit card information prior to orders being verified and goods being despatched.
The integrity of the ordering system is checked regularly by ArcherWeb, an independent
Internet service company.
You are the audit manager working for the external auditors of Porthos, and you have just
started planning the audit of the sales system of the company. You have decided to use test
data to check the input of details into the sales system. This will involve entering dummy
orders into the Porthos system from an online terminal.
Required:
List the test data you will use in your audit of the financial statements of Porthos to
confirm the completeness and accuracy of input into the sales system, clearly explaining
the reason for each item of data. (6 marks)
(c) You are also considering using audit software as part of your substantive testing of the data
files in the sales and inventory systems of Porthos.
(i) List and briefly explain some of the difficulties of using audit software.
(4 marks)
(ii) List the audit tests that you can program into your audit software for the sales
and inventory system in Porthos, explaining the reason for each test. (6 marks)
(20 marks)
Question 27 INSURANCE BROKERS
Your firm is the auditor of Insurance Brokers which operates from a number of branches and provides
insurance for the general public and businesses. The company obtains insurance from large insurance
companies, and takes a commission for its services. You have been asked to audit certain aspects of the
companys tangible non-current assets for the year ended 31 March.
The companys main non-current assets comprise:
(1) land and buildings;

(2) microcomputers, printers and related equipment which are used by staff;
(3) motor vehicles which are provided to directors and salesmen who visit customers.

The company has been operating for a number of years, and it maintains details of its office equipment
and motor vehicles on a computerised asset register. The company uses the following depreciation
rates:
(1) buildings 2% per annum on cost
(2) office equipment (including computers) 10% per annum on cost
(3) motor vehicles 25% per annum on cost.
You are concerned that the depreciation rate for the computers may be inadequate.
Required:
(a) List the audit procedures you would undertake in order to ascertain whether the
following assets are owned:
(i) land and buildings;

(ii) computers and motor vehicles. (7 marks)
(b) Describe the audit procedures that you would perform in order to reach a conclusion on
whether the depreciation rate of the computers is adequate. (6 marks)
(c) Discuss the matters that you would consider when deciding whether to modify your
auditors report if you are not satisfied that the depreciation of the computers is
adequate. State, with reasons, what kinds of audit modification (if any) would be
appropriate. (7 marks)
(20 marks)
Question 28 BASIS OF VALUATION
ISA 500 Audit Evidence requires auditors to obtain evidence that supports the relevant financial
statement assertions. One of these assertions is that of valuation. Evidence is therefore required to
ensure that assets or liabilities are recorded at an appropriate carrying value. Many audit failures are
associated with difficulties experienced by auditors in verifying this assertion in the face of attempts by
management to engage in creative accounting. In verifying valuation auditors need to determine that
the basis of valuation is consistent with accepted accounting practice usually aided by reference to
accounting standards (e.g. IFRSs). Additionally auditors need to obtain sufficient evidence as to the
values themselves. Valuation problems likely to be encountered by auditors include those associated
with determining:
(i) The appropriate amount of overhead carried forward as part of the cost of closing inventory.
(ii) The written down value of property, plant and equipment having a limited useful economic life.
(iii) Development costs deferred in the year and recognised as an intangible asset.
Required:
For each of the three items:
(a) State the acceptable basis of valuation. (6 marks)
(b) State with explanations the audit procedures to be performed in verifying the
appropriateness of the basis of valuation and the correctness of the actual amounts.
(14 marks)
Note: You are only required to consider audit procedures relevant to the valuation assertion.
(20 marks)

Question 29 ROCKS FOREVER
You are the audit manager in the firm of DeCe & Co, an audit firm with ten national offices.
One of your clients, Rocks Forever, purchases diamond jewellery from three manufacturers. The
jewellery is then sold from Rocks 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 Rocks 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 Rocks Forever, you have employed UJ, a firm of specialist
diamond valuers who will also be in attendance. UJ will verify that the jewellery is, in fact, made from
diamonds and that the jewellery is saleable with respect to current trends in fashion. UJ 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 marks)
(b) Explain the factors you should consider when placing reliance on the work of UJ.
(5 marks)
(c) Describe the audit procedures you should perform to ensure that jewellery inventory is
valued correctly. (5 marks)
(20 marks)
Question 30 REDBURN
(a) Explain the importance of audit planning and state TWO matters that would be
included in an audit plan. (6 marks)
Redburn Co, a publisher and producer of books of poetry, has been a client of your firm of Chartered
Certified Accountants for a number of years. The manager in overall charge of the audit has been
discussing the audit plan with the audit team, of which you are a member, prior to commencement of
the work. The audit manager has informed the team, among other things, that there has been a growing
interest in poetry generally and that the company has acquired a reputation for publishing poets who are
still relatively unknown.
During your audit you determine:
(i) Contracts with the poets state that they are given a royalty of 10% on sales. Free copies of the
books are provided to the poets and to some organisations such as copyright libraries and to
others, such as reviewers and university lecturers. No royalties are given on these free copies.
(ii) The computerised customer master file contains a code indicating whether a despatch is to
earn a royalty for the author. This code is shown on the sales invoice and despatch note when
they are prepared.
(iii) A computerised royalties file is held, all entries therein bearing the invoice number and date.

(iv) The company keeps detailed statistics of sales made, including trends of monthly sales by
type of customer, and of colleges where its books are recommended as part of course material,
based on reports from sales staff.
(v) Bookshops have the right to return books which are not selling well, but about 10% of these
are slightly damaged when returned. The company keeps similar records of returns as it does
for sales.
Required:
(b) Describe TWO procedures used to ensure that the sales statistics kept by the company
may be relied upon. (4 marks)
(c) Describe THREE substantive tests you should perform to ensure that the royalties
charge is accurate and complete, stating the objective of each test. (6 marks)
(d) A material figure in the statement of financial position of Redburn is the amount attributed to
inventory of books.
Required:
State TWO inherent risks that may affect the inventory figure and suggest ONE control
to mitigate each risk. (4 marks)
(e) The management of Redburn have told you that inventory is correctly valued at the lower of
cost and net realisable value. You have already satisfied yourself that cost is correctly
determined.
Required:
(i) Define net realisable value; (2 marks)
(ii) State and explain the purpose of FOUR procedures that you should use to
ensure that net realisable value of the inventory is at or above cost. (8 marks)
(30 marks)
Question 31 SPONDON
You are the senior in charge of the audit of Spondon, an expanding company which sells all its products
on credit. Its turnover for the year ended 31 March 2014 was $25 million.
On 31 March 2014 the total value of accounts receivable on the ledger was $5.3 million. Your tests of
control on the sales system have shown that there is a satisfactory division of duties in the sales system
and only minor errors were found in the tests of control.
Required:
(a) Discuss the extent to which a direct confirmation of accounts receivable is reliable in
providing audit evidence and in verifying the value of year-end balances. (8 marks)
(b) Describe the audit work you would undertake when following up the replies to the direct
confirmation in order to ensure an adequate test of the existence and amount of
Spondons accounts receivable where:
(i) the customer disagrees the balance and provides a different balance;
(ii) no reply to the confirmation request has been received. (12 marks)
(20 marks)

Question 32 CAMBRIDGE
Cambridge is a company that wholesales motor car spares to a large number of retail stores. Details of
trade receivables at the end of the reporting period were as follows.
Number % Value %
$
Nil balances 600 9.1
Credit balances 50 0.8 (120,000) (1.0)
$1 to $1,000 5,120 77.8 3,072,000 22.2
$1,001 to $10,000 600 9.1 4,620,000 33.4
$10,001 to $20,000 120 1.8 1,810,000 13.1
$20,001 to $50,000 60 0.9 2,350,000 17.0
Over $50,000 35 0.5 2,120,000 15.3
______ ____ _________ ____
6,585 100.0 13,852,000 100.0
______ ____ _________ ____
Required:
(a) State the objectives of direct confirmation of accounts receivable. (4 marks)

(b) Explain the following terms:
(i) positive confirmation;
(ii) negative confirmation. (4 marks)
(c) Describe how you might select a sample for direct confirmation of:
(i) balances over $50,000;
(ii) balances between $1 and $1,000. (4 marks)
(d) State what you understand by the term statistical sampling? How does this differ
from judgmental sampling? (2 marks)
(14 marks)
Question 33 TRACEY TRANSPORTERS
You are the external auditor of Tracey Transporters, a public limited company (TT). The companys
year end is 31 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 TTs offices. A
booking clerk checks the customers credit status on the receivables ledger and then the availability of
vehicles using the Vehicle Management System (VMS) software on TTs computer network. E-mails
are filed electronically by customer name in the e-mail programme used by TT. If the customers 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 TTs statement of financial position is the vehicles. The carrying amount of
the vehicles is $6 million out of total shareholders funds of $15 million as at 31 March 2014.
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 TTs financial statements. (10 marks)
(b) List and describe the audit work you should perform on the statement of financial
position figure for vehicles in TTs financial statements for the year ended 31 March
2014. (10 marks)
(20 marks)
Question 34 B-STAR
Background information
B-Star is a theme park based on a popular series of childrens books. Customers pay a fixed fee to enter
the park, where they can participate in a variety of activities such as riding roller-coasters, playing on
slides and purchasing themed souvenirs from gift shops.
The park is open all year and has been in operation for the last seven years. It is located in a country
which has very little rainfall the park is open-air so poor weather such as rain results in a significant
fall in the number of customers for that day (normally by 50%). During the last seven years there have
been on average 30 days each year with rain.
B-Star is now very successful; customer numbers are increasing at approximately 15% each year.
Ticket sales
Customers purchase tickets to enter the theme park from ticket offices located outside the park. Tickets
are only valid on the day of purchase. Adults and children are charged the same price for admission to
the park. Tickets are pre-printed and stored in each ticket office.
Tickets are purchased using either cash or credit cards.
Each ticket has a number comprising of two elements two digits relating to the ticket office followed
by six digits to identify the ticket. The last six digits are in ascending sequential order.
Cash sales
(1) All ticket sales are recorded on a computer showing the amount of each sale and the number
of tickets issued. This information is transferred electronically to the accounts office.
(2) Cash is collected regularly from each ticket office by two security guards. The cash is then
counted by two accounts clerks and banked on a daily basis.
(3) The total cash from each ticket office is agreed to the sales information that has been
transferred from each office.
(4) Total cash received is then recorded in the cash book, and then the general ledger.
Credit card sales
(1) Payments by credit cards are authorised online as the customers purchase their tickets.

(2) Computers in each ticket office record the sales information which is transferred
electronically to the accounts office.
(3) Credit card sales are recorded for each credit card company in a receivables ledger.
(4) When payment is received from the credit card companies, the accounts clerks agree the total
sales values to the amounts received from the credit card companies, less the commission
payable to those companies. The receivables ledger is updated with the payments received.
You are now commencing the planning of the annual audit of B-Star. The date is 3 December and B-
Stars year end is 31 December.
Required:
(a) List and explain the purpose of the main sections of an audit strategy document and for
each section, provide an example relevant to B-Star. (8 marks)
(b) (i) For the cash sales system of B-Star, identify the risks that could affect the
assertion of completeness of sales and cash receipts; (4 marks)
(ii) Discuss the extent to which tests of controls and substantive procedures could
be used to confirm the assertion of completeness of income in B-Star. (6 marks)
(c) (i) List the substantive analytical procedures that may be used to give assurance
on the total income from ticket sales for one day in B-Star;
(ii) List the substantive analytical procedures that may be used to give assurance
on the total income from ticket sales in B-Star for the year. (8 marks)
(d) List the audit procedures you should perform on the credit card receivables balance.
(4 marks)
(30 marks)
Question 35 CROMWELL
Cromwell sells fashion accessories through approximately 500 shops and has a head office.
Each shop operates an imprest system and holds a cash float of $500 to provide change for the till and
to cover sundry expenses. All cash takings are banked at the end of each working day.
You are the senior in charge of the audit and your manager has indicated that only a sample of the cash
balances held by the shops will be the subject of audit tests.
Many of the fashion accessories are purchased from overseas suppliers and the companys buyers
frequently travel abroad. The cashier at head office therefore holds a substantial amount of foreign
currency in her safe.
The company has recently expanded its accessories range and has received a bank loan of $250,000
repayable over three years.
Required:
(a) Describe the main factors that should normally be taken into account in determining a
sample size for substantive procedures (8 marks)

(b) List the audit tests that you would carry out, with respect to Cromwell, to substantiate
each of the following items included in the statement of financial position at the end of
the reporting period:
(i) the cash balances;

(ii) the bank loan. (12 marks)
(20 marks)
Question 36 COMPANY A
(a) Company A has a number of long and short-term payables, accruals and provisions in its
statement of financial position.
Required:
Describe the audit procedures you would apply to each of the three items listed below,
including those relating to disclosure.
(i) A 10-year bank loan with a variable interest rate and an overdraft (a bank
account with a debit balance on the bank statement), both from the same bank.
(5 marks)
(ii) Expense accruals. (4 marks)
(iii) Trade payables and purchase accruals. (6 marks)
(b) Company B has a provision in its statement of financial position for claims made by
customers for product defects under 1-year company warranties.
Required:
Describe the matters you would consider and the audit evidence you would require for
the provision. (5 marks)
(20 marks)
Question 37 WELFARE AND HELP FOR THE AGED TRUST (WHAT)
Welfare and Help for the Aged Trust (WHAT) has recently commenced operating from a community
centre in your locality, by providing facilities for the well-being of senior citizens in the area.
WHAT has been granted a licence by the local authority to occupy the community centre free of
charge, although all maintenance and running costs are being borne by the trust.
WHAT receives income from the following sources:
(1) Donations under deeds of covenant entered into by individuals. Individuals are
contractually bound to make donations over a specified period and the charity claims a refund
of basic rate income tax paid by the individual.
(2) Postal donations of cheques and cash.
(3) Door-to-door collections by volunteers with boxes and workplace collections.
(4) Other donations (several mini-buses have been given, either new or second hand, by large
businesses).

(5) Grants from local authorities.
(6) Sales of refreshments at the community centre.
(7) A variety of fund raising events organised by voluntary helpers.
The trustees have appointed your firm as auditors. You are the accountant in charge of the audit for the
year ending 31 December.
You have made an appointment with the finance executive of WHAT, who was appointed during the
year, in March, to obtain the further information you will require, and to discuss outline plans for the
audit. You have already been supplied with a detailed description of its accounting systems.
Required:
(a) Describe the further information, excluding that relating to the accounting system, that
you will require from the finance executive at your meeting, in order to plan your audit,
and explain the relevance of this information to your audit planning. (10 marks)
(b) Describe the controls over the above income which you would expect WHAT to operate.
(10 marks)
(20 marks)
Question 38 AUDIT OF SMALL BUSINESSES
Small businesses possess a combination of characteristics which make it necessary for the auditor to
adapt his audit approach to the circumstances surrounding the small business engagement.
Required:
(a) State the meaning of a small business. (2 marks)
(b) Describe the characteristics of small businesses and their consequences. (10 marks)
(c) Describe the audit procedures you would employ, in addition to the routine vouching of
sales and cash, to verify that all income due to the company has been recorded and
included in the accounts, and the problems you may experience in so doing, in the
following cases:
(i) a small manufacturing company which purchases and sells goods on credit;
(ii) a small retail store which purchases goods on credit and sells them for cash.
Assume in each case that the company keeps proper accounting records. (8 marks)
(20 marks)
Question 39 CALVA
You are an audit manager in an audit firm with ten offices and 250 staff. Your firm is the auditor of
Calva, a chain of supermarkets. Your firm has been the auditor of this client for many years.
All of the planning work and tests of control have been completed for Calva for the year ended 31
December. Staff are still working on substantive procedures. The company operates a continuous
inventory checking system with good records and you have tested this system and will be relying on the
records for the year-end figure.

The company is intending to invest a substantial amount in opening new stores during the next year and
it has been negotiating with both banks and property companies in relation to leases.
Required:
(a) Describe the objectives of the following and how these objectives will be met in the audit
of Calva:
(i) overall review of financial statements; (4 marks)

(ii) review of working papers. (6 marks)
(b) Describe the:
(i) auditors responsibilities with regard to subsequent events; (6 marks)

(ii) procedures that should be applied during the subsequent events review at
Calva. (4 marks)
(20 marks)
Question 40 OILRAKERS
(a) International Standard on Auditing 560 Subsequent Events explains the audit work required in
connection with subsequent events.
Required:
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 marks)
(b) You are the auditor of OilRakers which extracts, refines and sells oil and petroleum related
products.
The following events occurred in 2014 after the year ended 31 December 2013:
Date Event
15 February Bankruptcy of major customer representing 11% of the trade receivables
on the statement of financial position.
21 March Financial statements approved by directors.
22 March Audit work completed and auditors report signed.
1 May Accidental release of toxic chemicals into the sea from the companys oil
refinery resulting in severe damage to the environment.
23 May Financial statements issued to members of OilRakers.
30 May 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:
For each of the following three dates:

15 February 2014;
1 May 2014; and
30 May 2014,
(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 marks)
(ii) Explain the auditors responsibility and the audit procedures that should be
carried out. Your answer should assume that the directors agreed to make any
necessary changes to the financial statements. (9 marks)
(20 marks)
Question 41 AUDIT SCOPE
Auditors reports include a description of the scope of an audit in order to reduce misunderstandings of
the nature of audited financial statements.
Our responsibility is to express an opinion on these financial statements based on our audit. We
conducted our audit in accordance with International Standards on Auditing. Those standards require
that we comply with ethical requirements and plan and perform our audit to obtain reasonable
assurance about whether the financial statements are free of material misstatement.
An audit involves performing procedures to obtain evidence supporting the amounts and disclosures in
the financial statements. The procedures selected . An audit also includes evaluating the
appropriateness of accounting policies used and the reasonableness of accounting estimates made by
management, as well as evaluating the overall presentation of the financial statements.
We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for
our audit opinion.
Required:
Explain the meaning of the phrases underlined above, giving reasons for their inclusion in the
auditors report and state their significance to the reader of financial statements.
(20 marks)
Question 42 THETA
In January 2014, the head office of Theta was damaged by a fire. Many of the companys accounting
records were destroyed before the audit for the year ended 31 March 2014 took place. The companys
financial accountant has prepared financial statements for the year ended 31 March 2014 on the basis of
estimates and the information he has been able to recover. You have completed the audit of these
financial statements but have not been able to obtain sufficient audit evidence in all areas.
Required:
(a) Draft, for inclusion in the auditors report, wording appropriate to Theta. (5 marks)
Note: You are not required to reproduce the auditors report in full. Only the differences
from an unmodified report are required.
(b) Explain the reasons for your audit opinion. (3 marks)

(c) Explain and distinguish between the following forms of modified report:
(i) emphasis of matter;
(ii) qualified opinion;
(iii) disclaimer of opinion;
(iv) adverse opinion. (8 marks)
(16 marks)
Question 43 HOOD ENTERPRISES
You are the audit manager of Hood Enterprises Co. The companys annual turnover is over $10
million.
Required:
(a) Compare the responsibilities of the directors and auditors regarding the published
financial statements of Hood Enterprises. (6 marks)
(b) An extract from the draft audit report produced by an audit junior is given below:
Basis of Opinion
We conducted our audit in accordance with Auditing Standards. An audit includes

examination, on a test basis, of evidence relevant to the amounts and disclosures in the
financial statements. It also includes an assessment of all the estimates and judgements made
by the directors in the preparation of the financial statements, and of whether the accounting
policies are appropriate to the companys circumstances, consistently applied and adequately
disclosed.
We planned and performed our audit so as to obtain as much information and explanation as
possible given the time available for the audit. We confirm that the financial statements are
free from material misstatement, whether caused by fraud or other irregularity or error. The
directors however are wholly responsible for the accuracy of the financial statements and no
liability for errors can be accepted by the auditor. In forming our opinion we also evaluated
the overall adequacy of the presentation of information in the companys annual report.
Required:
Identify and explain the errors in the above extract.
Note: You are not required to redraft the report. (10 marks)
(c) The directors of Hood Enterprises have prepared a cash flow forecast for submission to the
bank. They have asked you as the auditor to provide a negative assurance report on this
forecast.
Required:
Briefly explain the difference between positive and negative assurance, outlining the
advantages to the directors of providing negative assurance on their cash flow forecast.
(4 marks)
(20 marks)

Question 44 MOWBRAY COMPUTERS
You are responsible for the audit of Mowbray Computers, a trading company whose financial year end
is 30 September 2014.
The company assembles microcomputers in a local factory from components purchased from the Far
East and sells them to major retailers and, by mail order, to individuals and businesses.
In the current year, there has been a recession and strong competition which has resulted in a fall in
sales and gross profit margin. Customers are taking longer to settle their accounts. This has led to a
trading loss and the company experiencing cash flow problems.
The companys management has recently prepared forecast information at the request of the companys
bankers.
Required:
(a) State, with reasons, the circumstances particular to Mowbray Computers which may
indicate that the company is not a going concern. (6 marks)
(b) Describe the audit work you would undertake in order to ascertain whether Mowbray
Computers is a going concern. (8 marks)
(c) Explain the effect on your auditors report on the financial statements of Mowbray
Computers for the year ended 30 September 2014 if:
(i) the financial statements give sufficient disclosure of the going concern
problems;
(ii) there is no disclosure of the going concern problems in the financial statements
and there is a serious risk that the company will fail in the foreseeable future.
(6 marks)
(20 marks)
Question 45 GREEN CO
Green Co grows crops on a large farm according to strict organic principles that prohibits the use of
artificial pesticides and fertilizers. The farm has an organic certification, which guarantees its
products are to be organic. The certification has increased its sales of flour, potatoes and other
products, as customers seek to eat more healthily.
Green is run by two managers who are the only shareholders. Annual revenue is $50 million with a net
profit of 5%. Both managers have run other businesses in the last 10 years. One business was closed
due to suspected tax fraud (although no case was ever brought to court).
Greens current auditors provide audit services. Additional assurance on business controls and the
preparation of financial statements are provided by a different accountancy firm.
Last year, a neighbouring farm, Black Co started growing genetically modified (GM) crops, the pollen
from which blows over Greens fields on a regular basis. This is a threat to Greens organic status
because organic crops must not be contaminated with GM material. Green is considering court action
against Black for loss of income and to stop Black growing GM crops.

You are an audit partner in Lime & Co, a 15 partner firm of auditors and business advisors. You have
been friends with the managers of Green for the last 15 years, advising them on an informal basis. The
managers of Green have indicated that the audit will be put out to tender next month and have asked
your audit firm to tender for the audit and the provision of other professional services.
Required:
(a) Using the information provided, identify and explain the ethical threats that could affect
Lime & Co. (8 marks)
(b) In respect of the going concern concept:

(i) Define going concern and state two situations in which it should NOT be
applied in the preparation of financial statements; (3 marks)
(ii) Explain the directors responsibilities and the auditors responsibilities
regarding financial statements prepared on the going concern principle.
(4 marks)
(c) List the audit procedures that should be carried out to determine whether or not the
going concern basis is appropriate for Green Co. (5 marks)
(20 marks)
Question 46 MONTEHODGE CO
(a) Discuss the advantages and disadvantages of outsourcing an internal audit department.
(8 marks)
(b) MonteHodge Co has a sales income of $253 million and employs 1,200 people in 15 different
locations. MonteHodge provides various financial services from pension and investment
advice to individuals, to maintaining cash books and cash forecasting in small to medium-
sized companies. The company is owned by six shareholders, who belong to the same family;
it is not listed on any stock-exchange and the shareholders have no intention of applying for a
listing. However, an annual audit is required by statute and additional regulation of the
financial services sector is expected in the near future.
Most employees are provided with on-line, real-time computer systems, which present
financial and stock market information to enable the employees to provide up-to-date advice
to their clients. Accounting systems record income, which is based on fees generated from
investment advice. Expenditure is mainly fixed, being salaries, office rent, lighting and
heating, etc. Internal control systems are limited; the directors tending to trust staff and being
more concerned with making profits than implementing detailed controls.
Four of the shareholders are board members, with one member being the chairman and chief
executive officer. The financial accountant is not qualified, although has many years
experience in preparing financial statements.
Required:
Discuss the reasons for and against having an internal audit department in MonteHodge
Co. (12 marks)
(20 marks)

Question 47 BRAMPTON CO
(a) Explain the difference between the interim audit and the final audit. (4 marks)
(b) You are the senior in charge of the audit of Brampton Co for the year ending 31 January and
are currently planning the year-end audit. Brampton specialises in the production of high
quality bread of various kinds.
During the interim audit you noted that, in the present economic down-turn, the company has
suffered as its costs are increasing and its prices have been higher than its competitors
because of lower production runs. One indicator of the problems facing the company is that it
has consistently used a bank overdraft facility to finance its activities.
At the time of the interim audit you had discussed with company management what actions
were being taken to improve the liquidity of the company and you were informed that the
company plans to expand its facilities for producing white bread as this line had maintained
its market share. The company has asked its bank for a loan to finance the expansion and also
to maintain its working capital generally.
To support its request for a loan, the company has prepared a cash flow forecast for the two
years from the end of the reporting period and the internal audit department has reported on
the forecast to the board of directors. However, the bank has said it would like a report from
the external auditors to confirm the accuracy of the forecast. Following this request the
company has asked you to examine the cash flow forecast and then to report to the bank.
Required:
(i) Explain whether you would be able to rely on the work of the internal auditors.
(6 marks)
(ii) Describe THREE procedures you would adopt in your examination of the cash
flow forecast. (6 marks)
(iii) Explain the kind of assurance you could give in the context of the request by
the bank. (4 marks)
(20 marks)
Question 48 QUICK QUESTIONS
Required: Answer the following questions with concise and specific bullet points. Complete
sentences are NOT required.
48.1 What does the existence of high control risk mean? (1 mark)
48.2 What internal controls would help to ensure that goods cannot be delivered to a customer
without an account receivable being recorded? (2 marks)
48.3 What are the principal internal control objectives in relation to the purchase of materials in a
manufacturing company? (3 marks)
48.4 Why do auditors perform walk-through checks? (1 mark)
48.5 What do you consider are the main disadvantages of using internal control questionnaires to
document and evaluate a companys internal control system? (2 marks)

48.6 In a computer information system, what is an application control? (1 mark)

48.7 What factors would affect your assessment of the sufficiency of audit evidence collected for a
particular account balance? (2 marks)
48.8 Eyeopener manufactures a range of domestic lighting products. Quarterly physical inventory
counts have revealed significant shortfalls compared to the perpetual inventory records.
Management has asked you as the companys auditor to investigate controls in this area.
Identify possible control weaknesses that could have led to the inventory losses. (3 marks)
(15 marks)
Question 49 JASPER, RUBY, GARNET & EMERALD
You are currently engaged in reviewing the working papers of several limited liability company audit
assignments recently carried out by your audit practice. Each of the audit assignments is nearing
completion, but certain matters have recently come to light which may affect your audit opinion on
each of the assignments. In each case the year end of the company is 30 September 2014.
(a) Jasper (Profit before tax $150,000)
On 23 October 2014 a letter was received informing the company that a customer, who owed
Jasper $30,000 as at the end of the reporting period, had been declared bankrupt on 17
October. It is expected that unsecured creditors, such as Jasper, will receive nothing in
respect of amounts owing to them. Jaspers management refuses to change the accounts to
provide for the loss, on the grounds that bankruptcy was declared after the statement of
financial position date.
Total trade receivables shown in the statement of financial position amounted to $700,000.
(b) Ruby (Profit before tax $500,000)
On 31 July 2014 a customer sued Ruby for personal damages arising from an unexpected
defect in one of its products. Shortly before the end of the reporting period Ruby made an
out-of-court settlement with the customer of $10,000, although this agreement is not reflected
in Rubys financial statements as at 30 September 2014. Further, the matter subsequently
became known to the press and was extensively reported. Rubys legal advisers have now
informed you that further claims have been received following the publicity, although they
are unable to place a figure on the potential liability arising from such claims which have not
yet been received. Ruby had referred to the claims received in a note to the financial
statements stating, however, that no provision had been made to cover them because the
claims were not expected to be material.
(c) Garnet (Profit before tax $250,000)
Audit work revealed that an item of investment property stated in the statement of financial
position at $500,000 had suffered a permanent impairment in its carrying value of $300,000.
The management of Garnet admits that the decline has occurred, but refuses to write down the
item on the grounds that other investment properties (not held for resale) have risen in value
and are stated at amounts considerably below their realisable values.
(d) Emerald (Profit before tax $100,000)
This client is a construction company, currently building a warehouse on its own premises,
and using some of its own workforce. The cost of labour and materials has been included in
the cost of the non-current asset in the statement of financial position; the total figure is based
on the companys costing records. The warehouse is almost complete and the cost shown in
the statement of financial position includes direct labour costs of $10,000. However, during
audit testing, it was discovered that the costing records, showing the direct labour costs for the
warehouse in the early part of the year, had been destroyed accidentally.

For each assignment and using the proforma answer provided:
(i) Assess materiality (e.g. $A represents x% of profit before tax, therefore material);
(ii) Identify relevant accounting requirements and state compliance or otherwise with them
(e.g. non-compliance IAS 16 (must depreciate));
(iii) State a suitable audit opinion (just one, e.g. modified except for). (12 marks)
(a) Jasper
Materiality
IFRSs
Audit opinion
(b) Ruby
Materiality
IFRSs
Audit opinion

(c) Garnet
Materiality
IFRSs
Audit opinion
(d) Emerald
Materiality
IFRSs
Audit opinion
Question 50 BURTON HOUSING
Your firm is the auditor of Burton Housing, a small incorporated charity and housing association. Its
principal asset is a large building which contains a restaurant and accommodation for 50 young people.
The charity is controlled by a management committee which comprises the voluntary chairman and
treasurer, and other voluntary members elected annually. However, day-to-day management is by a
chief executive who manages the full-time staff who perform accounting, cleaning, maintenance,
housing management and other functions.
You are auditing the companys financial statements for the year ended 31 March. Draft accounts have
been prepared by the treasurer from accounting records kept on a microcomputer by the bookkeeper.
The partner in charge of the audit has asked you to consider the audit work you would perform on
income from rents and expenditure in the restaurant.

For income from rents:
(a) the housing manager allocated rooms to individuals, and this information is sent to the
bookkeeper
(b) each week the bookkeeper posts the rent to each residents account on the sales ledger. All
rooms are let at the same rent
(c) rents are received from residents by reception staff who are independent of the housing
manager and bookkeeper. Reception staff give the rents to the bookkeeper
(d) the bookkeeper posts cash received for rents to the rents receivable ledger, enters them in the
cash book and pays them into the bank
(e) the housing manager reports voids (i.e. rooms unlet) to the management committee.
The restaurant comprises the manager and four staff, who prepare and sell food to residents and other
individuals. Restaurant expenditure includes only expenditure on purchasing food and wages of
restaurant staff.
The system for purchasing food comprises:
(a) the restaurant manager orders the food by sending an order to the suppliers;
(b) food received is checked by the restaurant manager;
(c) the restaurant manager authorises purchase invoices, confirming the food has been received;
(d) the bookkeeper posts the purchase invoices to the trade payables ledger;
(e) the bookkeeper makes out the cheques to pay the suppliers, which the chief executive signs.
The cheques are posted to the trade payables ledger and cash book.
The bookkeeper is responsible for paying the wages of staff in the restaurant. The restaurant manager
notifies the bookkeeper of any absences of staff.
Required:
Using the proforma answer provided suggest FIVE control procedures (i.e. internal controls) and
FIVE procedures for obtaining audit evidence for:
(i) rents received; and
(ii) expenditure in the restaurant.
(20 marks)

Control procedures Procedures for obtaining audit evidence
Limiting direct physical access to Analytical procedures

assets/records.
Enquiry
Approving & controlling documents.
Inspection
Controls over CIS.
Observation
Checking arithmetical accuracy of
records. Computation
Maintaining & reviewing control
accounts and trial balances.
Approving reconciliations.
Comparing:
internal data with external sources
of information;
results of cash/inventory counts
with accounting records; and
financial with budgeted results.
(i) Rents received (ii) Expenditure in restaurant

* * * * *
Question 51 DOCUMENTATION AND ENGAGEMENT LETTERS
(a) Auditors are required to document their understanding of the clients internal controls. There
are various options available for recording the internal control system. Two of these options
are narrative notes and internal control questionnaires.
Required:
Describe the advantages and disadvantages to the auditor of narrative notes and
internal control questionnaires as methods for documenting the system. (6 marks)
(b) ISA 210 Agreeing the Terms of Audit Engagements provides guidance on the content of
engagement letters and deals with the auditors responsibilities in agreeing the terms of the
audit engagement with management.
Required:
(i) State the purpose of an engagement letter. (1 mark)
(ii) List SIX matters that should be included within an audit engagement letter.
(3 marks)
(10 marks)
Question 52 COMPONENTS AND ELEMENTS
(a) ISA 315 Identifying and Assessing the Risks of Material Misstatement through Understanding
the Entity and Its Environment requires auditors to understand the entitys internal control.
An entitys internal control is made up of several components.
Required:
State the FIVE components of an entitys internal control and give a brief explanation of
each component. (5 marks)

(b) ISA 700 Forming an Opinion and Reporting on Financial Statements provides guidance on
the form and content of the auditors report and should contain a number of elements.
Required:
Describe FIVE elements of an unmodified auditors report. (5 marks)
(10 marks)
Question 53 PARKER
(a) Explain the term audit risk. (4 marks)
(b) You are the audit manager for Parker Co which sells books, CDs, DVDs and similar items via
two divisions: mail order and on-line ordering on the Internet. Parker is a new audit client.
You are commencing the planning of the audit for the year ended 31 December. An initial
meeting with the directors has provided the information below.
The companys turnover is in excess of $85 million with net profits of $4 million. All profits
are currently earned in the mail order division, although the Internet division is expected to
return a small net profit next year. Annual turnover is growing at the rate of 20% each year.
Net profit has remained almost the same for the last four years.
In the next year, the directors plan to expand the range of goods sold through the Internet
division to include toys, garden furniture and fashion clothes. The directors believe that when
one product has been sold on the Internet, then any other product can be as well.
The accounting system to record sales by the mail order division is relatively old. It relies on
extensive manual input to transfer orders received in the post onto Parkers computer systems.
Recently errors have been known to occur, in the input of orders, and in the invoicing of
goods following despatch. The directors maintain that the accounting system produces
materially correct figures and they cannot waste time in identifying relatively minor errors.
The company accountant, who is not qualified and was appointed because he is a personal
friend of the directors, agrees with this view.
The directors estimate that their expansion plans will require a bank loan of approximately
$30 million, partly to finance the enhanced web site but also to provide working capital to
increase inventory levels. A meeting with the bank has been scheduled for three months after
the end of the reporting period. The directors expect an unmodified auditors report to be
signed prior to this time.
Required:
(i) Identify and describe the matters that give rise to audit risks associated with
Parker. (10 marks)
(ii) Explain the enquiries you will make and the audit procedures you will perform
to assist you in making a decision regarding the going concern status of Parker
in reaching your audit opinion on the financial statements. (6 marks)
(20 marks)

Question 54 SMOOTHBRUSH PAINTS CO
Introduction and client background
You are an audit senior in Staple & Co and you are commencing the planning of the audit of
Smoothbrush Paints Co (Smoothbrush) for the year ending 31 August 2014.
Smoothbrush, a paint manufacturer, has been trading for over 50 years and operates from one central
site which includes the production facility, warehouse and administration offices.
Smoothbrush sells all of its goods to large home improvement stores, with 60% being to one large chain
store Homewares. The company has a one year contract to be the sole supplier of paint to Homewares.
It secured the contract through significantly reducing prices and offering a four-month credit period, the
companys normal credit period is one month.
Goods in/purchases
In recent years, Smoothbrush has reduced the level of goods directly manufactured and instead started
to import paint from South Asia. Approximately 60% is imported and 40% manufactured. Within the
production facility is a large amount of old plant and equipment that is now redundant and has minimal
scrap value. Purchase orders for overseas paint are made six months in advance and goods can be in
transit for up to two months. Smoothbrush accounts for the inventory when it receives the goods.
To avoid the disruption of a year-end inventory count, Smoothbrush has this year introduced a
continuous/perpetual inventory counting system. The warehouse has been divided into 12 areas and
these are each to be counted once over the year. The counting team includes a member of the internal
audit department and a warehouse staff member.
The following procedures have been adopted;
(1) The team prints the inventory quantities and descriptions from the system and these records
are then compared to the inventory physically present.
(2) Any discrepancies in relation to quantities are noted on the inventory sheets, including any
items not listed on the sheets but present in the warehouse area.
(3) Any damaged or old items are noted and they are removed from the inventory sheets.
(4) The sheets are then passed to the finance department for adjustments to be made to the
records when the count has finished.
(5) During the counts there will continue to be inventory movements with goods arriving and
leaving the warehouse.
At the year end it is proposed that the inventory will be based on the underlying records. Traditionally
Smoothbrush has maintained an allowance for slow-moving inventory based on 1% of the inventory
value, but management feels that as inventory is being reviewed more regularly this allowance is no
longer required.
Finance Director
In May 2014 Smoothbrush had a dispute with its finance director (FD) and he immediately left the
company. The company has temporarily asked the financial controller to take over the role while they
recruit a permanent replacement. The former FD has notified Smoothbrush that he intends to sue for
unfair dismissal. The company is not proposing to make any provision or disclosures for this, as they
are confident the claim has no merit.

Required:
(a) Identify and explain the audit risks identified at the planning stage of the audit of
Smoothbrush Paints Co. (10 marks)
(b) Discuss the importance of assessing risks at the planning stage of an audit. (4 marks)
(c) List and explain suitable controls that should operate over the continuous/perpetual
inventory counting system, to ensure the completeness and accuracy of the existing
inventory records at Smoothbrush Paints Co. (10 marks)
(d) Describe THREE substantive procedures the auditor of Smoothbrush Paints Co should
perform at the year end in confirming each of the following:
(i) the valuation of inventory; (3 marks)

(ii) the completeness of provisions or contingent liabilities. (3 marks)
(30 marks)
Question 55 CHUCK INDUSTRIES CO
Introduction and client background
You are the audit senior of Blair & Co and your team has just completed the interim audit of Chuck
Industries Co, whose year end is 31 January. You are in the process of reviewing the systems testing
completed on the payroll cycle, as well as preparing the audit programmes for the final audit.
Chuck Industries Co manufactures lights and the manufacturing process is predominantly automated;
however there is a workforce of 85 employees, who monitor the machines, as well as approximately 50
employees who work in sales and administration. The company manufactures 24 hours a day seven
days a week.
Below is a description of the payroll system along with deficiencies identified by the audit team:
Factory workforce
The company operates three shifts every day with employees working eight hours each. They are
required to clock in and out using an employee swipe card, which identifies the employee number and
links into the hours worked report produced by the computerised payroll system. Employees are paid
on an hourly basis for each hour worked. There is no monitoring/supervision of the clocking in/out
process and an employee was witnessed clocking in several employees using their employee swipe
cards.
The payroll department calculates on a weekly basis the cash wages to be paid to the workforce, based
on the hours worked report multiplied by the hourly wage rate, with appropriate tax deductions. These
calculations are not checked by anyone as they are generated by the payroll system. During the year
the hourly wage was increased by the Human Resources (HR) department and this was notified to the
payroll department verbally.
Each Friday, the payroll department prepares the pay packets and physically hands these out to the
workforce, who operate the morning and late afternoon shifts, upon production of identification.
However, for the night shift workers, the pay packets are given to the factory supervisor to distribute.
If any night shift employees are absent on pay day then the factory supervisor keeps these wages and
returns them to the payroll department on Monday.

Sales and administration staff
The sales and administration staff are paid monthly by bank transfer. Employee numbers do fluctuate
and during July two administration staff joined; however, due to staff holidays in the HR department,
they delayed informing the payroll department, resulting in incorrect salaries being paid out.
Required:
(a) For the deficiencies already identified in the payroll system of Chuck Industries Co:
(i) explain the possible implications of these; and

(ii) suggest a recommendation to address each deficiency. (12 marks)
(b) Describe substantive procedures you should now perform to confirm the accuracy and
completeness of Chuck Industries payroll charge. (6 marks)
(c) Last week the company had a visit from the tax authorities who reviewed the wages
calculations and discovered that incorrect levels of tax had been deducted by the payroll
system, as the tax rates from the previous year had not been updated. The finance director has
queried with the audit team why they did not identify this non-compliance with tax legislation
during last years audit.
Required:
Explain the responsibilities of management and auditors of Chuck Industries Co in

relation to compliance with law and regulations under ISA 250 Consideration of Laws
and Regulations in an Audit of Financial Statements. (4 marks)
(d) Chuck Industries has decided to outsource its sales ledger department and as a result it is
making 14 employees redundant. A redundancy provision, which is material, will be
included in the draft accounts.
Required:
Describe substantive procedures you should perform to confirm the redundancy

provision at the year end. (4 marks)
(e) Chuck Industries is considering establishing an internal audit (IA) department next year. The
finance director has asked whether the work performed by the IA department can be relied
upon by Blair & Co.
Required:
Explain the factors that should be considered by an external auditor before reliance can
be placed on the work performed by a companys internal audit department. (4 marks)
(30 marks)

Question 56 BEARSWORLD
You are the auditor of BearsWorld Co which manufactures and sells small cuddly toys by mail order.
The company is managed by Mr Kyto and two assistants. Mr Kyto 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 Kyto only visits the office once per 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. Turnover is over $52 million.
You are planning the audit of BearsWorld and are considering using some of the procedures for
gathering audit evidence recommended by ISA 500 as follows:
(i) Analytical Procedures;

(ii) Inquiry;
(iii) Inspection;
(iv) Observation;
(v) Re-calculation.
Required:
(a) For EACH of the above procedures:
(i) Explain its use in gathering audit evidence. (5 marks)

(ii) Describe one example for the audit of BearsWorld. (5 marks)
(b) Discuss the suitability of each procedure for BearsWorld, explaining the limitations of
each. (10 marks)
(20 marks)
Question 57 REDDY
Reddy and Co, Chartered Certified Accountants, is the external auditor of Drummoyne, a listed
company. On completing the audit for the year ended 30 June 2014 the following list of matters was
prepared for the partners attention.
(a) On 25 August 2014 Drummoyne agreed to a pay rise of 5% for all of its employees backdated
to 1 April 2014. No provision for this has been made in the financial statements. (5 marks)
(b) The draft Chairmans Statement, to be included in the Annual Report, states that the profits
have increased by 25%. It is true that operating profit has increased by 25% but, after
deducting reorganisation costs and losses on disposals of property, plant and equipment,
profit on ordinary activities, both before and after tax, has increased by only 4% over the
previous year. (5 marks)
(c) The audit revealed a major control weakness in the management of investments. The
company recently recruited a financial analyst, as an employee, to manage the investment of
surplus funds. Company policy is to invest in the shares of large quoted companies. The
audit discovered a number of situations where the financial analyst had made substantial
profits for the company by speculating in risky investments such as derivatives. Such
investments could result in massive losses. The matter was reported in writing to the chief
financial officer four months ago but no action has yet been taken. (5 marks)

(d) One of the companys oil tankers has just run aground on the coast of California. There is a
risk of a serious oil spill which could have a significant effect on the future of the company.
Further information will not be available until after the auditors report has been signed.
(5 marks)
Assume that each of these matters is potentially material and is to be considered independently of each
of the others.
Required:
Consider what further action Reddy and Co should take with respect to each of the matters listed.
(20 marks)


Answer 1 INTERNATIONAL AUDITING
(a) Definition of an audit
The objective of an audit of financial statements is to enable the auditor to express an opinion
whether the financial statements are prepared, in all material respects, in accordance with an
identified financial reporting framework. The phrases used to express the auditors opinion
are give a true and fair view or present fairly, in all material respects, which are
equivalent terms. A similar objective applies to the audit of financial or other information
prepared in accordance with appropriate criteria.
(b) Fundamental Principles
The auditor should comply with the Code of Ethics for Professional Accountants issued by
the International Ethics Standards Board for Accountants (IESBA). Ethical principles
governing the auditors professional responsibilities are:
Integrity at all times acting with honesty and being truthful;

Objectivity not allowing anything to influence professional judgement;
Professional competence and due care being up to date and having sufficient
technical knowledge for each assignment;
Confidentiality not to disclose or use information relating to a client improperly;
Professional behaviour being courteous and not bringing the profession into
disrepute.
(c) General principles of an audit of historic financial statements
The auditor should conduct an audit in accordance with International Standards on Auditing
(ISAs). Each standard contains the subject scope, auditors objectives, definitions and
requirements together with application and other material, which should be considered as a
whole. All of the standards must be considered to be related and an individual standard
should not be considered solely on its own.
The auditor must apply judgement in planning his work, gathering evidence and drawing
conclusions from evidence.
The auditor should plan and perform the audit with an attitude of professional scepticism
recognising that circumstances may exist which cause the financial statements to be
materially misstated (e.g. the auditor would ordinarily expect to find evidence to support
management representations and not assume that they are necessarily correct).
The auditor aims to give reasonable assurance that financial statements are free from
material misstatement. This is a high level of assurance, but cannot be absolute due to the
inherent limitations of an audit methodology.
(d) Authority of ISAs
ISAs are to be applied in the audit of financial statement. (ISAs are also applied,
adapted as necessary, to the audit of other information and related services.)
ISAs contain the subject scope, auditors objectives, definitions and requirements
together with application and other related material.

In exceptional circumstances, departure from an ISA may be judged necessary in

order to more effectively achieve the objective of an audit. However, the auditor
should be prepared to justify the departure.
ISAs need only be applied to material matters.
ISAs do not override local regulations governing the audit of financial statements in
a particular country. In the event that local regulations differ from or conflict with
ISAs, member bodies should comply with obligations of membership (e.g. to work
towards implementation of ISA or equivalent within that jurisdiction).
Answer 2 ISA 200
(a) Managements and auditors responsibilities
The management of an entity is responsible for:
the preparation and presentation of financial statements which give a true and fair
view (or are presented fairly) in accordance with the financial reporting framework
and statutory requirements. This responsibility includes:
selecting suitable accounting policies and applying them consistently;

making judgements and estimates that are reasonable and prudent;
that the financial statements are free from material misstatement;
stating whether applicable accounting policies have been followed;
preparing the financial statements on a going concern basis.
maintaining accounting records and implementing adequate internal controls for

safeguarding the assets and to minimise the risk of fraud or other irregularities.
The auditors are responsible for forming an independent opinion (e.g. in true and fair terms
in accordance with an identified financial reporting framework) based on their audit and for
reporting that opinion to the addressees of the auditors report.
(b) Inherent limitations facing an auditor
Tutorial note: It is vital to read requirements carefully. In an exam many candidates will
write about inherent risk when something else inherent is called for; in this case, limitations.
The inability to examine each transaction and each item making up an account
balance within normal time and cost constraints. This results in the necessity to rely
on evidence from samples and the consequent risk of sample error.
The auditors reliance on proper functioning of control systems to allow a reduction

in substantive procedures. Despite the evidence that an auditor gathers, controls
may in practice not be operating properly at all times.
Even given reasonable professional scepticism the inability of the auditor to detect
fraudulent misstatements carefully concealed by collusion or deliberate
misstatement by senior management.
The fact that audit evidence, mostly relating to past events, is rarely wholly
conclusive and the necessity for reliance on judgement as to the persuasiveness of
evidence.

(c) Significant types of judgements made by auditors
(i) In gathering evidence
Assessing risk and determining the appropriate audit strategy to be adopted. This
includes assessing:
the nature and degree of risk of misstatement at both the financial statement
level and the level of the account balance or class of transactions;
the design of internal controls and the effectiveness of the control environment
in determining the nature and extent of possible misstatements.
Planning tests of controls and evaluating the results of tests as to whether they
confirm the preliminary assessment of control risk.
Given the assessed levels of inherent and control risk, planning substantive
procedures as to their nature, timing and extent.
Planning substantive procedures such that sufficient appropriate evidence is

obtained. In turn this requires judgements as to:
the materiality of the items concerned;

the reliability of the evidence obtained; and
relevance of evidence as to each financial statement assertion.
(ii) In arriving at an opinion
In drawing conclusions and forming an opinion auditors need to consider whether:
they have sufficient appropriate evidence to express an opinion on the financial

statements taken as a whole and, if not, whether to report:
limitation on scope qualified opinion; or

limitation on scope disclaimer of opinion;
having sufficient appropriate evidence to form an opinion, the financial statements

as a whole show a true and fair view and, if not, whether to report:
disagreement qualified opinion; or

disagreement adverse opinion.
Answer 3 AUDIT COMMITTEE
(a) Improving the effectiveness of the external audit
Audit committees afford a means of strengthening the external auditors

independence.
An audit committee is a committee of the governing body of a corporate entity

which has delegated responsibility for the external financial reporting process and
internal control.
Over the last few years the value of audit committees has been recognised and these
committees have been established in many countries. Their development has varied
from country to country and has often been stimulated by corporate failure.

Thus it is perceived that the audit process will be helped by audit committees as
they will perhaps pre-empt unexpected corporate failure and undetected misconduct
by senior officials. The establishment of audit committees has been foremost in
North America and the UK but they are rapidly becoming adopted in many
countries (e.g. Europe, Australia, Malaysia and Singapore).
An audit committee can improve the effectiveness of the external auditors work by
increasing the assurance that the external auditors can derive from systems of
corporate governance and internal financial controls.
The committee will be involved in ensuring that the external auditor is independent
and will participate in the selection of the auditor by recommending certain firms
who have knowledge of their industry and reviewing the source and rationale for
selecting certain firms of auditors.
Additionally the terms and scope of the external audit and corporate governance
engagement will be discussed as will the management letter and its effect on the
current years audit.
The committee will encourage discussions with the external auditor as to how
internal controls might be improved, and the rationale as to the use of specialist
departments of the audit firm and specialist advisors.
A meeting of internal auditors, external auditors and the audit committee will
review the audit plan with a view to minimising duplication of work, the impact of
new auditing standards and providing value for money for the company. The
timing and nature of reports from the external auditors will be reviewed as to their
effectiveness and any contentious accounting issues discussed.
The opening up of communication channels between the external auditor and the
audit committee and two-way discussions enhances the quality of the audit and adds
value to the audit process.
The audit committee will further discuss with the internal and external auditor the
intended scope of their work with a view to satisfying itself that no unjustified
restrictions have been imposed by executive management.
Additionally the following duties of the audit committee may assist in the external
audit process.
dealing with difficulties in the performance of the audit such as non-

availability of client personnel;
reviewing the findings of the internal and external auditors;
reviewing the companys financial statements and annual report prior to
the submission to the board;
reviewing public announcements that have a financial impact;
reviewing and monitoring compliance with the corporate code of conduct,
and legal and statutory requirements.
Audit committees are seen as valuable not only for overseeing the external reporting
process and external audit but as a means of ensuring responsible corporate
governance. They are an aid in ensuring the professional independence of auditors
and the efficiency and effectiveness of the audit and the system of corporate
governance.

(b) Independence of audit committee members where only a voluntary code is in place
Tutorial note: The question refers to a voluntary code. Marks would not be awarded for
discussing codes that are in place because of legal or regulatory requirements.
The members of the audit committee generally comprise independent non-executive

directors (NED) the members of the New York Stock Exchange audit committees
and of the London Stock Exchange must comprise all independent NEDs. However
the NYSE is governed by law and the LSE by regulation both cannot be
considered to act on a voluntary basis.
Where the audit committee is voluntary, the general absence of regulations in this
area (e.g. only guidelines are followed) means that independence is often hard to
achieve. For example, what if NEDs sit on committees of several companies, there
may well be conflicts of interest. What if executive directors from one company act
as NEDs for another and vice-versa? Again, can they be considered as
independent? Additionally the company pays the NEDs salaries and this fact
ensures that independence is difficult to achieve under a voluntary code.
The NEDs often sit not only on the audit committee but also on several other board
committees making strategic contributions to the running of the business. They
have to balance their role as audit committee member and the monitoring of
executive directors and management with their role as corporate strategist.
In this situation, they are acting in several capacities and because of the complexity
of the NEDs role it may be difficult to act independently when it comes to
exercising their corporate governance role.
The internal structure of the company and the perception of the role of the audit
committee by the main board will determine the ability of the NEDs to exercise
independent judgement.
Some members of the audit committee may have previous executive involvement
with the company and have participation in share option schemes which is
inconsistent with the exercise of independent judgement.
It may be extremely difficult for a NED to exercise independent judgement when

they have any interest in the company, are appointed by the company and are
remunerated by the company.
(c) Regulation of audit committees
If the audit committee is not governed by statute or the rules of the stock exchange,
then several issues arise. One of the problems of allowing self-regulation in the area
of corporate governance and audit committees is that if prescriptive approaches are
advocated, they may not receive the support of key industry groups and in the
absence of major corporate failure or fraud, governments may be reluctant to
impose regulations on industry as it may be seen to be a further burden to
management.

Without statutory regulation, there will be inconsistency of practice and standards

between audit committees. Members of audit committees may find it difficult to
criticise management. The form of the annual report of the audit committee may
not be consistent without some form of strong regulation. Shareholders are poorly
informed about the working of the audit committee and there would seem to be
substantial benefits from making publication of the report of the audit committee a
statutory requirement. Greater transparency and disclosure can be uncomfortable
for companies but the current reliance on voluntary practices creates a market risk
which can be alienated through changes in statute and disclosure practices.
However the prescriptive approach to the formation of an audit committee may

result in disproportionate significance being given to its role and may impact on
corporate performance and long-term potential. Problems would also arise if a
single model audit committee were imposed on a wide range of companies of
different sizes and financial profiles, and different internal structures.
Many smaller companies would not see the benefits of appointing an audit
committee and they may feel that statutory regulation is counterproductive, with the
costs outweighing any benefits. However it is important that some form of
monitoring report is made to shareholders even in the case of small publicly quoted
companies.
If audit committees are unregulated then there is little formal requirement for
adherence to professional values of competence, independence or effective
reporting to shareholders. The identity and experience of the audit committees
members becomes an important issue in these circumstances.
Accountancy bodies will find it difficult to set standards for NEDs on audit
committees where such persons are non-accountants and the problems of
independence of NEDs set out in part (b) above may dictate that some form of
statutory regulation may be required.
Unlike Sarbanes-Oxley in the USA, the Corporate Governance Code of the London
Stock Exchange (LSE) does not prescribe by law the use of audit committees it is
a requirement under the regulations of the LSE on the basis of comply or
explain.
There is, however, a legal requirement that a statement is made by UK listed

companies of their compliance, or otherwise, with the Code. This statement is
reviewed by the companys auditors (the review is separate and not part of the
auditors statutory duty of auditing the financial statements).
Thus, although the audit committee requirements are strictly voluntary, the public
disclosure requirement means that UK-listed companies do have fully operational
audit committees following the Code they do not wish to have to justify why they
do not have such committees. Once established they must follow the spirit, as well
as the letter, of the Code.
The impact of this is that UK companies have the flexibility of applying the Code to
their circumstances and then justifying any departures the comply or explain
principle rather than a prescriptive one size fits all approach.

Answer 4 EASTFIELD DISTRIBUTORS
(a) Matters to consider and action to be taken
As Eastfield Distributors is a listed company:
fees from the external audit, the internal audit and other recurring work
performed for Eastfield Distributors should not exceed 15% of the practice
income for more than two consecutive years;
the audit firm should not prepare the annual financial statements (except in
emergency situations);
internal audit services can only be provided by the external auditor if they do
not cover a significant part of the internal controls over financial reporting;
financial accounting systems that generate information that is significant to
the accounting records or financial statements or amounts or disclosures that
are material to the financial statements; and
the audit committee must decide if there are any independence issues that
prevent the external auditor from providing the internal audit service.
With providing internal audit services, a self-review threat may arise where the
work carried out by the internal auditors will be relied upon and reviewed by the
external auditor. The fact that both the internal and external audit staff are provided
by the same firm makes the self-review threat.
This is thus a typical example of the use of the conceptual framework. There should
therefore be independence between the internal and external audit functions within
the audit firm. Different staff should carry out internal audit work from those who
undertake the statutory external audit. Ideally such staff should be from different
sections (e.g. internal audit services, external audit services) or even different
offices.
Eastfield Distributors must acknowledge their responsibility for internal audit

activities and for establishing, maintaining and monitoring the system of internal
controls. This would be included within the engagement letter.
The company must designate a competent employee, preferably within senior

management, to be responsible for internal audit activities.
As the company is a listed company, there should be an audit committee. The

scope, function and reporting requirements of the internal audit function should be
set by this committee.
To avoid a clear breach of independence internal audit staff should report to a

different partner from the engagement partner for the external audit.
The internal audit staff should be careful not to assume the role of management
when carrying out their work. This may create problems if the internal auditors are
asked to design the companys accounting systems in order to provide adequate
controls (which would be in breach of ACCAs Code of Conduct and Ethics, as the
company is listed).

For the internal auditors to be truly independent of the external auditors, they should
not report to partners in the audit firm. However this is impractical and unrealistic.
It is impractical, as the internal auditors will be employees of the audit firm

and their promotion will be determined by the audit firm. Thus, the audit firm
will have to be able to assess the quality of each employees work.
It is unrealistic, as external auditors use the work of internal auditors in

coming to their audit opinion. Thus, the external audit staff will have to
review the work of the internal auditors.
There will have to be a decision about which members of the audit staff should
perform this internal audit service. The staff should have a range of skills and range
from junior to qualified staff. It is important that internal audit staff are competent,
as otherwise this could adversely affect Eastfield Distributors opinion of the audit
firm. This will create the risk that Eastfield Distributors will want to change the
external auditor with the consequent risk to the external auditors independence
There will have to be an agreement about how much should be charged for the
internal audit service, and the services that will be provided. The charge will
probably be based on the number of hours worked by staff at Eastfield Distributors
and their level of experience.
An engagement letter should be agreed with Eastfield Distributors for the internal
audit work, which includes most of the matters listed above.
Whilst internal audit work is permitted with safeguards under the ACCA/IFAC
regulations, it is of interest to note that it would not be allowed under the Sarbanes-
Oxley Act of the USA. So if Eastfield Distributors was also listed in the USA, or
was a subsidiary of a holding company that was listed in the USA, acting as internal
auditors for Eastfield would be specifically barred.
(b) Advantages to Eastfield Distributors
The new internal auditors will be skilled in carrying out audit work, so the learning
time for the staff should be short compared with setting up an internal audit
department within the company.
The audit procedures and standard should be consistent with those of the external
audit. Thus, the external audit staff should be able to place reliance on the internal
auditors work in coming to understand, for example, the clients business risk
systems. This could reduce the cost of the external audit.
The audit firm may be able to provide staff with a wider range of skills than
Eastfield Distributors would be able to recruit as employees. For instance, the audit
firm may be able to provide specialists in computer auditing, where it would not be
economical to have a computer audit specialist as an employee.
Tutorial note: Another advantage, which is outside of the scope of the current F8 syllabus,
is the concept of extended assurance services. Basically the external auditor would carry out
extended testing of the financial systems, as required by the client, beyond that required for
audit purposes. This very often replaces internal audit testing of the systems and is overall
cost effective for the client.

Disadvantages to Eastfield
There may be problems with who is in charge of the internal audit staff. The
internal audit staff will be employees of the external audit firm. The client company
will probably have less control over the internal audit staff, and this may create
problems over the work they do and the reports they make.
Because of the ACCAs Code of Ethics and Conduct, the internal auditors will be
restricted in the work they do. For instance, as Eastfield Distributors is a listed
company, they will be prevented from working on a significant part of the internal
controls over financial reporting and financial accounting systems that generate
information that is significant to the accounting records or financial statements.
The internal audit staff will be skilled at performing work similar to the external
auditors, but they may have limited skills and experience of other work carried out
by internal auditors (e.g. advising on the purchase of a business).
Using the external audit firm to perform internal audit work on non-financial
controls and systems may be more expensive than the company employing its own
internal audit staff, as the external audit firm will want to cover its costs and make a
profit on the work.
There may be problems with the internal audit staff changing from time to time.
This will require the new staff to learn about Eastfield Distributors business. This
learning time is likely to be greater than if Eastfield Distributors employed its own
staff.
The requirement of the external audit firm to have to perform external audits (when
it is busy) may mean that Eastfield Distributors does not have sufficient internal
audit staff during periods when it wants them (e.g. at the end of the reporting period
for inventory counts and to help in preparation of the annual financial statements).
(c) Advantages to the audit firm
By having the internal auditors as part of the audit firms staff, the confidence of the
audit firm in their work will probably be greater than if the internal auditors were
employees of the client company. For audits of non-public interest clients, the
external auditor will probably be able to achieve a greater reduction in the external
audit work.
The service will provide additional income and profits to the audit firm. It may
provide a wider experience to the audit staff.
It may be possible to use the internal audit work to fill in periods when there is little
external audit work. For instance, in jurisdictions dominated by December 31 year
ends, there is little audit work from July to early September so more staff could be
employed in internal audit work during this period.
Disadvantages to the audit firm
The firm must be careful that independence is not contravened. It may be difficult
to ensure that none of the staff employed on internal audit work are part of the
external audit team. It may be very difficult to ensure that professional
independence is complied with at all times, as the internal auditors may be required
to make executive decisions or be involved in the preparation of the annual financial
statements.

If a dispute arises with the client over the internal audit work this is likely to affect
the audit firms relationship with the client. This may have implications on the
external audit.
The self-review threat is always present in that external auditors may not test work
done by internal audit adequately due to assuming that it will be of good standard.
A major fraud of failure of internal control and related publicity will be particularly
serious when both functions are performed by the same firm. Despite all
precautions the firm is unlikely to be seen to be independent.
Answer 5 ABEL & CO
(a) Shareholding by staff member
While partners are not allowed to hold shares in client companies there is no specific
prohibition in the ACCAs Code of Ethics and Conduct (the Code) on the holding of shares
in audit clients by audit staff providing the staff members concerned are not personally
involved in the audit of such clients.
However, many audit firms have adopted a prohibition on the holding of shares in audit
clients by audit staff as an in-house rule. If so, the firm should not make exceptions to its own
rules.
The argument that independence is not impaired because the holding is insignificant is
incorrect. If the holding is of such a size as is likely to influence the behaviour of the audit
staff member, then it is material. If the staff member was allowed to retain the shares then he
or she should not have been included in the audit team.
If the partner advised the staff member not to sell the shares until after the audit was
completed, this implies that that the firm has a general prohibition on audit staff holding
shares in audit clients. The audit partner is therefore encouraging the staff member to breach
the firms own rules.
In addition, the partner probably carried out insider dealing the use of privileged
information to secure a personal advantage (or advantage for others) in the trading of shares.
This is illegal in most jurisdictions.
(b) Management accounting services
Preparation of accounting records on behalf of a public interest company is normally

prohibited. An exception to this requirement allows such work to be performed in an
emergency situation which does not extend beyond the minimum period necessary and where
every care is taken that management accepts full responsibility for the work of the audit
firms staff member.
The assignment of a staff member to the position of management accountant is likely to

breach the rules on independence. They would more than likely be required to make
management decisions on behalf of the client (unless the duties are restricted to the provision
of data only) and their work could easily be used when preparing next years financial
statements.
The firm will thus be reporting on a statement of financial performance in which one of its
own employees had played an active part. This constitutes a significant self-review threat.

Tutorial note: An alternative answer could suggest that the work of the senior in winding up
the priors year audit be reviewed by a manager/partner unconnected with the client to
confirm that the standard of audit work was not in any way impaired by the knowledge that
he was to take up a new position. It could also be considered whether the audit senior could
participate in the audit of the current year financial statements (for which he has contributed
to the management accounting system). It might be suggested that if the management and
financial accounting systems are independent (as is sometimes the case) then he would not be
auditing his own work. However, the personal relationships which have built up over a 3
month period while he has effectively been an employee of the client alone might be sufficient
grounds for his removal from the audit team.
(c) Advice on controls
This raises a controversial area in auditor independence. While the reporting of control
weaknesses discovered during the audit is a required procedure, advising on the development
of new systems to overcome those weaknesses is seen by some critics as a possible threat to
independence. There is both a general and a specific issue.
The general issue is that audit firms generate revenues from clients for both audit and non-
audit work. However, contracts for non-audit work are given by management. In performing
the audit, the auditors may be reluctant to disagree with management for fear of losing non-
audit contracts.
The specific issue is that known as self-review. Since the firm designed the new internal
control system, there is a presumption, when evaluating control effectiveness at the next audit,
that there will be no weaknesses in the system.
The Code does not prevent auditors from providing non-audit services within the overall fee
limit of 15%. However, it does stress that, in advising the client, the audit firm must not make
executive decisions. The implementation of advice is the responsibility of management over
which the auditor has no control. At the next audit the auditor must check that the system has
been properly put into operation and that it is being operated effectively.
In addition, where the client is a public interest client, the firm could not provide this service
if it related to a significant part of the internal controls over financial reporting.
(d) Advice to non-audit clients

Although Abel & Co are not threatening their own independence, their action is in breach of
professional rules on second opinions. By offering advice they are prejudicing the
independence of the auditors of the company they are advising. In extreme cases they may be
helping to apply an intimidation threat to the auditor. Giving advice without being aware of
all relevant issues may also breach other principles (competence, integrity, professionalism).
This practice is sometimes referred to as opinion shopping and is carried out by companies
in order to exert pressure on their existing auditors. This casts doubt about the integrity of
this clients management which has implications for the inherent risk assessment of such a
client.
When invited to provide such advice, professional rules require Abel & Co to communicate
directly with the companys auditors to ensure that their advice is based on all available facts
relevant to the judgement. Abel & Co are under an ethical responsibility to decline to be
nominated as auditors and to write to the company retracting the advice previously given in
the light of further information.

Answer 6 PROFESSIONAL ETHICS
(a) Independence
It is important for external auditors to be independent of their audit clients because

external auditors act on behalf of the owners of the business (normally the
shareholders) and report on the financial statements prepared by management for
the benefit of shareholders.
They also have a duty to act in the public interest. Whilst they do not report to any
group other than the owners of the business, users of the business should be able to
expect that auditors are objective in their work and would thus flag any financial
difficulties with the entity (e.g. going concern).
If external auditors are not independent of their clients, for example if they hold
shares in the companies that they audit, their ability to form an objective opinion on
the financial statements is impaired.
External auditors must also be seen to be independent because if they are not, the
shareholders of the business and other users of the financial statements will not have
confidence in the auditors reports.
The ACCAs Code of Ethics and Conduct (the Code) requires that auditors are
independent, and that they are seen to be independent. The Code covers a number
of areas in which the auditors independence may be, or be seen to be, impaired.
(b) Billington Travel
(i) Statutory audit
The Code states that it is important that the firm is competent to undertake the audit;
it must have adequate resources in terms of staff with sufficient experience in this
sector. The fact that the services to be provided would constitute a substantial
amount of fee income indicates that the firm might not, at present, have those
resources.
It may be appropriate to consider whether experience in this sector can be bought in

by the recruitment of staff experienced in the audit of package holiday travel
companies.
The firm should consider whether staff are available at the right time of year and
whether the work fits in with the firms existing obligations.
The Code also states that the firm must be independent of its clients; in particular,
this means that it must not be considered to be dependent on the fee income from
one client (or group of clients).
As Billington Travel could be considered a public interest company, the fee income
(including income from additional services) should not exceed 15% of the gross
practice income for two consecutive years.
As the fee from the company would represent a substantial amount of fee income
and it is growing fast (implying fees are likely to grow) it is likely that the total
fees would well exceed 15% of the gross practice income. Unless the practice
would be able to reduce the % to below 15% (e.g. through growth of the practice)
within the two year period, the work should be declined.

(ii) Provision of other services
Preparation of financial statements: it is generally acceptable under the Code for

auditors to provide assistance with the preparation of financial statements for non-
public interest clients, provided that the client takes full responsibility for the
accounting records and financial statements and that the professional account is not
required to make any management decisions.
In addition, those preparing the financial statements are independent of those

performing the audit as far as possible, in order that the firm is seen to remain
independent.
It is important to know why Billington Travel needs assistance in this area and it
would be preferable in the long run for the company to be able to prepare its own
As discussed above (fees) if the company is considered to be a public interest

company, then the Code specifically bars the auditor from also preparing the
financial statements, unless clearly in an emergency.
Systems review: the external auditor is often well placed to provide assistance with
such reviews as the firm obtains a working knowledge of systems during the course
of the audit.
It is critical that this is just a review of the internal controls of the system and is not
involving any design or implementation function of the systems themselves.
If it is just a review, the requirements of the company may be covered through the
standard audit procedure of understanding the design and implementation of internal
control. If the client requires a separate assurance report on the system (covering
more than just the financial controls), then an appropriate safeguard would be that
the review team should not be the same as the audit team.
(c) (i) Actions to be taken
Review any code of conduct implemented by the company that deals with the
approach to use in such situations. If there is a procedure to follow (e.g. approach
the audit committee or senior director operating a whistle blowing function).
If no code
It may be appropriate to discuss the matter, discreetly, with other staff members to
establish whether or not it is of concern to them. It would be preferable to discuss
the matter with persons who are known to be reliable.
If the concerns are shared, it will be appropriate to discuss the matter with the chief
internal auditor to try to establish why the matter has not been reported, as there
may be a good reason.
If the chief internal auditor is able to offer assurance either that it is not necessary to
report the matter, or that the matter will be reported, no further action will be
necessary. Notes of the discussion should be documented.

If discussions are not satisfactory, or if the chief internal auditor undertakes to

report the matter but does not do so (within a reasonable time), the situation may be
more serious. It may be appropriate to have further discussions with the chief
internal auditor (which should also be documented).
If still not satisfied and the matter appears sufficiently serious it may be appropriate
to voice concerns to a more senior member of management for self-protection.
On the assumption that the matter is one of internal concern to the company and
there is no question of illegality, the question of reporting the matters to third parties
outside the organisation does not arise.
(ii) Doing nothing
The main danger of doing nothing is to risk facing accusations of not bringing
managements attention to the matter or of being actively involved in a cover-up.
Professional ethics do not permit professional accountants to take no action at all

where serious matters are concerned and to do nothing might, in extreme
circumstances, involve disciplinary proceedings by the ACCA, even as a student.
To do nothing might also result in damage to the employers business.
Answer 7 VISWA
(a) Internal matters and other procedures before appointment
The firm needs to consider a variety of commercial issues and ethical matters (under ACCAs
Code of Ethics and Conduct).
Internal matters
Before accepting appointment the firm should ensure that:
it has the necessary staff with appropriate competencies to complete the audit (this
seems likely given that the firm has other clients in this sector);
the staff are available at what is a busy time of year for the firm (it may be possible
that all of the staff with the necessary competencies are otherwise occupied);
the firm is independent of Viswa. It is unlikely that there will be any issues
concerning shareholdings in the client (because it is owned and run by two
entrepreneurs), however, there may be staff or partners who are related to the client
or are otherwise connected with it; and
there are no conflicts of interest that cannot be properly managed. Conflicts of

interest may exist because the firm has other clients in this sector.
Other procedures
The firm should:
seek the directors permission to communicate with the company accountant about
the nature of the disagreement and the directors should authorise the accountant to
co-operate with the firm;

seek the directors permission to communicate with the incumbent auditors. If

permission is refused, the appointment should not be accepted;
ask the client to write to the incumbent auditors notifying them of the change and
giving them permission to communicate with the firm (if Viswa refuses to give
permission to the incumbent auditors the appointment should not be accepted);
communicate with the incumbent auditors (preferably in writing) requesting all the
information which ought to be made available to enable the firm to decide whether
or not to accept the appointment (if there are no such matters, the incumbent
auditors should inform the firm of this);
seek appropriate transfer information (such as a copy of the last set of accounts and
a detailed trial balance reconciled to the accounts);
indicate a likely fee (or the basis on which fees are calculated) to Viswa, ensure that
this is acceptable and that the client is able to pay (by some form of credit check);
ensure that the incumbent auditor has properly resigned, been dismissed or has not
sought re-appointment in accordance with legal requirements.
(b) Starting the audit
It is inappropriate to start the audit before the procedures referred to above have been
completed because:
without the staff with appropriate competencies the firm will be in breach of the
Code (and may be found negligent if things were to go wrong);
without complying with the requirements relating to independence and conflicts of

interest, the firm will not only be in breach of the Code, but will lack objectivity and
may find that the client (or other party) objects to the appointment to another client
in the same sector;
without performing appropriate procedures the firm will be unable to form an

opinion on the integrity of the client it may find itself associated with an entity
engaging in doubtful or even illegal activities (taking account of the disagreement
over disclosures);
without agreeing a fee it is almost inevitable that misunderstandings or

disagreements will arise;
without communicating with the accountant and the incumbent auditor, it is quite
possible that disagreements over disclosures will arise, similar to those that have
arisen in the past;
without ensuring that the incumbent auditor is no longer in place, it will be

inappropriate for the firm to seek appointment.
(c) Engagement letter
The engagement letter is of benefit to both the client and auditor and helps prevent
misunderstandings. It confirms the auditors acceptance of appointment and constitutes a
contract between the auditor and the client. It summarises the respective responsibilities of
directors and auditors.

It contains details on:
the responsibilities of the directors (for accounting records, the financial statements
and the accounting policies on which they are based);
the responsibilities of auditors and the scope of the audit (their duty to conduct an
audit in accordance with auditing standards, to review accounting policies and
disclosures, to perform tests and to form an opinion on the financial statements);
the form of report to be issued;
other services to be provided;
the basis of calculation of fees;
applicable legislation.
Answer 8 CARLING
(a) Matters
Reason for dissatisfaction
The reason behind the change in appointment could indicate that it may not be appropriate to
accept the nomination. For example, if the present auditors have:
qualified the current years audit opinion (e.g. on-going concern grounds); or
declined to provide the additional services (e.g. on ethical grounds).
Permission to communicate
If permission to communicate freely with the current auditor is not granted the nomination
should be declined.
Inherent risk
Factors which are likely to increase inherent risk include:
Reliance by the bank on the audited financial statements (as well as the unaudited
management accounts); and
The dominance of Mr Thorburn as the owner-manager.
Objectivity
Objectivity in relation to the audit assignment could be threatened by:
Mr Thorburns dominance (as the majority shareholder he controls the audit

appointment);
The preparation of monthly management accounts (depending on the degree to

which they are integrated with financial information);
The audit partner appearing to assume an executive role at board meetings.

Human resources
Depending on the time taken to produce the management accounts (it could be the first week
of every month), there may be no suitable employee available after taking into account study
leave, holidays and commitments to existing clients.
The audit partners attendance at monthly board meetings could also be time consuming
depending on the amount of preparation required.
Expertise
Depending on the nature of Carlings business and the complexity of its cost and management
accounts, there may not be an employee or audit partner with the necessary expertise
available to provide the additional services.
Responsibilities
Responsibility for the preparation of management accounts must be assumed by the

management. The audit partner could not assume responsibility for any explanations given to
the directors.
Package of services
Mr Thorburn expects a range of services to be provided by the companys auditor. It is

possible that, in declining to provide the additional services, Mr Thorburn would not make the
audit appointment.
Fees
The fees for the additional services could easily exceed the audit fee. It may not be possible
for Mr Thorburn to justify such costs, especially when the company is dependent on the
banks support. Also, the company may not be able to pay promptly for the audit and
additional services provided.
(b) Actions
Discuss with Mr Thorburn the reasons for his dissatisfaction.
Obtain Mr Thorburns permission to communicate freely with the current auditor.

If refused, decline the nomination.
Write to the current auditor to enquire of any professional reason why the
nomination should not be accepted.
Consider the incumbents response. For example, if it casts doubt on Mr

Thorburns integrity (e.g. because he has not explained the real reason for change),
the nomination should be declined.
Explain to Mr Thorburn the respective responsibilities of directors and auditors in

relation to financial and management accounts and that these would be included in a
letter of engagement.
Briefly review the management accounts to ascertain:
the level of expertise and time required to prepare them;

to what extent they are integrated with financial information.

Review the bank overdraft facility and correspondence with the bank to assess the
degree of going concern risk.
Review employees suitability for the preparation of management accounts and their
availability.
(c) Conclusions
Assuming that there are no professional reasons why the audit appointment should not be
accepted:
(i) management accounts may be prepared (subject to employee availability) provided

that:
management assumes full responsibility;

the employee is not involved in the audit assignment;
(ii) it is unlikely that the audit partner could attend the board meetings as this would be
seen to detract from objectivity.
Marking scheme Marks
(a) Matters
Generally mark each matter identified
+ up to 1 marks for description up to a maximum 8
Professional reasons for change

etiquette
independence
responsibility
client integrity
Practical risk
resources
expertise
services
fees
(b) Actions
Generally 1 mark each matter (relevance should be
made apparent) up to a maximum 5
(c) Conclusion
Generally 1 mark each conclusion on additional services
clearly derived from the preceding analysis 2
__
15


Answer 9 WORKING PAPERS
(a)(i) Familiarisation with the client company
Tutorial note: Under ISA 315, an understanding of the entity and its environment is vital to
plan and execute the audit effectively. To gain such an understanding, reference should be
made to, for example, the following sources of information (a significant proportion of which
may be continuous in that it would be available throughout the financial year).
The entitys legal structure and constitution (e.g. memorandum and articles of
association). A copy should be kept on the permanent file.
The entitys strategy, objectives, business risks and approach to selecting and
applying accounting and financial reporting policies.
The latest available financial information which may be last years published
financial statements or this years draft financial statements as well as management
accounts and budgets for the year to date. This information will help to clarify the
current operating results and financial conditions of the client.
An organisation chart setting out the operating structure, geographical spread and
management reporting structure. This will give an idea of how the enterprise is run
and will help to identify the personnel most likely to be key audit contacts.
Full details of the companys risk management processes/procedures, including

internal control processes/procedures, the information system and the
processes/procedures by which management monitor the systems. This would
include procedure manuals, changes made to the systems and details of breaches
and the action taken during the year.
Industry data showing an analysis of the key financial and operating ratios typical of
this type of business and thereby permitting comparisons to be made. Such data can
be obtained from both government and industry sources or may be maintained
internally within the auditing firm.
Last years current audit file with particular reference to the problems arising during
the audit and how they were resolved in reaching the conclusion in the auditors
report (e.g. partner review notes, contentious issues, management letter, control
weaknesses letter, representation letter, revision of strategy and audit plans).
Press articles, reports, features concerning the client, and the industry that the client
operates in, would help to provide an awareness of any current developments
affecting the client.
Copy board minutes including sub-committees of the board (e.g. audit committee,
remuneration committee, risk committee) to determine any current plans,
developments or problems affecting the client.
The income tax file and relevant returns together with any correspondence with the
taxation authorities.
Copies of brochures and marketing literature will help to give an idea of the product
range and customer base for this client.
Communications to management made by external regulators.

Internal audit reports to establish the extent of the work performed by the
department and its findings.
Scope of internal audit procedures as instigated by any audit committee.
The correspondence file for details of all issues arising during the year which might
impact the audit.
The permanent file will also contain useful background information including
details of bankers, solicitors, related parties, major customers, suppliers, standards,
reporting and regulatory framework, extracts from statutory books.
A significant proportion of the information required will probably be stored and

accessed in electronic format (e.g. a specific knowledge base for the client).
(ii) Planning the current years audit
Audit strategy and audit plan determined at the time of the interim audit visit.
Interim audit and year-end inventory observation files to update the audit strategy
and approach, the need to carry out further work covering the time between the
interim visit and the end of the reporting period, and the use of substantive testing
procedures.
Last years current audit file with particular reference to the final audit notes for any
matters which will have continuing relevance to the year-end audit.
Notes made last year which were to be carried forward as important for this year.
Interim or management accounts to determine the current trading circumstances

together with any significant changes in the business since the interim audit visit.
Documented analytical procedures to note any factors likely to have a material

effect on the financial statements and to establish expectations of the results.
Minutes of the final audit planning meeting (assumption that interim and inventory
observation meetings already held) with the client and audit committee (if there is
one) which would cover, for example, the following issues:
updated interim financial results;

inventory observation results;
monthly management reports;
business risk procedures and activities since the interim visit;
major new products or services;
new/lost business;
planned acquisitions or disposals;
changes in personnel, management or accounting systems;
material events since the end of the reporting period;
timing of the audit including availability of management information;
new legislation or accounting and auditing requirements which may affect
the client.
The audit engagement letter to clarify the scope of our responsibilities and the form
of our auditors report.

Ethical considerations (e.g. independence) capabilities, resources.

Time control, billing and budget details for the client.
Working papers determining planning materiality and the assessment of risk to
consider the maximum amount of error which can be accepted and to focus the audit
effort on the high risk areas.
(b) Criteria
Tutorial note: Audit working papers must provide a documentary record of an audit
assignment and support the conclusions reached.
Evidence of procedures followed and the tests performed

Working papers must indicate the clients name, accounting period, a file reference, the areas
of the audit being covered and details of who performed the work and when. As an overall
requirement working papers should be neat, clear and concise with sufficient details to enable
someone, not involved in the audit, to understand what work has been performed.
In the interests of clarity, detailed explanatory information should be provided on supporting

schedules which should be suitably referenced and cross-referenced.
Record of information received, problems encountered and conclusions reached

Documenting details of all findings during the audit encourages the auditor to adopt a
methodical approach and ensures that problems are not overlooked. The working papers
should always summarise any significant matters or problems, and highlight any judgmental
aspects together with the auditors conclusions thereon.
Where judgmental areas have been reviewed it is important to note all relevant information
received from the client together with managements views, so that these views can be
compared with the auditors views.
Evidence of review
All working papers prepared by each member of the audit team must be reviewed by a more
senior member. Such a review must be evidenced on the working paper, detailing who has
performed it and when. This review is important as it ensures that sufficient work has been
performed and that the findings and results support the audit conclusions.
Degree of assurance given to the reporting partner

The reporting partner will need to satisfy himself that work delegated by him has been
properly performed by his review of the working papers. To achieve this, the reporting
partner would expect a summary of the significant points affecting the financial statements
and the auditors report, with details of how each matter has been dealt with.
Sufficient for the preparation of communications to management on internal controls

The working papers must give sufficient background details and examples of any weaknesses
to enable the report to management on internal controls to be written. In making such
comments, generalities and gratuitous observations should be avoided and all comments
should be adequately supported by facts.

Usefulness in future years
The working papers should provide sufficient detail to enable members of the audit team to
familiarise themselves with the assignment from year to year and to plan subsequent audits.
Evidence of adherence to standards
In the event of the auditors opinion being challenged, the working papers will provide
evidence that the auditor followed the basic principles prescribed by International Standards
on Auditing, the appropriate application of Practice Statements (IAPS) and any national
auditing standards over and above those required by ISAs. They will also illustrate that the
auditor has been competent in applying proper standards of skill and care in arriving at the
audit opinion.
For each relevant audit working paper adequately described (i.e. content and purpose) 1
Maximum for each of (i) and (ii) 6
(i) Familiarisation legal structure/constitution

financial statements
organisation chart
industry information
prior year current audit file
permanent audit file
brochures
(ii) Planning prior year current audit file

points forward
management accounts
analytical procedures schedules
systems documentation
minutes of planning meeting
engagement letter
Part (a) 12
For each criterion identified and point contributing to an explanation +1
Ideas clarity (of audit evidence)

completeness and quality (of information)
sufficiency (of audit work reports)
degree of assurance provided
future usefulness
adherence to ISAs/IAPSs
Part (b) 8
Maximum marks available 20

Answer 10 PLANNING DOCUMENTATION
(a) Overall strategy v Audit plan
These documents are prepared and updated during the planning process, which is an on-going
process throughout the audit.
The audit strategy sets the scope, timing and direction of the audit, and helps guide the
development of the more detailed audit plan. For example:
Determining the scope of the audit engagement. This covers the financial reporting
framework used, industry-specific law and regulation requirements, governance
requirements, locations of the components of the entity (may have different
requirements), terms of engagement, client assistance.
Ascertaining the reporting objectives. This deals with the timing of the audit and
communications required, deadlines for interim and final reporting; key dates for
expected communications with management and those charged with governance.
Establishing the direction of the audit. This deals with, for example, determination
of appropriate materiality levels, preliminary identification of areas where there may
be higher risks of material misstatement, preliminary identification of material
components and account balances, evaluation of whether the auditor may plan to
obtain evidence regarding the effectiveness of internal control, identification of
recent, industry, financial reporting or other relevant developments impacting upon
the entity.
The process of establishing the audit strategy helps the auditor to ascertain the nature, timing
and extent of resources necessary to perform the engagement
The detailed approach for the nature, timing and extent of the audit procedures is set out in
the audit plan.
The plan is more specific and concerns the principal audit areas. For example, tangible
assets, inventory, revenue cycle (i.e. sales, receivables and cash receipts), subsequent events
and going concern.
The plan consists of an audit programme for each area. Each programme typically contains:
Audit objectives (e.g. To ensure inventory is materially correctly stated);

Audit procedures (e.g. attendance at physical inventory count);
Timing of tests of control (usually interim audit procedures) and substantive
procedures (usually at the final audit).
The audit programme has to be much more detailed than the overall strategy in order to serve
as a set of instructions.
(b) Standardised audit programmes
Tutorial note: The Q refers only to the use of standardised AUDIT PROGRAMMES and not
working papers in general. Thus references to the use of standard letters and
documentation other than programs are not relevant to answering the question set.

Advantages
Their use can lead to more efficient planning in identifying the audit objectives and
adopting an approach based on these objectives. Greater assurance as to the
completeness of the audit approach is obtained than if it were started from scratch.
Standardised programmes facilitate delegation to junior staff and help to instruct in

basic audit techniques. They help to ensure that all assignments are planned and
conducted to a consistent quality.
A standardised approach makes the review of audit working papers easier.

Programmes may include sections to be completed, thereby reducing the need for
separate supporting working papers.
Disadvantages
Standardisation may lead to an overly mechanical approach. This may stifle

initiative because an alternative, more efficient approach may not be considered.
No account is taken of the particular circumstances of the individual enterprise.

This decrease in the use of professional judgement for a particular assignment might
result in over-auditing low risk or immaterial areas.
There is a risk that sufficient, relevant and reliable audit evidence may not be
obtained. For example, standard programs may not include tests on certain unusual
transactions or for specialised clients. Alternatively, some standard tests may be
marked as not applicable without considering a suitable alternative test.
Conclusion
Standard audit programmes may be useful on certain assignments to improve audit

efficiency but they cannot replace the need for professional judgement. Any
standard programme used must always be tailored to take into account each clients
situation and risks.
(c) Information in working papers relating to attendance at physical inventory count
Viewcos physical count arrangements and instructions should be obtained before

attending the count:
to assess the adequacy of the clients planned procedures; and

to ascertain whether clients staff are carrying out their instructions properly.
Pre-selected (e.g. high value) or randomly selected items chosen to ensure that an
adequate proportion or suitable sample of the final inventory value is tested (to
conclude satisfactorily on the population).
Results of test counts (i.e. serial/component references and quantities) provide

evidence as to the completeness and accuracy (or otherwise) of the count records.
Test counts also enable the auditor to assess whether the clients count procedures
and controls are working properly.
The sequence of count sheets issued and used will detect any additional items being
included subsequently to attending the count.

Inventories identified as damaged, obsolete or slow-moving must be detailed to

assess the adequacy of allowances for items with net realisable value less than cost.
Items owned by third parties must be recorded to ensure exclusion from the final
inventory valuation sheets.
Last goods movement document references for 31 December (i.e. goods received
note, stores requisition, despatch note/sales invoice) are needed to check the
accuracy of the year-end cut-off.
Movements, if any, during physical inventory counting to ensure items are not
omitted or double-counted in error.
Other points
A floor plan (sketch) of central warehouse should ensure complete coverage (by
management and auditor) of the physical inventory count.
Details (e.g. serial numbers) of finished goods held by third parties are required to
confirm the validity of their inclusion in the final inventory value.
The degree of assembly of incomplete TVs and VRs must be noted to assess
appropriateness of stage of completion used in valuing WIP.
Instances where the clients procedures have not been satisfactorily carried out (e.g.
damaged items not set aside) will be required for the report to management with
recommendations for improvements (e.g. in standing instructions for physical counts).
Answer 11 NORBERT
(a) Matters (b) Explanation/Planning point
Risk is increased by the specialised nature of Some continuity of audit staff is desirable to
the business. minimise the time required for familiarisation.
A senior member of the on-site team should have
yachting/nautical experience.
Operations have been extended to two The need for audit visits to document and test
locations. systems or to perform substantive tests and to attend
physical inventory counting, inspect tangible non-
current assets, etc must be assessed.
There may be scope for analytical procedures to
substantiate some of the costs of the yards
activities.
Expansion when trade is slack may create The adequacy of working capital available in both
going concern problems. the short and medium-term must be assessed.
Management should be asked to make projections
for next year.
Need to establish exactly why the yard was
purchased.

(a) Matters (b) Explanation
Value of new yard may be impaired because Need to be aware of indications of impairment.
of trading conditions
If the new yard has been provided as security for a
bank loan, actual value may be less than the loan
made.
If, for example, a customer becomes Net realisable value (NRV) of yachts built may be
bankrupt there may be no other purchaser less than cost. These are probably specialised,
interested in the same specification. luxury items and the valuation assertion is high risk.
Similarly, yachts built without orders may NRV tests using subsequent sales are unlikely to
not meet buyers requirements when market yield useful results given the tight reporting deadline
picks up requiring significant additional and end of season.
costs.
Risk is increased by exposure to Euro If the Euro weakens after a price has been agreed
fluctuations. with a customer, costs may not be recovered in full.
Exchange movements after the end of the reporting
period must be monitored.
Risk is high due to weak internal controls. Unless systems/controls have improved a
Controls at the yard may be particularly substantive audit approach must be adopted. There
poor if management exercises remote appears to be no scope for reducing the level of
supervision. year-end testing by interim tests of controls.
Research and development expenditure on Management may wish to carry forward as much
design amendment should be accounted for cost as possible to increase reported profit and net
in accordance with IAS 38 Intangible assets. assets. The justification for amounts capitalised
must be carefully considered, especially as the
company may cease to be a going concern.
The going concern assumption may not be This would have particular implications for the value
appropriate if the bank were to call in its of assets (e.g. NRV of yachts could be substantially
overdraft. reduced and development costs may have minimal,
if any, value). Management assessment/projection
should be requested.
Risk is increased by the banks reliance on Particular attention should be given to the accuracy
the auditors report. of bank overdraft/payables cut-off and the impact of
potential adjustments on key ratios (e.g. acid test
ratio).
The tight reporting deadline potentially Errors could arise because of the speed with which
increases audit risk. the client will need to prepare its year-end accounts.
The reduced time scale limits the extent of evidence
available after the end of the reporting period (e.g.
concerning NRV of inventory and debtor
recoverability). Need to determine whether clients
deadline is realistic.

(a) Matters (b) Explanation
A year-end confirmation of overseas trade Balances will need to be circularised at least one
receivables will not be appropriate (see month, possibly two, before the end of the reporting
above). period.
The time available for review after the end It may be appropriate to circularise suppliers for
of the reporting period may not be sufficient balances a month before the end of the reporting
to establish the completeness of recorded period and verify the material correctness of the roll-
period-end liabilities. forward (through analytical procedures and the
accuracy of cash book payments cut-off).
Management may be biased to presenting Particular attention should be given to the
financial statements which will ensure the appropriateness of accounting treatments in the more
banks continuing support thereby subjective areas (inventory valuation, exchange
increasing risk. translation, research and development and interest
capitalisation).
Substantial interest costs will increase the Ensure that financing costs are fully accrued and
companys financial burden. included in projection.
Trade fair costs may be incurred in the These may be carried forward if appropriate (e.g.
current year. promotional material likely to generate future
revenue). There is a risk of management bias.
Detection (residual) risk must be rendered Performance materiality is likely to be a relatively
lower than in the previous year because low monetary amount thereby increasing the level of
inherent risk is increased (control risk audit testing. Additional staff may be required for
probably unchanged). this reason, as well as the reduced timescale.
For each matter (circumstance/factor) clearly relevant to planning 1

For each explanation (reason) why taken into account and how it is resolved 1
Potential risk areas branch visit

staff continuity, availability
nature of business, specialised
business/economic environment
control environment
accounting policies (R&D), trade fair
management bias
third party reliance
reporting deadline
availability/sufficiency of evidence
going concern, management projection
reliance by bank
exchange risk
inventory valuation
Part (a) 10
Part (b) 10

Answer 12 AUDIT RISK
(a) Definitions
(i) Audit risk
The risk that the auditor gives an inappropriate audit opinion when the financial
statements are materially misstated. It comprises two elements:
(1) that the financial statements contain material errors before audit (may be
considered as inherent risk and control risk); and
(2) that the auditor fails to detect those errors (detection risk, sometimes
referred to as residual risk).
(ii) Inherent risk
The susceptibility of an assertion to misstatement that could be material

(individually or in aggregate) assuming no related internal controls.
An example of inherent risk is that the inventory of a computer manufacturer has a

high risk of obsolescence because of rapid technological change. Thus the assertion
that inventory is correctly valued may be at risk.
(iii) Control risk
The risk that a misstatement that could occur (at the assertion level) and be material
(individually or in aggregate) will not be prevented (or detected and corrected on a
timely basis) by the internal control system.
(iv) Detection risk
The risk that the auditor will not detect a misstatement that exists (in an assertion)
that could be material.
(b) Factors affecting inherent risk
In some business areas the inherent risk is small, because the value of the transactions and the
balance in the accounts are immaterial. For example, the petty cash transactions and balance
in many businesses.
Certain management and business factors do increase the audit risk, and this type of risk may
be classified as inherent risk.
Factors to be considered in determining inherent risk
Strong governance procedures may reduce inherent risk.
Companies that operate strong business risk processes and procedures may be
considered as having lower inherent risk.
If the managements competence is poor or there is a dominant chief executive, the

inherent risk is higher.
If management follow aggressive earnings policies, inherent risk is higher.

If there have been recent changes in senior management or in the staff who maintain
the accounting records, this increases inherent risk as they know less about the
operations.
A company which has going concern problems (e.g. is making losses and/or has
liquidity problems) has a higher inherent risk than a company with good profits and
no liquidity problems. Pressure may be placed on management to improve results
and the entitys financial position or assets will be overstated and liabilities
understated if the entity is not a going concern.
Changes in accounting systems and procedures may increase inherent risk (e.g.
greater risk of operational errors whilst the systems are being embedded and
operators being trained; risk of error as data is transferred from the old system to the
new).
Past audit experience may indicate higher inherent risk (e.g. a history of errors
found in year-end inventory valuation, estimates of provisions and cut-off
procedures).
Some types of business are riskier than others. For example, high technology
industries have a greater inherent risk because the companys products may become
obsolete and research and development may not be effective at producing
replacement products.
Small businesses usually have a higher risk of failure than large ones as they have
less financial resources and possible concentration on a single market or product
increases risk.
Companies which rely on a single customer or a single product are higher risk.
Companies which operate in capital industries (e.g. building companies, steel and
manufacturers of industrial plant) have a higher risk because demand falls more in a
recession than with companies which produce or sell products that are essential for
current consumption (e.g. staple food, basic clothing).
There is a higher risk where the company is raising new capital, purchasing another
business through a share swap or is defending itself against a takeover bid.
Management may be biased in reporting results and financial position in order to
maintain a high share price.
Where the businesss income is cash based, the inherent risk is high. However most
of these businesses have strong controls to reduce the risk of misappropriation of
the cash.
The inherent risk will be lower where the company has an effective internal audit
department (this could be considered as an element of the control risk).
(c) Quantifying control risk
Ascertaining and recording the system
In order to understand the entity and its internal control, the auditor must ascertain, record and
evaluate the internal controls. For the purchase system, this will specifically mean those
operating and financial statement controls at the assertion level.

The purchases system is ascertained by asking the management and staff how the system
operates and obtaining details of the documents used in the system. Narrative notes or a
flowchart will be used to record the purchases system.
The flowchart or notes show how purchases transactions are processed from raising the
purchase requisition to paying the supplier, and it is divided into the different departments or
staff who operate the system (e.g. the user, buying, goods received and accounting
departments and the cashier).
In this way the division of duties in the entire system for processing and recording the
purchase cycle will be shown.
Internal control questionnaire/evaluation
Either an internal control questionnaire (ICQ) or an internal control evaluation questionnaire

(ICEQ) is used to evaluate the controls. In some approaches used by auditors, the ICQ/ICEQ
are used as part of the overall approach to ascertaining and recording the system.
The internal control questionnaire asks specific control questions such as is a purchase order
raised for all goods and services ordered by the company. A yes answer indicates the
control exists, and a no answer shows there is a weakness in the control or no control exists.
An alternative method, using key controls in an ICEQ, sets broader questions requiring the
auditor to identify which steps or combination of procedures provide management with
assurance that a control objective is achieved (e.g. How does the client ensure that a
purchase order is raised for all goods and services required?).
Walk-through checks
Normally, a walk-through test (i.e. checking a small sample of items from the start to end of
the process) is used to check that the purchases system operates as recorded.
The flowchart will be corrected if the walk-through test shows the system operates in a
different manner from that originally recorded.
Alternatively, if the system is computerised, using CAATs would essential in order to walk
through the system.
Design and implementation of the control system
By considering the documented system notes and the answers to the ICQ or ICEQ the
effectiveness of the design of the system of internal control can be evaluated (on paper).
By carrying out a walk-through test the implementation of each control can be evaluated.
Both of these processes are essential requirements of ISA and must be carried out for every
entity that is audited.
Tests of control
The above procedures provide an understanding of the control system in theory. If it appears
to be providing the necessary control assurance the auditor may wish to rely on it to reduce
audit risk. Having so decided he needs to test if the controls have operated appropriately
through the reporting period.

If the controls are unreliable or they are not implemented, the auditor will not rely on them in
obtaining audit assurance. Assurance will come only from substantive procedures.
In some cases, it may be more effective to obtain all of the assurance from substantive testing,
regardless of the control system, for example, if volumes of transactions are small.
If the risk assessment requires reliance on the operation of internal controls at the assertion
level the operating effectiveness of the controls is assessed by carrying out tests of controls in
the purchases system.
If errors are found in the operating effectiveness of controls, the auditor will ascertain why
those errors have occurred. He may increase the sample of transactions in order to achieve
the required level of confidence (i.e. to within the tolerable error) if no further errors found.
Alternatively, there may be other controls which would prevent errors arising. Finally, he
may ascertain that the error was an explainable isolated incident (e.g. occurred on one day
only due to a particular reason) that had no material impact on the assertions, so there would
be little effect on the substantive audit work.
If it is clear that he cannot rely on the operating effectiveness of the controls, the auditor will
reassess audit risk with an appropriate change to the nature, timing and extent of substantive
tests.
In all cases where the auditor finds weaknesses within the system, he reports these to
management.
(d) Detection risk
(i) Effect of risk assessment
Essentially, the auditor wants to achieve a particular level of detection risk so that the audit
risk can be reduced to an acceptable level.
If the auditors risk assessment (i.e. inherent and control risk components) that financial
statements will contain material errors is low, the detection risk can be taken to be relatively
high. This implies that a higher level of audit assurance is being obtained from the operating
effectiveness of controls and a lower level from substantive testing.
Where no assurance can be placed upon the operating effectiveness of internal controls, the
level of assurance to be placed on substantive testing is higher. Hence, the extent of
substantive testing will need to be greater, or the nature or timing different.
In all cases, there must be some level of substantive testing (e.g. analytical procedures). The
operating effectiveness of controls can never be 100% because of the inherent limitation of
controls.
(ii) Trade payables and accruals
If a low value of detection risk is required (i.e. little if any reliance on effectiveness of
controls), the auditor will have to perform detailed substantive tests in verifying trade
payables and accruals. With a higher value of detection risk, limited substantive tests will be
carried out.

Essentially, verifying trade payables involves the key procedures of:

Agreeing the financial statements with the books and records;
Checking purchases and payables cut-off;
Reconciling suppliers statements to the balances on the accounts payable ledger, or
obtaining confirmations of balances.
In agreeing the financial statements with the books and records, control risk will be relatively
high when a manual accounting system is used, and relatively low when it is computerised.
So, with a computerised system less detailed checks (or 100% by using CAATs) will be
performed than with a manual system.
If the company has good controls over purchases cut-off, the auditor will check fewer
transactions than if controls are weak. In addition, if risk is low he may rely on requesting
supplier statement reconciliations from the client. If risk is higher confirmation of balances
through circularisation of suppliers directly would be carried out.
If risk is high (in particular because the operating effectiveness of controls is weak) the
auditor would carry out substantive transaction tests on the purchases system as well as
analytical review.
The auditor must assess the risk of material misstatement in accruals through understanding
the business and the nature of the types and value of accruals expected to be needed.
If controls are strong over recognising and recording accruals, the auditor may only check
accruals for those items considered material and also carry out analytical review in comparing
levels and types of accruals with previous years and from expectations through the audit of
other areas. Any unexpected fluctuations would be investigated.
If controls are weak, he would pay closer attention to the level of accruals, including the
possibility of overstatement as well as understatement of accruals, checking back to
supporting evidence.
Answer 13 HIVEX
(a) Performance
The company has increased its revenues by 12% and its gross profit by 16% which
in a competitive market is very good. However, increased operating expenses have
resulted in a reduction in operating profits of 20%.
The gross margin is very high; this is not abnormal in this sector, especially for
software (although the margin is high for hardware), but it may also be the result of
errors, because the information has been produced very quickly. This is also true of
the other figures.
Total expenses as a percentage of revenue have increased substantially with the

result that operating profit as a percentage of revenue has reduced by around a third.
The increase in the selling expenses as a percentage of revenue may reflect the need
for the company to spend more on advertising.
The increase in the distribution costs as a percentage of revenue may reflect

inefficiencies in the method of distribution in an industry that separates these
functions.

The administrative expenses as a percentage of revenue have halved. (However,

they do not represent a significant amount in absolute terms.)
The reduction in operating profits has been partially offset by increased net interest
receivable but profit before tax is still down 10%.
The reduction in profit before tax and the increased tax charge have resulted in a
reduction in profit after tax of over 40%.
Total dividends have been increased, despite the lower profits.
The reduction in earnings per share is partly due to the reduction in profits but there
is insufficient information to state whether it is also attributable to an increase in the
number of shares, although this seems likely.
(b) Higher risk areas and audit procedures
Gross margin and operating expenses
Obtain a detailed schedule of revenue and cost of sales showing the opening and
closing inventory figures for both software and hardware and perform a detailed
review of changes on (say) a monthly, quarterly and half-yearly basis.
Ascertain the accounting policies for revenue recognition for both software and
hardware and ensure that they were in accordance with IAS 18 Revenue. The
application of these policies to individual transactions should be tested. IAS 38
Intangible Assets requires that certain development costs be capitalised in the
statement of financial position and that research costs and costs that do not meet the
criteria for capitalisation be expensed.
Establish why all three categories of operating expenses have changed by enquiry
and by obtaining a schedule of operating expenses and a breakdown of the figures.
Perform detailed analytical procedures on operating expenses and cost of sales/gross

margins on a quarterly and monthly basis and increase detailed testing of
transactions in these areas in order to ensure that misclassifications have not
occurred.
Audit evidence provided by the verification of the inventory figures (such as

analytical procedures performed on the inventory levels and attendance at the
inventory count) will also provide evidence in relation to cost of sales.
It is possible that some reclassifications or errors have been made. Enquire and
verify reasons for the significant fluctuations.
Perform detailed substantive testing on samples of transactions in these areas from

source documentation (such as licensing documentation, payroll records, purchase
invoices for components, etc) through to the daybooks and check totals to ledger
accounts and the statement of comprehensive income (for completeness).
The extent of substantive procedures will depend on the extent to which controls are
shown to be effective and satisfactory results to analytical procedures obtained.

Interest receivable
Perform further analytical procedures on the interest costs and income and ensure
that these are in line with current interest rates and the values and types of
investments and borrowing held by the company.
Taxation
Obtain copies of the tax calculations for detailed review, and to corroborate
explanations provided by management.
Dividends and earnings per share
Enquire why dividends increased despite the lower profits, and establish whether
this trend can be maintained in the face of falling profits.
Establish whether there had been any share issue during the year that had affected
the calculation of the earnings per share and, if there had been, the purpose of the
share issue. Verify the transaction, including checking completeness of receipt of
proceeds and accuracy of processing the newly-issued shares.
Answer 14 FRAUD AND ERROR
(a) Internal audit function: risk of fraud and error
The internal audit function in any entity is part of the overall corporate governance
function of an entity. Corporate governance objectives include the management of
the risks to which the entity is subject that would prevent it achieving its overall
objectives such as profitability. Corporate governance objectives also include the
overarching need for the management of an entity to exercise a stewardship function
over the entitys assets.
A large part of the management of risks, and the proper exercise of stewardship,
involves the maintenance of proper controls over the business. Controls over the
business as a whole, and in relation to specific areas, include the effective operation
of an internal audit function.
Internal audit can help management manage risks in relation to fraud and error, and
exercise proper stewardship by:
(1) commenting on the process used by management to identify and classify

the specific fraud and error risks to which the entity is subject (and in
some cases helping management develop and implement that process);
(2) commenting on the appropriateness and effectiveness of actions taken by
management to manage the risks identified (and in some cases helping
management develop appropriate actions by making recommendations);
(3) periodically auditing or reviewing systems or operations to determine
whether the risks of fraud and error are being effectively managed;
(4) monitoring the incidence of fraud and error, investigating serious cases
and making recommendations for appropriate management responses.

In practice, the work of internal audit often focuses on the adequacy and
effectiveness of internal control procedures for the prevention, detection and
reporting of fraud and error. Routine internal controls (such as the controls over
computer systems and the production of routine financial information) and non-
routine controls (such as controls over year-end adjustments to the financial
statements) are relevant.
It should be recognised however that many significant frauds bypass normal internal
control systems and that in the case of management fraud in particular, much higher
level controls (those relating to the high level governance of the entity) need to be
reviewed by internal audit in order to establish the nature of the risks, and to
manage them effectively.
(b) External auditors: fraud and error in an audit of financial statements

External auditors are required by ISA 240 The Auditors Responsibility Relating to
Fraud in an Audit of Financial Statements to consider the risks of material
misstatements in the financial statements due to fraud. Their audit procedures will
then be based on a risk assessment.
Regardless of the risk assessment, auditors are required to be alert to the possibility
of fraud throughout the audit and maintain an attitude of professional scepticism,
notwithstanding the auditors past experience of the honesty and integrity of
management and those charged with governance.
Members of the engagement team must discuss the susceptibility of the entitys
financial statements to material misstatements due to fraud as part of their planning
procedures.
Auditors should:
make enquiries of management regarding managements assessment of fraud

risk, its process for dealing with risk, and its communications with those
charged with governance and employees;
enquire of those charged with governance (e.g. the audit committee) about the
oversight process and their understanding of managements assessment and
controls;
enquire of management and those charged with governance about any
suspected or actual instance of fraud;
consider fraud risk factors, unusual or unexpected relationships, and assess
the risk of misstatements due to fraud, identifying any significant risks;
evaluate the design of relevant internal controls, and determine whether they
have been implemented;
determine an overall response to the assessed risk of material misstatements
due to fraud;
develop appropriate audit procedures, including testing certain journal entries,
reviewing estimates for bias, and obtaining an understanding of the business
rationale of significant transactions outside the normal course of business;
enquire of management and those charged with governance about any
suspected or actual instance of fraud; and
obtain relevant management representations covering the above points.

Auditors are only concerned with risks that might cause material error in the
financial statements. External auditors might therefore pay less attention than
internal auditors to small frauds (and errors) although they must always consider
whether evidence of single instances of fraud (or error) are indicative of more
systematic problems.
In addition, whilst the quantitative element of the fraud may not be material, the
qualitative element may be (i.e. the fact that a fraud took place may be considered
material to the users of the financial statements).
It is accepted that because of the hidden nature of fraud, an audit properly
conducted in accordance with ISAs might not detect a material misstatement in the
financial statements arising from fraud. In practice, routine errors are much easier
to detect than frauds.
Where auditors encounter suspicions or actual instances of fraud (or error), they
must consider the effect on the financial statements, which will usually involve
further investigations. They should also consider the need to report to management
and those charged with governance.
Where serious frauds (or errors) are encountered, auditors need also to consider the
effect on the going concern status of the entity, and the possible need to report
externally to third parties, either in the public interest, for national security reasons,
or for regulatory reasons. Many entities in the financial services sector are subject
to this type of regulatory reporting and many countries have legislation relating to
the reporting of money laundering activities, for example.
(c) Nature of risks arising from fraud and error: Stone Holidays
Stone Holidays is subject to all of the risks of error arising from the use of computer
systems. If programmed controls do not operate properly, for example, the
information produced may be incomplete or incorrect. Inadequate controls also
give rise to the risk of fraud by those who understand the system and are able to
manipulate it in order to hide the misappropriation of assets such as receipts from
customers.
All networked systems are also subject to the risk of error because of the possibility
of the loss or corruption of data in transit. They are also subject to the risk of fraud
where the transmission of data is not securely encrypted.
All entities that employ staff who handle company assets (such as receipts from
customers) are subject to the risk that staff may make mistakes (error) or that they
may misappropriate those assets (fraud) and then seek to hide the error or fraud by
falsifying the records.
Stone Holidays is subject to problems arising from the risk of fraud perpetrated by
customers using stolen credit or debit cards or even cash. Whilst credit card
companies may be liable for such frauds, attempts to use stolen cards can cause
considerable inconvenience.
There is a risk of fraud perpetrated by senior management who might seek to lower
the amount of money payable to the central fund (and the companys tax liability)
by falsifying the companys sales figures, particularly if a large proportion of
holidays are paid for in cash.
There is a risk that staff may seek to maximise the commission they are paid by
entering false transactions into the computer system that are then reversed after the
commission has been paid.

Answer 15 KNITS
Tutorial note: Although a weakness letter was not required a similar style is used combining part (a) with (b). This makes it easier to mark. Also note that
some controls are made feasible by the small number of transactions per week (e.g. the sales rep telephoning to check customer creditworthiness, and the
factory supervisor checking goods despatches).
(a) Potential weaknesses (a) Reason (b) Controls
Sales ordering
Customers creditworthiness is not Goods may be supplied to a bad credit risk The executive director should set appropriate
checked before a sales order is resulting in financial loss to the company. (This credit limits for each customer.
accepted and fulfilled. risk is made more acute by the lack of credit
The sales representatives should be given up-to-
control procedures.)
date customer balance listing for their clients.
They should telephone Miss Jones to check on a
customer account balance if they suspect that the
credit limit may be exceeded by a new order being
placed.
Credit control
There are no effective credit control Accounts receivable may not be settled due to: Sales ledger balances should be independently
procedures. reviewed by the executive director.
lost goods
invoice error or omission (see below) A system of standard procedures should be
lost payment implemented to obtain prompt payment including:
customers taking advantage of poor credit
terms of payment on invoices (and
control (see below).
statements)
Delay in chasing accounts may result in telephone when payment overdue
permanent financial loss if disputes are not a series of warning letters.
promptly resolved.

Goods despatch
Records of goods despatched (e.g. In the event of customer query, there is no DNs should be a 3-part document. A copy could
despatch notes (DNs)) are not documentation to: then be retained in the warehouse (where there is
retained. more filing space) in numerical order.
confirm the despatch of goods
support the invoice raised. Miss Jones should record the DN number on each
invoice so that, in the event of query, the
warehouse copy can be found.
Invoicing
There are no procedures to ensure the The company could suffer financial loss if the DNs should be pre-numbered and Miss Jones
completeness and accuracy of accounts copy of a DN is lost or discarded before should check the sequence of numbers issued (e.g.
invoices raised. an invoice is raised. via a log, day book or pre-list) and investigate any
omissions.
Miss Jones should agree DN details to a customer
order and query any discrepancy regarding
product or quantity with the warehouse.
The customer order file should be reviewed
periodically (e.g. by Mrs Singh) and outstanding
orders queried with the warehouse.

Remittances
Lack of segregation of duties as Miss Miss Jones could make errors in the recording of Wherever possible additional controls should be
Jones, inter alia, records transactions transactions (invoices and cash) including failure implemented by Mrs Singh, for example:
and handles cash. to record transactions. Errors and omission could
mail opening
go undetected (and therefore uncorrected).
sales ledger control a/c reconciliations.
Understatement of sales invoices and/or cash The executive director should effectively
receipts could result in financial loss to the supervise Miss Jones duties by reviewing:
company (either directly or indirectly through loss
cash receipts
of customer goodwill).
sales ledger balances
sales ledger control a/c reconciliations.
Recording
No hard copies of sales ledger Management does not have the information The sales ledger should be printed monthly in the
accounts are produced. necessary (amounts owed to the company) to form of customer statements and an accounts
facilitate credit control (and decision-making). receivable listing. (This should be facilitated by
the computerised system.)
The lack of monthly statements may contribute to
customers being lax in settling their accounts (see
also above).

Other points
Goods despatch
Goods are despatched without any If the warehouse despatches the wrong goods Before orders are despatched by carrier, the
specific authorisation. (product or quantity): factory supervisor could check the goods and DN
details against the customers orders.
customer goodwill may be lost
unnecessary expense may be incurred in
rectifying the order.
Remittances
The mail opening is not supervised An error in the list of remittances may not be Mrs Singh should attend the mail opening and
and remittances are not checked. detected unless/until a customer queries an agree the list of remittances produced.
alleged underpayment.
The executive director should agree the amount to
be banked to the list total and paying-in slip.
The executive director should review bank
reconciliations.
Recording
A sales day book (SDB) and sales Invoice posting errors are likely to go undetected Miss Jones should use the SDB facility or produce
ledger control account are not and could result in loss of revenue (e.g. if amounts a manual invoice listing against which the total of
maintained. are understated by a transposition error or the the postings to the individual accounts receivable
invoice is omitted). can be checked.
Mrs Singh should compare the total of a list of
month-end balances to the sales ledger control a/c
balance (and produce a reconciliation if
necessary). The executive director should
confirm that a list is extracted monthly and review
reconciliations.

For each internal control weakness (max two weaknesses per system area) comprising
potential weakness 1
persuasive reason (possible effect) 1
feasible recommendation 1
Areas of system sales ordering

credit control
goods despatch
invoicing
remittances
recording
Effects ideas error (e.g. omission)
loss of asset (e.g. inventory, accounts receivable, cash)
consequential loss (e.g. customer goodwill)
Recommendations select from control environment + individual controls
but must be feasible to the business and circumstances of Knits
Answer 16 IBSON
Tutorial note: Although not specifically called for, the control objectives give structure. A flow
diagram of a typical purchase system would have also aided the planning of an answer.
(a)(i) Purchase and receipt of goods
To ensure that goods cannot be ordered without authorisation
Written orders are required for all purchases.

All orders are authorised before being placed.
Duties of requisitioning and authorisation are segregated.
Orders are pre-numbered and sequentially accounted for.
Copies of authorised orders are retained on file.
To ensure that goods cannot be received without authorisation
GRNs are matched with orders before the goods are accepted.
There are adequate procedures to deal with part delivery of orders.
To ensure that goods cannot be received without a liability being raised
Goods received are recorded immediately on receipt.

GRNs are pre-numbered and sequentially accounted for.
Invoices are recorded immediately on receipt.
Invoices are matched with GRNs before processing.
Unmatched GRNs are followed up at regular intervals.
Goods received are inspected as to quality and quantity before being accepted.
The accounts department receives a copy of all GRNs.
There is segregation of duties between receipt, recording of goods and
ordering/invoice processing.

(ii) Recording and settlement of liabilities
To ensure that a liability cannot be raised for goods not received
All invoices are matched to GRNs before being processed.

All invoices are processed on receipt.
There are adequate procedures for short delivered and returned goods.
Outstanding orders are followed up at regular intervals.
To ensure that suppliers cannot be paid for goods not received
Invoices are authorised for payment by a person with appropriate authority.

Payment signatories examine authorisation and invoices/GRNs/POs.
Suppliers statements are reconciled to bought ledger account balances.
To ensure that suppliers cannot be paid incorrect amounts
Invoice prices are checked and agreed.

Invoices calculations, extensions and additions are checked.
Invoices are cancelled on payment.
Bought ledger account balances are regularly reconciled to suppliers statements.
Procedures exist to deal with credit notes due.
Disputed items are followed up promptly with suppliers.
Disputed items remain unpaid until the dispute is settled.
Tutorial note: Note the difference in style when compared to Question 16 (Knots). Here you are asked
for procedures in a general purchase system. Specific weaknesses from the scenario are not asked for
until part (b).
(b) Weaknesses which might exist in the system
Weakness Recommendation
Unfulfilled orders are not followed up at Unfulfilled orders should be

regular intervals. As a result: regularly reviewed. Explanations
should be sought where the order
there may be delays in obtaining is overdue and appropriate action
important supplies; taken.
goods may be accepted for old

(superseded) orders which should have
been cancelled.
Unmatched GRNs are not followed up Unmatched GRNs should be

regularly. GRNs may remain unmatched reviewed regularly and any
because: unexplained items followed up
and corrected where necessary.
there is a delay in receiving goods;
the invoice has been incorrectly
matched to another GRN;
the invoice has been mislaid.

Weakness Recommendation
Invoices are not recorded until they are Invoices should be registered as
matched with a GRN. Any invoices lost soon as they are received, and
before matching would therefore go allocated a sequential number.
unnoticed.
Suppliers are paid on invoice without Suppliers statements should be

reference to the suppliers statement. reconciled on a regular basis to
Discrepancies could therefore go unnoticed. the bought ledger account
balances.
Invoice prices and calculations are not All details on invoices should be
checked as a matter of course. Incorrect checked before the invoice is
amounts could therefore be paid. authorised for payment. This
check should be evidenced by
initials or a stamp.
If the signatory signs the payment listing The payment listing for signature
without reference to the supporting should be accompanied by the
documents, it is possible that unauthorised authorised PRs and approved
payments could be made. invoices.
Invoices are not cancelled after payment, so Invoices should be stamped

it is possible that they could be paid twice. PAID after payment.
Answer 17 EASTWOOD ENGINEERING
(a) Starters and leavers test
Select two payrolls, the first at the start of the companys financial year and the second a
recent payroll and note:
employees not on the first payroll who are on the second payroll. These are
starters;
employees on the first payroll who are not on the second. These are leavers.
For both starters and leavers, ascertain the date each employee started or left from the
personnel department.
For starters check to the relevant payrolls that they were not paid before they started
employment. For most employees, the first payment should be at the end of the week or
month they started work and not for the previous week or month: in the case of manufacturing
employees, payment is a week later.
For leavers check to the relevant payrolls that they were not paid after they ceased
employment. For a sample check that pay for the correct number of days in the week or
month of departure was made, including any holiday pay or overtime/bonus entitlement.
An alternative way of performing this test is to start from the personnel records of staff who
have started or left during the period and checking to payroll as above.

(b) Wages pay-out
Attend a weekly pay packet preparation and ensure that it is secure. Select a small
sample of pay packets before they are sealed and confirm that all cash per payroll
totals is accounted for.
Before the wages are paid, take a copy of the payroll and check there is a pay packet
for each employee.
When the employee is given his wage, he should sign for it. The signature should
be test checked to the employees signature kept by the personnel department.
Mark the list as each employee collects his wage.
Observe to ensure that no employee receives more than one pay packet or one for
another employee. Note if this is happening.
At the end of the wages pay-out, check that there is a wage packet for each
employee who has not collected his wage. These will be the unmarked items on the
payroll list. These are unclaimed wages.
Check that these unclaimed wages are recorded in the unclaimed wages book. The
information recorded in the unclaimed wages book should include the payroll date
(and payment date, if different), the employees name and number, and the net
wage. Note any cases where unclaimed wages are not recorded in the unclaimed
wages book.
(c) Unclaimed wages
Check the number of unclaimed wage packets is about the same each week. If they
are significantly less in other weeks, this indicates that some unclaimed wages are
not recorded in the unclaimed wages book.
Check that there is a wage packet for each unclaimed wage recorded in the
unclaimed wages book.
Where employees have collected their wages, check that they have either signed for
the wage or there is a letter from the employee authorising another person to collect
the wage packet (e.g. when the employee is ill). Check the employees signature to
the personnel records.
Enquire into any wages not claimed within a reasonable period (e.g. two weeks).
The company should pay into the bank wage packets which have been unclaimed
(say) for more than a month. The date the wages were banked should be recorded
against details of each wage packet in the unclaimed wages book. For a sample of
bankings of unclaimed wages, check that the amount banked (per the cash journal)
agrees with the total net wages of the employees as recorded in the unclaimed
wages book. Enquire what steps the company took to pay the employee.
Report any weaknesses found to the companys management. The unclaimed wage packets
should be kept in a secure place (e.g. a safe). Ideally, unclaimed wages should not be dealt
with by employees in the wages department, and there should be an independent check
(probably by the accounts or personnel department) to ensure that proper procedures are
carried out and there is no fraud.

(d) Existence of employees
To verify the existence of employees, select a sample of employees from the most recent
payroll. The procedures for checking the existence of the employees will include:
For employees at head office and at sales branches visited, identify employees and
ask for a signature which will be checked to the personnel records.
Check employees to the personnel records, as being currently employed by the
company. The personnel department is independent from the wages department.
Department managers could be asked to sign a list of employees who work for them
and return it direct to the auditor.
If the employees are paid by cheque, the cheques can be inspected before they are
given to the employee or sent to their bank. If the bank is sent a list of employees to
be paid, the name of the employee on the list should be the same as on the payroll.
Other evidence of the existence of employees will include records of tax and health
insurance. For instance, there could be notifications from the tax authorities of
changes in tax allowance, and there will be an annual return to the tax authorities (at
the end of the tax year) which lists each employee.
Based on the results of these tests, determine whether all the employees on the payroll
actually work for the company. (It should be noted that the checks above are the variety of
methods which can be used to verify employees on the payroll, and in practice not all of them
would be used.)
Answer 18 SHW
(a) (i) Control and substantive procedures
Tests of control test the operating effectiveness of controls in preventing, detecting or

correcting material misstatements.
Substantive procedures are aimed at detecting material misstatements at the assertion level.
They include tests of detail of transactions, balances, disclosures and substantive analytical
procedures.
(ii) Example tests of control over sales invoicing
Inspect numerical sequence of sales invoices, if any breaks in the sequence noted,
enquire of management as to missing invoices.
Review a sample of sales invoices for evidence of authorisation by a responsible

official of any discounts allowed.
Inspect customer statements for evidence of regular preparation.
Example substantive procedures over sales invoicing
Select a sample of pre and post year end goods despatch notes and follow through to
pre or post year end sales invoices, to ensure the sales cut-off has been correctly
applied.
Perform an analytical review of monthly sales, compare any trends to prior years
and discuss significant fluctuations with management.

Review post year end credit notes to identify if any pre year end sales should be
removed.
(b) Deficiency report
Deficiency Control Test of Control
A junior clerk opens the post A second member of the Observe the mail opening
unsupervised. This could accounts team should assist process, to assess if the
result in cash being with the mail, one should control is operating
misappropriated. open the post and the second effectively.
should record cash received
in the cash log.
Cash and cheques are secured Cash and cheques should be Enquire of management
in a small locked box and ideally banked daily, if not where the cash receipts not
only banked every few days. then it should be stored in a banked are stored. Inspect
A small locked box is not fire proof safe, and access to the location to ensure cash is
adequate for security of this safe should be restricted suitably secure.
considerable cash receipts, as to supervised individuals.
it can easily be stolen.
Cash and cheques are only Cash and cheques should be Inspect the paying-in-books
banked every few days and banked every day. to see if cash and cheques
any member of the finance have been banked daily or
team performs this. less frequently.
Review bank statements

against the cash received log
to confirm all amounts were
banked promptly.
Cash should ideally not be The cashier should prepare Enquire of staff as to who
held over-night as it is not the paying-in-book from the performs the banking process
secure. Also if any member cash received log. Then a and confirm this person is
of the team banks cash, then separate responsible suitably responsible.
this could result in very individual should have
junior clerks having access to responsibility for banking
significant amounts of this cash.
money.
The cashier updates the cash The cashier should update Observe the process for
book and the sales ledger. the cash book from the cash recording cash received into
This is weak segregation of received log. A member of the relevant ledgers and note
duties, as the cashier could the sales ledger team should if the segregation of duties is
incorrectly enter a receipt and update the sales ledger. occurring.
this would impact both the
cash book and the sales
ledger. There is a risk of a
teeming and lading fraud.

Bank reconciliations are not Bank reconciliations should Review the file of
performed every month and be performed monthly. A reconciliations for evidence
they do not appear to be responsible individual should of regular performance and
reviewed by a senior member then review them. review by senior finance
of the finance department. team members.
Errors in the cash cycle may
not be promptly identified if
reconciliations are performed
infrequently.
(c) Substantive procedures over bank balance:
Obtain the companys bank reconciliation and check the additions to ensure
arithmetical accuracy.
Obtain a bank confirmation letter from the companys bankers.
Verify the balance per the bank statement to an original year end bank statement
and also to the bank confirmation letter.
Verify the reconciliations balance per the cash book to the year end cash book.
Trace all of the outstanding lodgements to the pre year end cash book, post year end
bank statement and also to paying-in-book pre year end.
Examine any old unpresented cheques to assess if they need to be written back into
the purchase ledger as they are no longer valid to be presented.
Trace all unpresented cheques through to a pre year end cash book and post year
end statement. For any unusual amounts or significant delays obtain explanations
from management.
Agree all balances listed on the bank confirmation letter to the companys bank
reconciliations or the trial balance to ensure completeness of bank balances.
Review the cash book and bank statements for any unusual items or large transfers
around the year end, as this could be evidence of window dressing.
Examine the bank confirmation letter for details of any security provided by the
company or any legal right of set-off as this may require disclosure.
Answer 19 SOURCES OF AUDIT EVIDENCE
(i) Oral management representations
These are clearly relevant to the completeness of sales. They are not relevant to the
occurrence, measurement or presentation of sales.
There is a high risk of management bias in this area which makes this evidence on its own,
unreliable. Internally-generated evidence is less reliable than external evidence. As oral
evidence is less reliable than written, the directors must confirm their representations in a
letter or board minute.

This evidence could never be sufficiently persuasive on its own for the auditors. Sales are
material to the statement of comprehensive income. There is also a high risk of theft of cash.
The auditor should attempt to identify and test any controls that management has put in place
over completeness of recording of sales. Depending on results the auditor should then
perform detailed additional tests on costs of sales and margins, including analytical
procedures.
Tutorial note: Oral management representations for sales suggest a small owner-managed
enterprise. Before accepting the representations in writing, the auditors knowledge of
managements reliability and previous experience of the business must be considered.
(ii) Flowcharts
Flowcharts provide background information to be used at the planning stage. They are
relevant to obtaining an understanding of the accounting system and control environment.
Their reliability depends on the competence of the internal audit staff, how long ago they
were updated and whether there have been subsequent changes. Walk-through tests of a
few transactions should be carried out each year to assess their reliability.
These flowcharts provide no persuasive evidence as to the completeness and accuracy of the
accounting records or the effective operation of internal controls. The auditor must perform
tests of the identified controls and substantive procedures to provide that evidence.
(iii) Year-end suppliers statement
These provide reasonable evidence as to the existence, completeness and valuation, but not
presentation of liabilities. They also provide evidence as to the recording of inventory cut-
off.
Although they are more reliable than documents from within the enterprise, they could
contain errors or discrepancies (e.g. year-end cash in transit). They may also not be received
from some suppliers, or be withheld (completeness).
To increase their reliability, they should be directly obtained from the supplier by the auditor
and reconciled (audited) to the payables balance.
As trade payables are a material balance in the statement of financial position and there is the
risk of understatement, this evidence alone, although critical, is not sufficient. Further
evidence would include specific cut-off analysis, analytical procedures on margins and
expenses and review of invoices recorded and payments made in the subsequent period.
(iv) Inspection
This is relevant to the existence, but not the presentation of non-current assets. It provides
corroborative evidence as to the rights to benefits from an asset. The physical condition of
assets is relevant to their valuation.
Direct observation by the auditor is the most reliable evidence available as to the existence
and condition of tangible assets.
This is sufficient evidence as to the existence, condition and possible impairment of a tangible
non-current asset. In conjunction with documentary evidence (e.g. a purchase invoice) rights
to benefits may also be verified when initially purchased. In subsequent years the fact that it
is still in use indicates control. Valuation will need to be verified through checking the annual
depreciation charge and expected useful life.

(v) Comparison of items of income and expenditure
This is relevant at the planning stage to identify matters requiring further investigation. It
also provides evidence as to the reasonableness of the amounts recorded.
Analytical procedures provide some of the most reliable evidence (being performed by the
auditor). The procedures must, however, be properly planned, conducted and documented,
and the reliability of underlying information assessed.
This procedure may provide sufficient evidence as to the completeness and accuracy of
trading results of low risk, immaterial, separately identifiable components of the business.
The persuasiveness of this evidence will depend upon the auditors previous experience of the
reliability of the accounting records and knowledge of the business.
Marking scheme
For each comment on appropriateness (i.e. relevance and reliability) and sufficiency 1
Maximum for any one of 5 sources 3

Answer 20 DELTA
Analytical procedures Purpose Use in the audit
(i) Planning stage
Calculate ratios (e.g. gross profit %, To identify overall business trends. The general financial condition and overall
quick ratio and inventory turnover) for performance will provide an impression of the
To assist in understanding Deltas
each shop and compare with budget and general health of the business. The market may be
business.
prior year. buoyant as vehicles are less likely to be replaced with
To detect unusual fluctuations for new models in the current recession.
further investigations.
Compare the above ratios, for each shop, To identify potential areas of Select shops which deviate significantly from the
with the companys average. Compare misstatement within individual shops. norm for detailed testing. A very low GP% could
the shops GP% with the industry indicate:
average.
unrecorded cash sales
overstated expenditure (e.g. wages)
understated year-end inventory.
Review the latest available analysis of To direct the audit of inventory to the Consider attending the next physical inventory count
inventory by location (including the locations most likely to be at risk of (30/11) for shops at which:
warehouse), and compare with year-end misstatement.
balances (book, physical and budget). the 31/5 discrepancy was significant
inventory levels appear to have changed
significantly since the year-end count (e.g.
because the last count was inaccurate).
Ascertain, by enquiry, what analytical To avoid duplication of analytical Audit effort should be directed to departures from
tools are employed by management. procedures adequately documented by budget identified by management for which no
management. reason has been established or corrective action
taken.

(ii) Substantive procedures
Review the year-end aged-inventory To identify items (of specific type and at Inventory turnover is likely to be relatively slow in
analysis and calculate inventory specific locations) where net realisable this industry (e.g. because it may be years before a
turnover by product type and location, value may be less than cost. new vehicle model requires certain spares). An
and compare with the prior year. improvement in the ratio may indicate that the
business is doing well and that an increase in
allowances in the current year is unnecessary.
Compare monthly sales, GP% and cash To identify unrecorded cash sales. A fall in sales, GP% and cash assets may indicate
and bank balances, for the year, by unrecorded sales (e.g. through misappropriation).
location. The maximum potential error can be calculated using
an average GP% for the business. (A fall in sales and
cash assets, but with a consistent GP%, will suggest a
decline in volume of sales.)
Tests in total or proof in total, that To reduce the extent of other, more Reconcile, within reasonable limits, the current year
is, direct verification of amounts by time-consuming, audit procedures. employee cost for HQ and the central warehouse with
reference to other data (the validity of that of the prior year.
To reduce sample sizes.
which has been established).
For each location, calculate major To confirm the reasonableness of A fall in one category of expense for a specific
expense items (e.g. property rentals, expenses and consistency of their location could indicate omission of a year-end
distribution costs) as a percentage of classification. accrual. Compensating increases and decreases may
total costs or turnover (say). reflect mispostings (misclassifications).
Compare financial information with To support the figures being audited. Comparison of payroll costs with headcount for
reliable non-financial information. current and prior year may indicate:
increases in overtime and/or rates of pay
a change in the mix of full and part time staff.

Review the accounting records for To confirm that there is nothing odd that Review, for example:
unusual items. requires explanation.
the general ledger for debits in income accounts
the cash book for round sum payments
depreciation expense accounts for 12 debits (if
calculated monthly).
(iii) Overall review stage
Prepare a summary of the major To compare findings with results of Inventory, cash, sales, wages, premises and
components of the financial statements substantive procedures (and ensure that distribution costs should be found to be inter-
for comparison with prior periods. corroborative explanations have been related/internally consistent with current business
obtained). conditions.
Recalculate the ratios obtained at the To identify any large or unusual Further enquiries and testing may be required to
planning stage. fluctuations that were not previously explain fluctuations before the final audit opinion can
apparent. be drawn.
If late fluctuations represent corrections to the clients

management information system, this will be reported
to management (with recommendations for
improvement).
Tutorial note: It has been assumed that the computerised information system
provides budgeted information against which to compare the monthly
management accounts described in the question.

For each analytical procedure described (i.e. identified + purpose + use) max 3

Maximum for (iii) 4
Audit areas inventory

statement of comprehensive income
statements of financial position
sales/cash receipts
employee costs
property costs
distribution costs
Procedures use of ratios

comparison of information
review of unusual items
confirmation of consistency
Purpose To . . .
Use make specific to Delta (i.e. a multi-branch

retailer, for cash, of vehicle spares)
Answer 21 ZAK CO
(a) ISA 520
(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 statement of profit and loss
and statement of financial position.
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.
(b) Net profit
Overall, Zaks result has changed from a net loss to a net profit. Given that sales have only
increased by 17% and that expenses, at least administration expenses, appear low, then there
is the possibility that expenditure may be understated.
Sales increase 17%
According to the directors, Zak has had a difficult year. Reasons for the increase in sales
revenue must be ascertained as the change does not conform to the directors comments. It is
possible that the industry as a whole, has been growing allowing Zak to produce this good
result.
Cost of sales fall 17%
A fall in cost of sales is unusual given that sales have increased significantly. This may have
been caused by an incorrect inventory valuation and the use of different (cheaper) suppliers
which may cause problems with faulty goods in the next year.
Gross profit (GP) increase 88%
This is a significant increase with the GP% changing from 33% last year to 53% in the current
year. Identifying reasons for this change will need to focus initially on the change in sales
and cost of sales.
Administration fall 6%
A fall is unusual given that sales are increasing and so an increase in administration to support
those sales would be expected.
Expenditure may be understated, or there has been a decrease in the number of administration
staff.

Selling and distribution increase 42%
This increase does not appear to be in line with the increase in sales selling and distribution
would be expected to increase in line with sales. There may be a misallocation of expenses
from administration or the age of Zaks delivery vans is increasing resulting in additional
service costs.
Interest payable small fall
Given that Zak has a considerable cash surplus this year, continuing to pay interest is
surprising. The amount may be overstated reasons for lack of fall in interest payment (e.g.
loans that cannot be repaid early) must be determined.
Investment income new this year
This is expected given cash surplus on the year, although the amount is still very high
indicating possible errors in the amount or other income generating assets not disclosed on the
extract from the statement of financial position.
(c) Obtaining a bank letter
Review the need to obtain a bank letter from the information obtained from the
preliminary risk assessment of Zak.
Prepare a standard bank letter in the format agreed with banks in the relevant
jurisdiction.
Obtain authorisation on that letter from a director of Zak for the bank to disclose
information to the auditor.
Where Zak has provided their bank with a standing authority to disclose
information to the auditors, refer to this authority in the bank letter.
The auditor sends the letter directly to Zaks bank with a request to send the reply
directly back to the auditors.
Answer 22 ACCOUNTING ESTIMATES
(a) Examples of accounting estimates why they are important
Simple accounting estimates such as allowances for depreciation, bad debts and obsolete
inventory are often regarded as straightforward, but they are important because, like more
complex provisions, they are easy to manipulate. They affect not only the profit figures, but
also operating, financial and liquidity ratios to which analysts pay great attention.
More complex estimates such as the fair value adjustments required for consolidations and the
valuation of financial instruments and intangible assets, are not only material but technical
and difficult. This renders comparison of financial position and performance difficult across
jurisdictions, where there are different rules, and even across companies in the same
jurisdiction where the bases of calculation differ. The disclosure of the basis of accounting
estimates is therefore increasingly important.

(b) Approach to the audit of accounting estimates
ISA 540 Auditing Accounting Estimates including Fair Value Estimates and
Related Disclosures requires that auditors apply a combination of the following:
review and test the process used by management to develop the estimate;
use an independent estimate for comparison with that of management;
review subsequent events which confirm the estimate made.
The independent estimate may be a costly process and may involve reliance on the
work of an expert.
The review of subsequent events may reduce or even eliminate the need for the
review and testing of the process used by management to develop the estimate,
although this is unlikely to be the case where pension liabilities or similar long-
term estimates are involved.
The comparison of accounting estimates made in the past with actual results not
only provides evidence in relation to the quality of the particular estimate
concerned, it also provides evidence in relation to the general competence of
management in making such estimates over a period of time.
In practice, the requirement to review and test the process used by management is
the most important. This involves the following:
the evaluation of data and assumptions on which the estimate is based;
testing the calculations;
consideration of management approval procedures.
A major problem in auditing estimates is the large range of apparently reasonable
assumptions underlying an estimate, which give a significant variation in the final
estimate.
Another problem in practice results from the fact that the auditor is not always an
expert in the evaluation of accounting estimates. In this event he may need to rely
on the work of an expert who reviews the work of the expert employed by the client
to perform the original calculations. This not only involves time and cost, but also
requires the co-operation of both the client and the clients expert. The auditor is
then in the position of having to adjudicate between possibly conflicting findings
of experts and to form an opinion as to whether the findings are so different or
sensitive, as to have a material effect on the financial statements.
It is not uncommon for auditors to have findings covering a very wide range of
values, all of which are reasonable and consistent with the auditors knowledge of
the business and management intentions.
(c) Reliance on management representations
ISA 580 Written Representations states that auditors should obtain written
management representations on matters material to the financial statements when
other sufficient appropriate evidence cannot reasonably be expected to exist.
Auditors normally seek to obtain corroborative evidence for management

representations and evaluate whether they are consistent with the other audit
evidence obtained. However, there may be no corroborative evidence in relation to
significant estimates where the estimate is made on the basis of management
assumptions.

Examples include management knowledge about a possible liability, or intention to

cease a line of activity.
Sometimes auditors do not need to seek representations in relation to some

estimates because corroborative evidence is available in the form of evidence
provided by experts (although that evidence is often based on management
assumptions), or other data held by the client.
Auditors sometimes seek to transfer responsibility for the audit to their clients by
seeking management representations management is likely to resist this. It is
therefore preferable, perhaps, for auditors not to seek representations on the figures
and disclosures included in the financial statements, but for them to seek
representations on the assumptions used in the calculations, and on completeness of
disclosure of matters requiring estimates to be made.
Answer 23 ESTIMATES
(a)(i) Warranty claims
Matters
The companys policy for claims under warranty. (For example, whether to repair,
replace, issue a credit note or cash refund.)
The bases/assumptions adopted to derive the amount provided.
What changes (if any) have been made to the prior year basis (e.g. in respect of new
products introduced or discontinued)?
Any mitigating factors (e.g. recourse to suppliers or insurance) which have been
identified and/or taken into account.
The extent to which repairs are carried out in-house.
Procedures
Obtain details of clients calculation of provision, including underlying assumptions

and related warranty repair cost records.
Read the terms and conditions on sales invoices to identify circumstances which
render the warranty agreement void (e.g. negligent use disclaimers and servicing
restrictions to authorised personnel).
Review records of claims received (including those notified after the end of the
reporting period) identifying those rejected (e.g. due to breach of warranty
conditions).
Vouch a sample of related labour costs to payroll/time-sheet analyses showing cost
of service engineering labour.
Consider managements expertise in determining accounting estimates (i.e. the
adequacy of provisions made in prior periods based on the extent to which they
have been utilised.)
Review correspondence with customers requesting work to be done under warranty
or identifying manufacturing defects.

Review the terms and conditions of suppliers of bought-in components (e.g.

whether any recourse or counter-claim clauses).
Document and test the system for recording powered garden tools returned and
authorising repairs under the terms of warranty.
Vouch a sample of entries in warranty cost records and related general ledger
accounts for costs of replacement bought-in components to suppliers invoices.
Review consumer reports in specialist consumer magazines commenting on the

reliability of the clients products.
Inspect the physical condition of returned tools.
Compare the level of clients insurance cover (e.g. in respect of defective product
sales) with prior year.
Determine the expected level of the warranty allowance.
Reperform clients calculations (e.g. extrapolation of legitimate claims as a
percentage of sales) to confirm their accuracy. Confirm that the basis of calculation
is fair.
Accept the clients calculation if not materially different from the auditors
expectation.
If material different, discuss with management to ascertain the reasons why.
Consider impact on audit report if management refuse to change their estimate.
(ii) Depreciation
Matters
The dates, during the year, on which the compressed air system was:
delivered;
installed;
operational.
Whether the system was installed by the supplier, a sub-contractor or in-house.

Basis on which costs other than the purchase price have been capitalised.
Managements policy for reviewing and revising estimated useful lives/residual values.
Procedures
Agree purchase price and date to suppliers invoice. Agree additional costs
capitalised (e.g. of installation) to in-house service engineers timesheets (say).
Physically inspect the asset and observe its operation.
If the compressed air system replaced a similar system, ascertain the following in
respect of the system which has been replaced:
actual useful life (by reference to acquisition date in the asset register);
residual value (scrap proceeds if any).

Compare estimated useful life and method applied (straight line/reducing balance)
to the compressed air system with that adopted for other items of equipment used in
the assembly department.
Reperform the calculation of depreciation in accordance with the stated policy (e.g.
full years charge in year of acquisition or time-apportioned).
Assess managements previous accuracy in estimating useful lives of assets.

Consider, for example:
the extent of fully depreciated assets still in use;
the amounts of profits and/or losses arising on disposal.
(b) Why difficult
By definition, accounting estimates are approximations. Auditors are therefore more likely to
need to exercise judgement in this areas facilitating precision.
Estimates may be based on forecast information rather than historic information (e.g. sales
returns forecasts for warranty provisions) and subject to a range of possible outcomes.
Formulae used to calculate provisions must be regularly reviewed by management (e.g. for
depreciation). Provisions may involve complex estimating processes requiring specialist
techniques.
Subjective areas provide scope for deliberate manipulation. Provisions are likely to be
understated if results are poor or if:
remuneration is linked to profit;
a take-over is pending;
bank may foreclose on loans.
Overstated provisions create hidden reserves to be utilised/overstate profits in a bad year.
Sufficient independent audit evidence may not be available to confirm or dispute the need for
(or adequacy of) an accounting estimate. Some reliance is likely to be placed on written
management representation.
Although the auditor may be of the opinion that individual estimates are not materially
understated (say), they may give rise to material misstatement if biased in one direction.
Provisions are accounted for as period-end adjustments rather than as a function of

transactions processed through the double-entry bookkeeping system.
Answer 24 LETTER OF REPRESENTATION
(a) Letter of representation
Auditors seek a letter of representation in order to obtain written audit evidence on

matters that are material to the financial statements when other sufficient
appropriate audit evidence cannot reasonably be expected to exist (ISA 580 Written
Representations).
Representations may be the only evidence which can reasonably be expected to be

available, but they cannot be a substitute for other audit evidence that could
reasonably be expected to be available. Such matters may include managements
intention to hold an item for long-term appreciation.

The letter also ensures that directors acknowledge their collective responsibility for
the presentation and approval of the financial statements. The letter is signed by
those with knowledge of the matters concerned, on behalf of management.
(b) Common categories of matters included in the letter of representation
Confirmation of responsibility for, and approval of, the financial statements.
Confirmation that all of the accounting records, and all related documentation (such
as minutes of management and shareholder meetings) have been made available,
and that company transactions have been properly reflected therein.
Confirmation of responsibility for establishing a control system to detect and correct

error.
Confirmation that there have been no irregularities involving management or

employees who have a significant role in internal control or that could have a
material effect on the financial statements.
Confirmation of the expected outcome of legal claims.
Confirmation of company plans in relation to certain tax provisions.
Confirmation of the completeness of disclosure of related party transactions.
Confirmation that there have been no subsequent events that require revisions to the
(c) Discussion of the content of the letter
It is important to discuss the contents of the letter at an early stage because directors
may disagree with what the auditors wish them to sign.
It is important in such cases for negotiations to take place and the letter to be
redrafted until it is acceptable to both auditor and client.
The management representation letter is often regarded as a critical piece of audit

evidence and if it is left to a late stage in the audit, when there is pressure on
auditors and clients alike, negotiations may be difficult.
(d) Management unwilling to sign and actions if management refuses to sign
Management is sometimes unwilling to sign because they feel that auditors should
be able to obtain independent evidence in relation to the relevant matters.
Alternatively, they may feel that the auditors are trying to shift responsibility for the
audit to them.
Sometimes, management is genuinely uncertain about whether it is sure of the

matters included. However, there are occasions on which management is trying to
hide from the auditors the fact that the income recorded is incomplete, or the fact
that there is an outstanding undisclosed legal claim against the company, for
example.

Auditors should attempt to negotiate an agreement, as noted above. A formal letter

may not be necessary, if management is able to provide some other written
confirmation, such as a note of a meeting. Alternatively, a list of issues may be
taken to the client to establish exactly which representations are causing the
problem, and the letter redrafted.
If management still refuses to sign, and the auditor feels that the matter is critical to
the financial statements, it may be necessary to qualify the audit report with an
except for (or even disclaimer of) opinion, on the basis of a limitation in the scope
of the audit.
Answer 25 METHODS OF EVIDENCE GATHERING
(a) Advantages and disadvantages
(i) Analytical procedures
Advantages
The main advantage of analytical procedures is that they can be used at all stages of
the audit to enquire into the absolute amounts to be included in the financial
statements, and into the relationships between those amounts.
Analytical procedures are a good test for the overall reasonableness of an amount.
They can be used on a global basis, and they can be split down into their constituent
elements.
Analytical procedures enable the auditor to make comparisons on a continuous

basis, taking prior years into account, and providing the auditor with a better
understanding of both the business as a whole, and of individual account areas.
Disadvantages
Analytical procedures often have to be performed on management accounts, or draft

or incomplete accounts before the final financial statements have been prepared.
This means that significant adjustments, which are often made at a late stage, are
not taken into account.
Without a prior and proper understanding of the business, the auditor may be
tempted to accept the results of analytical procedures that show no unusual
variations as evidence that there is nothing wrong, which may not be the case if
there have been significant changes in the business of which the auditor is unaware
(and which management may wish to hide from the auditors).
Auditors may also be tempted to accept plausible explanations for changes and
variations without much further substantiation, where further investigation may
actually be warranted.
(ii) Audit sampling
Advantages
Audit sampling enables the auditor to draw conclusions about a population without
testing all of the transactions or balances in the population as a whole.

Audit sampling also enables the auditor to concentrate on high risk or high value
items, and to differentiate between elements of a population which may be subject
to differing internal controls.
Disadvantages
There is always a risk that the auditors sample is not representative of the
population as a whole (known as sampling risk). Auditors calculate and accept
this risk, and perform other procedures to compensate for it, but it always remains a
risk.
Non-statistical sampling (the most common form of sampling used by auditors)

relies on the use of judgement in relation to materiality, analysing exceptions, and in
drawing conclusions, for example. Judgement can be abused, or simply fail,
particularly where staff are inexperienced.
(iii) Tests of controls
Advantages
Tests of controls enable the auditor to establish whether a control system in

operation is effective. If properly designed controls are operating as prescribed,
auditors can reduce the level of substantive testing required at the period-end.
Tests of controls mean that auditors do not have to concentrate all of their efforts on
substantive procedures at the period-end which would in many cases be impractical,
inefficient and not cost-effective.
Disadvantages
Tests of controls are often performed on a sample basis (disadvantages noted

above).
Tests of controls are often performed on routine transactions for which there are
high quality automated controls. The very high risk areas in financial statements are
often outside this area and relate to non-routine transactions and more intangible
environmental or general controls which are not easy to test.
(iv) Detailed testing of transactions and balances
Advantages
In detailed testing of transactions and balances, auditors are directly examining the
figures and assertions that appear in the financial statements.
Detailed testing enables the auditors to form a view as to whether the figures on
which he is reporting are fairly stated and often involves third party, written
confirmation which is a good source of audit evidence.
Disadvantages
Detailed testing of transactions and balances is often performed on a sample basis

(disadvantages noted above).

The level of testing of transactions and balances is determined by the level of

comfort obtained by the auditor from tests of controls. If an incorrect conclusion
has been obtained from tests of controls, it is likely that he will set an inadequate
level of testing of transactions and balances. (This may, however, be negated to
some extent by testing all items greater than the performance materiality level.)
(v) Computer-assisted audit techniques (CAATs)
Advantages
With computer based systems, CAATs enable the auditors to test a large volume of
data, or the operation of the controls in the system, accurately and quickly. They
are therefore very-cost efficient when operated properly.
CAATs reduce the level of human error in testing and enable a very high level of
audit evidence to be derived.
The use of CAATs frees up expensive human resources that would otherwise be
engaged in routine, mechanical work to concentrate on judgemental areas.
CAATs may be used 24/7 when fully embedded within the system. This can be
critical when key data for the auditor may only be available for a short period of
time. They will produce an audit data file that can be analysed at a later stage.
Disadvantages
CAATs are expensive to set up and require the co-operation of the client. It is
usually necessary for a continuing audit relationship to be present before it is worth
committing the audit resources.
Major changes in client systems often require major changes in CAATs, which is
expensive. If the audit fee is based on the assumption that the prior years CAATs
can be used, and a change is made without warning, the client may have unrealistic
expectations about the level of service that can be provided for the fee.
(b) Relationship between the methods of evidence gathering
Analytical procedures are often first used during the planning stage of the audit.
Materiality levels and levels of tolerable error are often derived (at least in part)
from analytical procedures. These are in turn used in audit sampling procedures.
Analytical procedures help the auditor determine the audit approach (the levels and
areas for tests of controls and detailed testing).
The results of tests of controls determine the level of detailed testing of transactions
and balances. Analytical procedures provide indirect evidence as to the effective
operation of internal controls (if controls are working, analytical procedures may
help prove that the population as a whole is fairly stated).
Detailed tests of transactions and balances are often performed towards the end of
the audit in conjunction with analytical procedures analytical procedures
compensate to an extent for the weaknesses in sampling procedures both for tests of
controls and detailed testing of transactions and balances (and vice versa).
Sampling is used for both tests of controls and detailed testing of transactions and
balances. Where CAATs are used, sampling may not be necessary because CAATs
can often be used to test the whole population, either for tests of controls, or for
detailed testing of transactions and balances.

Answer 26 PORTHOS
(a) The advantages of Computer-Assisted Audit Techniques (CAATs)
Tutorial note: Only four advantages asked four. Give the four best explanations you know to
maximise marks.
Enables the auditor to test program controls. Without the use of CAATs, auditors
would not be able to obtain sufficient assurance purely from substantive testing
alone.
Enables the auditor to test and analyse large volumes of data quickly and accurately.
This will also increase the overall confidence for the audit opinion. In theory, as
well as practice, 100% of a population or control action can be tested.
Allows the auditor to test the actual accounting system and records rather than
printouts which are only a copy of those records and could be incorrect.
Are cost effective after they have been setup as long as the company does not
change its systems.
Allows the results from using CAATs to be compared with traditional testing if
the two sources of evidence agree then this will increase overall audit confidence.
(b) Test data Reason for test

Input of an order for a negative number of Ensures that only positive quantities are
tennis racquets. accepted although the company cannot
despatch negative quantities anyway.
Input of an order for ten tennis racquets. There are reasonableness checks in the
system to identify possible input errors. A
warning message should appear on screen
asking the customer to confirm any order
for more than say two racquets.
Input of an order without payment details Ensures that orders are paid for prior to
being completed. despatch this also limits the number of
bad debts.
Input of invalid inventory code. Ensures that the computer detects the
invalid code and presents an error message
rather than taking the nearest code and
accepting that.
(b) Test data Reason for test
Input of invalid customer credit card details. Online checking of credit card details to the
credit card company ensures that goods
cannot be despatched without payment.
This will also limit the number of bad debts.
Input of invalid address. Ensures that the address is valid, possibly
by accessing a database of valid street
addresses or postal codes. If the code is not
valid an error message should be displayed.
This ensures that goods are only despatched
to valid addresses.

(c) Audit software
(i) Difficulties of using audit software
Substantial setup costs because the clients procedures and files must be understood
in detail before the audit software can be used to access and interrogate those files.
Audit software may not be available for the specific systems setup by the client,
especially if those systems are bespoke. The cost of writing audit software to test
those systems may be difficult to justify against the possible benefits on the audit.
The software may produce too much output either due to poor design of the
software or using inappropriate parameters on a test. The auditor may waste
considerable time checking what appear to be transactions with errors in them when
the fault is actually in the audit software.
Checking the clients files in a live situation. There is the danger that the clients
systems are disrupted by the audit program. The data files can be used offline, but
this will mean ensuring that the files are true copies of the live files.
(ii) Audit tests
Audit software Reason for test
Reperformance of casting of sales day book. Ensures that the computerised sales day book
has been cast correctly and helps to verify the
sales balance in the financial statements.
Estimation of total sales value made during Proof-in-total analytical review. Provides
the year by matching orders to dispatches assurance that all despatches were correctly
recorded in the inventory system and to sales invoiced.
price records.
Completeness check on all dispatch notes to Identifies any dispatch notes not invoiced.
sale invoices. Reasons must be established as may mean
unrecorded sales.
Analysis of inventory aging at the year end Help to detect inventory items which are
and after-date sales. relatively old which may need valuing at net
realisable value rather than cost.
Selecting a sample of inventory at the year Removes bias from sample selection as well
end as part of the physical verification. as being quicker than selecting the items
manually.
Checking completeness of sales invoice Ensures that all sales invoices are recorded in
numbers. the sales day book.
Check that all sales invoices have been paid All sales are paid for on ordering, unpaid
for by matching to credit card companies sales would be a violation of systems rules
payments. and would need to be investigated by the
auditor.

Audit software Reason for test
List large credit notes (perhaps more than The auditor will find reasons for the return
five racquets) issued during and after the year this is also a check on the accuracy of the
for investigation by the auditor. ordering system ordering errors may result
in customers returning goods later.
Review of after date credit notes may identify

possible window dressing by management.
Cut-off testing by matching year-end Ensuring all transactions recorded within the
transactions between records. correct period in all records sales,
receivable, cash, inventory.
Tutorial note: The most common mistake students make with CAAT-based questions is to confuse
audit software with test data.
Answer 27 INSURANCE BROKERS
(a) Audit procedures to establish ownership
(i) Land and buildings
Inspect legal documents providing title (e.g. title deeds, land registry certificate)
which should give a plan of the plot and buildings (i.e. offices) and state that it is
owned by the company.
If deeds are held by the bank, review the bank report for audit purposes for
confirmation of title deeds held (if any) as security against borrowings. Inspect the
deeds on a regular basis (e.g. every three years).
Inspect invoices and cash payments supporting expenditure in respect of the

buildings which corroborates (but does not prove) ownership (e.g. buildings
insurance, repairs, local property taxation).
(ii) Computers and motor vehicles
For all material additions during the year, inspect purchase invoice details
(including serial/registration numbers) and confirm invoice raised in name of the
company. For motor vehicles, inspect registration documents.
For a sample of motor vehicles held at the beginning of the year (selected from the
asset register) inspect vehicle registration documents (confirming that they are still
held in the name of the company).
Physically inspect a sample of motor vehicles and computer equipment held at the
beginning of the year and those items purchased during the year (selected from the
asset register) to confirm their continued existence and provide corroborative
evidence of their ownership. Where asset cannot be found, agree to appropriate
records as disposed.
Inspect invoices and cash payments supporting expenditure in respect of computers

and motor vehicles which corroborate (but does not prove) ownership (e.g.
hardware maintenance contracts, road tax, servicing).

(b) Depreciation rate of computers
Discuss with management their policy for renewal and upgrading of computers. If
they envisage replacement within a few years, then a depreciation rate of 10% per
annum is clearly too low. If they plan to defer purchase of new computers until
existing equipment is worn out consider whether this is realistic (i.e. whether the
current system has spare capacity to meet the companys foreseeable needs).
Review profits/losses on disposal/scrapping of computers and related equipment.

Consistent losses on disposal will confirm that the depreciation rate is too low.
Inspect the offices for unused computers, printers, etc. Items gathering dust may be
obsolete and should be discussed with management.
Select a sample of old computers from the asset register for physical verification
(they may be kept in a store room). If not in use and no steps are being taken to sell
them it would be prudent to assume they are worthless.
Consider the age of existing computers in use and the effect of technological
developments which would make them obsolete (e.g. many computers purchased
five years ago are excessively slow at running sophisticated packages).
Compare with depreciation rates being used for computers in the insurance industry
by reviewing a sample of relevant insurance company/broker published accounts.
(c) Auditors report
Matters to consider
The materiality of the understatement of the current year depreciation charge in the
context of:
the total statement of financial position value of assets;
the cost, accumulated depreciation and carrying amounts of computers;
the depreciation charge for the year; and
profit before tax.
If 20% (i.e. over 5 years) is more appropriate than 10%, the annual depreciation
charge on computers should be double. If the useful life is now reduced, the life
remaining will be much shorter. This will further increase the depreciation charge.
As computers are just one of the asset categories this may not be material to the
financial statements as a whole.
Although depreciation is an estimate, possible prior period adjustment if the rate

was clearly an error and the aggregate amount of uncorrected misstatement (i.e. the
cumulative effect of having under-provided depreciation in prior years) is material.
Audit modification
(1) Assuming the matter to be material with no adjustment to the financial statements
being made by the directors, the audit opinion should be qualified except for
disagreement with the accounting treatment. The effect on profit for the period and
carrying amount of non-current assets should be quantified.

(2) Alternatively, if the matter is not material or the directors adjust the financial
statements to reflect more suitable useful lives for computers, the audit opinion will
be unqualified.
Tutorial note: An adverse opinion would not be appropriate as the potential effect of the
disagreement concerns only one category of assets and could not render the financial
statements as a whole misleading.
Answer 28 BASIS OF VALUATION
Tutorial note: For clarity of presentation each asset or liability is considered separately and the
accounting basis is matched with the related audit procedures. This presentation is not specifically
required and candidates presenting their answer in the order stated in the question would not be
penalised. However, in answering questions, candidates should recognise that the layout of their
answer in an appropriate tabular form can be of assistance.
(i) Production overheads
(a) Accounting basis

IAS 2 Inventories requires that the cost of inventory include applicable production overhead
allocated on the basis of the normal level of activity. Procedures by which this requirement
may be achieved are many and varied. The auditor needs to identify these procedures and see
that they are reasonable and consistently applied.
(ii) Audit procedures

Identification of Consider the appropriateness of expenditure so
expenditure which is classified. For example purchasing department costs
classified as production may be included but only if most of its activity relates
overheads. to the purchase of inventory. Ensure the classification
is consistent throughout the company and with prior
periods.
Test the allocation of purchase and payroll transactions
to ensure those classified as production overheads are
consistent with entity policy.
Analyse balances of production overhead accounts to
ensure they are made up of appropriate items.
Overheads must be Consider the reasonableness of the basis to the entitys
allocated to units of circumstances. (For example, for some entities a single
output on an applicable overhead rate may be appropriate but for others a
basis. separate rate should apply to each production
department.) Ensure the basis is consistently applied.
Test accounting entries allocating production overheads
to work in progress for conformance with the laid down
basis. This will include verifying the base on which
overheads are allocated (e.g. machine hours or direct
labour hours recorded) against a particular batch, etc.
Similarly analyse the amount of overhead included in
the cost of finished goods.

The rate of allocation Identify the level of activity used as the denominator in
should be based on the determining the allocation rate with prior years or other
normal level of activity indications as to its being normal.
and should exclude
Verify the total amount used as the denominator (e.g.
overheads associated
labour or machine hours) with accounting records and
with abnormal
consider whether other audit procedures have verified
conditions.
the reliability of those records.
Analyse the makeup of the numerator to ensure that it

includes costs properly classified as production
overheads and excludes costs associated with abnormal
activity (e.g. abnormal wastage).
(ii) Written down value of property, plant and equipment
Items of property, plant and equipment having a limited useful economic life are required to
be written down to their residual value by a systematic charge for depreciation. IAS 16
Property, Plant and Equipment further requires that the charge for depreciation should
allocate the depreciable amount to the periods expected to benefit from its use. The method
used should have regard to the type of asset and their use in the business. IAS 16 also
requires regular review of useful economic lives and that residual value be determined on the
basis of price levels prevailing at the date of acquisition (or revaluation).
Tutorial note: limited means finite.
(b) Audit procedures

Determine useful For new assets, enquire into the validity of the chosen
economic life of economic life. This will include consideration of:
acquisitions and of
existing assets. the age and condition of similar assets already held
by the business;
changes in technology or the pattern of usage that
might affect useful life; and
decisions taken in the process of capital
expenditure budgeting that might influence the
planned date of disposal.
For existing assets consider the effect of major changes
in technology, patterns of usage or capital budgets.
Also identify recent asset retirements and consider the
implications of variations between the age of the asset
and its predicted useful life at acquisition.
For management estimates apply procedures applicable
to the audit of accounting estimates (e.g. the reliability
of estimates made in the past, assumptions on which the
estimates are based, accuracy of amounts on which the
estimate is based, etc).

Apply an appropriate Consider the appropriateness of the method in the light

method of depreciation. of guidance provided by IAS 16.
Ensure that the basis is consistently applied to similar
assets and is consistent with prior years.
Identify the costs and benefits associated with the use
of existing assets and consider whether they confirm
the appropriateness of the depreciation method used.
For example, if assets depreciated on a straight-line
basis are incurring substantially higher usage costs or
generating substantially lower revenues than when new,
change to a reducing balance basis may be appropriate.
Check the calculation of the depreciation charge for the
year.
(iii) Development costs deferred in the year
The amount deferred must represent development expenditure that meets all the asset recognition
criteria of IAS 38 Intangible Assets (e.g. demonstrable technically and commercially feasibility).
The amount deferred must not exceed the amount that is reasonably recoverable against future
sales or other revenues (IAS 36 Impairment).
(b) Audit procedures
Allocate expenditure to Analyse expenditure to ensure that it is properly

development projects. classified as development cost.
Examine evidence that costs are properly allocated to a
particular project. This evidence is likely to include:
formal specification and approval of the project;
detailed cost budget;
materials requisitions drawn against that budget by
an authorised requisitioner;
goods received notes or other evidence of the
receipt of materials, services, etc by the
department responsible for the project;
similar evidence for labour and overheads charged
to the project.
Determine the projects Physically inspect the project.

technical feasibility.
Examine evidence of tests of the new product, etc
carried out and the results of those tests.
Examine evidence of tests of consumer or user
acceptance of the suitability of the new product, etc.
Obtain expert evidence if necessary.

Determine the projects Examine the companys budget identifying total costs
commercial feasibility and benefits associated with the project.
(i.e. how future economic
benefits are to be Ensure that the amount deferred does not exceed the
generated). expected revenues after allowing for further costs and
expenditures.
Examine evidence as to the reliability of the budget:
consider the reliability of budgets relating to
previous development projects undertaken by the
company;
compare costs to date with budgeted amounts for
those costs to determine the reliability of future
budget costs;
review market research evidence as to future sales
revenues or similar evidence relating to projected
cost savings.
Form a view as to the reliability of the data as to
ensuring the recoverability of amounts to be deferred.
Consider evidence as to the ability of the company to
finance completion of the project. This review is likely
to be undertaken as part of the review of going concern.
Answer 29 ROCKS FOREVER
(a) Audit procedure Physical count Reason for procedure
Perform an overall review with client staff Check that clients physical count
and ensure that they are following the instructions are being followed as this will
clients physical count instructions. help to ensure that the count is complete and
Specifically ensure that: accurate.
Inventory is divided into appropriate Confirms a clear layout of inventory

sections for recording perhaps by ensuring items are not missed.
type of jewellery.
Staff are counting in pairs; one person Prevents collusion and provides a
checks the inventory and another check over security of inventory
records the details. (jewellery is high value) and that the
count sheets are not falsified.
Appropriate checks are in place to Check to ensure that inventory is not
ensure that each item of jewellery is double counted.
only counted once.
The shop is closed during the count. To ensure that there is no confusion
regarding which items are sold.
Count sheets are pre-numbered. To ensure that no count sheets are lost.
Obtain a sample of inventory items already Check to ensure that the inventory recorded
recorded on the inventory sheets and agree on the inventory sheets actually exists.
to the jewellery inventory.

For a sample of jewellery in the shop, agree Check to ensure that all inventory is
to the count sheets. recorded on the inventory sheets check for
completeness of recording.
Obtain a sample of count sheets, photocopy To check that details on the count sheets are
and place on the audit file. not amended post physical count and for
agreement to the final inventory sheets to
ensure quantities are recorded correctly.
Check all count sheets are returned after the Ensures that all sheets are accounted for and
physical inventory count. inventory is therefore not understated.
Obtain last inventory receipt note and sales To ensure that cut off is correct.
invoice numbers.
Subsequent checking should show that
goods received notes post physical count are
not included in payables for the year, and
sales invoices after the physical inventory
are not included in sales for the year.
Review the condition of the jewellery with To check that any inventory which is
the independent valuer. Ensure that there are damaged or unsalable is correctly valued.
no reasons why the inventory could be
obsolete (e.g. due to changes in fashion) or
damaged.
Form an opinion regarding the overall To confirm that inventory quantities have
accuracy of the physical count. been correctly recorded.
(b) Factors to consider when placing reliance on the work of UJ:
DeCe need to confirm that they actually need an expert. It is not clear whether DeCe have the
necessary skills in-house. However, given that Rocks Forever is the only client in the
diamond industry, then some assistance would be expected as valuing diamonds is difficult.
Check that the specialist has relevant experience in valuing diamond jewellery. Part of the
appointment process will include checking the work portfolio of UJ to show that they have
valued diamonds in other situations.
Ensure that UJ is a member of an appropriate professional body. This will help ensure that UJ
follow the appropriate ethical standards as these will be enforced by their professional body.
Check that UJ cannot be influenced by the client for example because they are employed by
Rocks Forever. Being employed by the client would imply less independence and limit the
value of the specialists report.
Check that the report produced by the specialist regarding the valuation of the diamonds
appears to be reasonable. Although DeCe do not have any other clients retailing diamonds,
basic price comparisons for a given weight of diamond could still be obtained from other
shops or Internet site to prove the accuracy of UJs figures.
(c) Audit evidence
The jewellery inventory should be valued at the lower of cost and net realisable value.
For a sample of jewellery on the final inventory sheets, trace the cost of those items to the
original purchase invoice, ensuring that the description of goods on the invoice matches the
jewellery.

For jewellery sold after the end of the year, check a sample of sales invoices back to the final
inventory sheets ensuring that the sales value exceeds the cost. Where sales value is less than
cost, ensure that the jewellery is stated at the realisable value on the inventory sheet.
Review the report of the professional valuer. Ensure that the inventory is genuine. For the
items checked by the valuer, agree the valuation to the items of jewellery on the inventory
statements. Where there is a difference, for example due to age of the inventory or where it is
unlikely to be sold due to changes in fashion, discuss with the client and agree a realistic
valuation.
In these situations, the value should be that provided by the professional valuer.
Where an item has been in inventory for a long period of time (perhaps over one year), check
the valuers report to find out whether any allowance is required.
Answer 30 REDBURN
(a) Audit planning importance
Audit planning is addressed by ISA 300 Planning an Audit of Financial Statements. The
standard notes that an audit plan will be developed after the overall audit strategy has been
established and then states that adequate planning benefits the audit of financial statements in
several ways, including the following:
Helping the auditor to devote appropriate attention to important areas of the audit.
Helping the auditor identify and resolve potential problems on a timely basis.
Helping the auditor properly organise and manage the audit engagement so that it is
performed in an effective and efficient manner.
Assisting in the selection of engagement team members with appropriate levels of

capabilities and competence to respond to anticipated risks and the proper
assignment of work to them.
Facilitating the direction and supervision of engagement team members and the
review of their work.
Assisting, where applicable, in coordination of work done by experts.
The following are examples of matters that would be included in the audit plan:
(i) A description of the nature, timing and extent of planned risk assessment procedures
sufficient to assess the risks of material misstatement.
(ii) This would include assessment of inherent risk and control risk at both the entity
and assertion level. An important element of the plan would be the understanding
and assessment of the control environment of the organisation.
(iii) A description of the nature, timing and extent of planned further procedures at the
assertion level for each material class of transactions, account balance, and
disclosure.

(iv) This would include an explanation of the decision
whether to test the operating effectiveness of controls (an important

decision is whether reliance is to be placed on controls).
on the nature, timing and extent of planned substantive procedures (this

would depend on the decision as to the level of control risk).
(v) Audit procedures required to be carried out for the engagement in order to comply
with ISAs, for example, the use of external confirmations to obtain sufficient
appropriate evidence at the assertion level.
Tutorial note: Marks would also be available for additional points such as:
Materiality
Timetable of detailed audit work
Allocation of work to team members.
(b) Appropriate procedures
Reconcile the sales statistics to the recorded sales in the accounting records.
Tutorial note: Other audit procedures should already have proven the validity of the
recorded sales.
Compare trends this year to those of prior years to ensure they are reasonable.
In this connection consider any changes in client circumstances and exercise

professional scepticism as these statistics are produced internally.
Discuss with management the analyses they have made and the actions they have
taken as a result of the statistical information available to them. They would
probably use them, for example, in deciding whether reprints of books are
necessary.
On a test basis check that the customer codes on the customer master file are
properly entered to ensure that the type of customer is properly identified.
Review reports from sales staff to ensure that information on college take-up of
books is accurate.
Tutorial note: As a general rule statistics that are kept on a day-to-day basis for the
companys own purposes, will be much more reliable than those prepared especially for the
auditor. However, the auditor should carry out procedures to ensure that they are accurate
enough for audit purposes.

(c) Royalties substantive tests
Appropriate substantive tests to satisfy the auditor that the royalties charge is accurate and
complete include:
Test Objective
(i) Compare the royalties charge with stated To satisfy the auditor that the royalties
sales revenue and obtain explanations charge to profit or loss is reasonable in
from management if the figures do not relation to stated sales revenue.
appear reasonable.
(ii) Compare budgeted royalties figure with To satisfy the auditor that the actual figures
actual figures. If variations are had been anticipated by management, thus
significant, obtain explanations from providing evidence as to their reliability.
management.
(iii) Review the sales statistics (proven in (b) This would be evidence that the royalties
above) to ascertain those despatches that charge was soundly based.
attract royalties.
(iv) Take a sample of recorded sales entries These are detailed tests to prove that
and check: royalties were due on despatches and that the
calculation of the royalty was accurate.
whether royalties are due in respect
of the customer.
if they are, that the entry in the
computerised royalties file has been
calculated at 10% according to the
contracts agreed with the published
poets.
(v) Take a sample of royalty payments and This is a test to prove that recorded royalty
agree to supporting despatch and sales payments have resulted from despatches and
documentation, checking in particular sales attracting royalties.
that all despatches are to individuals and
organisations attracting royalties.
(vi) Select sales for 15 days before the year This is to check that cut-off is accurate. The
end and 15 days afterwards and compare royalties charge should only include royalties
with the dates of despatch notes. on sales up to the cut-off date.
(vii) Calculate the expected level of royalty This test should provide the auditor with
payments based on monthly trend evidence as to the completeness and accuracy
information for type of customer. of royalties paid.
Obtain sales figures and multiply by
10%. Compare expectation to actual
royalties and obtain explanations from
management for any significant
variations.
This list is not exhaustive and other procedures may be appropriate.

(d) Book inventory
There are many inherent risks that may affect the inventory of books and some of these are set
out below, together with controls that would mitigate each risk.
Inherent risks Mitigating controls
Risk of deterioration. Books should be stored in a location with air

conditioning to keep them in saleable state.
Some books may not be saleable because of Maintenance of movement records to identify
lack of demand. slow-moving items.
Books may be defective and therefore not Inspection of books returned from customers
saleable. to identify those that are not in good
condition. Identification of defective items at
interim or period-end inventory counts.
Books may be attractive and easily Books to be kept in a secure location with
transportable, making attempted theft likely. restriction of entry to authorised personnel.
Poor counting of inventory at the period end. The use of independent and experienced
inventory counters.
The use of teams to cover specific areas of

the locations where inventory is held.
The use of pre-numbered inventory count

sheets.
And other inventory count procedures.
Poor cut-off as there may be movements of Movement of books out stopped during the
goods during the inventory count. count or only allowed by permission of
authorised official in charge of the count.
Book returns received during count held in

separate area. Identification of last
movements in and out.
Goods on sale or return are held by customers Detailed records should be maintained of
but should be included within inventory until goods on sale or return and this should be
the return period is passed. reviewed at the year end to ensure that any
goods within the return period have been
included in inventory.
(e) NRV
(i) Definition
Net realisable value is defined in IAS 2 Inventories as: the estimated selling price in the
ordinary course of business less the estimated costs of completion and the estimated costs
necessary to make the sale.

(ii) Audit procedures
Appropriate procedures to determine that net realisable value of book inventory is above cost
would include:
(1) Assessment of estimated proceeds from the sale of items of inventory. Sales price
in the period following the year end is one important element of net realisable value.
Procedures to determine sales prices include:
Obtain actual sales prices by reference to invoices issued after the year
end and determine that the sales were genuine by vouching sales invoices
to orders, despatch notes and subsequent receipt of cash.
If actual sales prices are not available, the auditor should obtain estimated
sales prices from management. It would be necessary to assess how
reasonable these estimated prices were. The auditor might be aided in this
respect by reviewing the reports from sales staff backed up by discussions
with management.
Particular attention should be paid to sales prices of books identified as

slow-moving.
Tutorial note: Slow-moving books might be identified by obtaining lists

of sales made in the preceding (say) six months and reviewing reports
from sales staff. The sales statistics would also be useful in this respect.
For damaged books disposal price may be nil or very low and the auditor
should examine records of disposal of such books in the past.
Tutorial note: Damaged books should have been identified during the
inventory count.
(2) Determine estimated costs to completion. These costs represent another important
element of net realisable value. Relevant procedures include:
Some books may still be in production and will initially be included in

inventory at cost to date; for example, they may have been printed but not
bound. The auditor should examine production budgets and actual costs
(for binding, for example) to determine actual costs to completion.
Tutorial note: It is not uncommon for publishers to print books but leave
them unbound until sales in the immediate future are expected.
Books returned may incur extra costs before they can be made ready for
resale and the auditor should examine cost records to obtain a reasonable
estimate of such costs.
(3) Determine costs to be incurred in marketing, selling and distributing directly related
to the items in question.
In general terms the auditor may determine the percentage relationship

between sales and selling and distribution expenses.
However, the distribution costs of heavy books are likely to be higher than
for (say) light paperback books and the auditor should assess whether the
cost weighting is reasonable.

(4) All of the above matters should be discussed with management bearing in mind that,
although they represent an internal source of evidence, they are the most informed
people regarding the saleability of books on hand and regarding determination of
the various elements of net realisable value.
(5) Discuss with management the need for an inventory allowance for slow-moving
and/or obsolete books.
Answer 31 SPONDON
(a) Direct confirmation reliability
There are two types/methods of direct confirmation. In either case the customer is requested
to reply direct to the auditor.
Positive confirmation (most common)
The auditor writes a letter to the customer (on the clients headed paper) asking the customer
to reply and confirm the accuracy of the balance shown or state in what respect he is in
disagreement (or to provide a balance).
For non-replies the auditor obtains no evidence and additional procedures have to be carried
out (see (b) below). However, when a reply is received, this provides good (third party and
written) evidence of the existence of the customer, as the customer replies direct to the audit
firms office and the reply cannot be intercepted by the client.
Negative confirmation
A similar procedure is carried out, but the customer is asked to reply only if the amount stated
is disputed. A negative confirmation is therefore used when internal controls over a large
number of small accounts are expected to be strong.
Frequently, with positive confirmations the percentage of customers who reply is low. With a
negative confirmation, the percentage who reply is even lower (as only those who disagree
with the balance are requested to reply). However, it cannot be assumed that those who do
not reply agree the balance (as many customers never reply to any confirmation request, and
some of these customers will disagree the balance). So, a negative confirmation alone
provides weaker evidence of the reliability of accounts receivable on the sales ledger, as many
customers who do not reply may disagree with the balance.
Some limitations in the reliability of the evidence
Some customers reply agreeing the balance for every confirmation request, even
when there is a difference. In some cases they sign the reply as agreeing the balance
without checking their purchase ledger.
The customer may dispute a correct amount when the balance on the clients sales
ledger as a result of timing differences (e.g. cash and goods in transit). This does
not make the reply unreliable as cut-off tests will confirm reconciling items.
Some customers reply saying our accounting system does not allow us to confirm
the balance, hence only the existence of the customer is confirmed. (However, the
customer may be able to confirm that a specific invoice is unpaid.)

Agreement of the balance by the customer does not confirm that it is recoverable
(e.g. because of cash flow problems, the customer may be unable to pay).
Nevertheless, this is a serious weakness of a direct confirmation. Checking cash
received after the end of the reporting period is the best way of verifying the
recoverability of the debt.
Although the great advantage of direct confirmation is that it confirms the existence
of the customer, it is time-consuming to carry out, and, because of the limitations
described above, it is a less efficient way of verifying the value of trade receivables
than other techniques (e.g. review of aged accounts receivable at the end of the
reporting period and checking after-date cash).
Direct confirmation is usually carried out on only a sample of accounts receivable,

which is often a small proportion of the number and value of total sales ledger
balances. Sampling risk (i.e. that the auditors sample may show that sales ledger
balances are agreed by customers, but this is unrepresentative of the whole
population of accounts receivable) reduces the reliability of audit conclusions.
(b) Follow up replies to direct confirmation request
(i) The customer disagrees the balance and provides a different balance
The difference will comprise timing differences, for example goods and cash in
transit and other differences (e.g. disputed items).
Cash in transit should be agreed to cash book receipts and bank statements after the
end of the reporting period.
For goods in transit (on the clients sales ledger but not on the customers purchase
ledger), the corresponding delivery note and invoice should be dated shortly before
the end of the reporting period. The validity of the trade receivable can be
confirmed by reference to ultimate payment (or customer orders).
If there are problems in reconciling balances, the auditor should contact the
customer and request the make-up of the balance on the customers purchase ledger.
If goods despatched some time before the end of the reporting period have not been
posted to the customers purchase ledger, it is probably a disputed item. The
invoice and correspondence with the customer should be inspected to assess
whether the debt is recoverable (e.g. if the invoice was posted to the wrong
customers account it may be recoverable from the correct customer).
Cash in transit is cash on the customers purchase ledger which is not on the clients
sales ledger until shortly after the end of the reporting period.
To confirm entries of cheques received in Spondons cash book and sales ledger the
bank reconciliation should be reviewed. Lodgements (dated per paying-in slips)
should be credited by the bank in a matter of days.
Other differences should be quantified and verified (e.g. discounts taken by the
customer, or debit notes posted to the customers purchase ledger) and assessed for
inclusion (or otherwise) in the bad and doubtful debt allowance.

(ii) No reply to the confirmation request has been received
Internal evidence (i.e. generated by the company) is less reliable than a direct
confirmation, so checking sales invoices, dispatch notes and order confirmations
does not prove the existence of the trade receivable.
More reliable evidence available within the company will be documentation from
the customer (e.g. orders filed in the sales department, correspondence with the
credit controller, signed delivery advice notes).
After-date cash (including cheques) confirms not only the existence but the
amount of the accounts receivable. Only the most recent (unbanked) cheques will
be available for the auditor to inspect, but there should be remittance advices from
customers showing the invoices being paid.
Finally, the customer can be telephoned and asked if he purchases goods from the
client (e.g. by asking the debtors purchasing manager/buyer).
(i) & (ii) To confirm recoverability
Test check the aged debt analysis by confirming the dates of individual postings to a
sample of sales ledger accounts.
Any balances subsequently cleared by cash received since the end of the reporting
period can be considered good.
After-date cash received in respect of old or particularly large balances should be

traced to the bank statement to confirm that any cheques have cleared (and not
bounced).
For year-end accounts receivable being paid in a regular manner (e.g. the oldest
months balance is settled each month), it is probable that the outstanding balance is
recoverable.
Individual old outstanding items are probably doubtful as they are likely to be in
dispute. Correspondence with the customer may confirm the need for an allowance
to be made.
Customers with cash flow (going concern) problems may be settling only a small
amount of what they owe when legal action is being threatened and should be
discussed with the credit controller.
Answer 32 CAMBRIDGE
(a) Objectives of direct confirmation of accounts receivable
To verify the completeness accuracy, existence and ownership of trade receivable

balances at the end of the reporting period. Thus, a direct confirmation is a
substantive procedure which can be carried out to substantiate the trade receivables
figure at the end of the reporting period.
To provide additional evidence of the adequacy (or otherwise) of the system of

internal controls over sales and trade receivables. As the receivables balance is the
end result of transactions over a period of time, confirmation of receivables can also
be considered as partly a systems/compliance/ controls test.

To check the accuracy of cut-off and help draw attention to irregularities (e.g.
teeming and lading and window-dressing).
(b) Methods of confirmation
(i) Positive
A letter is sent to customers asking them to reply saying that they either agree or disagree
with the balance stated (i.e. a reply is always sought and non-replies must be followed up by
the auditor).
This method is preferred when there is high inherent and/or control risk, for example, where
there are:
weak internal controls;
suspicions of irregularity or amounts in dispute;
numerous bookkeeping errors.
(ii) Negative
A letter is sent to customers asking them to reply only if they do not agree with the balance as
stated. If no reply is received it is assumed that the customer agrees with the balance. This
method is most appropriate when:
there are good internal controls; and
a large number of small accounts.
(c) Selecting a sample
(i) Balances over $50,000
There are 35 balances over $50,000 representing 15.3% in value of trade receivables. The
number of these balances selected would depend on the materiality level in the accounts as a
whole. If balances of $50,000 and over are material to the accounts, it is possible that 100%
testing of these balances would be carried out.
(ii) Balances between $1 and $1000
There are 5,120 balances between $1 and $1,000 representing 33.4% in value of trade
receivables. Once a sample size has been calculated the selection from these balances should
be on a representative basis. For example, random selection, interval or systematic selection
(every nth item), value-weighted selection (e.g. MUS, i.e. every nth $). The sample size will
depend on risk assessment, but it will not need to be very large to give a valid conclusion on
the whole population.
(d) Statistical v judgmental sampling
Statistical sampling is a method of sample design, selection and evaluation which has a
mathematical base (probability theory) such that audit conclusions can be drawn with a
specific level of confidence (i.e. sampling risk is measured).
Judgmental sampling is non-statistical sampling. This includes, for example, selecting items
on a haphazard basis. Consequently, sampling risk cannot be quantified.

Answer 33 TRACEY TRANSPORTERS
(a) Audit test Reason for test

Perform analytical review on If records of availability of vehicles are kept
monthly revenue, comparing to this may provide some evidence of
numbers of available vehicles. If completeness of recorded revenue.
possible, calculate utilisation rates.
Review management accounts and To confirm whether significant under-
commentary on revenue. recording of revenue is occurring. Evidence
on completeness.
With clients permission, create To confirm the completeness and accuracy
dummy customers and enter orders of recording of orders by the computer
into the VMS from an input terminal. system.
Ensure vehicle is correctly allocated
and charges are made accurately,
before deleting transactions.
For a 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 filing of the e-mails means
that details of vehicle hire regarding
that completeness of e-mail orders cannot
time and dates are accurately
easily be determined. No test is possible on
recorded.
telephone orders.
Review hard copy customer To check for evidence of orders being sent
complaint files and e-mail files on by customers but not entered into TTs sales
computer for evidence of unfilled system correctly. Also for evidence of
orders. failure to record orders.
For a sample of bookings in the To check for completeness of transfer of
VMS, trace details to the list of sales information between the two programmes.
invoices raised maintained in the The test can be carried out manually or (for
receivables ledger programme. the whole year) by using computer audit
software. 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 each
VMS, agree the rental amount being individual vehicle hire. Evidence of
charged to standard charges held in undercharging would indicate that sales are
the receivables ledger file. understated. This can be achieved for the
whole year by incorporation into the
computer audit software testing programme.
Cast the list of invoices in the To ensure that the total sales for that month
receivables ledger programme for are accurate. Transfer of data to the nominal
one month. Trace total sales to the ledger ensures that the total sales amount is
general ledger programme. recorded correctly in the ledger. Again, can
be achieved for the whole year through
computer audit software.
Cast the monthly sales figures in the The final cast and checking ensures that the
general ledger and agree to the financial accounts figure is accurate.
financial statements. Investigate any
Casting tests can be carried out manually or
discrepancies.
using computer audit software (covering the
whole year).

(b) Audit work on Vehicles.
Obtain non-current asset register from client. Cast the cost, depreciation and carrying amount
columns of the register and agree to the financial statements of TT.
Agree opening balances to last years closing balances/comparatives.
Additions
Obtain a breakdown of additions from management/asset register and for a sample:
Agree to board minute or similar documentation for evidence of authority to

purchase vehicle (occurrence assertion);
Agree details to purchase invoice or similar document for evidence of accurately
recording initial value and ownership (occurrence, accuracy and rights assertions).
Existence
Select from opening balances and additions, a sample of vehicles for physical inspection
(existence assertion).
Because of the location of the vehicles at any one time, it will be necessary to consider the
timing of the inspection and the logistics of inspecting. For example commencing from the
year-end physical inventory observation (e.g. fuel, spare parts) through to the end of the audit;
organising other auditors to inspect the vehicles where they are at the year end.
When inspecting, consider physical condition of vehicle looking for indication of physical
impairment (valuation assertion).
If the vehicle cannot be physically inspected (e.g. on hire and cannot be accessed for
inspection) obtain alternative evidence of existence (e.g. GPS tracking data, hire contracts,
payment for hire, service costs and records).
Disposal
Obtain a detailed list from management of the vehicles that have been disposed of during the
year. Agree the list from the asset register.
From the existence test, where there is no evidence of any vehicle not existing at the year-
end, trace to the list of disposals (for completeness assertion). If not included, discuss with
management why the vehicle cannot be verified.
For a sample of material disposals during the year (for occurrence assertion):
ensure asset has been removed from the non-current asset register;
check calculation of profit or loss on sale;
agree correct treatment of registration documents (e.g. sent to appropriate authorities
for re-issue to new owners); and
agree receipt on sale to the cash book and bank statement.
Review profits and losses generated on sale of vehicles and ensure these are not excessive. If
they are check the accuracy of the depreciation rates used as this may indicate over or under
charge of depreciation. (Valuation and accuracy assertions.)

Compare sales income to sale of similar vehicles with similar mileage and ensure comparable.
Depreciation
Agree opening balances to prior year (accuracy assertion).

Confirm rates, expected useful lives and method of calculation consistent with prior year and
still appropriate (valuation assertion).
Test the calculation of depreciation in the non-current asset register, ensuring that the rates
used are those disclosed in the financial statements. (Valuation and accuracy assertions.)
Recalculate depreciation charge for the year (accuracy and valuation). Ensure correctly
accounted for in asset register and general ledger.
Recalculate accumulated depreciation on vehicles disposed of during year. (Accuracy)
Financial statements
Agree totals in non-current asset register to the financial statements, ensuring vehicles are
disclosed separately in the non-current assets note (material item). (Classification and
understandability assertions.)
Ensure that the accounting policy for depreciation is clearly stated in the financial statements
and is the same as last year (Classification and understandability assertion).
Answer 34 B-STAR
(a) Audit strategy document
Section of document Purpose Example from B-Star
Understanding the entitys Provides details of the Size of the theme park sector
environment industry area that the and expected growth over the
company is in along with next few years.
specific information about
the activities and strategies
of the individual client.
Understand the accounting Details of accounting Accounting policy for sales

and internal control systems policies of the client and sales are stated net of sales
previous assessments of taxes.
internal control systems
Reliance on control systems
indicating the expected
in B-Star may be limited due
extent of reliance on those
to lack of documentation of
systems.
controls.
Risk and materiality The assessment of risk for Materiality for sales to be 5%
the client and risk of fraud of turnover.
and error and the
B-Star receives cash sales
identification of significant
audit work required to
audit areas.
determine the completeness
The materiality level for of sales.
audit planning purposes.

Consequent nature, timing Details of the focus on audit Audit software could be used
and extent of audit work on specific areas. to provide analytical
procedures Detail on the extent of use of procedures on the sales of B-
audit software and possible Star.
reliance on internal audit.
Co-ordination, supervision Details the extent of B-Star has only one location
and review of audit work involvement of experts, audit staff will be required
client locations and staffing to work there for X weeks.
requirements for the audit.
(b) Completeness assertion
(i) Risks
The computer system does not record sales accurately and/or information is lost or
transferred incorrectly from the ticket office computer to the accounts department
computer.
Cash sales are not recorded in the cash book; cash is stolen by the accounts clerks.
Tickets are issued but no payment is received that is the sale is not recorded.
Cash is removed by the ticket office personnel, by the security guards or by the
account clerks.
The account clerks miscount the amount of cash received from a ticket office.
(ii) Extent of procedures
Tests of controls
Tests of control are designed to ensure that documented controls are operating effectively. If
controls over the completeness of income were expected to operate correctly, then the auditor
would test those controls.
In B-Star, while controls could be in operation (e.g. the account clerks agreeing physical cash
to computer summaries) there is no indication that the control is documented; that is the
computer summary is not signed to show the comparison has taken place. The auditor could
use the test of inquiry asking the clerks whether the control has been used, and observation
actually watching the clerks carry out the controls. As noted above though, lack of
documentation of the control does mean relying on tests of control for the assertion
completeness of income has limited value.
Substantive procedures
Substantive procedures include analytical procedures and other procedures.
Analytical procedures include the analysis of significant ratios and trends and subsequent
investigation of any trends or relationships that appear to be abnormal. These procedures can
be used effectively in B-Star as an approximation of income that can be obtained from
sources other than the cash receipt records.

Other procedures, or tests of detail, are normally used to verify statement of financial position
assertions and include obtaining audit evidence relevant to specific assertions. However, they
could be used in B-Star to trace individual transactions through the sales/cash systems to
ensure all ticket sales have been recorded (completeness assertion). The use of other
procedures will be time consuming.
(c) Substantive analytical procedures
(i) Completeness of income for one day
Obtain proof in total. Tickets sold times price should equal days income.
Compare daily sales to budgeted daily sales (for example weekends and bank
holidays would expect more income).
Compare sales with previous days and account for changes such as variations for
weather.
Compare sales to souvenirs sales (more people in park means more souvenir sales).
Compare ticket offices day-by-day and staff rotation to see if sales lower
someday/some staff (attempt to identify fraud also).
Compare the expected sales from ticket numbers to the total sales amount from cash
and credit sales for each ticket office.
(ii) Completeness of income for the year
Obtain the sales income from the previous year. Multiply this by 15% to provide a
rough estimate of the income for this year.
Obtain information on the number of days with rain during the last year. Where this
is more or less than 30, adjust the income estimate by 1/730 down for each day of
rain above 30 or 1/730 up for each day of rain less than 30. (Note: B-Star only
attracts 50% of the normal number of customers on a rainy day; hence one day of
rain decreases total customers by 1/730 in the year.)
Compare actual income to budgeted income for the year. Ask the directors to
explain any significant deviations.
Obtain industry information on the popularity of theme parks, and change in

customer numbers. Compare these trends to the results obtained by B-Star. Where
B-Star performed significantly better or worse than average, obtain explanations
from the directors.
(d) Audit of year-end credit card receivable
Agree the balances on each credit card companys ledger account to the list of
receivables.
Cast the list of receivables and agree the total to the total on the receivables ledger
control account.
For the last day of the financial year and the first day of the new financial year,
agree total sales income from ticket office records to the cash book and receivables
ledger ensuring they are recorded in the correct period.

For a sample of material balances and a random sample of immaterial items,
Obtain direct confirmation from the credit card company of the amount due to B-
Star using a receivables confirmation letter.
Where direct confirmation is not possible, obtain evidence of cash receipt after the
end of the financial year. Agree the amount on the bank statements post year-end of
B-Star to the amount due in the receivables ledger (less any commission due).
Review after date sales day book for debit notes indicating that sales may have been
overstated in the prior year.
Obtain the financial statements of B-Star and ensure that the receivables amount is
disclosed as a current asset net of commission due to the credit card companies.
Answer 35 CROMWELL
(a) Factors in determining substantive sample sizes
Risk (and assurance required)
The audit (or ultimate) risk of drawing an incorrect conclusion (e.g. forming an unqualified
audit opinion when the financial statements do not show a true and fair view) is a key factor.
The greater the risk of material errors arising (inherent risk) the larger the sample size
should be. The sample size may however be reduced if the clients system of internal control
is strong and so prevents or corrects such errors (i.e. control risk is low).
It is in the nature of sampling that there cannot be absolute assurance that a sample is
representative of the population from which it is drawn. This sampling risk increases the
smaller the sample size.
Other substantive procedures
More than one substantive procedure may be planned to detect remaining material errors (i.e.
those not prevented or corrected by the clients system of internal control). The sample size
for any one substantive procedure will be smaller the greater the reliance to be placed on the
results of other substantive procedures.
Tolerable error
The sample size for a substantive procedure will take into account the maximum error (say
$5,000) that can be accepted (called tolerable error) and still conclude that the audit objective
has been met (e.g. cash at bank is not materially overstated). The greater the tolerable error
the smaller the sample size required to achieve the required level of precision.
Expected error
Errors increase the imprecision of sampling results because they affect the assessment of the
population from which the sample is drawn. The more errors expected the larger the sample
size should be. If the expected errors are ignored (when calculating the sample size) the
sample will have to be subsequently extended when errors arise and the sample results do not
achieve the assurance required.

Population value
The greater the monetary value of the population to the financial statements, the larger the
sample sizes that may be required (unless materiality is increased proportionately). However,
the number of sampling units in a large population has little, if any, effect on sample size.
Stratification
Sample sizes can be made smaller by effective stratification of a monetary population to

reduce the degree of variation between items in the sub-strata (sub-populations). For
Cromwell the cash at bank and in hand population may be stratified into:
500 cash floats of $500 each;
x foreign currency cash balances; and
x bank account balances.
Samples sizes should direct the audit effort to reflect the materiality of each stratum.
(b) (i) Cash balances
At shops
Count cash at a selection of shops on a surprise visit basis.
Reconcile the cash balance with vouchers for the imprest amount.
Review vouchers to check they have been properly authorised and relate to bona
fide expenditure.
Check cut-off between cash in hand and cash in bank to ensure that no banking has
been counted twice or omitted.
Analytically review daily banking to identify trends and deviations from the
expected amount.
Vouch banking on the last day of the year to cash book and bank reconciliation to
ensure correct treatment.
At head office
Ascertain the system for obtaining foreign currency.
Check that the amount in the safe has been properly authorised and if appropriate
can be reconciled to specific trips.
Count the currency and agree its translation into sterling at the rates prevailing at the
end of the reporting period.
Obtain confirmation from buyers of the amounts they held at the end of the
reporting period.
Ascertain amounts of cash in the hands of buyers who are either abroad at the end of
the reporting period or who have been advanced money in order to travel.
Confirm that amounts advanced to buyers have been properly authorised (e.g. by
reference to approved advance requisitions).

Check that amounts held by buyers have been included in the cash balance at the end
of the reporting period and that translation rates used are consistent with those for
currency in the safe.
Review exchange rate movements since the end of the reporting period to assess the
need for any relevant disclosure.
(ii) Bank loan
Obtain confirmation from the bank of the amount of the loan and the interest and
repayment terms.
Agree the classification in the financial statements (e.g. between Current
liabilities and Non-current liabilities Interest bearing borrowings).
Check the calculation of the income and expenditure account charge for interest.
Agree the rate used for the conversion of the loan.
Review cash flow forecasts and budgets to ascertain whether repayment of the loan
is feasible.
Confirm that the treatment of interest is consistent with the loan agreement, and is
correctly disclosed as a finance expense
Check the extent of any security for the loan and that the existence and extent of the
security has been disclosed.
For each factor (affecting substantive sample sizes) described max 2
Ideas (ISA 530) risk (inherent/control/sampling)

tolerable error
expected error
population value
stratification
Part (a) 8
For each audit test made specific to the circumstances of Cromwell 1
Techniques of audit testing (ISA 500)
Analyse
Enquire and confirm
Inspect
Observe
compUte
Part (b) 12

Answer 36 COMPANY A
(a) Company A
(i) 10-year bank loan and bank overdraft
Authorisation for the loan and overdraft should be checked to the minutes of a
board or other relevant meeting.
The details of contracts with the bank and any relevant correspondence should be
examined. Any covenants restricting the use of securities held against the loans
should be examined and the clients compliance with the covenant checked. If
covenants have not been complied with, the implications for the company and the
financial statements should be considered.
The response to the year-end bank confirmation should be examined. It should

provide details of the amounts outstanding and the amounts paid and payable during
the year in terms of both interest (loan and overdraft) and capital (loan only). In
both cases, details of any security held for the loan and overdraft should be
requested.
Analytical procedures should be applied to the interest paid in the statement of

comprehensive income, and to the interest and capital paid and outstanding at the
period-end for the loan.
The bank reconciliation should be checked to ensure that the overdraft has been
properly reconciled to the records, and that there are no old or significant
outstanding amounts that need to be adjusted for.
The amount payable at the year end should include amounts payable in one year,
which should be included in current payables, and amounts payable in over one
year. The notes to the financial statements should also disclose amounts payable in
over five years.
The auditors should ensure that appropriate disclosures are made in the notes to the
accounts in accordance with legislation and International Financial Reporting
Standards. In particular, where assets are held as security, this should be disclosed
in the notes relating to the assets.
(ii) Expense accruals
If accruals are not material, analytical procedures may be sufficient audit evidence.
From their understanding of the business, prior year financial statements, audit work
carried out, budgets and expectations, the auditor should be able to determine the
form and level of accruals required.
A schedule of accruals should be obtained and checked for arithmetical accuracy.
Individual accruals should be reviewed by comparison with the auditors

expectations. Significant variations should be investigated, particularly if accruals
have been made in previous periods but have not been made in the current period.
After date payments should be reviewed to identify potential payments of accruals.

Calculations of a sample of amounts payable should be checked for accuracy, by
reference to subsequent invoices.

If any accruals are payable more than one year after the end of the reporting period,
an appropriate split should be made in the statement of financial position.
(iii) Trade payables and purchase accruals
The nature and extent of testing will depend on the quality of controls over trade
payables, as evidenced by interim testing of internal controls. Evidence in relation
to the completeness of trade payables and accruals is important, but not always easy
to obtain.
The auditors will need to use their professional judgement (in relation to the risk of
understatement of trade payables) as to whether or not supplier statements obtained
through the client can be relied upon, or, as is more common, direct confirmation of
trade payables with the suppliers is required.
It is sometimes possible to rely on supplier statement reconciliations instead of

direct confirmation, but this depends on the availability of supplier statements.
Where supplier statement reconciliations are performed, it is important to be aware
of the possibility of forged or altered statements originals rather than copies
should be examined. Some combination of supplier statement reconciliations and
direct confirmation is often used.
Selecting the suppliers to confirm should be based on the reciprocal population of

purchase turnover. High purchase turnover indicates a probable material trade
payable at the year end.
In addition, the payables closing balances should be compared to those of the prior
year. For any supplier that has a significantly lower balance this year, compared
with the prior year, must be considered for confirmation.
An open balance confirmation (requesting the supplier to state the balance owing)
should be prepared on the clients letterhead, signed by the client but sent by the
auditor. The confirmation should require the supplier to send the appropriate
statement.
When the reply is received (directly by the auditor) the reconciling differences
should be fully audited. If no reply is received, alternative procedures should be
applied (e.g. telephoning the supplier, evidence of existence, auditing the makeup of
balance, after date payment).
Analytical procedures should be applied to the ageing and level of trade payables by
comparison with prior periods. Variations should be investigated and substantiated,
with particular attention being paid to old outstanding amounts.
Full cut-off testing of the purchases account and payables control account (linking
to the cash account and inventory) should be carried out. In addition, after date
invoices and payments should be reviewed to identify liabilities not yet recorded
(e.g. goods received before the year end, but not invoiced until after the year end).
A schedule of purchase accruals (e.g. goods received but not invoiced by the year-
end) should be obtained and checked for arithmetical accuracy. Where post year-
end invoices and payments indicate liabilities not recorded in the purchases account
and payables control account before the year end, they should be included as
purchase accruals. If not, there is a possible understatement.

A review of correspondence with trade creditors should be performed and any legal
department should be requested to provide details of disputes with creditors.
If any trade payables are payable more than one year after the end of the reporting
period, an appropriate split should be made in the statement of financial position.
(b) Company B
Provisions for manufacturing warranty claims are heavily dependent on the

judgement of directors. The auditors should establish how the directors have
arrived at the provision and assess it for reasonableness in the light of previous
provisions and claims. More work will be required if there has been a significant
discrepancy between provisions and claims in the past and more work will be
required if the company does not have significant experience in dealing with this
type of warranty claim.
Such warranties are often underwritten by insurance and any arrangements with the
insurance company should be checked in detail so that the substance of the
transaction can be reflected in the financial statements.
The auditors should prepare their own estimate of the necessary provision from their
understanding of the business, the detail of past claims, the costs involved and the
level of sales (including new products introduced and changes in sales-mix) made
during the current year.
Auditors should check the calculation of the directors provision for arithmetical
accuracy and to ensure that it is calculated in accordance with the method
determined by directors. This can be achieved by reviewing the level of claims and
payments both before and after the period-end.
Where the auditors estimate is materially different from that of the directors,
explanations must be sought.
A review of correspondence with customers should be performed and any legal

department should be requested to provide details of disputes with customers
relating to claims.
Answer 37 WELFARE HELP FOR THE AGED TRUST (WHAT)
Tutorial note: Although this question is based on a charity, the key element that is being examined is a
cash-based small enterprise system.
(a) Further information Relevance to planning
The income mix for the year and seasonal All material income sources must be identified,
trends. since income is received from a broad range of
sources. Collections and donations are likely to be
material and dealt with by inexperienced volunteers.
The ways in which covenant income is Existing covenant donations should be a consistent
raised (e.g. through wealthy individuals and stable source of income and relatively easy to
or general fund-raising campaigns). verify.

Further information Relevance to planning
The procedures for ensuring tax effective Special attention should be given to identifying new
covenant giving, and the extent to which covenants to ensure completeness of income and
covenants are renewed. income tax recovery.
The strategy for postal donations, whether Receipts in response to a mailshot appeal are
on an ad hoc basis or as a result of likely to be material.
specific campaigns or appeals. Related
expenditure incurred (e.g. postage). The One-off receipts will depend on the adequacy of the
extent of repeat donations and whether accounting system and internal controls to ensure
there is a seasonal trend. completeness of recording
Plans for door-to-door and workplace Central planning of collections results in a more
collections including the extent to which even spread of income which is easier to reconcile
they are planned centrally or initiated by to head office records. (Sporadic collections and
volunteers. inadequate recording cause problems in assessing
completeness of income.)
Analysis of other donations and related
expenses (e.g. mini-bus depreciation and The value of donated assets is potentially material
running expenses). The method of and may be misstated if professional valuations are
valuation and accounting treatment of not sought.
capital donations whether they are
capitalised or taken to the income and (If not recorded at a value, non-cash assets may be
expenditure account. omitted altogether. Their existence will be
evidenced/corroborated by related expenses being
The local authorities providing grants and incurred.)
the nature of the grants capital, revenue
or both (and any utilisation conditions Grants, if material, should be treated in accordance
attached by the donor). with IAS 20. Audit work must take into account
any specific local authority reporting requirements.

The pricing policy adopted for the sale of Adoption of a consistent pricing policy will assist
refreshments. Whether bulk supplies are analytical procedures.
obtained at a discount or any inventory is
donated. A sales income analysis for Variations in discounts may affect gross margins.
each day should facilitate effective
opening hours. One-off events provide irregular sources of income
and may have different control processes.
Diary dates of fund-raising events and
details of main income sources and Events outside the community centre may be difficult
associated expenses. The review to control. Attendance at some events may need to be
procedures adopted to ensure effective planned.
use of volunteer resources.
(b) Controls over income
Tutorial note: A small enterprise staffed mainly by volunteers would be expected to suffer
such problems as inadequate training and lack of segregation of duties. It is essential,
however, that controls exist over the receipt and recording of income to ensure maximum
social benefit is gained from the companys objectives and that public credibility is
maintained. The following controls over income could reasonably be expected to exist.

Deeds of covenant
Institution of regular review by a responsible official to ensure that all amounts are
duly received. (Most deeds of covenant will probably be paid by bankers order
and this method of payment should be encouraged.)
Regular monitoring to ensure that all the payments covenanted are obtained
including income tax refunds.
Postal donations
At least two persons to be present at opening of mail.

Immediate recording of receipts on a post list.
Prompt banking of the money to ensure maximum interest earned.
Independent reconciliation of cash book receipts with post list.
Door-to-door and work-place collections
Pre-numbering and sealing of collecting boxes and tins.

Official collector name and photo badges given to collectors for identification.
Prompt collection and removal of proceeds from boxes.
At least two persons to be involved in counting and recording.
Prompt banking of cash intact (i.e. not using the money collected to pay expenses).
Capital item donations
Safe-keeping of documents of title or registration (e.g. vehicle registration form).

Safe custody of donated assets (e.g. vehicles should be fitted with alarms and locked).
Use restricted to company business by:
having authorised drivers;
installing tachographs (spy in the cab).
Local authority grants
Regular discussion with local authority official to ensure all available grants are
obtained and that specific payments are received.
Authorisation, by directors, of disbursement of grants to ensure expenditure
complies with the terms of the grant.
Sales of refreshments at the social centre
If turnover justifies it, a till should be used for all takings which should be banked
daily and intact.
Inventory of confectionery, sweets, etc should be securely held.
Overall tests on gross profit percentage should be made at (say) monthly intervals
by the finance director.
Some degree of supervision may need to be present to prevent losses of inventory
through staff pilferage. Spot checking may suffice.

Fund-raising events
Tutorial note: The controls required here must reflect the type of activity but the following
basic points will normally be applicable.
Approval by the board of trustees.

Adequate records of income for each event.
Clear responsibility for cash handling allocated to two persons.
Takings are banked promptly intact.
Expenses are separately authorised and paid.
For each item of information and its relevance to planning 2
Ideas income mix

covenant fund-raising methods
strategy for postal donations
plans for collections
accounting treatment of capital donations
nature of grants
refreshments pricing policy
nature of fund-raising events
Part (a) 10
For each control 1
Part (b) 10
Answer 38 AUDIT OF SMALL BUSINESSES
(a) Meaning of a small business
Businesses that have few employees or a low level of turnover or of total assets. Such
businesses usually display either or both of the following characteristics:
limited segregation of duties; and
domination by senior management or owner overall all essential aspects of the

business.
(b) Characteristics
Limited segregation of duties
A small business typically allocates fewer resources to financial accounting functions than
larger businesses. Managers will tend to concentrate their efforts on operational areas (e.g.
sales and marketing) rather than ensuring that assets are safeguarded and that a proper
accounting system is maintained.

Possible consequences of limited accounting resources are:
informal or inadequate record keeping (there is therefore greater risk that financial
statements will be inaccurate or incomplete); and
greater reliance being placed on the auditor to assist in preparation of accounting

records and financial statements. (Managers may incorrectly assume they have
been relieved of responsibility for accurate financial reporting.)
Because a small business typically does not have many accounting employees it is often not
practicable to segregate duties among different individuals to the same extent as in other
businesses. Therefore it may not be possible to rely on internal control to detect fraud or
errors. For example:
personnel responsible for accounting records may also have access to assets that are
easily concealed, moved or sold; and
it may not be possible to set up a system of independent checking (with the result
that there will be greater risk that errors will not be detected).
Use of computer facilities may increase control risk. For example, in a microcomputer
environment it is common for users to be able to perform two or more of:
initiating and authorising source documents;

entering data into the system;
operating the computer;
changing programs and data files;
using or distributing output;
modifying the operating systems.
Domination by senior management or owner
Senior managers or owners who actively participate in the business may dominate the
operation of the entity (particularly the internal control systems and production of financial
statements).
This may have some advantages
Domination can compensate for otherwise weak internal controls (e.g. where owner
personally signs all cheque payments).
When owner is not involved, there is greater risk that employee fraud or error may
occur and will not be detected.
The major disadvantage is that internal controls can be overridden. The risk of management
fraud is greater. For example, an owner can make disbursements without providing
supporting documentation.
(c) Additional audit procedures and problems experienced
(i) Small manufacturing company
Select a sample of purchase invoices and identify the sales relating to the goods
purchased. This may not be practicable because steel, for example, may be
purchased in bulk and used on different sales orders, with different levels of wastage.

Assess the risk of cash sales being unrecorded. They may be either specific orders
from customers or sales of scrap. Scrap sales should exist, and the level of these
should be compared with previous years to ensure reasonableness. Visit the
companys factory to identify, in broad terms, the level of scrap.
Scrutinise job cards which relate to orders completed or in progress. These cards
may identify customers who do not appear in the sales ledger. Some jobs may be
done for cash, which is not recorded in the books of account, or the sales ledger may
not include all customers.
Compare the gross profit margins by month and with previous years. Any material
omission of sales from the books of account will affect gross profit. However, there
may be a constant level of suppressed sales over the years, and such analytical
procedures will not highlight any distortions in gross profit.
(ii) Small retail store
Check till rolls to cash received summaries. This will highlight any sales which
have been made but not recorded. However, there always exists the probability that
the till/cash register will be bypassed when a sale is made, so this procedure may
not be effective in all circumstances.
Select a sample of purchase invoices during the year and identify the sales relating
to the goods purchased. This will only be possible if sales invoices are raised.
Problems may arise if the cash received from suppressed sales is used to purchase
goods for resale in cash, which in turn are not included in the books of account.
Gross profit margins should be compared by period and with previous years. If
there are any significant variations they should be investigated fully. However, if
the store sells many different product lines, fluctuations may occur because of the
product mix.
Analyse the amount and types of purchase during the year and calculate a
theoretical mark-up on certain representative lines. These mark-ups can be
weighted to generate an aggregate mark-up for all goods purchased. This
theoretical mark-up can then be compared to the disclosed mark-up and any
significant differences can be investigated.
Answer 39 CALVA
(a) Objectives
(i) Overall review of financial statements
The objective of a review of financial statements is to provide the auditor with

sufficient audit evidence, when taken together with the conclusions drawn from the
other audit work, to form an opinion on the financial statements. This includes
determining whether the information in the financial statements is properly
presented and disclosed in accordance with accounting standards, legislation and
other regulatory requirements. Calva is a listed company and will therefore have to
comply with stock exchange disclosure requirements. The usual means of
achieving this is by the completion of a disclosure checklist.
Auditors should consider the appropriateness of accounting policies in particular

and whether they have been consistently applied, particularly where changes have
been made.

Auditors should also consider whether the financial statements as a whole are
consistent with the auditors knowledge of the business. This involves
consideration of the aggregate effect of uncorrected misstatements, any overall bias
in presentation and will normally involve analytical procedures on the final
financial statements. This exercise involves the application of professional
judgement and, in the case of Calva, it is likely to be carried out by senior manager
or the audit engagement partner.
(ii) Review of working papers
The objective of a review of working papers is to ensure that all work has been
properly planned, executed and recorded and that all outstanding matters have been
followed up.
In the case of Calva, it is likely that some work will have already been reviewed. It
is common for audit seniors or audit managers to review the work of audit juniors.
There will also be a final partner review of the file.
Where working papers are prepared manually, staff normally evidence review of
working papers by initialling the working paper. Review comments are often
written in red and referred to the person preparing the working paper or to the
partner where significant matters of judgement are concerned. Where papers are
prepared electronically, electronic signatures can be used.
It is important that a detailed review of working papers takes place in areas that are
critical to the audit. In this case, critical areas are likely to include inventory
(despite the fact that it is well-controlled, it is still a material item), cash, non-
current assets and sources of finance.
It is also important during the final stages of the audit of Calva that all outstanding
areas (i.e. the substantive areas) are completed, reviewed and any issues arising
followed up. It is very easy for apparently insignificant matters to slip through the
net at this stage where both auditors and client are under pressure.
(b) Subsequent events
(i) Responsibilities
ISA 560 Subsequent Events deals with this issue.
Auditors should perform procedures designed to obtain sufficient appropriate audit

evidence that all material subsequent events up to the date of the audit report which
require adjustment or disclosure in the financial statements have been properly
made.
If matters requiring adjustment or disclosure are discovered after the date of the
audit report but before the financial statements are issued, or even after they have
been presented, auditors should ascertain whether and how any necessary changes
are to be made to the financial statements.
The decision as to whether financial statements should be changed is that of the

directors. Auditors cannot change their minds once the audit report has been
signed except in the rare cases when new financial statements are issued. The
auditors then issue a new audit report which should make reference to the previous
financial statements and audit report.

If auditors consider that the financial statements contain material errors or are
misleading, they will quantify their audit opinion and may exercise any right to
speak at general meetings and to make written representations to members.
If matters are discovered long after the financial statements have been issued, it is
common to deal with the matter as a prior period adjustment in the subsequent
(ii) Subsequent events review procedures
These include making enquiries of management as to how they have ensured that
subsequent events have been identified, although it is likely that in this case the
company will rely on the audit firm to help them with this.
Auditors will read the minutes of management, shareholders and other meetings and
review relevant accounting records. In this case, they are likely to review any
budgets or cash flow forecasts. It is likely that these will have been prepared as a
result of the negotiations with the bank.
In the case of Calva, the auditors are likely to enquire as to the possibility of any
new share or loan issue to fund the expansion which may require disclosure. They
may also enquire as to any significant changes in the property market that might (if
the supermarket properties are carried at valuation) require either disclosure or
adjustment in the accounts.
Answer 40 OILRAKERS
(a) Audit procedures to be used prior to the audit report being signed
Review procedures established by management to try and ensure that subsequent

events are identified.
Read minutes of the meetings of directors, the audit committee and shareholders and
enquire into unusual items.
Obtain and read the companys latest interim accounts as well as any budgets and
cash flow forecasts.
Correspond with the companys lawyers to obtain evidence concerning litigation

and claims that were in existence prior to the year end and for those made after the
year end.
Review books, records and correspondence and making enquiries of management

as to whether any subsequent events have occurred such as:
new borrowing commitments;
significant sales of assets;
new shares or debentures issued;
assets being destroyed by flood, fire, etc or impounded by the government;
unusual accounting adjustments made or being contemplated.
Check whether any events have occurred that could call into question the validity of
the going concern assumption.

(b) 15 February
(i) 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 allowance on the
profit and loss account is understated. An adjustment for the amount of the
receivable should be made in the financial statements, if it is material.
(ii) The bankruptcy of the major customer takes place after the end of the year but
before the financial statements and the auditors report are signed. As the auditors
report has not been signed, the auditor is still responsible for identifying material
events that affect the financial statements. This means that audit procedures should
be carried out which are designed to identify this event.
Specific procedures
Confirm that the customer will not pay to a letter from the receiver/liquidator/
administrator or similar authorised person.
Confirm the amount due from the customer to invoices raised prior to the year end.
Verify the adjustment to the financial statements decreasing the receivable balance
and increasing the bad debt write off to profit or loss.
Include the amount in the management representation letter to confirm no other

amounts are due from the customer.
1 May
(i) The accidental release of toxic chemicals occurred after the end of the reporting
period. Since the spillage arose after the year end, no adjustment appears to be
necessary. However, the event may be significant in terms of the operations of the
company (a large legal claim could arise) and so disclosure of the event would be
expected, as a non-adjusting event.
(ii) The accidental release of toxic chemicals takes place after the auditors report has
been signed but before the financial statements are sent to the members. At this
stage of the audit, the auditor does not have any responsibility to actively perform
procedures or make inquiries regarding the financial statements. The management
of OilRaker are responsible for telling the auditor about any significant events, such
as this one.
When the auditor becomes aware of the event (e.g. management informs him) and it
may materially affect the financial statements (in terms of a disclosure being
required) the auditor must act.
Specific procedures
Obtain information concerning the chemical release from management, reading

local press and discuss with the companys lawyers the latter may be able to
indicate whether there is any legal liability, and its possible cost.
Discuss the appropriate accounting treatment with the directors, confirming that
disclosure is required in the circumstances, if material.

Read the disclosure note to confirm that the matter is adequately explained in the
Withdraw the signed auditors report and update the subsequent events review to
the date of signing the new auditors report.
Obtain an updated letter of representation from the directors confirming that there
are no other events requiring disclosure.
Issue a new auditors report to include an emphasis of matter paragraph (on the
basis that knowledge of the spill is fundamental to the users understanding of the
financial statements) to draw attention to the full disclosure noted in the financial
statements. Date the new auditors report no earlier than the date of approval by
management of the amended financial statements.
30 May
(i) The fire at an oil well means that OilRakers oil production (and presumably profits)
will fall in the next financial year. The fire though does not provide additional
evidence of conditions existing at the end of the reporting period nor would it be
disclosed in the financial statements which were issued a week earlier. However,
disclosure of the event may be legally required or should be made to shareholders as
a matter of good governance practice.
(ii) The fire at an oil well takes place after the financial statements have been issued. At
this time, the auditor has no obligation to make any inquiry at all regarding the
If the auditor becomes aware of the event (e.g. informed by management or through
a general review of the financial press) then the potential effect on the companys
ability to continue trading (i.e. will the company be a going concern 12 months
from the issued financial statement year end) needs to be considered.
Specific procedures
Confirm the legal requirements (of the company and auditors) for the disclosure of
such events (after the date of issuing the financial statements) for the jurisdiction
under which the company operates.
Reviewing the directors assessment of the going concern impact including the
financial impact of the loss of oil, reputational damage, potential of legal claims
(and whether they are covered by insurance) and the cost of cleaning up the
environmental damage.
If required or allowed to by law:
inquiring of the directors how the shareholders will be informed of the
situation, and advising them on the need to inform; and
agreeing the draft announcement to ensure that shareholders are informed of
the true likely impact of the accident.
If the company is required (by law) to issue a new set of financial statements, the
procedures of the auditor will be similar to those described above for the event of 1
May.

Answer 41 AUDIT SCOPE
Meaning Reason (Note) Significance
in accordance with ISAs
Certain basic principles and essential To inform readers of the scope of audit. In exceptional circumstances, when a
procedures have been followed. departure from this approach is appropriate,
To assure the reader that the audit has been this must necessarily be made clear.
Objectives and general principles governing carried out in accordance with established
an audit have been followed which requires, standards. A consistent approach to all audits is being
inter alia, obtaining sufficient evidence. adopted (through required adherence to
To achieve clear communication with readers. Standards).
The form and content of the auditors report
complies with reporting Standards.
reasonable assurance
The auditors degree of confidence is To convey the fact that the assurance provided Subsequent discovery of a misstatement is not
appropriate to the circumstances. cannot be absolute, due to inherent limitations necessarily evidence of the audit having been
of the audit process. inadequately conducted.
The auditors report does not constitute a
guarantee.
are free of material misstatement
The financial statements do not contain errors To stress that the audit is directed towards Some errors and omissions may have occurred
or omissions which are significant to the view detecting errors of any consequence. but they would not influence the reader.
being presented in the accounts.
To convey the concept of materiality is
fundamental to the conduct of the audit.

Meaning Reason (Note) Significance
significant estimates made by management
The information given in financial statements Management cannot assert the correctness Assurance is being given concerning the
does not consist of facts alone (e.g. useful of all amounts in the same way as, for reasonableness of the managements
lives of non-current assets are estimated and example, a bank balance. judgments.
many provisions are accounting estimates).
overall financial statement presentation
Disclosure is sufficient to enable the The way in which information is disclosed Users must take care when considering
information conveyed to be properly may be even more important than the specific items of information in isolation.
understood. underlying amounts or facts themselves.
The auditor has considered the financial

statements presented as a whole.
our opinion
The auditors conclusion(s) on the financial To comply with statutory or other An independent view is being expressed by a
statements as a whole are a judgment, not a requirements to report an opinion on truth competent expert.
guarantee or certification. and fairness or fair presentation.
Tutorial note: Specifically, the question requires reason for inclusion in the auditors report rather than (say) the reason for audits being conducted in the
manner being described.

Answer 42 THETA
(a) Draft audit report extracts
Apart from the change in the first sentence of the introductory paragraph, the rest of that
paragraph and the management responsibilities paragraph will follow the standard wording.
Only those elements that differ from the standard unmodified audit report are given as the
answer
We were engaged to audit the accompanying financial statements of Theta .
Auditors Responsibility
Our responsibility is to express an opinion on these financial statements based on conducting

the audit in accordance with International Standards on Auditing. Because of the matters
described in the Basis for Disclaimer of Opinion paragraph below, we were not able to obtain
sufficient appropriate audit evidence to provide a basis for an audit opinion.
Basis for disclaimer of opinion (extract)
The evidence available to us was limited because a significant number of the companys key
accounting records were destroyed by fire in January 2014. The financial statements
therefore include significant amounts based on estimates. In these circumstances there were
no satisfactory audit procedures that we could adopt to obtain all the information and
explanations we consider necessary to enable us to express an opinion.
Disclaimer of Opinion
Because of the significance of the matters described in the Basis for Disclaimer of Opinion
paragraph, we have not been able to obtain sufficient appropriate audit evidence to provide a
basis for an audit opinion. Accordingly we do not express an opinion on the financial
statements.
Tutorial note: The choice of opinion (i.e. disclaimer) must be justified in (b).
(b) Reasons for audit opinion
The fire has resulted in limitations in audit work and evidence necessary to form an
opinion cannot be obtained.
It is a matter of fact that accounting records adequate for audit purposes have not
been kept and all information and explanations necessary for audit purposes have
not been received.
The phrase on the basis of estimates implies for example carrying amounts of
tangible non-current assets, inventory valuations, recoverable amounts of trade
receivables, provisions for unrecorded liabilities, revenue and cost of sales for
which no supporting documentary evidence is available.
Disclaimer
The effect of the limitation is so material and pervasive that it is not possible to
express an opinion on the financial statements.

(c) Forms of modified audit opinion
(i) Emphasis of matter
An emphasis of matter is clearly distinguishable from other modifications (e.g.

qualified opinions) in that it does not affect the auditors opinion.
An emphasis of matter paragraph highlights a matter affecting the financial

statements which is discussed in the notes to the financial statements, for example,
going concern.
The paragraph is included after the opinion paragraph Without qualifying our
opinion (above) we draw attention to Note X.
(ii) Qualified opinion
An except for opinion is expressed when the auditor cannot express an unqualified opinion
but the effect of the matter is not so material and pervasive as to require an adverse opinion or
disclaimer of opinion.
(iii) Disclaimer of opinion
An auditor is unable to express (i.e. disclaims) an opinion when the effect of the limitation
on available evidence (limitation of scope) is so material and pervasive that the auditor has
been unable to obtain sufficient appropriate audit evidence (which may be reasonably
expected to be available).
(iv) Adverse opinion
The effect of the matter for which the auditor has sufficient audit evidence, but does not agree
with the directors assertions (disagreement) is so material and pervasive that the auditor
concludes that an except for qualification is not adequate to disclose the misleading or
incomplete nature of the financial statements.
Distinctions
There are three issues which distinguish the form of modified reports
EITHER the matter does not affect the auditors opinion (i.e. (i)) or it does (i.e. (ii), (iii) and
(iv))
If the audit opinion is affected, then
EITHER there is sufficient appropriate evidence on a matter for the auditor to disagree with
the amount, treatment or disclosure in the financial statements (as in (iv));
OR there is insufficient evidence due to scope limitation (in (iii)).
EITHER the matter is so material and pervasive (as in (iii) & (iv)) resulting in Because of
the significance of (extreme opinions);
OR not so material and pervasive (as in (ii)) resulting in an except for opinion.

Answer 43 HOOD ENTERPRISES
(a) Preparation of financial statements

The directors are normally required to prepare the financial statements of the company using
the appropriate law of their country and in accordance with the International Financial
Reporting Standards (IFRSs). The auditors are normally required to check or audit those
financial statements, again in accordance with the legislation of their country and the
International Statements on Auditing.
Fraud and error

The directors are responsible for preventing and detecting fraud and error in the financial
statements, no matter how immaterial this may be. Auditors are responsible for ensuring that
the financial statements show a true and fair view; in other words that the financial statements
are materially correct. Auditors are not required to detect immaterial fraud or error.
Disclosure
The directors must ensure that there is adequate disclosure of all matters required by statute
and IFRSs in the financial statements. The auditor will check that disclosure requirements
have been complied with and, where required disclosures have not been made, provide this
information in the auditors report.
Going concern
The directors are responsible for ensuring that the company will continue in operational
existence for the foreseeable future, and report to the members in the published financial
statements if this is unlikely to be the case. The auditor will check the accuracy of the
directors workings and assumptions and if these are considered incorrect or inappropriate,
then the audit report may be modified or qualified to bring the situation to the attention of the
members of the company.
(b) Errors in the extract

The basis of opinion paragraph will not meet the requirements of ISA 700 for the following
reasons:
The use of the term Auditing Standards is not clear, because the report does not state which
auditing standards have been used (e.g. International Auditing Standards). Neither does the
statement explain what the auditing standards require of the auditor (e.g. comply with ethical
requirements, plan and perform the audit, obtain reasonable assurance). This provides
uncertainty regarding the actual standard of work performed.
The assessment of estimates and judgements made by the directors normally relates to
significant amounts only, rather than all of those estimates and judgements. The use of the
word all implies that the audit was more thorough than it probably was. Replacing the word
all with the word significant will show that the audit testing was focused on material
amounts only.
Stating that time was a factor in obtaining information and explanations for the audit is not
correct as this implies 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. Logically, if the audit
were incomplete, insufficient audit evidence would have been obtained and a scope limitation
would be appropriate.

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 auditor provides reasonable assurance that the financial statements are free
from material misstatement, which clearly implies that audit techniques are limited.
The disclaimer regarding errors appears to limit the auditors liability. However, it does not
belong in the basis of opinion paragraph. It appears to severely limit the basis of the auditors
opinion to stating that the directors are responsible for all errors. Directors responsibilities
are 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.
As the auditor is not required to audit the whole of the annual report of a company, it is
inappropriate to refer to disclosure in that report when checking overall adequacy of
presentation. The only requirement of the auditor concerning other information is to review
such information for errors and inconsistencies compared to the financial statements. If there
are no matters to raise, nothing is said by the auditor. If there are matters within the other
information that are inaccurate, inconsistent or misleading, then such matters would be
reported through the use of an Other Matter paragraph. Adequacy of presentation can only be
confirmed regarding items actually audited, which is basically the financial statements.
The last point to note is that the format of the extract is not strictly in accordance with the
examples given within ISA 700 and ISA 705. These examples are not prescriptive but
demonstrate how the requirements of ISA 700/5 may be met. It is, however, highly unusual
that auditors do not follow (very closely) the examples given, especially for unmodified
reports.
(c) Positive and negative assurance
A positive assurance report means that the auditor has carried out sufficient work (e.g.
following International Standards on Auditing) to be able to state, for example, that financial
information shows a true and fair view (and is free from material error) based on appropriate
criteria (e.g. International Financial Reporting Standards).
A negative assurance report means that nothing came to the attention of the professional
accountant during his work which indicated the financial information being reported on had
errors in it. However, the extent of the work carried out is normally less (e.g. based on
enquiry and analytical review) which means that a lower level of assurance can be given
compared to an audit.
For a cash flow forecast, a positive assurance report could not be given because a forecast
relates to future events. It is not possible to say with reasonable certainty what the cash
balance would be in, for example, one years time.
Advantages of providing negative assurance
The user of the financial information receives some comfort that the information is
correct, even though that assurance is less than positive assurance.
The report adds some credibility to the financial information because it has been
reviewed by a professional accountant.
For the preparer, the report will be more cost effective than obtaining a full positive
assurance report.

Answer 44 MOWBRAY COMPUTERS
(a) Circumstances Reasons
Fall in sales due to recession and Reducing product prices (to try to maintain
stiff competition. sales/market share) results in a fall in gross
profit (GP) margin (with consequent effect
on net profit).
Fall in small GP margin and Lack of profits to fund asset replacement

trading loss. and increase in working capital
requirements. Losses create liquidity
problems.
Circumstances Reasons
Certain microcomputers may be Technological change may be too rapid for

obsolete. Mowbray to adapt. Sales will decline
(thereby losing out to the competition).
Customer base (retailers and The gross profit margin on wholesales is

through mail order). likely to be very small. There is a higher
risk of bad debts arising from mail order
customers paying by instalments.
Higher level of trade receivables Credit control may be less strict when
and increased risk of bad debts. making sales in a recessive and highly
competitive market.
Increased supplier payment period. Mowbray may not be able to delay payments
to its main Far East supplier. (Extending
payment periods of bills of exchange may
carry prohibitive interest charges.) Delays
in accounting for VAT, income tax, PAYE,
etc may incur penalties.
Increasing inventory levels due to Mowbray is likely to carry high volumes of

obsolesce and reduced sales. components (to allow for lead time from Far
East). This may increase the cost of
technical obsolescence (if parts held cannot
be used in newer models).
Lack of funding for research and If Mowbray cannot keep up with its
development. competitors, its market share will decline
further.
Foreign competition for products. Countries with low labour costs may be able
to assemble the microcomputers more
cheaply.

(b) Audit work
To ascertain whether Mowbray can meet its debts as they fall due
Obtain a written statement (management representation) from the directors

confirming their considered view that the company is a going concern.
Review managements profit and cash flow forecasts for the next financial year (and
beyond, if available) to ascertain, inter alia, the companys working capital
requirements.
Confirm the appropriateness of relevant assumptions (e.g. average collection period,

inventory turnover) by comparison with those ascertained by analytical procedures.
Request a statement of any borrowing facilities to be included in the bank letter.
Review the day-to-day utilisation of the bank overdraft facility (assumed) and its
proximity to the current limit.
Discuss with the credit controller (or financial accountant) the current pressures
under which the company is being placed by larger retail customers seeking
extended credit terms and mail order customers.
Undertake sensitivity analysis on clients forecasts to variable factors both within

the companys control and outside it.
Review the level of trade and other payables (including VAT and income tax and
whether any penalties are being incurred) after the end of the reporting period and
the extent to which they are financing short-term needs.
To ascertain whether Mowbray can otherwise continue in business (i.e. return to profitable
trading)
Obtain a copy of the latest mail order catalogue/price list identifying new models,
special offers (at below cost?), etc.
Compare Mowbrays price list with those of major competitors. Review latest
edition of consumer magazines for comment on Mowbrays products.
Review production schedules/order books to ascertain whether the volume of trade

is picking up.
Review the terms of the contract with the Far Eastern supplier(s). Review the
payment period and any correspondence for evidence of any deterioration in trading
relations.
Inspect the assembly line and despatch area. Has the level of activity visibly
slackened since last audit visit?
Review exchange rate fluctuations since the end of the reporting period. Discuss
with management any proposed changes to their risk management of foreign
exchange exposure.
Calculate inventory turnover by major product and component and compare with
year-end figures. Further deterioration may confirm technical obsolescence

(c) Effect of auditors reports
(i) Sufficient disclosure
The audit opinion will be unqualified. The report will include an emphasis of matter
paragraph referring to the going concern problem.
(ii) No disclosure
The audit opinion must be modified on the grounds of disagreement on disclosure. Assuming
that we do not disagree with the basis of preparation, the form of modification is most likely
to be qualified except for.
Explanation
An unqualified opinion is only appropriate if, inter alia, there is adequate disclosure of all
information relevant to the proper understanding of the financial statements. Therefore
opinion in (ii) cannot be unqualified.
Sufficient disclosure (in (i)) is likely to encompass
a description of principal conditions raising doubt about ability to continue on operation

for the foreseeable future
a statement that there is significant uncertainty that the entity may be unable to realise its
assets and discharge its liabilities in normal course of business
a statement that the financial statements do not include any adjustments relating to the
recoverability and classification of recorded assets or to amounts and classification of
liabilities (that may be necessary if the entity is unable to continue as a going concern).
Lack of this disclosure (in (ii)) means that the financial statements will not present a true and
fair view (or present fairly) of the state of Mowbrays affairs and of its results for the year
ended 30 September 2014. The auditors report can state that except for the absence of
disclosures, the financial statements show a true and fair view.
A significant uncertainty about going concern which is not resolved but adequately disclosed
is reported by adding an emphasis of matter paragraph. This highlights the problem by
drawing attention to the note in the financial statements that discloses the matter. It makes it
clear that the appropriateness of the going concern assumption has been taken into account in
forming the audit opinion but does not qualify the opinion.
Answer 45 GREEN
(a) Ethical threats
Self-review threat
If Lime & Co provides audit and other professional services to Green, then the firm will be
preparing the financial statements and also auditing those financial statements. This will
result in a self-review threat as the firm will be auditing its own work. Lime & Co should be
advised to tender only for the audit work.

Management threat
There is a risk that Lime & Co will make decisions that the managers of Green should make
(e.g. in choosing accounting policies to apply to the financial statements). It is possible that
these types of decisions have been made before, on an informal basis, as the partners in Lime
& Co already know and give advice to the managers of Green.
Advocacy threat
This threat arises because Lime & Co may be asked to present details of Greens financial
statements and profit forecasts in court to support its application to stop Black growing
genetically modified (GM) crops. Lime & Co may be seen to be supporting a client in court,
which may limit the firms independence in relation to the audit work.
Familiarity threat
Having been friends with the managers of Green for some time means that management
decisions may not be questioned (due to this close personal relationship). As there is a clear
lack of independence any assurance work for Green will require a different engagement
partner.
Fee income
Acceptance of audit and professional services work from Green will result in an increase in
fee income. To retain independence, Lime & Co needs to ensure that fee income does not
exceed 15% of the total practice income.
Association threat
Although the managers of Green are not criminals, they appear to lack integrity in their
business affairs. The partners in Lime & Co need to decide whether they want to be
professionally associated with Green as any criminal activity in the future may have an
adverse effect on the firms reputation and image. Specifically Lime & Co will not want to be
seen to be associated with or advising a firm which is breaking the law.
Cease trading payment of fees
The farm may lose organic certification if the GM crops continue to be grown next to Greens
farm. There is a risk that Lime & Co may not be paid for services provided should Green
cease trading.
(b) Going concern
(i) Definition
IAS 1 Presentation of Financial Statements defines the going concern concept as the
assumption that the entity will continue in operational existence for the foreseeable future.
The farm may lose organic certification if the genetically modified crops continue to be
grown next to Greens farm.
This means that Green may not be a going concern.

An entity will normally use the going concern basis unless:
It is being liquidated or has ceased trading, or

The directors have no realistic alternative than to liquidate the company or to cease
trading.
(ii) Respective responsibilities
The directors responsibility regarding going concern is to prepare the financial statements of
an entity on the basis that it is a going concern. This will mean being able to demonstrate that
the entity is a going concern and that the assets and liabilities of the entity reflect the going
concern status. If the entity is not a going concern, the directors must prepare the financial
statements to reflect that fact, including revalued assets and liabilities together with
appropriate disclosures.
The auditors responsibility regarding going concern is to form an opinion on the

appropriateness of managements assessment of the going concern status of the entity and the
adequacy of disclosures, if any. The auditor will collect sufficient and appropriate audit
evidence to ensure use of the going concern assumption is valid.
To be clear, the auditors are not responsible for ensuring that the company is a going concern;
this is a responsibility of the directors.
(c) Audit procedures
In the case of Green, audit procedures on going concern will include:
Obtaining cash and profit forecasts from the directors. Ensure that these have been
properly prepared (e.g. are arithmetically correct) and show that Green will continue
trading. Appropriate adjustments should have been made for the decrease in sales
resulting from contamination of Greens farm.
Review the order books for Green to determine the level of future sales.
Contacting Greens lawyers to determine the progress, if any, on the court case
against Black.
Review the financial status of Green during the audit to identify other indicators of
a going concern problem such as failure to repay loans or decrease in sales.
Review correspondence, if any, with the organic certification authority to determine

whether Greens organic status has been withdrawn.
Contacting Greens bank to ascertain whether any loan or overdraft agreements are
due for renewal and whether these will be renewed.
Obtaining written representation from the directors confirming that they are not
aware of any circumstances other than those evaluated by the auditor, so they expect
Green to continue as a going concern.

Answer 46 MONTEHODGE CO
(a) Outsourcing internal audit
Advantages of outsourcing internal audit
Staff recruitment
There will be no need to recruit staff for the internal audit department; the outsourcing
company will provide all staff and ensure staff are of the appropriate quality.
Skills
The outsourcing company will have a large pool of staff available to provide the internal audit
service. This will provide access to specialist skills that the company may not be able to
afford if the internal audit department was run internally.
Set up time
The department can be set up in a few weeks rather than taking months to advertise and
recruit appropriate staff.
Costs
Costs for the service will be agreed in advance. This makes budgeting easier for the recipient
company as the cost and standard of service expected are fixed.
Flexibility (staffing arrangements)
Staff can be hired to suit the workloads and requirements of the recipient company rather than
full-time staff being idle for some parts of the year.
Disadvantages of outsourcing internal audit
Staff turnover
The internal audit staff allocated to one company may change frequently; this means that
company systems may not always be fully understood, decreasing the quality of the service
provided.
External auditors
Where external auditors provide the internal audit service there may be a conflict of interest
(self-review threat), where internal audit work is then relied upon by external auditors.
Cost
The cost of the outsourced service may be too high for the company, which means that an
internal audit department is not established at all. There may be an assumption that internal
provision would be even more expensive.
Confidentiality
Knowledge of company systems and confidential data will be available to a third party.
Although the service agreement should provide confidentiality clauses, this may not stop
breaches of confidentiality (e.g. individuals selling data fraudulently).

Control
Where internal audit is provided in-house, the company will have more control over the
activities of the department; there is less need to discuss work patterns or suggest areas of
work to the internal audit department.
(b) Need for internal audit
For establishing an internal audit department
Value for money (VFM) audits
MonteHodge has some relatively complex systems such as the stock market monitoring
systems. Internal audit may be able to offer VFM services or review potential upgrades to
these systems checking again whether value for money is provided.
Accounting system
While not complex, accounting systems must provide accurate information. Internal audit can
audit these systems in detail ensuring that fee calculations, for example, are correct.
Computer systems
Maintenance of computer systems is critical to MonteHodges business. Without computers,

the company cannot operate.
Internal audit could review the effectiveness of backup and disaster recovery arrangements.
Internal control systems
Internal control systems appear to be limited. Internal audit could check whether basic
control systems are needed, recommending implementation of controls where appropriate.
Effect on audit fee
Provision of internal audit may decrease the audit fee where external auditors can place
reliance on the work of internal audit.
This is unlikely to happen during the first year of internal audit due to lack of experience.
Image to clients
Provision of internal audit will enable MonteHodge to provide a better image to its clients.
Good controls imply client monies are safe with MonteHodge.
Corporate governance
Although MonteHodge does not need to comply with corporate governance regulations,
internal audit could still recommend policies for good corporate governance. For example,
suggesting that the chairman and chief executive officer roles are split.
Compliance with regulations
MonteHodge is in the financial services industry. In most jurisdictions, this industry has a
significant amount of regulation.

An internal audit department could help ensure compliance with those regulations, especially
as additional regulations are expected in the future.
Assistance to financial accountant
The financial accountant in MonteHodge is not qualified. Internal audit could therefore
provide assistance in compliance with financial reporting standards, etc as well as
recommending control systems.
Against establishing of internal audit department
No statutory requirement
As there is no statutory requirement, the directors may see internal audit as a waste of time
and money and therefore not consider establishing the department.
Accounting systems
Many accounting systems are not necessarily complex so the directors may not see the need
for another department to review their operations, check integrity, etc.
Family business
MonteHodge is owned by a few shareholders in the same family. There is therefore not the
need to provide assurance to other shareholders on the effectiveness of controls, accuracy of
financial accounting systems, etc.
Potential cost
There would be a cost of establishing and maintaining the internal audit department. Given
that the directors consider focus on profit and trusting employees to be important, then it is
unlikely that they would consider the additional cost of establishing internal audit.
Review threat
Some directors may feel challenged by an internal audit department reviewing their work
(especially the financial accountant).
They are likely therefore not to want to establish an internal audit department.
Answer 47 BRAMPTON CO
(a) Interim v final audit
The interim audit, as its name suggests, is that part of the whole audit that takes place before
the year end. The auditor uses the interim audit to carry out procedures that would be
difficult to perform at the year end because of time pressure. The final audit, on the other
hand, will take place after the year end and concludes with the auditor forming and expressing
an opinion on the financial statements for the whole year subject to audit. It is important to
note that the final opinion takes account of conclusions formed at both the interim and final
audit.
Typical work carried out at the interim audit includes:
Consideration of inherent risks facing the company.

Tutorial note: Risk would be initially considered at the planning stage, but is, in
fact, reassessed at all audit stages.
Recording the system of internal control.
Carrying out tests of control on the companys internal control system and
evaluating its effectiveness to determine the level of control risk.
Performing sufficient substantive testing of transactions and balances to be satisfied

that the books and records are a reliable basis for the preparation of financial
statements.
Identification of potential problems that may affect the final audit work. A basic
aim is to ensure as far as possible that there are no undetected problems at the year
end.
Typical work carried out at the final audit includes:
Follow up of items noted at the inventory count.

Substantive testing of balances and disclosures.
Obtaining confirmations from third parties, such as bankers and lawyers.
Analytical reviews of figures in the financial statements.
Reviews of events after the reporting period.
Consideration of the going concern status of the organisation.
Tutorial note: At the final audit the auditor would carry out tests to ensure that the
conclusions formed at the interim audit were still valid.
(b) Year-end audit
(i) Reliance on internal audit
The external auditors would normally be able to use the work of the internal auditors provided
that:
They are independent (in this case, of the accounting department and finance
director to whom the accounting department reports). It appears that they have
reported to the whole board, which would be a factor increasing their independence.
It would be even better if they had strong links with the audit committee (if
applicable).
They are competent. The auditors would have formed a view in past years of their
reliability by considering the background (including qualifications and experience,
particularly as regards forecasting) of the internal audit staff and by examining their
reports and working papers. The auditors may also have reviewed some aspects of
their work in the current year to the same end.
Effective communication, whether there is likely to be effective communication

between the internal auditors and the external auditor.
They have exercised due professional care, the work would need to have been
properly planned including detailed work programmes, supervised, documented and
reviewed.

The company is experiencing difficulties due to the economic down turn and it
requires the loan in order to expand. Management might place pressure upon the
internal auditors to present the cash flow forecast in a more favourable light. This
would impact the independence of the internal auditors.
The auditor would still take full responsibility for any report that is issued.
(ii) Cash flow forecast
Audit procedures adopted in the examination of the cash flow forecast would include:
Check that the opening balance of the cash forecast is in agreement with the closing
balance of the cash book, to ensure the opening balance of the forecast is accurate.
Consider how accurate company forecasts have been in the past by comparing past
forecasts with actual outcomes. If forecasts have been reasonably accurate in the
past, this would make it more likely that the current forecast is reliable.
Determine the assumptions that have been made in the preparation of the cash flow
forecast. For example, the company is experiencing a poor economic climate, so
cash flows from sales and realisation of receivables would be expected to decrease
or remain stable. The auditors are also aware that costs are rising so they would
expect cost increases to be reflected in the cash forecasts.
Examine the sales department detailed budgets for the two years ahead and, in
particular, discuss with them the outlets that they will be targeting. This would help
the auditor determine whether the cash derived from sales is soundly based.
Examine the production departments assessment of the non-current assets required

to increase the production of white bread to the level required by the sales
projections. Obtain an assessment of estimated cost of non-current assets,
reviewing bids from suppliers, if available. This would provide evidence on
material cash outflows.
Consider the adequacy of the increased working capital that will be required as a
result of the expansion. Increased working capital would result in cash outflows
and it would be important to establish its adequacy.
If relevant review the post year-end period to compare the actual performance
against the forecast figures.
Recalculate and cast the cash flow forecast balances.
Review board minutes for any other relevant issues which should be included within
the forecast.
Review the work of the internal audit department in preparing the cash flow
forecast.
(iii) Assurance
The auditor would inform management that it would not be possible to give a report on the
accuracy of the cash flow forecast. The forecast is an assessment of cash flows in the future
which is uncertain, particularly in the second year.

The bank should be informed that the kind of report that the auditor could give is a limited
assurance or negative assurance report. The auditor would be able to state in their report the
kind of work they had carried out, the assumptions that management had made and then to
give a negative form of assurance in which they would state, among other things, that nothing
had come to their attention that would cause them to believe that the assumptions do not
provide a reasonable basis for the cash forecast. They could then go on to say that the
forecast has been properly prepared on the basis of the assumptions.
This is assuming that this kind of opinion is appropriate in the light of the work they have
performed.
Answer 48 QUICK QUESTIONS
48.1 Meaning high control risk

Clients IC system will fail to prevent/detect on a timely basis material errors.
An audit approach relying on tests of controls is unlikely to be suitable/ efficient.
Sufficient appropriate audit evidence needs to be obtained entirely from substantive
procedures.
( mark each point contributing to meaning)
Total marks obtainable 1
48.2 Internal controls to ensure account receivable recorded

Gate security to check all goods despatched to pre-numbered delivery note (DN).
Sequence checking of delivery notes and matching to invoices.
Pre-numbered invoices sequentially accounted for (e.g. sales day book listing).
Monthly reconciliation of trade receivables ledger to control account.
( mark each control)
48.3 Internal control objectives materials purchases

To ensure that
Purchases are requisitioned promptly (e.g. when inventory level falls to a
predetermined re-order level).
Amounts purchased are not excessive (e.g. not predetermined reorder quantity).
All purchases are appropriately authorised (i.e. bona fide).
Only goods received of correct quantity and quality are accepted.
If approved, goods received are recorded promptly and inventory records
updated.
Suppliers are only paid in respect of materials actually received.
Materials purchased are correctly analysed to appropriate general ledger codes.
( mark each objective)

48.4 Reasons performing walk-through checks (ISA 315)

To obtain knowledge of the design and operation of the system.
To confirm no reason to suppose that system does not operate in manner recorded.
( mark each reason)
48.5 Disadvantages ICQs

To document
Provide insufficient detail for full understanding of system (i.e. documents
involved/ departments responsible). Flowcharts or narrative notes will be used to
document systems.
Concentrate on ICs rather than the accounting system in which they operate
(excessive form-filling in small systems with few ICs).
Precise answers to some questions are not always clear.
To evaluate
Facilitate only preliminary evaluation any reliance on ICs must be based on
results of tests of control.
Lack of overview and depiction of sequence of events/responsibilities (difficulty of
setting out information in manner facilitating overall comprehension).
( mark each disadvantage)
48.6 Application control

Specific controls over relevant accounting applications (e.g. sales invoicing)
maintained by the computer.
Manual or programmed to ensure completeness/accuracy of accounting records and
authorisation of transactions therein.
( mark each point)
48.7 Factors sufficiency of audit evidence (ISA 500)

Nature and level of inherent risk.
Nature of A&IC systems and assessment of control risk.
Experience gained in previous audits.
Materiality of items.
Audit findings (e.g. fraud or error).
Source and reliability of information (i.e. persuasiveness).
( mark each factor)

48.8 Control weaknesses inventory losses

Inaccurate physical counts due to:
careless omission;
inaccurate cut-off;
incorrect identification of units (e.g. 1 box v 3 bulbs).
Raw materials are informally requisitioned and inventory records incompletely
updated for transfers to production.
Goods despatch notes are not raised in all cases (resulting in unrecorded sales).
Poor gate security goods despatch without proper authorisation/documentation.
Inaccurate recording of goods received quantities onto inventory records, for
example:
duplication (e.g. if advice note and GRN both received and recorded);
incorrect identification of unit quantity.
Goods returned (damaged/faulty) recorded on inventory records are not physically
returned to inventory.
( mark each control weakness)
Answer 49 JASPER, RUBY, GARNET & EMERALD
(a) Jasper
Materiality
$30,000 represents 20% of PBT and 4.3% of total receivables, therefore material.
Accounting standards
Non-compliance IAS 10 (adjusting event further evidence of conditions existing

at reporting date).
Also contrary to concepts of prudence (The Framework) and matching (accrual

basis per IAS 1).
Audit opinion
Modified except for.

(b) Ruby
Materiality
$10,000 represents 2% of PBT so not material. BUT, 5 similar claims represents

10% PBT therefore potentially material.
Non-compliance IAS 37 (non-disclosure of contingent liability arising from claims

not yet received).
Audit opinion
(c) Garnet
Materiality
$300,000 exceeds $ m PBT ( net loss) therefore highly material.
Non-compliance IAS 16 (write down impairment to recoverable amount).
Recoverable amount of individual assets must be determined separately (IAS 16),

unrealised gains and losses should not be offset (IAS 1).
Audit opinion
(d) Emerald
Materiality
$10,000 represents 10% of PBT which is material. However, only part of this
amount cannot be confirmed therefore matter may be immaterial. Alternative work
on estimating the relevant cost may be possible.
Cost of self-constructed asset includes labour costs (IAS 16) therefore compliance.
Audit opinion
Unmodified.

Answer 50 BURTON HOUSING
Tutorial note: The question called for just 5 controls and 5 evidence procedures.
(i) Rents received (ii) Expenditure in restaurant
Keys to rooms to restrict access to Restricted access to kitchen and locked
residents. storage of food and beverage.
Cold storage of perishable food.
Pre-numbered (three-part) rent receipts Pre-numbered purchase orders (POs).
issued by reception staff. Authorisation by chief executive of
Authorisation of credit notes, etc by chief purchase invoices over pre-determined
executive. limits.
Password to access microcomputer. Batch processing of purchase invoices.

Microcomputer in secure location
(locked office).
Independent check (by chief executive) Independent checking (by chief
of rents posted to sales ledger by executive) of wage payments.
bookkeeper.
Monthly trial balances (extracted by Maintain a wages control a/c in the

bookkeeper) reviewed by management nominal ledger.
committee.
Monthly bank reconciliation (by Monthly reconciliation of the creditors

bookkeeper) reviewed by chief ledger control a/c to the list of balances
executive. extracted from the purchase ledger.
Comparison of total of rent receipts with Comparing quantity and quality of food
cash book receipts and bank statements. stock before placing an order.
Compare monthly rents with prior year Compare food costs to sales and month
(seasonal fluctuations?). by month and with prior year (similarly
Proof in total (e.g. occupancy wage costs and gross profit %).
according to housekeeping room rate). Proof in total (e.g. weekly cost of
restaurant staff number of weeks).
Ask housing manager the reasons for Ask restaurant manager about levels of:
voids.
absenteeism; and
Ask chief executive reasons for issuing shrinkage.
credit notes.
Inspect rooms frequently void (e.g. to Inspect restaurant just before closing to
confirm unsuitable for letting). assess wastage (shrinkage = theft).
Credit notes and bad debt write-offs. Purchase invoices (for authorisation).
Observe reception staff issuing receipts. Observe wages pay-out (do employees
sign on for receipt).
Test check arithmetic accuracy of sales Re-perform last CLC a/c reconciliation.
ledger and cash book (reperform casts). Also suppliers statement reconciliations.

Answer 51 DOCUMENTATION AND ENGAGEMENT LETTERS
(a) Methods of documenting the system
Narrative notes
Advantages
The main advantage of narrative notes is that they are simple to record, after discussion with
the company these discussions are easily written up as notes.
Additionally, as the notes are simple to record, this can facilitate understanding by all
members of the team, especially more junior members who might find alternative methods
too complex.
Disadvantages
Narrative notes may prove to be too cumbersome, especially if the system is complex.
This method can make it more difficult to identify missing internal controls as the notes
record the detail but do not identify control exceptions clearly.
Questionnaires
Internal control questionnaires are used to assess whether controls exist which meet specific
objectives or prevent or detect errors and omissions.
Advantages
Questionnaires are quick to prepare, which means they are a cost effective method for
recording the system.
They ensure that all controls present within the system are considered and recorded; hence
missing controls or deficiencies are clearly highlighted.
Questionnaires are simple to complete and therefore any members of the team can complete
them and they are easy to use and understand.
Disadvantages
It can be easy for the company to overstate the level of the controls present as they are asked a
series of questions relating to potential controls.
Without careful tailoring of the questionnaire to make it company specific, there is a risk that
controls may be misunderstood and unusual controls missed.
(b) ISA 210
(i) Purpose of an engagement letter
An engagement letter provides a written agreement of the terms of the audit engagement
between the auditor and management or those charged with governance.
Confirming that there is a common understanding between the auditor and management, or
those charged with governance, of the terms of the audit engagement helps to avoid
misunderstandings with respect to the audit.

(ii) Matters to be included in an audit engagement letter
The objective and scope of the audit.
The responsibilities of the auditor.
The responsibilities of management.
Identification of the financial reporting framework for the preparation of the

Expected form and content of any reports to be issued.
Elaboration of the scope of the audit with reference to legislation.
The form of any other communication of results of the audit engagement.
The fact that some material misstatements may not be detected.
Arrangements for planning and performing the audit, including the composition of
the audit team.
The expectation that management will provide written representations.
The basis on which fees are computed and any billing arrangements.
A request for management to acknowledge receipt of the audit engagement letter

and to agree to the terms of the engagement.
Arrangements concerning the involvement of internal auditors and other staff of the
entity.
Any obligations to provide audit working papers to other parties.
Any restriction on the auditors liability.
Arrangements to make available draft financial statements and any other

information.
Arrangements to inform the auditor of facts that might affect the financial
statements, of which management may become aware during the period from the
date of the auditors report to the date the financial statements are issued.
Answer 52 COMPONENTS AND ELEMENTS
(a) Internal control components
ISA 315 Identifying and Assessing the Risks of Material Misstatement through Understanding
the Entity and Its Environment considers the components of an entitys internal control. It
identifies the following components:
(i) Control environment
The control environment includes the governance and management functions and the
attitudes, awareness, and actions of those charged with governance and management
concerning the entitys internal control and its importance in the entity. The control
environment sets the tone of an organisation, influencing the control consciousness of its
people.

The control environment has many elements such as communication and enforcement of
integrity and ethical values, commitment to competence, participation of those charged with
governance, managements philosophy and operating style, organisational structure,
assignment of authority and responsibility and human resource policies and practices.
(ii) Entitys risk assessment process
For financial reporting purposes, the entitys risk assessment process includes how
management identifies business risks relevant to the preparation of financial statements in
accordance with the entitys applicable financial reporting framework. It estimates their
significance, assesses the likelihood of their occurrence, and decides upon actions to respond
to and manage them and the results thereof.
(iii) Information system including relevant business processes and communication
The information system relevant to financial reporting objectives, which includes the
accounting system, consists of the procedures and records designed and established to initiate,
record, process, and report entity transactions (as well as events and conditions) and to
maintain accountability for the related assets, liabilities, and equity.
(iv) Control activities relevant to the audit
Control activities are the policies and procedures that help ensure that management directives
are carried out. Control activities, whether within information technology or manual systems,
have various objectives and are applied at various organisational and functional levels.
(v) Monitoring of controls
Monitoring of controls is a process to assess the effectiveness of internal control performance

over time. It involves assessing the effectiveness of controls on a timely basis and taking
necessary remedial actions. Management accomplishes the monitoring of controls through
ongoing activities, separate evaluations, or a combination of the two. Ongoing monitoring
activities are often built into the normal recurring activities of an entity and include regular
management and supervisory activities.
(b) Audit report elements
Title The title should clearly indicate that it is the report of an independent auditor; this
distinguishes this report from any other.
Addressee The auditors report should be addressed as required by the circumstances of the
engagement. This is determined by law or regulation but is usually to the shareholders.
Introductory paragraph This identifies the entity which entitys financial statements have
been audited, states that the financial statements have been audited, identifies the title of each
statement that comprises the financial statements, refers to the summary of significant
accounting policies and other explanatory information, and specifies the date or period
covered by each financial statement.
Managements responsibility for the financial statements This description includes an

explanation that management is responsible for the preparation of the financial statements in
accordance with the applicable financial reporting framework, and for such internal control
that management determines is necessary to enable the preparation of the financial statements
that are free from material misstatement, whether due to fraud or error.

Auditors responsibility This states that the responsibility of the auditor is to express an
opinion on the financial statements based on the audit and that the audit was conducted in
accordance with International Standards on Auditing and ethical requirements and that the
auditor plan and perform the audit to obtain reasonable assurance about whether the financial
statements are free from material misstatement.
Opinion paragraph When expressing an unmodified opinion this states that the financial
statements present fairly or give a true and fair view in accordance with the applicable
financial reporting framework.
Other reporting responsibilities If addressed in the auditors report, these are explained in
a separate section Report on Other Legal and Regulatory Requirements.
Signature of the auditor The auditors report must be signed. This is the personal name of
the auditor or, if a partner is signing on behalf of the audit firm, then the name of the firm.
Date of the auditors report This must be no earlier than the date on which the auditor has
obtained sufficient appropriate audit evidence on which to base the auditors opinion on the
Auditors address The name of the location where the auditor practises.
Answer 53 PARKER
(a) Audit risk
According to ISA 200 Overall Objectives of the Independent Auditor and the Conduct of an
Audit in Accordance with ISAs:
Audit risk is the risk of giving an inappropriate opinion on the financial statements; for
example failing to qualify when the financial statements contain a material error. It is a
function of the risks of material misstatement and detection risk, often formulated as:
Audit Risk = Inherent Risk Control Risk Detection Risk
Inherent risk
This is the risk of an assertion to a misstatement that could be material, either individually or
when aggregated with other misstatements, assuming there are no related controls.
Control risk
This is the risk that the internal control system will fail to prevent or detect a material error.
The auditors preliminary assessment of controls will help determine control risk.
Detection risk
This is the risk that the auditor will fail to detect a misstatement that exists in an assertion that
could be material. For a given level of audit risk, the acceptable level of detection risk bears
an inverse relationship to the assessment of the risk of material misstatement at the assertion
level.

(b) (i) Matters giving rise to risk
Over-trading
The turnover of Parker is growing quite rapidly, although this growth is not matched in net
profits. The company has been expanding into the Internet, and plans to introduce other
product lines for sale in this division. There is the risk that the business will exhaust any cash
reserves as it continues to expand but does not generate sufficient additional cash to pay for
that expansion.
In this situation suppliers may go unpaid and at the extreme the business will be forced into
liquidation. Therefore the financial statements may not adequately disclose doubts about
going concern. The directors must be asked to prepare a projection to remove the doubt. This
will be examined by the auditor.
Internet trading
The decision to expand the Internet business may cause other problems for Parker. Selling of
books and CDs appear to be related as they are both forms of entertainment and the customer
knows what the product is like. Selling toys may fall into a similar category, but garden
furniture and clothes are different. Garden furniture is bulky and will certainly cost more to
deliver while clothes are sold more on taste and a high level of returns can be expected.
Specific risks with this decision therefore relate to:
The overall ability of management to run the business given its apparent lack of knowledge of
Internet trading.
The need to setup and manage systems for the sales of many new products.
The need to allow for a much larger volume of returns.
The possibility of inventory obsolescence if Parker overstocks on clothes which go
out of fashion.
Control environment
The whole environment in which the control systems should be operating appears weak.
There are errors in the systems, the extent of which are not known, and the directors and the
accountant do not appear to be inclined to attempt to remedy the situation.
The skills of the accountant may also be questioned because he appears to have been
appointed not on merit, but from some personal relationship with the directors. Other errors
may also have occurred which have not been detected. The risk is that the financial
statements may have material errors in them.
Bank loan
The directors require additional finance to expand the business. To provide this finance it is
likely that the bank will require sight of the audited financial statements; the directors of
Parker expect the audit to be completed prior to meeting the bank. The auditor may need to
write to the bank to disclaim reliance on the audit report for the purposes of making a bank
loan.
There is a risk to the audit firm of being sued if the bank relies on the report and sustains
financial loss. There is also a risk to Parker that the loan is not obtained and the company
goes into liquidation. The financial statements may need to be prepared on a break-up basis,
if the going concern basis is not justified.

First year of audit
The audit is also risky for the audit firm because it is the first year of an audit and the client
has expectations about the type of auditors report to be produced. The accounting systems
also appear to be unreliable, again increasing the risk of material error. The audit firm must
ensure that sufficient time and resources are allocated to the audit to ensure that the audit
opinion can be supported. Pressure from the directors to complete the audit quickly will have
to be resisted.
(b) (ii) Going concern enquiries and procedures
Review the financial position of the company in detail. Budgets and cash flow forecasts
showing income and expenditure for at least the next 12 months must be reviewed. The
accuracy of these forecasts can be determined in part by checking how accurate past forecasts
were. If the directors have not produced this information, then the auditor will ask them to
produce it.
If not already done so, obtain a standard audit bank confirmation letter. Confirm that the
overdraft and loan facilities have not been exceeded. Also confirm review dates (although it
appears this will be three months after the end of the year) and confirm with directors what
accounting information will be expected at these dates.
Review correspondence with the bank for signs of strain with the bank. A poor relationship
implies that further loans may not be granted and alternative finance will be required.
However, it is unlikely that any details of the relationship with their client will be provided by
the bank.
Make enquiries with the directors regarding the availability of other finance which will be
necessary for the planned expansion. Obtain supporting evidence for this finance, such as
letters confirming amounts available and interest rates payable.
As close as possible to the date of the auditors report, review the most recent management
accounts to help determine the extent of any additional finance required.
Obtain a letter of representation from the directors confirming their responsibility for
preparing cash flow forecasts and for the overall going concern status of Parker.
Use all the evidence obtained to take a view on the going concern status of Parker and review
the adequacy of disclosure (if any) in the accounting policy note to the financial statements.
Answer 54 SMOOTHBRUSH
(a) Audit risks
Identification Explanation
Smoothbrush supplies 60% of its goods to Per IAS 2 Inventories, inventory should be stated at
Homewares at a significantly reduced selling the lower of cost and net realisable value (NRV).
price, hence inventory may be overvalued. Therefore, as selling prices are much lower for goods
sold to Homewares, there is a risk that the NRV of
some inventory items may be lower than cost and
hence that inventory could be overvalued.
Recoverability of receivable balances as Smoothbrush has extended its credit terms to
receivables may be overstated. Homewares from one month to four months. Hence
there is an increased risk as balances outstanding
become older, that they may become irrecoverable.

Valuation of plant and equipment. The production facility has a large amount of unused
plant and equipment. As per IAS 16 Property, Plant
and Equipment and IAS 36 Impairment of Assets, this
plant and equipment should be stated at the lower of
its carrying value and recoverable amount, which
may be at scrap value depending on its age and
condition.
Cut-off of purchases and inventory may not Smoothbrush imports goods from South Asia and the
be accurate. paint can be in transit for up to two months. The
company accounts for goods when they receive them.
Therefore at the year end only goods that have been
received into the warehouse should be included in the
inventory balance and a respective payables balance
recognised.
New inventory system introduced in the year. Smoothbrush has introduced a continuous/perpetual
This could result in inventory balances being inventory counting system in the year. These records
misstated. will be used for recording inventory at the year end.
If the records and new system have not initially been
set up correctly then there is a risk that the year end
balances may not be fairly stated.
Inventory may be overstated as Smoothbrush Unless all slow-moving/obsolete items are identified
no longer has an allowance for slow-moving at the year end and their value written down, there is
items. a risk that the overall value of inventory may be
overstated.
Provisions/contingent liability disclosures The companys finance director (FD) has left and is
may not be complete. intending to sue Smoothbrush for unfair dismissal.
However, the company does not intend to make any
provision/disclosures for sums due to the FD.
Under IAS 37 Provisions, Contingent Liabilities and

Contingent Assets, if there is a present obligation, a
probable outflow of resources to settle the obligation
and a reliable estimate can be made of the obligation
then a provision should be recognised.
If the obligation is only possible, or if there is a

present obligation but it is not recognised as there is
not a probable outflow of resources, or the amount of
the obligation cannot be measured with sufficient
reliability then a contingent liability should be
disclosed, unless the likelihood of payment is remote.
Detection risk is higher due to the changes in The financial controller has been appointed as
the finance department. temporary FD and this lack of experience could result
in an increased risk of errors arising in the financial
statements. In addition the previous FD is not
available to help the finance or audit team.

Inventory may be over or understated if the The inventory counts are to cover all of the inventory
perpetual inventory counts are not complete lines. If any areas of the warehouse are not counted
and accurate. then this will need to be done at the year end.
In addition inventory adjustments arising from the

counts must be verified and updated by an
appropriate member of the finance team to ensure
that the records are accurate.
(b) Assessing risks
ISA 315 Identifying and Assessing the Risks of Material Misstatement Through
Understanding the Entity and Its Environment, requires auditors to identify and assess the
risks of material misstatement, whether due to fraud or error, at the financial statement and
assertion levels.
It is vitally important for auditors to assess engagement risks at the planning stage, this will
ensure that attention is focused early on the areas most likely to cause material misstatements.
A thorough risk assessment will also help the auditor to fully understand the entity, which is
vital for an effective audit.
Any unusual transactions or balances would also be identified early, so that these could be
addressed in a timely manner.
In addition, as most auditors adopt a risks based audit approach then these risks need to be
assessed early in order for the audit strategy and detailed work programmes to be developed.
Assessing risks early should also result in an efficient audit. The team will only focus their
time and effort on key areas as opposed to balances or transactions that might be immaterial
or unlikely to contain errors.
In addition assessing risk early should ensure that the most appropriate team is selected with
more experienced staff allocated to higher risk audits and high risk balances.
A thorough risk analysis should ultimately reduce the risk of an inappropriate audit opinion
being given. The audit would have focused on the main risk areas and hence all material
misstatements should have been identified, resulting in the correct opinion being given.
It should enable the auditor to have a good understanding of the risks of fraud, money
laundering, etc.
Assessing risk should enable the auditor to assess whether the client is a going concern.
(c) Controls over the perpetual/continuous inventory system.
Control Explanation
The inventory count team should Currently the team includes a warehouse staff member
be independent of the warehouse and an internal auditor. There should be segregation of
team. roles between those who have day-to-day responsibility
for inventory and those who are checking it. If the same
team are responsible for maintaining and checking
inventory, then errors and fraud could be hidden.

Control Explanation
Timetable of counts should be The warehouse has been divided into 12 areas that are
regularly reviewed to ensure that each due to be counted once over the year. All inventory
all areas are counted. is required to be counted once a year, hence if the
timetable is not monitored then some areas could be
missed out.
Movements of inventory should Goods will continue to move in and out of the warehouse
be stopped from the designated during the counts. Inventory records could be under/over
areas during continuous/ stated if product lines are missed or double counted due
perpetual inventory counts. to movements in the warehouse.
Inventory counting sheets should The inventory sheets produced for the count have the
be pre-printed with a description quantities pre-printed, therefore a risk arises that the
or item code of the goods, but the counting team could just agree with the record quantities,
quantities per the records should making under counting more likely, rather than counting
not be pre-recorded. the inventory lines correctly.
A second independent team By counting the lines twice this should help to ensure
should check the counts completeness and accuracy of the counts, and hence that
performed by the inventory count any inventory adjustments are appropriate.
team.
Inventory checks should be Currently the team is comparing the records to the
performed in two ways; from inventory in the warehouse. Two way counting ensures
records to inventory physically that inventory lines are not over or understated. If the
present in the warehouse and count is only performed from the records to the
from the warehouse to the warehouse then this will only ensure existence or
records. overstatement of the records. To ensure completeness is
addressed then the inventory in the warehouse must be
compared to the records as well.
Any damaged or obsolete goods Damaged or obsolete goods should be written down or
should be moved to a designated provided against to ensure that they are stated at the
area, where a responsible official lower of cost and NRV. This may not involve fully
then inspects it, it should not be writing off the inventory item as is currently occurring.
removed from the sheets. This is an assessment that should only be performed by a
suitably trained member of the finance team, as opposed
to the inventory count team.
After the count, the inventory At the year end the inventory of Smoothbrush will be
count sheets should be compared based on the records maintained. Hence the records must
to the inventory records, any be complete, accurate and valid. It is important that only
adjustments should be individuals authorised to do so can amend records.
investigated and if appropriate
Senior members of the finance team should regularly
the records updated in a prompt
review the types and levels of adjustments, as recurring
manner by an authorised person.
inventory adjustments could indicate possible fraud.

(d) Substantive procedures to confirm valuation of inventory
Select a representative sample of goods in inventory at the year end, agree the cost
per the records to a recent purchase invoice and ensure that the cost is correctly
stated.
Select a sample of year end goods and review post year end sales invoices to
ascertain if NRV is above cost or if an adjustment is required.
For a sample of manufactured items obtain cost sheets and confirm:
raw material costs to recent purchase invoices

labour costs to time sheets or wage records
overheads allocated are of a production nature.
Review aged inventory reports and identify any slow moving goods, discuss with
management why these items have not been written down.
Compare the level/value of aged product lines to the total inventory value to assess
whether the allowance for slow-moving goods of 1% should be reinstated.
Review the inventory records to identify the level of adjustments made throughout
the year for damaged/obsolete items. If significant consider whether the year-end
records require further adjustments and discuss with management whether any
further write downs/allowance may be required.
Follow up any damaged/obsolete items noted by the auditor at the inventory counts
attended, to ensure that the inventory records have been updated correctly.
Substantive procedures to confirm completeness of provisions or contingent liability
Discuss with management the nature of the dispute between Smoothbrush and the
former finance director (FD), to ensure that a full understanding of the issue is
obtained and to assess whether an obligation exists.
Review any correspondence with the former FD to assess if a reliable estimate of

any potential payments can be made.
Write to the companys lawyers to obtain their views as to the probability of the
FDs claim being successful.
Review board minutes and any company correspondence to assess whether there is
any evidence to support the former FDs claims of unfair dismissal.
Obtain a written representation from the directors of Smoothbrush confirming their

view that the former FDs chances of a successful claim are remote, and hence no
provision or contingent liability is required.

Answer 55 CHUCK INDUSTRIES CO
(a) Payroll system implications and recommendations
Implication Recommendation
Clocking in process
As there is no supervision of the clocking in The clocking in and out procedures should
process then, as witnessed, employees can be supervised by a responsible official to
clock in multiple employees simply by using prevent one individual clocking in multiple
their employee swipe cards. This will result employees. In addition, Chuck Industries
in a substantially increased payroll cost. could consider linking the access to the
factory floor with the employee swipe card
system. Hence employees can only access
the factory one at a time upon presentation of
their employee swipe card.
In addition, this could create a weaker control Employees should be reminded about the
environment whereby employees consider it importance of following Chuck Industries
acceptable not to follow controls. policies and procedures, especially in
relation to the clocking in/out process.
Without supervision/monitoring of the Overtime hours should be reviewed by the

clocking in or out process, employees could production supervisor prior to payment, to
try to boost their hours worked by clocking ensure that only previously authorised
out several hours after their shift has finished, overtime is paid for.
this will lead to invalid and unauthorised
overtime payments.
Wages calculations
The wages calculations are generated by the A senior member of the payroll team should
payroll system and there are no checks recalculate the gross to net pay workings for
performed. Therefore, if system errors occur a sample of employees and compare their
during the payroll processing then this would results to the output from the payroll system.
not be identified. This could result in wages These calculations should be signed as
being over or under calculated, leading to an approved before wages payments are made.
additional payroll cost or loss of employee
goodwill.
Hourly wage increase
The hourly wage has been increased by the All increases of pay should be proposed by
Human Resources (HR) department and the HR department and then formally agreed
notified to the payroll department verbally. by the board of directors.
As payroll can be a significant expense, any
decision to increase this should be made by
the board as a whole and not just by HR.
The payroll department should not accept Written notification of the increase should be
verbal notifications of pay increases as it sent to payroll and HR and only then should
could be an unauthorised increase, or an effort the pay rise be incorporated into the payroll
by an employee in HR to increase the pay of package.
certain members of staff, such as their friends.

Implication Recommendation
Wage payout
The factory supervisor should not be given Consideration should be given to operating a
the pay packets of the night shift staff as this shift system for the payroll department on
is a significant amount of cash, being Fridays. This will ensure that there are
approximately one-third of the workforce. sufficient payroll employees to perform the
This cash will not be in a secure location and wages payout to the night shift employees.
so is open to the risk of theft. Therefore the same controls applied to the
morning and late afternoon shifts can be put
in place for the night shift.
In addition, the supervisor is not sufficiently Employees who miss the payout will need to
independent to pay wages out. He could wait until Monday for their pay. No factory
adjust pay packets to increase those of his supervisor should be allowed to hand out
close friends whilst reducing others. wages.
For employees absent on pay day, the Pay packets of absent employees should be
supervisor retains the wages and only returns safely secured in the safe overnight and then
them on Monday. This cash is therefore not banked on Monday.
secure and is susceptible to loss or theft.
Joiners/leavers
Notification of joiners and leavers should be During periods of illness or holidays, key
made on a timely basis to the payroll roles of the affected employees should be
department, even if some staff are on holiday. reallocated to other members of the team to
Otherwise Chuck Industries could continue ensure that controls are maintained.
making payments to employees who have left,
Forms for new joiners should be completed
or pay new employees late, resulting in a loss
when they are appointed with appropriate
of employee goodwill.
start dates filled in, these should then be
distributed to all relevant departments. This
should reduce the risk of new joiners being
missed out by the payroll department.
(b) Payroll substantive procedures
Agree the total wages and salaries expense per the payroll system to the detailed
trial balance, investigate any differences.
Cast a sample of payroll records to confirm completeness and accuracy of the

payroll expense.
For a sample of employees, recalculate the gross and net pay and agree to the
payroll records to verify accuracy.
Re-perform calculation of statutory deductions to confirm whether correct

deductions for this year have been included within the payroll expense.
Compare the total payroll expense to the prior year and investigate any significant
differences.

Review monthly payroll charges, compare this to the prior year and budgets and
discuss with management any significant variances.
Perform a proof in total of total wages and salaries, incorporating joiners and
leavers and the pay increase. Compare this to the actual wages and salaries in the
financial statements and investigate any significant differences.
Select a sample of joiners and leavers, agree their start/leaving date to supporting
documentation, recalculate that their first/last pay packet was accurately calculated
and recorded.
For salaries, agree the total net pay per the payroll records to the bank transfer
listing of payments and to the cashbook.
For wages, agree the total cash withdrawn for wage payments equates to the weekly
wages paid plus any surplus cash subsequently banked to confirm completeness and
accuracy.
Agree the year-end tax liabilities to the payroll records, and subsequent payment to
the post year-end cash book to confirm completeness.
Agree the individual wages and salaries per the payroll to the personnel records and
records of hours worked per clocking in cards.
(c) Laws and regulations
Under ISA 250 management have a responsibility to ensure that the operations of Chuck
Enterprises are conducted in accordance with the provisions of laws and regulations. This
includes compliance with laws and regulations that determine amounts and disclosures in
financial statements, including tax liabilities and charges.
Auditors are not responsible for preventing non-compliance with laws and regulations, and
cannot be expected to detect non-compliance with all laws and regulations. They have a
responsibility to obtain reasonable assurance that the financial statements are free from
material misstatement, whether caused by fraud or error.
Blair & Cos responsibility differs in relation to the two different categories of laws and
regulations identified below:
Laws and regulations which have a direct effect on the determination of material
amounts and disclosures in financial statements. Here the auditor is responsible for
obtaining sufficient appropriate audit evidence regarding compliance.
Laws and regulations which do not have a direct effect on the determination of
material amounts and disclosures in financial statements, but may affect the entitys
ability to continue to trade. Here the auditors responsibility is limited to specified
audit procedures to help identify non-compliance with those laws and regulations
that may have a material effect on the financial statements. This includes inquiring
with management whether the entity is in compliance with such laws and
regulations, and inspecting correspondence with relevant licensing or regulatory
authorities.
Blair & Co also has a responsibility to remain alert, by maintaining professional scepticism, to
the possibility that other audit procedures may bring instances of identified or suspected non-
compliance with laws and regulations.

(d) Substantive procedures to verify redundancy provision
Discuss with the directors of Chuck Industries whether they have formally
announced their intention to make the sales ledger department redundant, to confirm
that a present obligation exists at the year end.
If announced before the year end, review supporting documentation to verify that
the decision has been formally announced.
Review the board minutes to ascertain whether it is probable that the redundancy
payments will be paid.
Obtain a breakdown of the redundancy calculations by employee and cast it to

ensure completeness.
Recalculate the redundancy provision to confirm completeness and agree

components of the calculation to supporting documentation.
Review the post year-end period to identify whether any redundancy payments have
been made, compare actual payments to the amounts provided to assess whether the
provision is reasonable.
Obtain a written representation from management to confirm the completeness of

the provision.
Review the disclosure of the redundancy provision to ensure compliance with IAS
37 Provisions, Contingent Liabilities and Contingent Assets.
(e) Reliance on internal audit
ISA 610 Using the Work of Internal Auditors details the factors the external auditors should
consider in order to place reliance on the work of the internal audit (IA) department as
follows:
Objectivity
They should consider the status of IA within the company and if they are independent of other
departments, in particular the finance department. Consideration should also be given to who
IA reports to; whether directly to those charged with governance or to a finance director.
Technical competence
The technical competence of IA staff should be considered. Consideration should be given to

whether they are members of a professional body and have relevant qualifications and
experience.
Due professional care
The external auditors should consider if the IA department have exercised due professional
care, the work would need to have been properly planned including detailed work
programmes, supervised, documented and reviewed.

Communication
In order to place reliance there needs to be effective communication between the internal
auditors and the external auditor. This is most likely to occur when the IA department is free
to communicate openly and regular meetings are held throughout the year.
Answer 56 BEARSWORLD
(a) Procedures for gathering audit evidence
(i) Use
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.
Observation involves looking at a process or procedure as it is being performed to ensure that

the process actually works as documented.
Re-calculation means the checking of the mathematical accuracy of documents or records.
(ii) Example
Analytical procedures
Review of sales income month on month to try to identify whether income has been under-
stated, possibly by cash being taken prior to banking. There is no control over the opening of
post so cash could be withdrawn by one assistant, and the deficit made up by a fraud on
customers.
Inquiry
Obtain statements from suppliers to confirm the completeness of liabilities at the end of the
year. As there is no control over purchases, invoices could have been mis-placed resulting in
a lower purchases and suppliers figure.
Inspection
The assets of the company, namely cuddly toys in inventory at the end of the year, can be
inspected to ensure all inventory is recorded and that the toys are saleable in their current
condition.
Observation
Procedures such as the opening of cash and recording of customer orders can be observed to
ensure that the administrator is recording all orders in the sales day book and cash books.

Re-calculation
Checking additions in the cash book to confirm that the total amount of cash recorded is
accurate and can be included in the sales figure (cash receipts normally equal sales because
there are no receivables).
(b) Suitability
Analytical procedures
This method of collecting evidence will be useful in BearsWorld because it will help to
identify unusual changes in income and expenditure. As BearsWorld is a relatively small
company, monitoring gross profit will show relatively small changes in sales margin or
purchasing costs. Decisions by Mr Kyto to amend margins can therefore be traced into the
actual sales made.
However, the technique may be limited in its application because it will not detect errors or
omissions made consistently year on year. If either assistant is defrauding the company (for
example by removing cash) each year, then analytical procedures will not detect this.
Inquiry
Inquiry evidence will be very useful in the audit of BearsWorld, especially where this is
derived from third parties. Third party evidence is generally more reliable than client
originated evidence as there is a decreased likelihood of bias. Suppliers can therefore be
verified using supplier statement reconciliations. A review of any customer complaints file (if
these letters are kept) will also help to identify any orders that have not been despatched.
External inquiry evidence will be less useful in the audit of sales and receivables because
goods are paid for prior to despatch there are no receivables. Internal evidence will be
available from Mr Kyto and the assistant; however the lack of segregation of duties means
that this will not be so reliable.
Inspection
Inspection of documents within BearsWorld will be useful, particularly regarding checking

whether expenses are bona fide. All purchase invoices, for example, should be addressed to
BearsWorld and relate to purchases expected from that company (e.g. cuddly toys for resale,
office expenses, etc).
Inspection of documents can take a long time; however, given the poor internal control
system within BearsWorld, the auditor may have no choice but to use this method of
gathering evidence.
The fact that an invoice is addressed to the company does not confirm completeness of
recording so inspection of the cash book for unusual payments verified by checking the
purchase invoice will also be required. Additional substantive testing would also be required
due to poor controls.
Observation
Observation may be useful because it will show how the assistants verify documents.
However, no information is provided on any internal controls within BearsWorld so simply
viewing how documents are checked without any evidence of checking has limited benefit.
Observation tests will be of limited usefulness because the assistants may act differently when
an auditor is present. The same problem will apply to any observation checking carried out
by Mr Kyto.

Re-calculation
Re-calculation evidence is very useful for checking additions on invoices, balancing of

control accounts, etc. This means that the arithmetical accuracy of the books and records in
BearsWorld can be confirmed.
The main weakness of re-calculation checking is that calculations can only be carried out on
figures that have been recorded. If there are any omissions then checks cannot be carried out.
Answer 57 REDDY
(a) Subsequent event
The agreement to pay a backdated pay rise is an adjusting event since it clearly relates to a
prior period even though the extent of the pay rise was unknown as at the year end (IAS 10
Events After the Reporting Period). Reddy should confirm the pay rise by sighting the
agreement, check the computation of the amount outstanding as at the end of the reporting
period and assess the materiality of the effect on profit.
They should recommend the directors to provide for the backdated pay for the period from 1
April to 30 June as a liability in the statement of financial position as at 30 June and to adjust
expense accounts in the statement of comprehensive income as appropriate. If the directors
do not do so then it represents a disagreement. If the amount is material, the auditors report
will need to be modified by way of a qualified (except for) opinion due to disagreement.
(b) Other information
The Chairmans statement would appear to represent a material inconsistency with the audited
financial statements in accordance with ISA 720 The Auditors Responsibility Relating to
Other Information in Documents Containing Audited Financial Information. It suggests that
operating profit represents the true level of performance.
IAS 1 Presentation of Financial Statements, however, requires items such as reorganisation

costs and profits or losses on disposal of property, plant and equipment to be included in
arriving at a measure of profit from ordinary activities for the period (also IAS 8 Accounting
Policies, Changes in Accounting Estimates and Errors). Reddy should advise the Chairman
to amend the information in his statement to avoid the apparent inconsistency.
If the Chairman refuses Reddy should consider the inclusion of an other matter paragraph
immediately after the unqualified opinion paragraph in the auditors report. As the financial
statements do show a true and fair view and the Chairmans statement is not included within
the audit scope, a standard unmodified opinion would be issued.
(c) Internal control
Although advising audit clients of weaknesses discovered in internal controls is not the
primary objective of an audit, various jurisdictions have held the auditor to be negligent if
failure to make proper communication of such information results in losses being incurred by
the company. It is generally known that potential losses from unauthorised trading of this
kind can be very large, especially as the trader makes ever-greater trades (bets) in attempting
to cover their losses (Barings Bank, Society Generale, UBS).

Jane should review more recent dealings to see if any have been entered into speculatively it
is possible that the practice has ceased even though no action has yet been taken. If such
transactions are still being entered into, Jane should discuss with the chief financial officer if
there has been a change in company policy. If so, this should be evidenced in board minutes
and Jane should update the permanent audit file.
Tutorial note: Reference could also be made that if policy has not changed, the letter point
should be redrafted (and to more senior management).
Since the chief financial officer appears not to have taken appropriate action Reddy must, as a
matter of urgency, raise the matter with the Board of Directors or, if the company has one, the
Audit Committee.
(d) Subsequent event
This is a non-adjusting event (IAS 10). On the basis of the preliminary information it would
appear to be of a magnitude to require disclosure. The disclosure should describe the nature
of the event and an estimate of its financial effect (i.e. the cost of cleaning up operations and
of liability to pay compensation) or a statement that such an estimate cannot be made. If the
company is unwilling to disclose the event in the notes to its financial statements then Reddy
are in disagreement with management and must issue a qualified opinion in their auditors
report.
Disclosure may be required in the directors report as well as in a note to the financial
statements.

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ACCA

AUDIT AND ASSURANCE

STUDY QUESTION BANK

For Examinations to June 2015

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Copyright 2014 DeVry/Becker Educational Development Corp. All rights reserved.

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Question Page Answer Marks Date worked

1 International auditing 1 1001 16

3 Audit committee 1 1003 20

PROFESSIONAL CODES OF ETHICS AND CONDUCT

4 Eastfield Distributors 2 1007 20

7 Viswa (ACCA J04) 4 1014 20

9 Working papers 5 1019 20

10 Planning documentation 6 1023 20

UNDERSTANDING THE ENTITY

FRAUD, LAWS AND REGULATIONS

14 Fraud and error (ACCA D04) 8 1034 20

19 Sources of audit evidence 13 1047 15

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Question Page Answer Marks Date worked

22 Accounting estimates 15 1055 15

24 Letter of representation (ACCA J02) 16 1059 20

COMPUTER-ASSISTED AUDIT TECHNIQUES

25 Methods of evidence gathering (ACCA J04) 16 1061 20

27 Insurance Brokers (ACCA J95) 17 1066 20

28 Basis of valuation 18 1068 20

EXTERNAL CONFIRMATIONS, RECEIVABLES AND SALES

31 Spondon (ACCA D95) 20 1078 20

LOANS, BANK AND CASH

LIABILITIES, PROVISIONS AND CONTINGENCIES

36 Company A (ACCA D02) 24 1090 20

SMALL BUSINESS AND NOT-FOR-PROFIT ORGANISATIONS

37 Welfare Help for the Aged Trust (WHAT) 24 1092 20

39 Calva (ACCA D03) 25 1097 20

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Question Page Answer Marks Date worked

THE AUDITORS REPORT ON FINANCIAL STATEMENTS

41 Audit scope 27 1102 20

44 Mowbray Computers (ACCA J94) 29 1108 20

46 MonteHodge Co (ACCA J08) 30 1113 20

USING THE WORK OF INTERNAL AUDIT

47 Brampton Co (ACCA D09) 31 1115 20

POINT DEVELOPMENT EXERCISES

48 Quick questions 31 1118 15

FURTHER PRACTICE QUESTIONS

51 Documentation and engagement letters (ACCA J11) 37 1123 10

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Question 1 INTERNATIONAL AUDITING

(a) Define an audit. (2 marks)

Question 2 ISA 200

Question 3 AUDIT COMMITTEE

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Question 4 EASTFIELD DISTRIBUTORS

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Question 5 ABEL & CO

Question 6 PROFESSIONAL ETHICS

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(i) the statutory audit of Billington Travel; (4 marks)

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In addition Mr Thorburn has requested that:

Question 9 WORKING PAPERS