Documente Academic
Documente Profesional
Documente Cultură
AUDIT AND
ASSURANCE
QUESTION BANK
ICAP
Question
Bank
Notice
Emile Woolf International has made every effort to ensure that at the time of writing the
contents of this study text are accurate, but neither Emile Woolf International nor its directors
or employees shall be under any liability whatsoever for any inaccurate or misleading
information this work could contain.
ii
C
Contents
Page
Questions
Section A
Section B
17
Section C
71
Section D
77
Answers
iii
iv
I
Index to Objective test and long-form
questions and answers
Question
page
Answer
page
17
77
Levels of assurance
18
79
Shamsuddin
18
79
Core concepts
18
80
Threats
19
81
19
82
19
83
Audit process
19
84
20
85
10
Fundamental principles
20
87
11
Oops
20
87
12
20
88
13
21
88
Saad Co
21
89
15
Alpha
21
90
16
22
90
17
Shahid Corporation
22
91
18
Assertions
22
91
Question
page
Answer
page
19
23
93
20
ASPL
23
93
21
AMF
24
94
22
24
95
23
SPL
25
95
24
25
96
25
26
97
26
Dynamic
26
98
27
Changing Terms
26
99
28
EL
27
99
29
Calm Co
27
100
30
Azam
27
100
31
Hurricane
27
102
32
Zakir Co
29
104
33
Hajira
30
106
34
Tahir Co
30
108
Internal control
35
Controls
31
110
36
Shahzad
31
111
37
Waheed Engineering
32
112
38
Danish
33
113
39
Roses Anytime
34
115
40
Trade Receivables
35
117
41
Granger
35
119
Audit evidence
42
Nobel
36
122
43
Masoom Limited
37
122
44
Sky Blue
37
123
45
Direct confirmations 1
37
123
46
Chill
37
124
47
Sales sampling
38
124
48
PQR
38
125
49
39
126
50
Related parties
39
127
vi
Question
page
Answer
page
51
Direct confirmations 2
39
127
52
Working papers
39
128
53
Al-Shams
39
128
54
Auditors expert
40
129
55
ADL
40
130
56
Guava & Co
40
131
57
RP Planning
41
132
58
Manufacturing inventories
41
132
59
Wedge & Co
41
135
60
MWL
41
136
61
BPR
42
137
62
Taskeen Co
42
138
63
Wings
43
140
64
Glasses2Go
43
142
65
ISA 620
44
144
66
Cuddly World
45
144
67
45
146
68
Tahira Transporters
46
148
69
Willow
47
150
70
Sparkle Forever
48
152
71
Bubbles
48
154
72
ISA 500
49
156
73
Javeria Co
49
157
74
Porridge
50
158
75
Trembridge Engineering
51
160
76
51
162
77
Heidi Co
52
163
Scenarios
78
Zeedin Co
52
165
79
Sahito Co
54
168
80
Bashir Co
55
170
57
173
Completion
81
Analytical Procedures
vii
Question
page
Answer
page
82
Auditor Responsibility
57
175
83
Al-Badr
57
175
84
58
176
85
59
177
86
60
177
87
60
178
88
Hafiz Limited
61
179
89
61
180
90
61
180
91
Ranjha Limited
62
181
92
Pervasive effects
63
182
93
63
183
94
64
184
95
64
184
96
64
185
97
Written Representations
65
185
98
Shahrukh and Co
65
186
99
Kazmi-Wassan
66
186
100
RK Resourcing
67
188
101
Rake Enterprises
67
191
Review engagements
102
ISRE 2400
68
192
103
Karim
68
193
104
IFI
69
194
viii
SECTION
Are responsible for ensuring that the company complies with the law
Are responsible for ensuring that the company pays its tax by the due date
Because the risk to the accounts of their being incorrectly stated is greater
When an auditor is proposed for removal from office, which one of the following is he
NOT permitted to do?
A
Assuming that it is not the first appointment of the auditor, who is responsible for the
appointment of the auditor?
A
the directors
the shareholders
10
12
13
14
15
A matter is material if the auditor and the directors both decide that further work
needs to be done in the area under question
Considering the work to be done by the client staff e.g. internal audit
Considering whether the financial statements show a true and fair view
Audit risk is composed of 3 factors. Which of the following is NOT one of those factors?
A
Compliance risk
Detection risk
Control risk
Inherent risk
Analytical review
17
18
19
20
The risk of the auditor carrying out a test the wrong way round
The risk that the sample does not reflect the population
The risk of the auditor reaching the wrong conclusions from testing
Systematic selection
Pervasive selection
Random selection
Haphazard selection
Which of the following are you unlikely to see in the current file of auditors working
papers?
A
According to ISA 500, the strength of audit evidence is determined by which two
qualities?
A
Which of the following is normally the most reliable source of audit evidence?
A
Internal audit
Suppliers statements
Board minutes
Analytical review
22
23
24
25
The design of the internal control system and the implementation of the controls
The design of the internal controls and the implementation of the control system
The implementation of the controls and the correctness of the accounting records
The design of the internal control system and the correctness of the accounting
records
According to ISA 315, which of the following is NOT an element of the control
environment?
A
Participation of management
Information processing
Commitment to competence
Performance reviews
Physical controls
Organisational structure
Segregation of duties
The opening of the post should not be the same person who banks the cheques
27
28
29
An internal control questionnaire is sent from the internal auditors to the external
auditors during the audit to request ideas for improving the internal control
system.
A circle is used to indicate the starting and ending points of the process.
Triangles are used to show decision points. Each path emerging from the triangle
must be labelled with one of the potential answers.
A pentagon is used to link a particular step of the process to another page or part
of the flowchart. Letters are placed in the pentagon to clarify continuation.
Surveillance video
30
Asymmetric key ciphers these use related (often identical) keys to both encrypt
and decrypt information. This is sometimes called shared secret between two or
more parties
Block ciphers data is encrypted one data unit (typically 1 byte) at a time in the
same order it was received. The simplest method is to use translation tables
which offset the input blocks across an array of the table. Enhanced encryption
can be achieved by combining two or more tables
Symmetric key ciphers these use related (often identical) keys to both encrypt
and decrypt information. This is sometimes called shared secret between two or
more parties
Stream ciphers this is where fixed length blocks are encrypted and streamed
across the network with a high speed connection
32
33
34
Which one of the following is NOT an internal control you would expect to see in a
sales system?
A
Which one of the following is NOT an internal control you would expect to see in a
purchases system?
A
All invoices are grid-stamped to create the companys own invoice system
Marketing
Checking that all purchase invoice are authorised by the proper people
Where a list of approved suppliers exists, checking that orders are placed only
with suppliers on such a list
35
Placing orders
Goods received
37
38
39
40
Completeness
Occurrence
Cash flow
Existence
Inspection
Enquiry
Analytical procedures
Estimates
Confirmation during a telephone call with the Managing Director that there are no
loans outstanding
At what stage of the audit do ISAs 315 and 520 require the auditor to use analytical
procedures?
A
Depreciation
Accrued revenue
42
43
44
45
Land only
Buildings only
Purchased goodwill
Non-purchased goodwill
Which of the following is NOT a substantive test for the audit of non-current assets?
A
Goodwill
Investments
47
48
49
50
Analytical review
Computation
Observation
Delegation
Which of the following is NOT a substantive test for the audit of inventories?
A
Test the accuracy of net realisable value through the review of post year-end
sales
Have satisfactory explanations been explained for all material inventory count
differences
Check that all administrative overheads have been correctly accrued for in the
valuation of inventories
Which of the following is NOT a substantive test for the audit of receivables?
A
Check reasons for debit balances (and ensure they are disclosed under
payables)
If the client has performed the reconciliation, the auditor must cast the whole
reconciliation
10
52
53
54
55
Sales orders
Supplier statements
Which of the following audit procedures is primarily intended to provide audit evidence
as to existence?
A
Debentures
Bank loans
Deferred income
Contingent assets
Provisions
Contingent liabilities
A customer's insolvency
11
57
58
Which of the following statements about the audit of related parties is correct?
A
The main audit concern in relation to related parties is the adequacy of the
disclosures of the related parties that have been identified.
A company should disclose both the nature of related party relationships and the
amount of related party transactions.
With related party transactions, there is some risk of collusion and fraud.
60
The auditor may work with a specialist. What effect does this have on the auditors
responsibilities?
A
The auditor and client have joint responsibility for the specialist
Responsibility for a group audit is shared by the group auditor and any
component auditors.
A group auditor may rely on the work done by a component auditor without the
need to assess its quality.
The group auditor sets the group materiality level for the financial statements as
a whole and component materiality levels for components audited by component
auditors.
12
61
62
63
Which of the following statements about the principal auditor in a group audit is
INCORRECT?
A
The principal auditor is responsible for the opinion on the group financial
statements as a whole.
The principal auditor can demand information and explanations from the
secondary auditor.
The principal auditor needs to consider the materiality of the portion of the group
audited by him.
The principal auditor can demand co-terminus year-ends for all group companies.
A component auditor should provide the group auditor with access to its relevant
auditing documentation.
A component auditor should provide the group auditor with a report of work
performed unless the group auditor specifically states that this is not necessary.
When there is a joint audit, one of the firms must act as the senior firm in the
audit.
Which of the following items should be communicated by a group auditor to the group
management?
1
1, 2, 3 and 4
1 only
1 and 4 only
1, 2 and 4 only
You have been proposed as auditor of a company. What is the first step that you
should take?
A
13
65
66
67
68
Which one of the following may auditors NOT perform for their client?
A
Which of the following are fundamental ethical principles for professional accountants?
1
Competence
Compliance
Integrity
Objectivity
1, 2 and 3 only
1, 3 and 4 only
2, 3 and 4 only
1, 2 and 4 only
An auditor should not accept a loan on favourable commercial terms from an audit
client because of the threat to his or her independence. The threat would be a:
A
Self-interest threat
Self-review threat
Advocacy threat
Familiarity threat
Purchasing goods from an audit client on normal commercial terms does not
create a threat to the auditors independence.
An auditor who was recently a director of an audit client must not be assigned to
the audit team for that client.
They should be used only when there is a lack of other substantive audit
evidence
They should be used only when there is other substantive audit evidence to
complement it
14
70
71
72
73
Which of the following would you not use as a benchmark for comparison when
undertaking analytical procedures?
A
Previous years
Budget
The gap between how the directors of a company perform their duties and how
the shareholders expect them to perform
The gap between how the directors of a company perform their duties and how
the general public expects them to perform
The gap between the public perception of the role of company auditors and their
statutory role and responsibilities
The gap between the auditors own perception of their duties and how they are
set out in the Companies Act
Introductory paragraph specifying the pages to which the report relates and the
accounting convention adopted
Positive assurance
Negative assurance
No assurance
15
75
76
77
one audit firm should audit the IFI and a different firm should audit the financial
statements for the year as a whole.
one accountancy firm should review the IFI and a different firm should audit the
financial statements for the year as a whole.
the same firm should audit the IFI and the financial statements for the year as a
whole.
the same firm should review the IFI and the financial statements for the year as a
whole.
The auditor could not conduct any tests due to lack of controls.
The auditor did not find anything to indicate that a material misstatement exists.
16
SECTION
ICAPs code of ethics has specified five principles of professional ethics for
chartered accountants. The circumstances in which a chartered accountant
operates may give rise to specific threats to compliance with these principles.
Required:
(b)
(i)
(ii)
17
Levels of assurance
Distinguish between absolute and reasonable assurance. Identify the type of
assurance that is expected in an audit of the financial statements, clearly outlining the
reasons to justify your point of view.
(8)
Shamsuddin
Shamsuddin a newly qualified chartered accountant has recently established his
practice in the name of Shamsuddin & Co., Chartered Accountants. He is continuously
trying to expand his practice and in this process he came across the following
situations:
(i)
One of his friends, who is the owner of an advertising agency, has offered to
provide significant discount for publicity of his new practice.
(ii)
(iii)
Design Limited has contacted Shamsuddin and informed him that they are willing
to appoint him as their external auditor in the next AGM at a fee of Rs. 200,000 if
he completes the audit in a month. However, in case of delay in the audit work
the audit fee will be reduced to Rs.150,000.
(iv)
Required:
Shamsuddin is inclined to accept the above offers. Discuss the options available with
him in each of the above situations.
(10)
Core concepts
(a)
(b)
(7)
During the audit team planning meeting, a member of the audit team passed a
comment that based on past experience with the client, he was confident that the
management of the client was honest and there was no issue as regards
management integrity or risk of fraud in the Company. The audit manager
responded that the auditor should always maintain an attitude of professional
scepticism throughout the audit.
Required:
Briefly describe Audit Scepticism and elaborate on the response of the audit
manager.
(8)
(Total: 15 marks)
18
Threats
A chartered accountant is required to comply with five fundamental principles
specified by ICAPs Code of Ethics. However, compliance with the fundamental
principles may potentially be threatened by a broad range of circumstances.
Required:
Briefly describe the categories of threats that may potentially affect
compliance with the fundamental principles. Give two examples for each category.
(10)
Burewala Bank Limited (BBL) is a listed audit client of Umer and Company,
Chartered Accountants (UCC). BBL has granted a house loan of Rs. 5 million to a
partner in UCC.
(4)
(b)
Kamal was the audit manager during the last years annual audit of Faisalabad
Textile Mills Limited (FTML). He has joined FTML as their Manager Finance,
prior to the commencement of the current years audit.
(8)
(Total: 12 marks)
(b)
Bilal and Company has received an offer for appointment as auditors of IJK
Limited. The total paid up capital of the company is Rs. 990 million whereas its
ordinary share capital is Rs. 130 million.
Faryal, the wife of a partner in Bilal and Company, is a director in LMN
Limited which holds 50 million non-voting preference shares and 2 million
ordinary shares in IJK Limited. Faryal also holds 10,000 shares in LMN Limited.
The par value of both types of shares is Rs. 10 each.
(4)
(Total: 7 marks)
Audit process
The purpose of an external audit and its role are not well understood. You have been
asked to write some material for inclusion in your firms training materials dealing with
these issues in the audit of large companies.
Required:
(a)
Draft an explanation dealing with the purpose of an external audit and its role in
the audit of large companies, for the inclusion in your firms training materials.
(7)
19
(b)
The external audit process for the audit of large entities generally involves two or
more recognisable stages. One stage involves understanding the business and
risk assessment, determining the response to assessed risk, testing of controls
and a limited amount of substantive procedures. This stage is sometimes known
as the interim audit. Another stage involves further tests of controls and
substantive procedures and audit finalisation procedures.
This stage is
sometimes known as the final audit.
Describe and explain the main audit procedures and processes that take place
during the interim and final audit of a large entity.
(7)
(Total: 14 marks)
10
Fundamental principles
Explain each of the FIVE fundamental principles of ICAPs Code of Ethics
11
(5)
Oops
Explain the situations where an auditor may disclose confidential information about a
client.
(8)
12
20
(5)
13
Saad Co
You are a manager in the audit firm of Ajmal & Co; and this is your first time you have
worked on one of the firms established clients, Saad Co. The main activity of Saad Co
is providing investment advice to individuals regarding saving for retirement, purchase
of shares and securities and investing in tax efficient savings schemes. Saad is
regulated by the relevant financial services authority.
You have been asked to start the audit planning for Saad Co, by Mr Sher, a partner in
Ajmal & Co. Mr Sher has been the engagement partner for Saad Co, for the previous
nine years and so has excellent knowledge of the client. Mr Sher has informed you that
he would like his daughter Zhura to be part of the audit team this year; Zhura is
currently studying for her first set of exams for her ICAP qualification. Mr Sher also
informs you that Mr Faisal, the audit senior, received investment advice from Saad Co
during the year and intends to do the same next year.
Required:
(a)
Explain the ethical threats which may affect the auditor of Saad Co.
(3)
(b)
For each ethical threat, discuss how the effect of the threat can be mitigated.
(3)
(Total: 6 marks)
15
Alpha
The following three entities have approached Alpha & Company, Chartered
Accountants (the firm) for appointment as their statutory auditors. In each case there
are following issues which need to be considered before the firm decides to accept the
assignments.
(i)
21
(ii)
(iii)
Required:
In each case specify the minimum conditions specified by Companies Ordinance,
1984, which should be fulfilled in order to accept the audit engagement.
16
(9)
(7)
(b)
(ii)
In how many days after the date of auditors report, the auditor is required
to complete the assembly of his final audit file?
(7)
(Total: 14 marks)
17
Shahid Corporation
Azeem and Company have been the auditors of Shahid Corporation Limited, a
listed company, for the past many years. You have been appointed as the audit
engagement manager.
Briefly explain the matters which you would consider while assessing the following:
(a)
(5)
(b)
(3)
(Total: 8 marks)
18
Assertions
(a)
(b)
(ii)
(2)
The auditors assessment of materiality and audit risk may be different at the
time of initially planning the engagement from at the time of evaluating the results
of audit procedures.
Briefly describe the reasons which may lead to such a change in the
auditors assessment.
22
(3)
(c)
Briefly describe the assertions used by the auditors in respect of the following:
(i)
account balances
(ii)
(iii)
(7)
(Total: 16 marks)
19
20
(a)
(b)
(c)
The directors of Fazal Limited (FL) have decided to appoint Syed & Company,
Chartered Accountants, as external auditor of the company. One of the partners
spouse holds 1,000 shares in the subsidiary of FL.
(d)
The directors of Najam (Pvt.) Limited having paid-up capital of Rs. 4.5 million
have appointed Mr Dawood to act as the external auditor of the company. Mr
Dawood has been awarded a diploma in International Financial Reporting
Standards by the Institute of Chartered Accountants of Pakistan and has
completed the mandatory period of training from a leading firm of chartered
accountants.
(e)
All directors of Hussain Associates (Pvt.) Limited are chartered accountants. The
company has recently received an offer for appointment as the external auditor of
Masood (Pvt.) Limited which has a paid-up share capital of Rs. 1,000,000.
(10)
ASPL
You are the Audit Manager on the audit of Al-Salam Pakistan Limited (ASPL) for the
year ended June 30, 20X3. ASPL is engaged in the manufacture of a wide range of
plastic products. While reviewing the initial work performed by the audit team, the
following matters have come to your notice:
(i)
The quantity of material scrapped during the year is materially different from the
quantity of scrap sold. The companys records show nil balance both at the
beginning and at the close of the year. No reconciliation for the difference has
been provided by the company.
(ii)
Sales for the year have increased by 7% over the previous year. However, it
has been noted that sales in the last two weeks of June 2010 have been
exceptionally high and represent 15% of the annual sales. The audit working
papers carry the following observations in respect of the above:
70% of the sales in the last two weeks of June were made to two new
customers whose credit assessment has not been formally documented;
23
(iii)
During the year, ASPL purchased a machine for Rs. 25 million. The payment
voucher is duly supported by the invoice from the supplier. However, the fixed
assets schedule provided by the client shows the amount capitalized as Rs. 2.5
million. Depreciation has been charged on this amount. The difference of Rs.
22.5 million is appearing in the Bank Reconciliation Statement.
Required:
(a)
Analyse each of the above situations and assess whether it represents a fraud or
an error.
(6)
(b)
What action would you take to deal with the above matters?
(9)
(Total: 15 marks)
21
AMF
Al-Madad Foundation (AMF) is a charitable organization. It receives donations which
are utilized to help the destitute persons in accordance with the rules and regulations
prescribed by the AMFs Trust Deed.
The donations are received from the following sources:
(i)
Cash collected from the general public through charity boxes placed at
key points in hospitals, airports, superstores etc.,
(ii)
cash and cheques received from individuals and institutions at AMFs office; and
(iii)
Donations received in case of (ii) and (iii) above, often contain specific instructions for
utilisation of the donated amount for specific purposes e.g. for education of orphan
children.
Required:
(a)
(3)
(b)
Briefly discuss the effect of each of these risks on the audit of AMF.
(3)
(Total: 6 marks)
22
(4)
(b)
You have been appointed as the auditor of a company which was previously
audited by another auditor. Being a new client, what additional considerations
would you take into account while performing the preliminary engagement
activities prior to commencement of the audit?
(5)
(Total: 9 marks)
24
23
SPL
Strawberry Pakistan Limited (SPL) was incorporated on March 1, 20X3. The directors
of SPL are in the process of appointing the first statutory auditor of the company. They
have requested your firm to submit a proposal for the statutory audit assignment. A
partner of your firm has asked you to draft the proposal after assessing whether the
preconditions for the audit exist.
Required:
(a)
(b)
What are the steps that you would perform in order to ensure that preconditions
for the audit exist?
(c)
Discuss whether your firm may or may not accept the assignment if one of the
preconditions for the audit is not present.
(Total: 15 marks)
24
(b)
(c)
(d)
(e)
Mr Sadiq has recently joined your firm as a partner. He has served on the
Board of Directors of Strawberry Limited (SL) until 30 June 20X0, as a
Government nominee. In the Annual General Meeting of SL held on 31 August
20X2, a shareholder has proposed the name of your firm for appointment as the
external auditors for the year ending 30 June 20X3.
(Total: 11 marks)
25
25
List the benefits associated with holding timely discussion among the team
members in respect of matters susceptible to material misstatements.
(5)
(b)
Required:
(i)
(ii)
Non-routine transactions
Judgmental matters
(6)
(Total: 11 marks)
26
Dynamic
In the planning phase of the audit of Dynamic Limited for the year ending 30 June
20X3, you have calculated the following ratios from the management accounts of
the company for the eight months ended 29 February 20X3:
Eight months
period ended
29 February 20X3
Year ended
30 June 20X2
Year ended
30 June 20X1
35%
120
1.5
0.78
0.91
132
40%
105
2.3
1.6
1.67
86
40%
78
2.6
1.7
2.1
68
Required:
Identify the prospective audit risks which the auditor should consider while planning the
audit.
(9)
27
Changing terms
An auditor may agree to a change in the terms of engagement provided there is a
reasonable justification for doing so.
Required:
(a)
List the circumstances in which the management may request the auditor to
change the terms of an audit engagement.
(b)
(c)
List the steps that the auditor should consider, if he is unable to agree to a
change in the terms of engagement.
(Total: 9 marks)
26
28
EL
List the important matters that are required to be included in an audit engagement letter.
(6)
29
Calm Co
ISA 315 Identifying and Assessing the Risks of Material Misstatement Through
Understanding the Entity and its Environment deals with the auditors responsibility to
identify and assess the risks of material misstatement in the financial statements,
through understanding the entity and its environment, including the entitys internal
control.
Required:
30
(i)
(3)
(ii)
Outline the sources of audit evidence the auditor can use as part of risk
assessment procedures.
(3)
(Total: 6 marks)
Azam
Azam is a charity whose constitution requires that it raises funds for educational
projects. These projects seek to educate children and support teachers in certain
countries. Charities in the country from which Azam operates have recently become
subject to new audit and accounting regulations.
Charity income consists of cash collections at fund raising events, telephone appeals,
and bequests (money left to the charity by deceased persons). The charity is small and
the trustees do not consider that the charity can afford to employ a qualified
accountant. The charity employs a part time book-keeper and relies on volunteers for
fund raising.
Your firm has been appointed as accountants and auditors to this charity because of
the new regulations. Accounts have been prepared (but not audited) in the past by a
volunteer who is a recently retired Chartered Accountant.
Required:
(a)
Describe the risks associated with the audit of Azam under the headings inherent
and control risks and detection risk and explain the implications of these risks for
overall audit risk.
(10)
(b)
List and explain the audit tests to be performed on income and expenditure from
fund raising events.
(10)
Note: In part (a) you may deal with inherent risk and control risk together. You are not
required to deal with the detail of accounting for charities in either part of the question.
(Total: 20 marks)
31
Hurricane
You are the audit manager in charge of the audit of Hurricane, a limited liability
company. The companys year-end is 31 December, and Hurricane has been a client
for seven years. The company purchases and resells fittings for ships including
anchors, compasses, rudders, sails etc. Clients vary in size from small businesses
making yachts to large companies maintaining large luxury cruise ships. No
manufacturing takes place in Hurricane.
27
Gross profit
7,930
8,951
Administration costs
(4,994)
(4,758)
Distribution costs
(2,500)
(2,500)
Net profit
436
1,693
3,600
4,500
200
6,000
500
10,300
1,278
4,052
1,590
11,420
1,000
5,300
6,300
1,000
3,000
10,300
1,000
5,764
6,764
2,058
2,598
11,420
Other information
The industry that Hurricane trades in has seen moderate growth of 7% over the last
year.
Non-current assets mainly relate to company premises for storing inventory. Ten
delivery vehicles are owned with a net book value of Rs 30m
Inventory is stored in ten different locations across the country, with your firm
again having offices close to seven of those locations.
Required:
(a)
ISA 300 Planning an Audit of Financial Statements, states that an auditor must
plan the audit.
Explain why it is important to plan an audit.
(b)
(5)
Using the information provided above, prepare the audit strategy for Hurricane for
the year ending 31 December 20X4.
(15)
(Total: 20 marks)
28
32
Zakir Co
(a)
(2)
(ii)
the different types of analytical procedures available to the auditor; and (3)
(iii)
(3)
Zakir Co sells garden sheds and furniture from 15 retail outlets. Sales are made to
individuals, with income being in the form of cash and debit cards. All items purchased
are delivered to the customer using Zaks own delivery vans; most sheds are too big for
individuals to transport in their own motor vehicles. The directors of Zak indicate that
the company has had a difficult year, but are pleased to present some acceptable
results to the members.
The income statements for the last two financial years are shown below:
Income statement
31 March
20X4
31 March
20X3
Rs m
Rs m
7,482
6,364
(3,520)
(4,253)
3,962
2,111
(1,235)
(1,320)
(981)
(689)
Interest payable
(101)
(105)
Revenue
Cost of sales
Gross profit
Operating expenses
Administration
Investment income
145
1,790
(3)
253
(950)
Required:
(b)
As part of your risk assessment procedures for Zakir Co, identify and provide a
possible explanation for unusual changes in the income statement.
(9)
(c)
Required:
Explain the procedures necessary to obtain a bank confirmation letter from Zakir Co.s
bank.
(3)
(Total: 20 marks)
29
33
Hajira
(a)
Explain the term audit risk and the three elements of risk that contribute to total
(4)
audit risk.
The Hajira charity was established in 1960. The charitys aim is to provide
support to children from disadvantaged backgrounds who wish to take part in
sports such as tennis, badminton and football.
Hajira has a detailed constitution which explains how the charitys income can be
spent. The constitution also notes that administration expenditure cannot exceed
10% of income in any year.
The charitys income is derived wholly from voluntary donations. Sources of
donations include:
(i)
(ii)
(iii)
The rules regarding the taxation of charities in the country Hajira is based are
complicated, with only certain expenditure being allowable for taxation purposes
and donations of capital being treated as income in some situations.
Required:
34
(b)
Identify areas of inherent risk in the Hajira charity and explain the effect of each
(12)
of these risks on the audit approach.
(c)
Explain why the control environment may be weak at the charity Hajira.
(4)
(Total: 20 marks)
Tahir Co
One of your audit clients is Tahir Co a company providing petrol, aviation fuel and
similar oil based products to the government of the country it is based in. Although the
company is not listed on any stock exchange, it does follow best practice regarding
corporate governance regulations. The audit work for this year is complete, apart from
the matter referred to below.
As part of Tahir Co.s service contract with the government, it is required to hold an
emergency inventory reserve of 6,000 barrels of aviation fuel. The inventory is to be
used if the supply of aviation fuel is interrupted due to unforeseen events such as
natural disaster or terrorist activity.
This fuel has in the past been valued at its cost price of Rs.150 a barrel. The current
value of aviation fuel is Rs.1,200 a barrel. Although the audit work is complete, as
noted above, the directors of Tahir Co have now decided to show the real value of this
closing inventory in the financial statements by valuing closing inventory of fuel at
market value, which does not comply with relevant accounting standards. The draft
financial statements of Tahir Co currently show a profit of approximately Rs.5m with net
assets of Rs.1.7 billion.
30
Required:
(a)
List the audit procedures and actions that you should now take in respect of the
above matter.
(6)
(b)
For the purposes of this section assume from part (a) that the directors have
agreed to value inventory at Rs.150/barrel.
Having investigated the matter in part (a) above, the directors present you with
an amended set of financial statements showing the emergency reserve stated
not at 6,000 barrels, but reported as 60,000 barrels. The final financial
statements now show a profit following the inclusion of another 54,000 barrels of
oil in inventory. When queried about the change from 6,000 to 60,000 barrels of
inventory, the finance director stated that this change was made to meet
expected amendments to emergency reserve requirements to be published in
about six months time. The inventory will be purchased this year, and no liability
will be shown in the financial statements for this future purchase. The finance
director also pointed out that part of Tahir Co.s contract with the government
requires Tahir Co to disclose an annual profit and that a review of bank loans is
due in three months. Finally the finance director stated that if your audit firm
qualifies the financial statements in respect of the increase in inventory, they will
not be recommended for re-appointment at the annual general meeting. The
finance director refuses to amend the financial statements to remove this
fictitious inventory.
Required:
(i)
(ii)
Discuss to which groups the auditors of Tahir Co could report the fictitious
(6)
aviation fuel inventory;
(iii)
Discuss the safeguards that the auditors of Tahir Co can use in an attempt
to overcome the intimidation threat from the directors of Tahir Co.
(4)
(Total: 20 marks)
INTERNAL CONTROL
35
Controls
(a)
If the auditor plans to rely on controls that have not changed since they were last
tested, the auditor should test the operating effectiveness of such controls at
least once in every third audit. Identify the situations in which the auditor may
(4)
decide to test the controls again, in the very next audit.
(b)
(10)
(Total: 14 marks)
36
Shahzad
(a)
31
(9)
(b)
Your firm is the auditor of Shahzad Limited (SL), a listed company, which is a
wholesaler of consumable products. SL records its sale on delivery of goods and
maintains up to date computerised inventory records.
A full inventory count was conducted at the year end. The senior who attended
the physical stocktaking at the central warehouse has observed the following
matters:
(i)
The inventory count took place on January 1, 20X3 under the supervision
of the Inventory Controller. No movement of inventory took place on that
day.
(ii)
(iii)
(iv)
(v)
(vi)
(vii) At the end of the count, all inventories against which advances from
customers had been received were removed from the physical inventory
on the instruction of the Inventory Controller.
Required:
Identify the weaknesses in the system of inventory count. Give appropriate
explanations to support your point of view.
(9)
(Total: 18 marks)
37
Waheed Engineering
Your firm is the external auditor of Waheed Engineering, a listed company, which has
revenue of Rs100 million. The head office site includes the manufacturing unit, the
accounting functions and main administration. There are a number of sales offices in
different parts of the country. Waheed Engineering does not have an internal audit
department.
At the interim audit you have been assigned to the audit of the wages system. This will
involve obtaining an understanding of the wages system, testing the controls and
performing substantive procedures in order to verify wages transactions.
The wages records are maintained on a computer and all the wages information is
processed at the head office. Some of the employees in the manufacturing unit are
paid in cash, and all other employees have their wages paid directly into their bank
account.
Manufacturing employees are paid their wages a week in arrears. All other employees
are paid at the end of each week or month.
32
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 misstated 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' (in part (c) below) arise when
manufacturing employees are not present to collect their wages (when they are paid
out in part (b)). 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/her wage packet 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)
Describe the normal controls you would expect to see in a wages system and
explain their purpose.
(10)
(b)
Describe how you would verify that employees are not paid before they
commenced work for the company.
(5)
(c)
Describe the audit procedures you would carry out in connection with attending a
pay out of wages in cash to manufacturing employees.
(5)
(d)
Describe the substantive procedures on transactions you would carry out on the
unclaimed wages system.
(5)
(e)
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)
(Total: 30 marks)
38
Danish
Your firm has recently been appointed as auditor to Danish, a private company that
runs a chain of small supermarkets selling fresh and frozen food, and canned and dry
food. Danish has very few controls over inventory because the company trusts local
managers to make good decisions regarding the purchase, sale and control of
inventory, all of which is done locally. Pricing is generally performed on a cost-plus
basis.
33
Each supermarket has a stand-alone computer system on which monthly accounts are
prepared. These accounts are mailed to head office every quarter. There is no
integrated inventory control, sale or purchasing system and no regular system for
inventory counting. Management accounts are produced twice a year.
Trade at the supermarkets has increased in recent years and the number of
supermarkets has increased. However, the quality of staff that has been recruited has
fallen. Senior management at Danish are now prepared to invest in more up-to-date
systems.
Required:
(a)
Describe the problems that you might expect to find at Danish resulting from poor
internal controls.
(8)
(b)
39
Roses Anytime
(a)
ISAs identify a number of key procedures which auditors should perform if they
wish to rely on internal controls and reduce the level of substantive testing they
perform. These include:
(i)
(ii)
walk-through tests;
(iii)
audit sampling;
(iv)
(v)
Required:
Briefly explain each of the procedures listed above.
(b)
(10)
Roses Anytime sells Roses wholesale. Customers telephone the company and
their orders are taken by clerks who take details of the Roses to be delivered, the
address to which they are to be delivered, and account details of the customer.
The clerks input these details into the company's computer system (whilst the
order is being taken) which is integrated with the company's inventory control
system. The company's standard credit terms are payment one month from the
order (all orders are despatched within 48 hours) and most customers pay by
bank transfer, An accounts receivable ledger is maintained and statements are
sent to customers once a month. Credit limits are set by the credit controller
according to a standard formula and are automatically applied by the computer
system, as are the prices of Roses.
Required:
Describe and explain the purpose of the internal controls you might expect to see
in the sales system at Roses Anytime over the:
(i)
(6)
(ii)
collection of cash.
(4)
(Total: 20 marks)
34
40
Trade Receivables
There are many reasons for maintaining internal control systems. These include the
need to ensure that:
(i)
(ii)
(iii)
(iv)
In the context of receivables, list and describe the types of error, omission and
misappropriation of assets that can occur in practice where internal controls are
weak or non-existent.
(8)
(b)
Explain why even a good system of internal control will not necessarily prevent or
detect errors, omissions and the misappropriation of assets in a receivables
system, and explain why a good system of internal control is important to
auditors.
(4)
(c)
List the main internal controls that you would expect to be in operation in the
receivables system at a small manufacturing company with a computerised
(7)
accounting system.
(d)
Explain why external auditors seek to rely on the proper operation of internal
controls wherever possible.
(5)
(Total: 24 marks)
41
Granger
Granger is a privately owned incorporated business that operates a garage which
repairs and services motor vehicles. Most customers are required to pay by cash or
cheque on collecting their vehicle. Credit accounts are available to business
customers, These customers sign the invoice on collection of the vehicle and their
business is billed monthly. Separate series of pre-numbered invoices are drawn up by
the foreman for cash sales and for credit sales. All customer accounts are maintained
by the receptionist. His duties include the following:
Cash sales
Collect cash or cheques from customers on collecting their vehicle.
At the end of the day, check the numerical sequence of cash sales invoices, add the
sales total and agree the total to the amount of cash and cheques received.
Record the total cash sales in the cash receipts book.
Credit sales
Obtain the customer's signature on the copy invoice of business account customers.
Enter the invoices in numerical sequence in the sales journal and post the customer's
account in the accounts receivable ledger.
35
Send monthly statements to credit account customers and follow up overdue accounts.
List the balances on the accounts receivable ledger at the end of the month and
reconcile the total with the control account in the general ledger.
Write off uncollectible balances to bad debts.
Cash receipts
Open the mail, extract cheques from credit account customers, record them in the cash
receipts book and post the accounts receivable ledger,
Make up the day's banking of cash (and cheques) from both cash and credit sales,
prepare the deposit slip and bank the cash (and cheques).
All other accounting duties are the responsibility of two further accounts clerks and all
are subject to supervision by the garage manager.
Required:
(a)
(i)
(ii)
(b)
As a member of the audit staff of the company's external auditors, you visit the
garage and make a count of cash on hand. You subsequently compare details of
unbanked cash receipts that you counted with the entry in the cash receipts
boots for that date. Although the total in the cash receipts book is the same, the
amount of banknotes and coins is less and there is a cheque from a business
customer that you did not record.
Required:
(i)
(ii)
(4)
Explain the irregularity that the discrepancy between the cash count and
cash receipts book might lead you to suspect, and describe how you would
investigate the discrepancy.
(4)
(Total: 20 marks)
AUDIT EVIDENCE
42
Nobel
You are the manager on the audit of Nobel Limited, a listed company, which
manufactures automotive parts and air-conditioners for motor vehicle assemblers.
Annual sale of the Company is Rs. 850 million and profit before tax is Rs. 60 million.
Your review of the audit working paper file has disclosed the following outstanding
issues:
(i)
The company is facing a potential legal claim from Mehran Motors Limited
(MML) in respect of defective air conditioners supplied to them. A claim for Rs.
25 million being the cost of replacement of air conditioners and lost production
time has been lodged with the Company by MML. The management is of the
36
view that the claim is not justified, as the air conditioners were properly
functioning and had been tested for quality and that the defects have arisen
because of the negligence of MML and its technicians. However, a provision of
Rs. 2 million has been made in the financial statements in this respect.
(ii)
43
(6)
Masoom Limited
As the manger on the audit of Masoom Limited you want the management to appoint
experts to assist you on certain matters.
Explain the circumstances where auditor may use the work of an expert and the
auditors responsibilities in this regard.
(7)
44
Sky blue
Mr Mubarak is the audit senior on the audit of Sky Blue Limited. While comparing the
draft financial statements with the previous year, he noted many unusual fluctuations.
Briefly explain the procedure he should follow, in the above situation.
(6)
45
Direct confirmations 1
Direct confirmations from third parties provide independent audit evidence that
certain account balances and items in the financial statements are properly recorded
and disclosed.
Required:
(a)
(2)
(b)
Briefly describe the risks associated with each of the above type of confirmation
and the steps that an auditor usually takes to avert such risks.
(5)
(c)
Explain why and under what circumstances an auditor may decide to use
negative confirmation requests. Also, identify the circumstances where the
auditor may use a combination of positive and negative confirmations.
(6)
(Total: 13 marks)
46
Chill
You are the engagement manager on the audit of Chill Limited. During the course of
audit, you have been provided an Actuarial Valuation Report on the Companys
Employees Retirement Benefits Scheme. You have noted that the report has
been prepared by M/s Saleem and Company which is not well known to you.
Required:
Briefly describe the matters that you would consider before using the report prepared
by Saleem and Company.
(5)
37
47
Sales sampling
(a)
You are the audit manager on a client where an annual sale is Rs. 640 million.
During the course of annual audit the following table was developed by an
audit team member, to categorize the annual sales:
Rs.
Category A
300 million
Category B
200 million
Category C
140 million
Total
640 million
Sohail, a team member, is of the view that if verification of all the transactions in
category A is carried out, there is no need to perform further procedures.
However, other team members do not agree and consider that proper sampling
should be carried out from the total population and categorization should be
ignored.
Required:
As an audit manager of the job, you are required to:
(b)
(i)
Explain how audit efficiency could be improved by using the above table.
(ii)
List other ways in which the sales population may be categorized and what
precaution should be taken while carrying out such categorization.
(iii)
Sohail
(11)
48
PQR
During the audit of PQR Limited you have been assigned the task of evaluating the
work performed by the internal audit department of the company on certain specific
areas.
Required:
(a)
Describe how you would evaluate the work performed, in order to determine the
extent of reliance that may be placed thereon.
(6)
(b)
List the important differences between internal and external audit with respect
to the following:
Independence
Objectives
Reporting
(8)
(Total: 14 marks)
38
49
(6)
(b)
(6)
(Total: 12 marks)
50
Related parties
Describe the procedures that the auditor may perform, in order to ensure the
completeness of the information provided by the management, about related parties.
(6)
51
Direct confirmations 2
Direct confirmations of balances due from customers are obtained to satisfy the
objective of ensuring that the customer exists and owes the specified amount to the
company at a certain date.
Required:
(a)
State the circumstances in which an auditor may decide not to circulate the
requests for direct confirmation.
(5)
(b)
What are the factors that an auditor considers while designing the requests for
direct confirmation?
(5)
(c)
(6)
(Total: 16 marks)
52
Working papers
The preparation of working papers is an integral part of the auditors responsibilities.
Identify the factors that the auditor should consider while determining the form, content
and extent of audit working papers.
(7)
53
Al-Shams
Al-Shams Limited is an unquoted public company. A large part of its business is
carried out with persons / organisations related to the management or the
shareholders.
Required:
(a)
State any eight procedures which an auditor may perform for determining the
existence of related parties or related party transactions.
(8)
(b)
39
54
Auditors expert
When expertise in a field other than accounting or auditing is necessary to
obtain sufficient appropriate audit evidence, the auditor has to determine whether to
use the work of an auditors expert.
Required:
List down the sources from where the auditor may get the information regarding
the experts competence, capabilities and objectivity.
(6)
55
ADL
(a)
(b)
(ii)
(5)
You are the audit manager on Apple Distribution Limited (ADL). While reviewing
the audit planning documentation, you found that the audit team has selected
100 out of a total of 2,550 debtors for balance confirmation. The details are as
follows:
Balances due from government and some of the related parties were
ignored as prior years working papers showed that they never responded to
requests for confirmation.
Required:
(i)
(ii)
56
Guava & Co
You are the training manager at Guava & Co., Chartered Accountants. Some
trainees in the firm have requested you to clarify the following issues:
(a)
Can the auditor discard any audit document, forming part of his opinion, after
the issuance of the auditors report?
(b)
The changes that can be incorporated during the final file assembly process
citing three such examples.
(c)
The circumstances under which it becomes necessary to modify the existing audit
documents or add new audit documents after the issuance of the auditors report
and the matters that should be documented in such a situation.
Required:
Offer appropriate explanations for each of the above issues.
40
(11)
57
RP planning
As the auditor of a listed company with a number of related parties, what steps
would you consider as part of your audit planning to ensure that all related party
relationships and transactions are identified and disclosed in the financial statements.
(13)
58
Manufacturing inventories
List the substantive procedures that may be performed by the auditor to verify the
amount of inventories as appearing in the financial statements of a manufacturing
concern.
(15)
59
Wedge & Co
(a)
You are the audit manager of W edge & Co, a firm of Chartered Accountants.
The audit seniors on various jobs have sought your advice in respect of the
following independent situations:
(i)
(ii)
Number of debtors has increased from 4,500 to 5,000 and the amount of
debtors as a percentage of total assets has also increased.
(iii) The expected amount of misstatement has decreased from Rs. 300,000
to Rs. 200,000 whereas the monetary amount in respect of which an
appropriate level of assurance is required has increased by Rs. 50,000.
Required:
State with reasons, the effect of each of the above issues on the sample size of:
(i)
(b)
(c)
(9)
(Total: 20 marks)
60
MWL
You are currently in the planning phase of the audit of Mineral Water Limited (MWL) for
the year ended 30 June 2012. The following information is available to you:
Customer
Segment
Super
markets
Wholesalers
Retailers
Five star
hotels
No. of
Balance
Customers outstanding
12
20,014
10
10-20 21-30
days
days
days
Rs. in thousand
8,125
5,053
6,396
31-90
days
> 90
days
311
129
65
553
7
14,910
4,743
7,694
5,078
1,756
2,805
454
278
201
209
187
111
47,361 17,764 15,663 12,054 1,244
636
41
6,019
1,798
2,793
3,150
724
1,784
50% provision for doubtful debts has been made by MWL against balances
outstanding for more than 30 days whereas the balances outstanding for more than 90
days have been fully provided.
Required:
(a)
Indicate what would be the basis for selecting debtors for circularising positive
and negative requests for confirmations.
(6)
(b)
Briefly explain as to how you would deal with a situation where a debtor confirms
a balance which is different from the amount appearing in the confirmation
request.
(8)
(Total: 14 marks)
61
BPR
List the substantive procedures that may be performed by an auditor to verify the
following:
(a)
(6)
(b)
Payroll
(8)
(c)
(6)
(Total: 20 marks)
62
Taskeen Co
(a)
(b)
(i)
In the context of ISA 530 Audit sampling, explain and provide examples of
the terms sampling risk and non-sampling risk.
(4)
(ii)
42
Required:
Briefly explain each of the sample selection methods suggested by the audit
manager, audit senior and audit junior, and discuss whether or not they are
appropriate for obtaining a representative sample of sales invoices.
(9)
(c)
Define materiality and explain why the auditors of Taskeen Co must form an
opinion on whether the financial statements are free from material misstatement.
(5)
(Total: 20 marks)
63
Wings
Wings is an airline. The company owns some of its fleet of aircraft. Other aircraft are
leased from third parties. Wings has an internal audit function that has recently
expanded. Your firm is the external auditor to Wings. Your firm has been asked to
investigate the extent of which it may be able to rely on the work of internal audit in the
following areas:
The company outsources its in-flight catering and payroll functions to different service
organisations.
Required:
(a)
Explain why the work of internal auditors, in the three areas noted above, is likely
to be useful to you as the external auditor.
(9)
(b)
Explain how the quality of the internal audit function is likely to influence the
extent of your reliance on internal audit work.
(5)
(c)
Describe the audit evidence you will seek relating to internal controls over the
out-sourced functions (in-flight catering and payroll).
(6)
(Total: 20 marks)
64
Glasses2Go
ISA 230 Audit Documentation establishes standards and provides guidance regarding
documentation in the context of the audit of financial statements.
Required:
(a)
(3)
(b)
You have recently been promoted to audit manager in the audit firm of Sadia &
Co. As part of your new responsibilities, you have been placed in charge of the
audit of Glasses2Go, a long established audit client of Sadia & Co. Glasses2Go
sells spectacles; the company owns 42 stores where customers can have their
eyes tested and choose from a range of frames.
Required:
List the documentation that should be of assistance to you in familiarising
yourself with Glasses2Go. Describe the information you should expect to obtain
from each document.
(8)
43
(c)
The time is now towards the end of the audit, and you are reviewing working
papers produced by the audit team. An example of a working paper you have just
reviewed is shown below.
Client name: Glasses2Go
Year end: 30 April 20X3
Working paper: Payables transaction testing
Audit assertion: To make sure that the purchases day book is correct.
Method: Select a sample of 15 purchase orders recorded in the purchase
order system. Trace details to the goods received note (GRN), purchase
invoice (PI) and the purchase day book (PDB) ensuring that the quantities
and prices recorded on the purchase order match those on the GRN, PI
and PDB.
Test details: In accordance with audit risk, a sample of purchase orders
were selected from a numerically sequenced purchase order system and
details traced as stated in the method. Details of items tested can be found
on another working paper.
Results: Details of purchase orders were normally correctly recorded
through the system. Five purchase orders did not have any associated
GRN, PI and were not recorded in the PDB. Further investigation showed
that these orders had been cancelled due to a change in spectacle
specification. However, this does not appear to be a system weakness as
the internal controls do not allow for changes in specification.
Conclusion: Purchase orders are completely recorded in the purchase day
book.
Required:
Explain why the working paper shown above does not meet the standards
normally expected of a working paper.
Note: You are not required to reproduce the working paper.
(9)
(Total: 20 marks)
65
ISA 620
ISA 620 Using the work of an auditors expert contains guidance where the auditor uses
the work of an expert to provide knowledge relevant to the audit, which the audit firm itself
does not possess. Before the firm can rely on the work of the expert, ISA 620 requires the
firm to assess that work.
Required:
(i)
Set out FOUR examples of financial statement areas where the audit firm might
be likely to rely upon the work of an expert employed by the audit firm.
(2)
(ii)
Set out the main procedures an audit firm should apply before relying on the work
of such an expert.
(4)
(Total: 6 marks)
44
66
Cuddly World
You are the auditor of Cuddly World, a company which manufactures and sells small
cuddly toys by mail order. The company is managed by Mr Kabir and two assistants.
Mr Kabir authorises important transactions such as wages and large orders, one
assistant maintains the payables ledger and orders inventory and pays suppliers, and
the other assistant receives customer orders and despatches cuddly toys. Due to other
business commitments Mr Kabir only visits the office once a week.
At any time, about 100 different types of cuddly toys are available for sale. All sales are
made cash with order there are no receivables. Customers pay using credit cards
and occasionally by sending cash. Revenue is over Rs 5.2 million.
You are planning the audit of Cuddly World and are considering using some of the
procedures for gathering audit evidence recommended by ISA 500 as follows:
(1)
analytical procedures;
(2)
inquiry;
(3)
inspection;
(4)
observation;
(5) recalculation.
Required:
(a)
(b)
(5)
(ii)
(5)
Discuss the suitability of each procedure for Cuddly World, explaining the
limitations of each.
(10)
(Total: 20 marks)
67
(ii)
(iii)
(6)
Note: No marks will be awarded for showing the calculation of the ratio, all parts
carry equal marks.
(b)
45
68
Tahira Transporters
You are the external auditor of Tahira Transporters, a public limited company (TT). The
company's year-end is 11 March. You have been the auditor since the company was
formed 24 years ago to take advantage of the increase in goods being transported by
road. Many companies needed to transport their products but did not always have
sufficient vehicles to move them. TT therefore purchased ten vehicles and hired these
to haulage companies for amounts of time ranging from three days to six months.
The business has grown in size and profitability and now has over 550 vehicles on hire
to many different companies. At any one time, between five and 20 vehicles are
located at the company premises where they are being repaired; the rest could be
anywhere on the extensive road network of the country it operates in. Full details of all
vehicles are maintained in a non-current asset register.
Bookings for hire of vehicles are received either over the telephone or via e-mail in TT's
offices. A booking clerk checks the customer's credit status on the receivables ledger
and then the availability of vehicles using the Vehicle Management System (VMS)
software on TT's computer network. E-mails are filed electronically by customer name
in the e-mail program used by TT. If the customer's credit rating is acceptable and a
vehicle is available, the booking is entered into the VMS and confirmed to the customer
using the telephone or e-mail. Booking information is then transferred within the
network from the VMS to the receivables ledger programme, where a sales invoice is
raised. Standard rental amounts are allocated to each booking depending on the
amount of time the vehicle is being hired for. Hard copy invoices are sent in the post for
telephone orders or via e-mail for e-mail orders.
The main class of asset on TT's statement of financial position is the vehicles. The net
book value of the vehicles is Rs6 million out of total shareholders' funds of Rs15 million
as at 31 March 20X3.
Required:
(a)
List and explain the reason for the audit tests you should perform to check the
completeness and accuracy of the sales figure in TT's financial statements.
(10)
(b)
List and describe the audit work you should perform on the statement of financial
position figure for vehicles in TT's financial statements for the year ended 31
March 20X3.
(10)
(Total: 20 marks)
46
69
Willow
As a staff member of R and A Chartered Certified Accountants you are assigned to the
audit of tangible non-current assets of Willow for the year ended 31 March 20X3. R and
A have been the auditors of Willow for many years. You obtain the following schedule
of movements on property, plant and equipment and analysis of additions from the
companys accountant.
Property
Rs m
Cost or valuation
1 April 20X2
Additions
Disposals
Revaluations
31 March 20X3
Accumulated depreciation
1 April 20X2
Provision
Written back on disposal
Adjustment on revaluation
31 March 20X3
Carrying amount
31 March 20X3
31 March 20X2
Total
Rs m
340
120
460
275
123
(72)
326
615
123
(72)
120
786
24
5
(24)
213
30
(65)
178
237
35
(65)
(24)
183
455
316
148
62
603
378
Description
Cost
Rs m
New Models
55
Drill Suppliers
34
Hoist Co
18
Sundry below Rs 1m
16
123
The companys accountant also advises you that the property was revalued following a
valuation by the companys property manager who is a professionally qualified valuer.
During your verification of depreciation you discover that most plant and machinery is
fully depreciated. Moreover you discover that, due to oversight, depreciation has
continued to be provided on fully depreciated items. As at the beginning of the year the
amount of overstatement was Rs 43m. The accountant suggests the correction be
made by reducing the current years charge for depreciation.
47
Required:
(a)
State, with reasons, the initial audit procedures you would perform on the
schedules provided by the companys accountant.
(3)
(b)
Outline the substantive audit procedures you would apply in verifying additions to
plant and machinery. Your answer should identify procedures applicable to each
of the financial statement assertions.
(8)
(c)
(d)
70
Sparkle Forever
You are the audit manager in the firm of Dandy & Co, an audit firm with ten national
offices. One of your clients, Sparkle Forever, purchases diamond jewellery from three
manufacturers. The jewellery is then sold from Sparkle Forevers four shops. This is the
only client your firm has in the diamond industry.
You are planning to attend the physical inventory count for Sparkle Forever. Inventory
is the largest account on the statement of financial position with each of the four shops
holding material amounts. Due to the high value of the inventory, all shops will be
visited and test counts performed.
With the permission of the directors of Sparkle Forever, you have employed JJ, a firm
of specialist diamond valuers who will also be in attendance. JJ will verify that the
jewellery is, in fact, made from diamonds and that the jewellery is saleable with respect
to current trends in fashion. JJ will also suggest, on a sample basis, the value of
specific items of jewellery. Counting will be carried out by shop staff in teams of two
using pre-numbered count sheets.
Required:
71
(a)
List and explain the reason for the audit procedures used in obtaining evidence in
relation to the inventory count of inventory held in the shops.
(10)
(b)
Explain the factors you should consider when placing reliance on the work of UJ.
(5)
(c)
Describe the audit procedures you should perform to ensure that jewellery
inventory is valued correctly.
(5)
(Total: 20 marks)
Bubbles
Bubbles manufactures and distributes soft drinks. Its inventories are controlled using a
real-time system which provides accurate records of quantities and costs of inventories
held at any point in time. This system is known within the company as the 'Stockpop'
system and it is integrated with the purchases and sales system. Bubbles has an
internal audit department whose activities encompass inventories.
No year-end inventory count takes place Inventories are held in several large
warehouses where non-stop production takes place.
48
Your firm is the external auditor to Bubbles and you have been asked to perform the
audit of inventories, Inventories include finished goods and raw materials (water, sugar,
sweeteners, carbonating materials, flavourings, cans, bottles, bottle tops, fastenings
and packaging materials).
Your firm, which has several offices, wishes to rely on the 'Stockpop' system to provide
the basis of the figure to be included in the financial statements 'for inventories. Your
firm does not wish to ask the company to conduct a year-end inventory count.
Required:
(a)
Describe the audit tests that you would perform on the `Stockpop' system during
the year in order to determine whether to rely on it as a basis for the raw
materials and finished goods figures to be included in the financial statements.
(11)
Note: You are not required to deal with work in progress.
(b)
Describe the audit tests you would perform on the records held by Bubbles at the
year end to ensure that raw materials and finished goods are fairly stated in the
financial statements.
(9)
(Total: 20 marks)
72
ISA 500
ISA 500 Audit evidence identifies seven main testing procedures. One of these is
external confirmation.
Required:
(a)
(b)
(2)
(8)
(Total: 10 marks)
73
Javeria Co
Javeria Co has a significant number of cash transactions and recent non-current asset
purchases have been financed by a bank loan. This loan is repayable in equal annual
instalments for the next five years.
Required:
(a)
Explain the procedures to obtain a bank report for audit purposes from Javeria
Co.s bank and the substantive procedures that should be carried out on that
report.
(5)
(b)
List the further substantive procedures that should be carried out on the bank
balances in Javeria Co.s financial statements.
(5)
(Total: 10 marks)
49
74
Porridge
Porridge is a small manufacturing company of which your firm of Chartered Certified
Accountants is the external auditor. You have been assigned to the audit of trade
payables.
The audit file indicates that control risk for purchases and payments transactions is
assessed as slightly less than high because of limitations in the extent of segregation
of duties due to the small number of accounts personnel. There are no other identified
control problems or prior year audit problems.
Narrative notes on the accounting system contain the following descriptions.
Purchases of other goods and services are delivered directly to the requisitioning
department and no GINs are issued.
The accounts department checks suppliers' invoices with purchase orders, and
(b)
(c)
Outline substantive procedures you would apply in your audit of trade payables
relating to production department purchases.
(6)
(d)
a payables
(4)
(Total: 20 marks)
50
75
Trembridge Engineering
Your firm is the auditor of Trembridge Engineering, and you have been asked to
suggest the audit work you will carry out in verifying accounts payable and purchase
accruals at the company's year end of 30 September 20X3. You attended the inventory
count at the year end.
The company operates from a single site and all raw materials for production are
received by the goods inwards department. When the materials are received they are
checked for quantity and quality to the delivery note and purchase order, and a multipart goods received note is made out and signed by the storekeeper. If there are any
problems with the raw materials, a discrepancy note is raised which gives details of the
problems (e.g. incorrect quantities or faulty materials).
The purchase accounting department receive the purchase invoices, check them to the
purchase order and goods received note and post them to the purchase ledger. At the
end of each month, payments are made to suppliers. The purchase ledger is
maintained on a PC.
The main sundry payables and accruals at the year end include:
(i)
(ii)
(iii)
Required:
Describe in detail the audit work you will carry out to:
(a)
(b)
(c)
(8)
(5)
(7)
(Total: 20 marks)
76
ISA 620 Using the Work of an auditors Expert explains how an auditor may use
an expert to obtain audit evidence.
Required:
Explain THREE factors that the external auditor should consider when assessing
the competence and objectivity of the expert.
(3)
(b)
(c)
Auditors have various duties to perform in their role as auditors, for example, to
assess the truth and fairness of the financial statements.
Required:
Explain THREE rights that enable auditors to carry out their duties.
(3)
List FOUR assertions relevant to the audit of tangible non-current assets and
state one audit procedure which provides appropriate evidence for each
assertion.
(4)
(Total: 10 marks)
51
77
Heidi Co
Following a competitive tender, your audit firm Cal & Co has just gained a new audit
client Heidi Co. You are the manager in charge of planning the audit work. Heidi Co.s
year end is 30 June 20X3 with a scheduled date to complete the audit of 15 August
20X3. The date now is 3 June 20X3.
Heidi Co provides repair services to motor vehicles from 25 different locations. All
inventory, sales and purchasing systems are computerised, with each location
maintaining its own computer system. The software in each location is the same
because the programs were written specifically for Heidi Co by a reputable software
house. Data from each location is amalgamated on a monthly basis at Heidi Co.s head
office to produce management and financial accounts.
You are currently planning your audit approach for Heidi Co. One option being
considered is to re-write Cal & Co.s audit software to interrogate the computerised
inventory systems in each location of Heidi Co (except for head office) as part of
inventory valuation testing. However, you have also been informed that any computer
testing will have to be on a live basis and you are aware that July is a major holiday
period for your audit firm.
Required:
(a)
(b)
(i)
Explain the benefits of using audit software in the audit of Heidi Co;
(4)
(ii)
Explain the problems that may be encountered in the audit of Heidi Co and
for each problem, explain how that problem could be overcome.
(10)
SCENARIOS
78
Zeedin Co
Zeedin Co assembles fridges, microwaves, washing machines and other similar
domestic appliances from parts procured from a large number of suppliers. As part of
the interim audit work two weeks prior to the company year-end, you are testing the
procurement and purchases systems and attending the inventory count.
Procurement and purchases system
Parts inventory is monitored by the stores manager. When the quantity of a particular
part falls below re-order level, an e-mail is sent to the procurement department
detailing the part required and the quantity to order. A copy of the e-mail is filed on the
store managers computer.
52
Staff in the procurement department check the e-mail, allocate the order to an
authorised supplier and send the order to that supplier using Electronic Data
Interchange (EDI). A copy of the EDI order is filed in the order database by the
computer system. The order is identified by a unique order number.
When goods are received at Zeedin, the stores clerk confirms that the inventory agrees
to the delivery note and checks the order database to ensure that the inventory were in
fact ordered by Zeedin. (Delivery is refused where goods do not have a delivery note.)
The order in the order database is updated to confirm receipt of goods, and the
perpetual inventory system updated to show the receipt of inventory. The physical
goods are added to the parts store and the paper delivery note is stamped with the
order number and is filed in the goods inwards department.
The supplier sends a purchase invoice to Zeedin using EDI; invoices are automatically
routed to the accounts department. On receipt of the invoice, the accounts clerk checks
the order database, matches the invoice details with the database and updates the
database to confirm receipt of invoice. The invoice is added to the purchases database,
where the purchase day book (PDB) and suppliers individual account in the payables
ledger are automatically updated.
Required:
(a)
(b)
(c)
(d)
List SIX audit procedures that an auditor would normally carry out on the
purchases system at Zeedin Co, explaining the reason for each procedure. (12)
List FOUR audit procedures that an auditor will normally perform prior to
attending the clients premises on the day of the inventory count.
(2)
(i)
State the aim of a test of control and the aim of a substantive procedure. (5)
(ii) In respect of your attendance at Zeedin Co.s inventory count, state one
test of control and one substantive procedure that you should perform. (4)
On the day of the inventory count, you attended depot nine at Zeedin. You
observed the following activities:
1.
Pre-numbered count sheets were being issued to clients staff carrying out
the count. The count sheets showed the inventory ledger balances for
checking against physical inventory.
2.
All count staff were drawn from the inventory warehouse and were counting
in teams of two.
3.
Three counting teams were allocated to each area of the stores to count,
although the teams were allowed to decide which pair of staff counted
which inventory within each area. Staff were warned that they had to
remember which inventory had been counted.
4.
Information was recorded on the count sheets in pencil so amendments
could be made easily as required.
5.
Any inventory not located on the pre-numbered inventory sheets was
recorded on separate inventory sheets which were numbered by staff as
they were used.
6.
At the end of the count, all count sheets were collected and the numeric
sequence of the sheets checked; the sheets were not signed.
Required:
(i)
(ii)
List the weaknesses in the control system for counting inventory at depot
nine.
(3)
For each weakness, explain why it is a weakness and state how that
weakness can be overcome.
(9)
(Total: 35 marks)
53
79
Sahito Co
Introduction audit firm
You are an audit senior in Bachani & Co, a firm providing audit and assurance
services. At the request of an audit partner, you are preparing the audit programme for
the income and receivables systems of Sahito Co.
Audit documentation is available from the previous years audit, including internal
control questionnaires and audit programmes for the despatch and sales system. The
audit approach last year did not involve the use of computer assisted audit techniques
(CAATs); the same approach will be taken this year. As far as you are aware, Sahitos
system of internal control has not changed in the last year.
Client background sales system
Sahito Co is a wholesaler of electrical goods such as kettles, televisions, MP3 players,
etc. The company maintains one large warehouse in a major city. The customers of
Sahito are always owners of small retail shops, where electrical goods are sold to
members of the public. Sahito only sells to authorised customers; following appropriate
credit checks, each customer is given a Sahito identification card to confirm their
status. The card must be used to obtain goods from the warehouse.
Despatch and sales system
The despatch and sales system operates as follows:
1.
Customers visit Sahitos warehouse and load the goods they require into their
vans after showing their Sahito identification card to the despatch staff.
2.
3.
One copy of the GDN is sent to the accounts department, the second copy is
retained in the despatch department.
4.
Accounts staff enter goods despatch information onto the computerised sales
system. The GDN is signed.
5.
The computer system produces the sales invoice, with reference to the inventory
master file for product details and prices, maintains the sales day book and also
the receivables ledger. The receivables control account is balanced by the
computer.
6.
Invoices are printed out and sent to each customer in the post with paper copies
maintained in the accounts department. Invoices are compared to GDNs by
accounts staff and signed.
7.
Paper copies of the receivables ledger control account and list of aged
receivables are also available.
8.
Information on receivables
The chief accountant has informed you that receivables days have increased from 45
to 60 days over the last year.
54
Range of debt
receivables
15
Less than Rs 0
Total debt
Rs
(87,253)
Current Rs
1 to 2
months
old Rs
More than 2
months old
Rs
(87,253)
197
Rs 0 to Rs 20,000
2,167,762
548,894
643,523
975,345
153
Rs 20,001 to
50,000
5,508,077
2,044,253
2,735,073
728,751
1,495,498
9,084,084
750,235
3,256,129
23
388
Rs 50,001 or more
672,750
72,513
4,051,346
1,776,609
80
Explain the steps necessary to check the accuracy of the previous years internal
control questionnaires.
(4)
Using information from the scenario, list SIX tests of control that an auditor would
normally carry out on the despatch and sales system at Sahito Co and explain
the reason for each test.
(12)
(c)
State and explain the meaning of FOUR assertions that relate to the direct
confirmation of receivables.
(4)
(d)
(i)
(ii)
Bashir Co
Introduction
Bashir Co assembles specialist motor vehicles such as lorries, buses and trucks. The
company owns four assembly plants to which parts are delivered and assembled into
the motor vehicles.
The motor vehicles are assembled using a mix of robot and manual production lines.
The human workers normally work a standard eight hour day, although this is
supplemented by overtime on a regular basis as Bashir has a full order book. There is
one shift per day; mass production and around the clock working are not possible due
to the specialist nature of the motor vehicles being assembled.
Wages system shift workers
Shift-workers arrive for work at about 7.00 am and clock in using an electronic
identification card. The card is scanned by the time recording system and each
production shift-workers identification number is read from their card by the scanner.
The worker is then logged in as being at work. Shift-workers are paid from the time of
logging in. The logging in process is not monitored as it is assumed that shift-workers
would not work without first logging in on the time recording system.
Shift-workers are split into groups of about 25 employees, with each group under the
supervision of a shift foreman. Each day, each group of shift-workers is allocated a
specific vehicle to manufacture. At least 400 vehicles have to be manufactured each
55
day by each work group. If necessary, overtime is worked to complete the days quota
of vehicles. The shift foreman is not required to monitor the extent of any overtime
working although the foreman does ensure workers are not taking unnecessary or
prolonged breaks which would automatically increase the amount of overtime worked.
Shift-workers log off at the end of each shift by re-scanning their identification card.
Payment of wages
Details of hours worked each week are sent electronically to the payroll department,
where hours worked are allocated by the computerised wages system to each
employees wages records. Staff in the payroll department compare hours worked from
the time recording system to the computerised wages system, and enter a code word
to confirm the accuracy of transfer. The code word also acts as authorisation to
calculate net wages. The code word is the name of a domestic cat belonging to the
department head and is therefore generally known around the department.
Each week the computerised wages system calculates:
(i)
gross wages, using the standard rate and overtime rates per hour for each
employee,
(ii) statutory deductions from wages, and
(iii) net pay.
The list of net pay for each employee is sent over Bashirs internal network to the
accounts department. In the accounts department, an accounts clerk ensures that
employee bank details are on file. The clerk then authorises and makes payment to
those employees using Bashirs online banking systems. Every few weeks the financial
accountant reviews the total amount of wages made to ensure that the management
accounts are accurate.
Termination of employees
Occasionally, employees leave Bashir. When this happens, the personnel department
sends an e-mail to the payroll department detailing the employees termination date
and any unclaimed holiday pay. The receipt of the e-mail by the payroll department is
not monitored by the personnel department.
Salaries system shift managers
All shift managers are paid an annual salary; there are no overtime payments.
Salaries were increased in July by 3% and an annual bonus of 5% of salary was paid in
November.
Required:
(a)
(b)
(c)
(d)
56
COMPLETION
81
Analytical procedures
(a)
Analytical procedures are an important part of the audit process and a tool
which the auditor uses during the various phases of an audit.
Required:
(i)
(ii)
Describe the factors that the auditor needs to consider while designing
and performing analytical procedures as substantive procedures.
(4)
(iii)
(b)
82
Auditor responsibility
The auditor is required to issue an audit report at the end of the audit, which sets out
his opinion on the financial statements. An important element of the audit report is
the statement of auditors responsibility.
Required:
Narrate the matters that should be contained in the statement of auditors responsibility
as included in an audit report issued under ISA-700 The Independent Auditors Report
on a Complete Set of General Purpose Financial Statements.
(8)
83
Al-Badr
Al-Badr & Company, Chartered Accountants, have conducted the statutory audit of the
financial statements of Al-Qasim Limited, a listed company, for the year ended June
30, 20X3 under the requirements of the Companies Ordinance, 1984. The job in
charge has drafted the following audit report:
Auditors Report to the Directors
We have audited the annexed balance sheet of Al-Qasim Limited as at June 30, 20X3
and the related profit and loss account and statement of changes in equity together
with the notes forming part thereof, for the year then ended and we state that we have
obtained all the information and explanations which, to the best of our knowledge and
belief, were necessary for the purposes of our audit.
We conducted our audit in accordance with the auditing standards. These standards
require that we plan and perform the audit to obtain reasonable assurance about
whether the above said statements are free of any material misstatement. An audit
includes examining evidence supporting the amounts and disclosures in the above said
statements. An audit also includes assessing the accounting policies and all estimates
made by management, as well as, evaluating the overall presentation of the above said
statements. We believe that our audit provides a reasonable basis for our opinion and,
after due verification, we report that:
57
(a)
in our opinion:
(i)
the balance sheet and profit and loss account together with the notes
thereon have been drawn up in conformity with the Companies Ordinance,
1984, and are in agreement with the books of account and further in
agreement with accounting policies consistently applied;
(ii)
the expenditure incurred during the year was for the purpose of the
companys business;
and
(iii)
(b)
in our opinion and to the best of our information and according to the
explanations given to us, the balance sheet, profit and loss account and
statement of changes in equity together with the notes forming part thereof
conform with International Financial Reporting Standards, and give the
information required by the Companies Ordinance, 1984, in the manner so
required and respectively give a true and fair view of the state of the companys
affairs as at June 30, 20X3 and of the profit and changes in equity for the year
then ended; and
(c)
in our opinion, no zakat was deductible at source under the Zakat and Ushr
Ordinance, 1980 (XVIII of 1980).
Al-Badr & Company
Chartered Accountants
Karachi
Dated: September xx, 20X3
Required:
Identify and explain (where necessary) the errors in the above audit report.
(Note: You are not required to redraft the report.)
84
(Total: 12 marks)
58
disclosures in the above said statements. An audit also includes assessing the
accounting policies and significant estimates made by management, as well as,
evaluating the overall presentation of the above said statements. We believe that our
audit provides a reasonable basis for our opinion and, after due verification, we report
that:
(a)
in our opinion, proper books of accounts have been kept by the company.
(b)
in our opinion:
(i)
the balance sheet and profit and loss account together with the notes
thereon have been drawn up in conformity with the Companies Ordinance
1984, and are in agreement with the books of account and are further in
accordance with accounting policies consistently applied;
(ii)
the expenditure incurred during the year was in accordance with the objects
of the Company; and
(iii)
(c)
in our opinion and to the best of our information and according to the
explanations given to us, the balance sheet, profit and loss account, statement of
comprehensive income, cash flow statement and statement of changes in equity
together with the notes forming part thereof, on form with the approved
accounting standards as applicable in Pakistan and give the information required
by the Companies Ordinance, 1984, in the manner so required and respectively
give a true and fair view of the state of the Companys affairs as at 30 June 2012;
and
(d)
in our opinion, no zakat was deductible at source under the Zakat and Ushr
Ordinance, 1980.
Chartered Accountants
Date: 01 September 2012
Required:
Identify the errors in the above report vis--vis a standard statutory audit report
(Note: You are not required to redraft the report.)
(Total: 15 marks)
85
59
(10 marks)
86
87
60
The directors have refused to make a provision against the debt on the grounds
that the liquidator was appointed after the balance sheet date. They have also
refused to make any provision in respect of the work in process as they are
planning to sell the machinery being manufactured to another customer for Rs. 15.7
million.
The profit after tax of MIL is Rs. 85 million. The materiality level is 10% of profit
after tax.
(06)
(c) Swat Limited has invested Rs. 150 million in a business which is not mentioned in
the object clause of its Memorandum of Association. However, the object clause
was amended a week before the signing of the audit report.
(05)
Required:
In the light of the relevant requirements, discuss how should the auditor deal with the
above situations and describe the impact thereof on the audit report. (Total: 15 marks)
88
Hafiz Limited
You are the manager responsible for the audit of Hafiz Limited (HL), a listed company,
whose fieldwork in respect of the statutory audit is in progress. You are reviewing the
following issues which were brought to your attention by the audit team:
(i)
HLs parent company is registered in a foreign country and has asked your firm to
also provide an audit report on a separate set of financial statements which have
been prepared under the accounting framework prevalent in that country.
(05)
(ii)
Required:
Discuss how would you deal with each of the above issues and what may be the
implications thereof on your audit report.
(Total: 10 marks)
89
(b)
Give three examples each of circumstances which may necessitate the inclusion
of the following in the auditors report:
(i)
(03)
(ii)
(03)
(Total: 10 marks)
90
During the year the company has changed its policy of valuation of property,
plant and equipment from historical cost to revalued amount. For this purpose,
the services of Professional Valuers (Private) Limited were hired. They have
61
The company was sued for breach of contract by a customer claiming damages
of Rs. 10 million. The legal advisor has confirmed the managements assertion
that no liability existed at the balance sheet date. However, while reviewing the
customers files, you found an email from the Manager (Legal Department)
addressed to the Chief Executive in which he has opined that the company will
have to pay atleast 50% of the damages claimed.
(04)
(c)
With effect from 01 July 2010, the company has introduced a policy of providing
one year warranty on its television sets. No warranty is provided on the other
products. Sales of television sets aggregated Rs. 20 million, whereas the total
sales for the year amounted to Rs. 80 million.
(07)
The company has a customer support department which provides after sales services
on all products. For defects not covered under the warranty, the company bills the
customers at
25% above cost. The management has included a note in the draft financial statements
stating that no provision has been made in respect of the warranty, as the amount
cannot be measured reliably.
(d) The directors have decided not to disclose earnings per share as the same had
reduced significantly on account of issuance of 100% bonus shares. The disclosure
was however made in all previous financial statements.
(03)
Required:
Express your views on each of the above situations and discuss the impact thereof on
the audit report.
(Total: 20 marks)
91
Ranjha Limited
Ranjha Limited (RL), a listed company, is engaged in the manufacture of fast moving
consumer goods.
The draft financial statements for the year ended March 31, 2011 show a profit before
taxation of Rs. 12 million and total assets of Rs. 300 million.
As the audit manager, you are reviewing the following issues which were brought to
your notice by the audit team:
(i)
On June 1, 2010 RL acquired a plant at a cost of Rs. 50 million. The plant has a
useful life of 10 years with no residual value. RL follows the policy to depreciate
the plant on the straight line method. On January 1, 2011 the plant suffered
physical damage due to a fire in the factory. The technician from the
manufacturer has inspected the plant and reported that the damage has
affected its production capacity which has now been reduced by 30%.
(ii)
During the year a petition has been filed against RL by one of its customers for
recovery of Rs. 20 million, along with mark-up, damages and compensation, on
the ground that materials supplied by RL were defective. RL has filed a written
statement in the Court denying the allegations.
RLs legal advisor is of the view that the final liability of the company may range
from 0% to 50%.
However, at this point of time, it is not possible to determine the amount with
reasonable degree of accuracy. No provision in this regard has been made in the draft
financial statements.
62
(iii)
The management has decided to adjust the amount short provided, over the
remaining useful life of the software.
Required:
Discuss the matters that may be of significance to you as an auditor in respect of each
of the above issues. Also explain their implication on the audit report.
(12 marks)
92
Pervasive effects
(a)
Briefly explain the term pervasive effects on the financial statements. (04 marks)
(b)
As the engagement partner, you have reviewed the audit working papers of
Apricot Engineering Limited (AEL). The audit team has highlighted the following
matters in the working papers.
(i)
The company has issued a bank guarantee to one of its related parties
after the balance sheet date. No disclosure in this regard has been made in
the draft financial statements.
(ii)
AEL has paid a dividend after many years. Zakat has been appropriately
deducted and deposited in the Central Zakat Fund.
(iii)
Subsequent to the year end, a major debtor has declared bankruptcy. The
company expects to recover only 20% of the outstanding amount. The
management has refused to make a provision but is ready to disclose the
fact by way of a note.
(iv)
Required:
Discuss the impact of each of the above matters on your audit report.
93
(10 marks)
The auditor is required to issue an audit report at the end of the audit, which sets
out his opinion on the financial statements. An important element of the audit
report is the statement of auditors responsibility.
Required:
Narrate the matters that should be contained in the statement of auditors responsibility
as included in an audit report issued under ISA-700 The Independent Auditors Report
on a Complete Set of General Purpose Financial Statements.
(b)
Identify the situations in which an auditor may modify his report without affecting
his opinion. Also explain how such a modification should be presented in the
audit report.
63
94
95
(04)
96
(11)
64
97
Written representations
One of the objectives of obtaining a written representation from management is to
ensure that the management knows and acknowledges its responsibility for the
preparation of the financial statements and for the completeness of the information
provided to the auditor.
Required:
Specify the situations which may create doubts as to the reliability of written
representations. What course of action would the auditor take in such a situation? (7)
98
Shahrukh and Co
Shahrukh and Company, Chartered Accountants, have conducted the statutory
audit of the financial statements of Karim Limited, a listed company, for the year
ended 30 June 20X3 under the Companies Ordinance, 1984. The job in charge has
drafted the following audit report:
Auditors Report to the Members
We have audited the annexed balance sheet of Karim Limited (the Company) as at 30
June 20X3, and the related Income and Expenditure Account, Statement of
Comprehensive Income, Cash Flow Statement and Statement of Changes in Equity
together with the notes forming part thereof, for the year then ended and we state that
we have obtained all the information and explanations which were necessary for the
purposes of our audit.
It is the responsibility of the companys management to establish and maintain a
system of internal control and prepare and present the above said statements in
conformity with the approved auditing standards and the requirements of the fourth
schedule to the Companies Ordinance, 1984. Our responsibility is to audit these
statements.
We conducted our audit in accordance with the auditing standards as applicable in
Pakistan. These standards require that we plan and perform the audit to obtain
reasonable and limited assurance about whether the above statements are free of any
misstatement. An audit includes examining evidence supporting the amounts and
disclosures in the above said statements. An audit also includes assessing the
accounting policies and significant estimates made by management, as well as,
evaluating the overall presentation of the above said statements. We believe that our
audit provides a reasonable basis for our opinion and, after due verification, we report
that:
(a)
in our opinion, proper books of accounts have been kept by the company.
(b)
in our opinion:
(i)
(ii)
(iii)
(c)
the balance sheet and profit and loss account together with the notes
thereon have been drawn up in conformity with the Companies Ordinance
1984, and are in agreement with the books of account and are further in
accordance with accounting policies consistently applied;
the expenditure incurred during the year was in accordance with the objects
of the Company; and
the business conducted, investments made and the expenditure incurred
during the year were for the purpose of the Companys business;
in our opinion and to the best of our information and according to the
explanations given to us, the balance sheet, profit and loss account, statement of
comprehensive income, cash flow statement and statement of changes in equity
together with the notes forming part thereof, conform with the approved
accounting standards as applicable in Pakistan and give the information required
65
in our opinion, no zakat was deductible at source under the Zakat and Ushr
Ordinance, 1980.
Chartered Accountants
Date: 01 September 20X3
Required:
Identify the errors in the above report vis--vis a standard statutory audit report.
(12)
99
Kazmi-Wassan
You are the manager in charge of the audit of Kazmi-Wassan, a listed company which
manufactures specialist cars and other motor vehicles for use in films. Audited revenue
is Rs 140 million with profit before tax of Rs 7.5 million.
All audit work up to, but not including, the obtaining of written representations has been
completed. A review of the audit file disclosed the following outstanding points:
Tigers Purr
The company is facing a potential legal claim from the Tigers Purr company in respect
of a defective vehicle that was supplied for one of their films. Tigers Purr maintains that
the vehicle was not built strongly enough while the directors of Kazmi-Wassan argue
that the specification was not sufficiently detailed. Dropping a vehicle 50 metres into
the river and expecting it to continue to remain in working condition would be unusual,
but this is what Tigers Purr expected. Solicitors are unable to determine liability at the
present time. A claim for Rs 4 million being the cost of a replacement vehicle and lost
production time has been received by Kazmi-Wassan from Tigers Purr. The directors
opinion is that the claim is not justified.
Depreciation
Depreciation of specialist production equipment has been included in the financial
statements at the amount of 10% pa based on reducing balance. However, the
treatment is consistent with prior accounting periods (which received an unmodified
auditors report) and the companies in the same industry and sales of old equipment
show negligible profit or loss on sale. The audit senior, who is new to the audit, feels
that depreciation is being undercharged in the financial statements.
Required:
(a)
(b)
(c)
66
100 RK Resourcing
You are the auditor of RK Resourcing, a limited liability company which extracts,
refines and sells oil and petroleum related products.
The audit of RK Resourcing for the year ended 30 June 20X3 had the following events:
Date (20X3)
Event
15 August
21 September
22 September
1 November
23 November
30 November
Required:
(a)
(b)
15 August 20X3
1 November 20X3, and
30 November 20X3:
(i)
State whether the events occurring on those dates are adjusting or nonadjusting according to IAS 10 Events After the Reporting Period, giving
reasons for your decision.
(6)
Explain the auditors responsibility and the audit procedures that should be
carried out.
(9)
(ii)
Compare the responsibilities of the directors and auditors regarding the published
financial statements of Rake Enterprises.
(6)
An extract from the draft audit report produced by an audit junior is given below:
Auditors responsibility
'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
67
(10)
(Total: 16 marks)
REVIEW ENGAGEMENTS
102 ISRE 2400
(a)
Explain the meaning of assurance and give two examples of types of assurance
which can be provided, distinguishing between the two in terms of the level of
assurance offered by each of them.
(4)
(b)
ISRE 2400 Engagements to review financial information sets out the objective,
general principles and procedures to be applied to a review engagement.
Required:
Set out the main types of procedures which an accountant should perform when
carrying out a review engagement.
(4)
(Total: 8 marks)
103 Karim
Karim & Company, Chartered Accountants are engaged in the review of interim
financial information of Babar Textiles Mills Limited for the half year ended June 30,
20X3. The increase in oil and energy prices and current inflationary trend prevailing in
the country has resulted in substantial losses and the Companys outlook is negative.
Moreover, in view of recessionary pressures being faced by the US and many of the
EU economies, some of the large customers in those countries have not renewed their
orders and many others are expected to follow. Consequently, the company has
decided to lay off 40 percent of its workforce gradually, over the next few months.
The companys management acknowledges the severity of the situation but is
reluctant to provide specific details in the interim financial information. However, it has
given a note containing general indications about the future prospects of the company.
Required:
Describe how the auditor should address the above issue and the implications it may
have on the review report of interim financial information.
(9)
68
104 IFI
The auditor should have an understanding of the entity and its environment to enable
him to plan the engagement and select the inquiries, analytical and other review
procedures.
Required:
State the procedures which an auditor may perform, to update his understanding of the
entity and its environment, while carrying out an engagement to review interim financial
information.
(10)
69
70
SECTION
71
10
12
13
14
15
17
18
19
20
72
22
23
24
25
27
28
29
30
32
33
34
35
37
38
39
40
73
42
43
44
45
47
48
49
50
52
53
54
55
57
58
74
60
61
62
63
65
66
67
68
70
71
72
73
75
76
77
75
76
SECTION
Objectivity:
A chartered accountant should not allow bias, conflict of interest or undue
influence of others to override professional or business judgments.
Professional competence and due care:
A chartered accountant has a continuing duty to maintain the required
professional knowledge and skill to ensure that a client or employer
receives competent professional service based on current developments
in practice, legislation and techniques. A chartered Accountant should act
diligently and in accordance with applicable technical and professional
standards when providing professional services.
Confidentiality:
Confidential information acquired as a result of professional and business
relationships should not be disclosed to third parties without proper and
specific authority unless there is a legal or professional right or duty to
disclose. Confidential information acquired as a result of professional and
business relationships should not be used for personal advantage of the
chartered accountant or third parties.
77
Professional Behaviour:
A chartered accountant should comply with relevant laws and regulations
and should avoid any action that discredits the profession.
(ii) The threats to compliance with the fundamental principles may be
categorized as follows:
Self-interest threats:
These may occur as a result of the financial or other interests of a
chartered accountant or of an immediate or close family member.
Self-review threats:
These may occur when a current assignment requires re-evaluation of
the opinion previously expressed by the same chartered accountant.
Advocacy threats:
These may occur when a chartered accountant promotes a position or
opinion to the point that subsequent objectivity may be compromised.
Familiarity threats:
These may occur when, because of a close relationship, a chartered
accountant becomes too sympathetic to the interests of others.
Intimidation threats:
These may occur when a chartered accountant may be deterred from
acting objectively by threats, actual or perceived.
(b)
78
Levels of assurance
Reasonable assurance is a concept relating to the accumulation of the audit
evidence necessary for the auditor to conclude that there are no material
misstatements in the financial statements taken as a whole.
Whereas absolute assurance provides a guarantee that the financial statements are
free from material misstatements.
An audit carried out in accordance with ISAs is designed to provide reasonable
assurance that the financial statements taken as a whole are free from material
misstatement, whether due to fraud or error. In an audit-engagement, the auditor
provides a higher, but not absolute, level of assurance that the information subject to
audit is free of material misstatements.
An auditor cannot obtain absolute assurance because there are inherent limitations in
an audit that affect the auditors ability to detect material misstatements. These
limitations result from factors such as:
(i)
(ii)
The inherent limitations of any accounting and internal controls system (for
example, the possibility of collusion);
(iii)
The fact that most audit evidence is persuasive rather than conclusive.
the gathering of audit evidence, for example, in deciding the nature, timing
and extent of audit procedures; and
(ii)
Further, other limitations may affect the persuasiveness of evidence available to draw
conclusions on particular financial statement assertions (for example, transactions
between related parties)
Shamsuddin
(i)
As per the Code of Ethics for Chartered Accountants issued by ICAP, the
practicing chartered accountants are not allowed to publicize their services in
a manner as is done by other normal businesses.
Appropriate newspaper/magazine may be used to inform the public of the
establishment of a new practice. But such announcements should be limited
to a bare statement of facts giving due consideration to the appropriateness
of the area of distribution of the newspaper/magazine and number of
insertions.
What practicing members write or say should not be promotional of
themselves or their firm.
79
The Code of Ethics for Chartered Accountants issued by ICAP states that:
Chartered Accountants in practice should be careful not to quote fee lower
than that charged by the chartered accountants in practice previously
carrying out the audit unless scope and quantum of work materially differs
from the scope and quantum of work carried out by the previous auditor.
Keeping in view of the above, it is not advisable for Shamsuddin to accept
the audit unless the reduction in fee is on account of the reason discussed
above.
(iii)
As per the Code of Ethics for Chartered Accountants, issued by ICAP, the
professional fees should not be contingent upon the findings or results of
such services.
Condition imposed by Design Limited impairs the objectivity of the auditor on
account of self-interest threat. Therefore, Shamsuddin should not accept
such a proposal.
(iv)
Core concepts
(a) The managements responsibilities in relation to the financial statements
include the following:
The overall responsibility for the preparation and presentation of the
financial statements.
Identifying the financial reporting framework to be used in the preparation
and presentation of the financial statements.
Designing, implementing and maintaining internal controls relevant to the
preparation and presentation of financial statements that are free from
material misstatement whether due to fraud or error.
Selecting and applying appropriate accounting policies.
Making accounting estimates that are reasonable in the circumstances.
(b) Audit Scepticism
Audit scepticism is an attitude of professional scepticism which means that the
auditor should recognize the fact that circumstances may exist that may cause
the financial statements to be materially misstated. Consequently, he should
make a critical assessment with a questioning mind of the validity of audit
evidence obtained. He should remain alert to audit evidence that contradicts or
brings into question the reliability of documents and responses to inquiries and
the reliability of other information obtained from management and those
charged with governance.
80
Elaboration on the response of the audit manager that auditor should always
maintain an attitude of professional scepticism throughout the audit:
Although the auditor cannot be expected to disregard past experience of the
honesty and integrity of the entitys management and those charged with
governance, the auditors attitude of professional scepticism is particularly
important in considering the risks of material misstatement on account of
changes in circumstances.
Threats
Following are the categories of threats that may potentially affect the fundamental
principles:
(i)
Self-interest threats
This may occur as a result of the financial or other interests of a chartered
accountant or of an immediate or close family member.
A financial interest in a client or jointly holding a financial interest with a
client.
Undue dependence on total fees from a client.
Having a close business relationship with a client.
Concern about the possibility of losing a client.
Potential employment with a client.
Contingent fees relating to an assurance engagement.
A loan to or from an assurance client or any of its directors or officers.
(ii)
Self-review threat
This may occur when a previous judgment needs to be re-evaluated by the
chartered accountant responsible for that judgment.
The discovery of a significant error during a re-evaluation of the work of the
chartered accountant in practice.
Reporting on the operation of financial systems after being involved in their
design or implementation.
Having prepared the original data used to generate records that are the
subject matter of the engagement.
A member of the assurance team being, or having recently been, a director
or officer of that client.
A member of the assurance team being, or having recently been, employed
by the client in a position to exert direct and significant influence over the
subject matter of the engagement.
Performing a service for a client that directly affects the subject matter of the
assurance engagement.
81
(iii)
Advocacy threats
This may occur when a chartered accountant promotes a position or opinion to
the point that subsequent objectivity may be compromised.
Promoting shares in a listed entity when that entity is a financial statement
audit client.
Acting as an advocate on behalf of an assurance client in litigation or
disputes with third parties.
(iv)
Familiarity threats
This may occur when, because of a close relationship, a chartered accountant
becomes too sympathetic to the interests of others.
A member of the engagement team having a close or immediate family
relationship with a director or officer of the client
A member of the engagement team having a close or immediate family
relationship with an employee of the client who is in a position to exert direct
and significant influence over the subject matter of the engagement.
A former partner of the firm being a director or officer of the client or an
employee in a position to exert direct and significant influence over the
subject matter of the engagement.
Accepting gifts or preferential treatment from a client, unless the value is
clearly insignificant.
Long association of senior personnel with the assurance client.
(v)
Intimidation threats
This may occur when a chartered accountant may be deterred from action
objectively by threats, actual or perceived.
Being threatened with dismissal or replacement in relation to a client
engagement.
Being threatened with litigation.
Being pressured to reduce inappropriately the extent of work performed in
order to reduce fees.
(ii)
82
Safeguards:
As the Companies Ordinance, 1984, restricts a person who is indebted to the
company from being auditor of the said company, therefore the course of
action available to the partners of UCC is to withdraw from the engagement or
repayment of the loan by the partner concerned.
(b)
(i)
(ii)
(iii)
(iv)
(v)
(vi)
83
(b)
Audit process
(a)
(b)
The external audit has a long history that derives largely from the
separation of the ownership and management of assets. Those who own
assets wish to ensure that those to whom they have entrusted control are
using those assets wisely. This is known as the 'stewardship' function.
(ii)
(iii)
(iv)
The requirement for a statutory audit is a public interest issue: the public is
invited to invest in enterprises, it is in the interests of the capital markets
(and society as a whole) that those investing do so in the knowledge that
they will be provided with 'true and fair' information about the enterprise,
This should result in the efficient allocation of capital as investors are able
to make rational decisions on the basis of transparent financial information.
(v)
The requirement for an audit can help prevent investors from being
defrauded, although there is no guarantee of this because the external
audit has inherent limitations. Reducing the possibility of false information
being provided by managers to owners is achieved by the requirement for
external auditors to be independent of the managers upon whose financial
statements they are reporting.
(vi)
The interim audit generally involves risk assessment, the testing of internal
controls, and certain analytical and other substantive procedures. Many of
these procedures are often performed concurrently.
(ii)
84
(iii)
Final
(iv)
(v)
(vi)
Auditing standards
Both national and international bodies produce Auditing Standards.
International Standards on Auditing (ISAs) are produced by the
International Audit and Assurance Standards Board (IAASB), a committee
of the International Federation of Accountants (IFAC). IFAC is an
international organisation of professional accountancy bodies, including
ICAP.
National standard-setters are expected to aim for compatibility with ISAs as
far as possible and some (for example the UK) issue their own version of
ISAs. National accountancy bodies will then adopt all of the auditing
standards produced by their own standard setting body. Failure by auditors
to comply with auditing standards will then lend them open to disciplinary
action by their own accountancy body.
Local legislation will usually require recognised supervisory bodies to have
rules and practices as to the manner in which these standards are to be
applied in practice. Each supervisory body will adopt auditing standards in
order to meet local legislation and each body will be required to have
arrangements in place for the effective monitoring and enforcement of
compliance with those standards. Failure to apply relevant auditing
standards is a factor which a supervisory body will take into account when
deciding whether persons are fit and proper to be eligible for appointment
as company auditor.
85
(ii)
Fraud
Currently the responsibility within a company for the prevention and
detection of fraud rests with management. The auditor is not responsible for
preventing fraud but audit procedures should be designed to give the
auditor a reasonable expectation of detecting any material misstatements,
whether intentional or unintentional, in a companys financial statements.
(iii)
Non-audit services
There is no objection in principle to a practice providing non-audit services
but care must be taken not to perform management functions or make
management decisions. The key factor is that there is no conflict of interest
between audit and the other services provided.
Accountancy work, however, should not be performed for a public company
except in emergency situations. The scale and nature of such work should
be regularly reviewed.
In all cases in which a practice is concerned in the preparation of
accounting records for an audit client, the following safeguards should be
observed:
the client should accept responsibility for the records as its own;
the practice should make appropriate audit tests even where it has
processed or maintained certain records.
Other types of non-audit work such as valuation services and internal audit
services are prohibited where the management threat or self-review threats
are too great.
Local legisalation will also usually provide that an auditor may not be an
officer or employee of a client company. Thus it is necessary for the auditor
to ensure that he does not make executive decisions.
(iv)
Duration of appointment
Local legislation usually provides that a company shall at each general
meeting appoint an auditor to hold office from the conclusion of that
meeting until the conclusion of the next general meeting at which accounts
are laid. Although the ICAP Code does not specifically deal with the length
of audit appointments it recognises that using the same senior personal on
an engagement over a long period of time may create a familiarity threat.
Safeguards might include rotating senior staff or review by an independent
party.
(b)
Auditing standards
ISAs are set by the IAASB whose members are mainly drawn from the
members of the auditing profession. The local disciplinary procedures
applied against an auditor for non-compliance with an auditing standard are
enforced by the professional bodies of accountants. Thus politicians have
criticised this self-regulatory procedure believing it to be open to abuse and
lacking independence. The argument put forward is that auditing standards
should be set by an independent body.
86
(ii)
Fraud
It is quite apparent from the press and audit research that the public believe
that the auditor should and in fact does search for fraud during the conduct
of an audit. In view of the scandals over the years, the public expectation of
the extent of an audit has increased. The public finds it difficult to accept
that an auditor has no responsibility for the detection and reporting of fraud,
especially when one sees the high social cost of recent scandals.
(iii)
Non-audit services
Audit firms do not act exclusively in the capacity of auditors for their clients.
Audit work is in some cases, not the main business of audit firms. Auditors
provide many other services to their clients including tax advice, brand
name valuation and recruitment advice. Audit firms are dependent upon the
fees earned from non-audit services, and this dependency can affect the
auditors attitude to the audit. If an audit firm loses the audit, the financial
loss to the auditors can be significantly more than just the audit fee if he
provides other services to the client.
(iv)
Duration of appointment
It has been argued that the long-term nature of the company audit
engagement can lead to a loss in auditor independence due to an
increasing familiarity with the companys management. In many countries
the audit appointment has to be terminated after a fixed number of years. If
the audit appointment was for a fixed maximum period, then auditors would
not be under the same pressure to maintain their client base if they know
that their relationship with the company was for a limited period, and that
audit appointments would be rotated.
10
Fundamental principles
Fundamental principles
Integrity. A professional accountant should be honest and straightforward in performing
professional services.
Objectivity. A professional accountant should be fair and not allow personal bias,
conflict of interest or influence of others to override objectivity.
Professional competence and due care. When performing professional services, a
professional accountant should show competence and duty of care by keeping up-todate with developments in practice, legislation and techniques.
Confidentiality. A professional accountant should respect the confidentiality of
information acquired during the course of providing professional services and should
not use or disclose such information without obtaining client permission.
Professional behaviour. A professional accountant should act in a manner consistent
with the good reputation of the profession and refrain from any conduct which might
bring discredit to the profession.
11
Oops
Confidential information
General rules
Information obtained during an audit is normally held to be confidential; that is it will not
be disclosed to a third party.
87
However, these rules are general principles only; more detailed guidance is also
available to accountants, as explained below.
ICAPs Code of Ethics and Conduct obligatory disclosure
As noted above, ICAPs Code of Ethics and Conduct confirms that when a member
agrees to work for a client in a professional capacity, it is an implied term of that
agreement that the member will not disclose a clients affairs to any other person.
The recognised exceptions to this rule are where a member knows or suspects that his
client has committed treason, or is involved in drug trafficking or terrorist offences. In
these situations, information must be disclosed to a competent authority. The actual
disclosure will depend on the laws of the jurisdiction where the auditor is located.
The auditor may also be obliged to provide information where a court demands
disclosure. Refusal to provide information is likely to be considered contempt of court
with the auditor being liable for this offence.
ICAP Code of Ethics and Conduct voluntary disclosure
A member may also disclose client confidential information voluntarily, that is without
client permission, in a limited number of situations.
12
To protect a members interests e.g. to allow a member to sue a client for unpaid
fees or defend an action for negligence.
Where there is a public duty to disclose e.g. the client has committed an action
against the public interest such as unauthorised release of toxic chemicals.
13
(i)
External auditors are unable to fulfil their duties to shareholders if they are not
independent of the entity on which they are reporting.
(ii)
If external auditors have an interest in the financial statements on which they are
reporting, they may not be objective. For example, if, in the case of a listed
company, they have prepared the financial statements on which they are
reporting, their view may not be considered objective.
(iii)
(iv)
If they provide a significant level of additional services to the entity, some argue
that they cannot report objectively as auditors to shareholders.
The main problem for the auditors will be gaining sufficient evidence to
determine whether any amounts should be provided for and/or disclosed in
the financial statements of the two companies.
88
14
(ii)
The lawyers refuse to provide anything other than informal evidence and
this will almost certainly not be sufficient to form an audit opinion.
(iii)
(iv)
It may be possible for the auditors to suggest to the companies that it would
be very helpful for the lawyers to provide some indication as to their view of
the likely outcome and the amounts involved, in order to avoid a modified
opinion.
(v)
The auditors should also take note of the progress of any legal proceedings
and any proceedings that may be instigated by the public health authorities
as such authorities might impose significant fines, and they might even
close the businesses down, which has implications for the going concern
status of both.
(vi)
The auditors may also seek written representation under ISA 580 from the
management about the likely outcome of the case to be obtained.
Saad Co
(a) Ethical threat
Mr Sher, the engagement partner has Mr Sher should be rotated from being
been involved with the client for the last engagement partner. He can still contact
nine years.
the client but should not be in the
This means he may be too familiar with position of signing the audit report.
the client to be able to make objective
decisions due to this long association.
There is no ethical rule which stops Mr
Sher recommending Zhura for the audit,
or letting Zhura take part in the audit,
providing Zhura has the appropriate
skills. If she does not have the
appropriate skills then there could be a
breach of the need for an audit team to
demonstrate professional competence
and due care.
89
15
Alpha
(i)
The firm is not qualified for appointment as auditor of Safe Bank because it is
indebted to the bank.
The firm may accept appointment by terminating the lease agreement and
reducing the credit card balance to Rs 500,000.
(ii)
The firm is not qualified for appointment as auditor of PCL as one of the firms
partners had been a director of PCL during the past three years.
There is no way for the firm to accept the appointment except that the partner
resigns from the firm.
(iii)
16
The form and content of audit engagement letters may vary from client to client,
but they would generally include reference to:
The fact that because of the test nature and other inherent limitations of
an audit, together with the inherent limitation of internal control, there is
an unavoidable risk that even material misstatements may remain
undiscovered.
(b)
90
17
Shahid Corporation
(a)
Whether the firm and the engagement team can comply with ethical
requirements
(b)
18
For example, a client may have started to expand its business operation into an
area where the firm does not possess the necessary knowledge or expertise.
The auditor may decide not to send a new engagement letter for each period.
However, under the following situation it may be appropriate to send a new
engagement letter:
Any indication that the client misunderstands the objective and scope of
the audit
Assertions
(a)
(i)
(ii)
91
(b)
(c)
Analytical procedures.
The auditors assessment of materiality and audit risk at the planning stage may
change later i.e. at the time of evaluating the results of audit procedures, on
account of the following:
change in circumstances
because the auditor may have intentionally set the materiality at a lower
level, to reduce the likelihood of undiscovered misstatement and hence
provide a margin of safety.
(i)
(ii)
(iii)
92
19
20
The appointment of Farrukh & Co. will be in order because the firm would not
be considered indebted to the company as the period for which the utility dues
are unpaid does not exceed 90 days.
(b)
(ii)
Directors have lost their authority to appoint external auditors after the
expiry of 60 days from date of incorporation.
(c)
Syed & Co. shall not be appointed as auditor of the company because his
spouse holds shares in its associated company. However, the firm can be
appointed as auditor of Fazal Limited if the spouse of the partner disinvests the
shares within 90 days of appointment.
(d)
(e)
ASPL
(a) (i)
(ii)
(iii)
(i)
(b)
93
(iii)
21
AMF
(a) Areas of Inherent Risk
(i)
Donations
Donations may fall, especially where donors own income is limited or
declining, or there is a change in the circumstances.
No control over the completeness of donations (especially over the cash
donations).
(ii) Expenses
Donations are spent outside the aims and objectives of AMF.
Donations are not spent in accordance with donors instructions.
(b) Effect on the audit approach
(i)
It is difficult to estimate that income in the future will be sufficient to meet the
expenditure of the AMF. Audit of the going concern concept (as in ensuring
that the AMF can still operate) will therefore be quite difficult.
(ii) Audit tests are unlikely to be effective to meet the assertion of completeness.
The audit report may need to be modified and qualified to explain the lack of
evidence stating that completeness of income cannot be confirmed.
(iii) Careful review of expenditure will be necessary to ensure that expenditure is
not ultra vires the objectives of the AMF. The auditor will need to review the
trust deed and other documents of the AMF carefully in this respect.
(iv) The use of donations received for specific purposes would have to be
checked to ensure that instruction of donors has been followed.
94
22
23
SPL
(a)
(b)
(ii)
In order to establish whether the preconditions for an audit are present, we will:
(i)
(ii)
to provide us with
x
95
(c)
If a precondition for an audit is not present, the matter would be discussed with
the management. Unless required by law or regulation to do so, we will not
accept the proposed audit engagement, if the pre-conditions are not met.
However, if the financial reporting framework is prescribed by law or regulation
and it would have been unacceptable but for the fact that it is prescribed by law
or regulation, the audit engagement will be accepted only if the following
conditions are met:
(i)
(ii)
Our opinion on the financial statements will not include such phrases
as "present fairly, in all material respects," or "give a true and fair
view" unless it is expressively required to be stated under the law or
regulation.
If the above conditions are not present and still we are required by law or
regulation to undertake the audit engagement, we shall:
24
(i)
(ii)
(i)
(ii) The firm would not be deemed indebted to the company as the amount of
debt is not exceeding Rs. 500,000.
(b)
(i)
(ii) Banana Limited and Water Melon Limited are not associated companies as
the common director is a Government nominee.
96
(c)
(i)
(ii)
(iii) The fact that 40% of the shareholding is owned by Blue Black Limited does
not disqualify Mr Zaheer as the auditor of LPL.
25
(d)
Before accepting the offer Walnut and Company, Chartered Accountants, apart
from obtaining professional clearance from the existing auditor is also required to
inform the ICAP (Institute) and obtain prior clearance from the Institute.
(e)
(i)
(ii)
(iii)
(ii) Allows the engagement team members to exchange information about the
business risks to which the entity is subject to and about how and where the
financial statements might be susceptible to material misstatement, due to
fraud or error.
(iii) Assists the engagement team members to gain a better understanding of
the potential for material misstatement in the areas assigned to them.
(iv) Develop an understanding; about the results of the audit procedures that
they perform on specific areas may affect other aspects of the audit
including the decisions about the nature, timing and extent of further audit
procedures.
(v) Provides a basis upon which engagement team members communicate and
share new information obtained throughout the audit that may affect the
assessment of risks of material misstatement or the audit procedures
performed to address these risks.
(b)
(i)
97
(2)
(3)
(4)
26
(1)
(2)
Dynamic
The prospective audit risks are as follows:
Overstatement of Debtors:
Average period for outstanding debtors has reached to four months which is
indicative of a risk of inadequate provision against doubtful debts.
Overstatement/ Understatement of Inventories:
The inventories turnover rate has decreased to 3 times per year from 5 times in 20X1.
It is indicative of the following types of risks:
(a)
Obsolescence of inventories.
(b)
98
27
Changing terms
(a)
(b)
(c)
(ii)
(iii)
(ii)
(iii)
28
(i)
Withdraw from the audit engagement where possible under applicable law
or regulation; and
(ii)
EL
Key Components of Audit engagement letter:
Reference to the expected form and content of any reports to be issued by the
auditor and;
A statement that there may be circumstances in which a report may differ from
its expected form and content.
99
29
Calm Co
Risk assessment procedures
(i)
Purpose
The main purpose of risk assessment procedures is to help the auditor
obtain an understanding of the audit client.
The procedures will provide audit evidence relating to the auditors risk
assessment of a material misstatement in the clients financial statements.
The auditor will also obtain initial evidence regarding the classes of
transactions at the client and the operating effectiveness of the clients
internal controls.
Finally, the auditor may identify risks in other areas such as being
associated with a particular client or not being able to follow ethical
guidelines of ICAP.
(ii)
30
Azam
(a)
Charities such as Azam can be viewed as inherently risky because they are
often managed by non-professionals and susceptible to fraud. In Azams
case inherent risk is likely to be high as there is no full-time accountant and
volunteers are used to raise funds.
(ii)
(iii)
Azams small size also reduces the opportunity for segregation of duties
and thus increases control risk and susceptibility to fraud.
(iv)
(v)
Azam is likely to have a high level of control risk because formal internal
controls are expensive and unlikely to be in place. This means that
donations are susceptible to misappropriation and Azam will have had to
rely heavily on the trustworthiness of volunteers.
(vi)
Inherent risk is also increased due to the fact that Azam has not been
audited previously which could lead to a greater risk of misstatement of
opening balances.
100
Detection risk
(vii) Detection risk comprises sampling risk and non-sampling risk. It is possible
with Azam that all transactions will be tested and therefore sampling risk
(the risk that samples are unrepresentative of the populations from which
they are drawn) eliminated.
(viii) Non-sampling risk is the risk that auditors will draw incorrect conclusions
because, for example, mistakes are made, or errors of judgement are made
in interpreting results, or because the auditors are unfamiliar with the client.
As this is Azams first audit non-sampling risk is increased.
Audit risk
(ix)
(b)
Audit risk is the product of inherent risk, control risk and detection risk that
the auditors will issue an inappropriate audit opinion. This risk can be
managed by decreasing detection risk by altering the nature, timing and
extent of audit procedures applied. As inherent risk is high and controls
likely weak (as is likely to be the case with Azam) more audit work will be
performed in appropriate areas in order to reduce audit risk to an
acceptable level by reducing detection risk.
(ii)
Perform cash counts at the events to provide evidence that cash has been
counted correctly and that there is no collusion between volunteers to
misappropriate funds.
(iii)
(iv)
(v)
Review the income and expenditure of fund raising events against any
budgets that have been prepared and investigate any significant
discrepancies.
(vi)
(vii) Obtain representations from the trustees to the effect that there are no
outstanding unrecorded liabilities for such events again for completeness
of expenditure and liabilities.
101
31
Hurricane
(a)
(b)
So that attention is devoted to the important areas of the audit. Planning will
also help to identify problem areas so they can be addressed in a timely
fashion.
Audit strategy
Client:
Hurricane
Interim audit
Final audit
102
This is the first year that International Standards on Auditing (ISAs) are relevant
to this company. A detailed check will be required to ensure that no changes are
required to the audit plan.
The overall audit approach will be to use tests of control where possible.
However, the fall in gross profit indicates that sales may be understated or cost of
sales (COS) overstated, so additional substantive procedures may be required in
this area.
Materiality determination
Materiality will initially be set at to 1% of revenue as this figure appears to be
more accurate than gross profit.
Materiality on the statement of financial position will be based on net asset
values.
Performance materiality will be set for specific areas.
Identification of risk areas with a higher risk of misstatement
A review of the draft financial statements for the company shows the following
risks:
Sales have increased by 12% but COS by 19%. There is a risk of COS
being overstated.
Non-current assets have fallen by Rs. 900m, which is significant given that
most non-current assets are land and buildings. The reason for sale must
be ascertained.
Non-current liabilities have also fallen by Rs1 billion. While not necessarily
linked to the fall in non-current assets, there is a possibility that non-current
assets have been sold to pay off the liabilities.
Test count inventory at the year end and agree to the computerised
inventory records (and vice versa) to test their accuracy. Note that the client
will not be counting inventory at the year end but relying on the
computerised system.
Test check bookings into and out of inventory from the purchases and sales
systems.
103
32
The client appears to be a going concern, although the fall in gross profit
must be investigated. Cash and profit forecasts for the next 12 months
must also be obtained to confirm ongoing profitability and that the fall in
cash balances will not continue.
Zakir Co
(a)
(i)
(ii)
(iii)
104
(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 income 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 20X3. 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 balance sheet extract.
(c)
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 your
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.
105
33
Hajira
(a)
Audit risk
Audit risk is the risk that an auditor gives an inappropriate opinion on the financial
statements being audited.
Inherent risk is the susceptibility of an assertion to a misstatement that could be
material individually or when aggregated with misstatements, assuming that there
are no related controls. The risk of such misstatement is greater for some
assertions and related classes of transactions, account balances, and
disclosures than for others.
Control risk is the risk that a material error could occur in an assertion that could
be material, individually or when aggregated with other misstatements, will not be
prevented or detected on a timely basis by the companys internal control
systems.
Detection risk is the risk that the auditors procedures will not detect a
misstatement that exists in an assertion that could be material, individually or
when aggregated with other misstatements.
(b)
106
(c)
107
34
Tahir Co
(a)
(b)
Review GAAP to ensure that there are no exceptions for aviation fuel or
inventory held for emergency purposes which would suggest a market
valuation should be used.
Discuss the matter with the directors to obtain reasons why they believe
that market value should be used for the inventory this year.
Warn the directors that in your opinion, aviation fuel should be valued at the
lower of cost or net realisable value (that is Rs.150/barrel) and that using
market value will result in a modification to the audit report.
If the directors will not amend the financial statements, quantify the effect of
the disagreement in the valuation method the sum of Rs.6.3m is material
to the financial statements as Tahir Co.s income statement figure is
converted from a profit to a loss of Rs.1.3m although net assets decrease
by only about 03%.
If the directors will not amend the financial statements, draft the relevant
sections of the audit report, showing a qualification on the grounds of
disagreement with the accounting policy for valuation of inventory.
(i)
108
Therefore, in reaching the audit opinion and performing audit work, the
external auditor takes into account the concept of materiality. In other
words, the external auditor is not responsible for checking all the
transactions. Audit procedures are planned to have a reasonable likelihood
of identifying material fraud.
Discussion among the audit team
A discussion is required among the engagement team placing particular
emphasis on how and where the entitys financial statements may be
susceptible to material misstatement due to fraud, including how fraud
might occur.
Identification of fraud
In situations where the external auditor does detect fraud, then the auditor
will need to consider the implications for the entire audit. In other words, the
external auditor has a responsibility to extend testing into other areas
because the risk of providing an incorrect audit opinion will have increased.
(ii)
(iii)
109
35
Controls
(a)
(b)
On account of the following factors, the auditor may decide, not to rely on
audit evidence obtained in prior audits:
Control Environment:
The control environment includes the attitudes, awareness and actions
of management and those charged with governance concerning the
entitys internal control and their importance in the entity.
(ii)
(iii)
110
Monitoring of Controls:
Managements monitoring of controls includes considering whether they
are operating as intended and that they are modified as and when
appropriate.
36
Shahzad
(a) The components of internal controls are as follows:
(i)
Control environment:
The control environment includes the attitudes, awareness and actions of
management and those charged with governance concerning the entitys
internal control and their importance in the entity.
(ii)
Monitoring of controls:
It is a process of assessing the design and operation of controls on a timely
basis and taking necessary corrective actions on account of change in
conditions.
(b) Following weaknesses in inventory count are identified from audit seniors
observations:
(i)
(ii)
(iii)
111
(v)
37
Waheed Engineering
(a)
(b)
(c)
Control
Purpose
To prevent loss/theft.
(ii)
Employees not listed on the second payroll should have left during the year
and employees not listed on the first payroll should have started during the
period.
(iii)
(iv)
Also tax authority official forms should confirm departure and start dates.
The main reason for carrying out this exercise is to ensure that all
employees are bona fide i.e. payments are being made to authorised
employees.
Before attendance I will review the payroll to ensure that a pay packet
exists for all employees.
(ii)
Each employee should sign for the pay package when they collect it. As
they sign, the auditor should verify the signature to the contract of
employment.
(iii)
It should be ensured that no one employee collects more than one pay
packet.
112
(d)
(e)
38
(iv)
All unclaimed wages should be listed; the payroll date, name and amount
noted.
(v)
The unclaimed wages should then be stored in the safe until collected.
(ii)
(iii)
After a certain period, say a month, all unclaimed wages should be returned
to the bank so the details for each pay package should be agreed from the
unclaimed wages book to the banking slip.
(iv)
(ii)
(iii)
The finance directors could be asked to sign a copy of the payroll to verify
that all the employees are bona fide.
(iv)
(v)
Danish
(a)
(ii)
(iii)
(iv)
(v)
All of the problems noted above are likely to be exacerbated where local
managers or staff are either inexperienced or possibly dishonest the
question states that poorer quality staff have been recruited recently.
113
(vi)
(ii)
(iii)
114
(iv)
39
Roses Anytime
(a)
Key procedures
(i)
(ii)
Walk-through tests
The purpose of walk-through tests is for the auditors to establish that their
recording of the accounting and internal control system is adequate.
Auditors trace a number of transactions from source to destination in the
system, and vice versa. For example, customer orders can be traced from
the initial documentation recording the order, through to the related entries
in the daybooks and ledgers.
It is common for walk-through tests to be performed at the same time as
tests of controls, where auditors are reasonably confident that systems are
recorded adequately.
(iii)
Audit sampling
Auditors perform tests of controls and tests of detail on a sample basis in
order to form conclusions on the populations from which the samples are
drawn.
It is not possible in anything but the very smallest of entities to take any
other approach, as testing 100% of a population may be impractical, not
cost effective and not accurate because populations are too large and
because of human error.
115
(v)
(b)
Internal controls
(i)
The computer system should apply the credit limits set by the credit
controller and the system should reject any orders that exceed
customer credit limits at the point at which the order is taken, so that
the customer can be advised. Any override of credit limits should be
authorised by the credit controller.
116
(ii)
40
From time to time, there should be a check to ensure that the credit
limits within the system are being properly calculated and properly
applied to individual transactions. Similar considerations apply to
prices maintained within the system.
The computer system should also reject any order for which there are
no Roses available so that orders cannot be taken for Roses that
cannot be delivered.
There should be controls in place to deal with credit notes and other
discrepancies involving the price, type or quality of Roses delivered in
order to maintain the accuracy of records and customer goodwill.
Collection of cash
Trade Receivables
(a)
Where internal controls are weak, the errors that occur may include the
issue of invoices and credit notes for the wrong amounts, the issue of
invoices and credit notes to the wrong customers, the incorrect recording of
invoices, credit notes, cash and contras in the ledgers and daybooks, and
the incorrect setting of credit limits.
(ii)
Where internal controls are weak, invoices, credit notes cash and contras
may simple go unrecorded.
(iii)
The effect of this will be that receivables may be under or over-stated in the
records and that the company will not receive that money that is due to it,
or that goodwill with customers is damaged.
(iv)
117
(c)
No internal control system is perfect and all internal control systems are
subject to inherent weaknesses. This means that auditors can never rely
on the proper operation of the internal control systems alone. Even if their
tests show that the system appears to be working perfectly, it will be
necessary to perform some substantive testing.
(ii)
(iii)
(iv)
Fraudulent collusion can happen both within the company and outside the
company. Those who have the right to authorise the issue of credit notes
may authorise false credit notes for customers who are their friends. Those
who have access to cash and the receivables records may collude to
misappropriate cash, and make entries in the accounting records to hide
the misappropriation. This is sometimes known as teeming and lading.
(ii)
(iii)
(iv)
The issue of statements to customers at the end of each month (from the
ledger) showing how much is owed by the customer.
(v)
Arithmetical and accounting controls over the issue of invoices and credit
notes, some of which may be computerised, in order to ensure that they are
calculated correctly in accordance with authorised prices.
(vi)
The use of batch and hash totals, document counts and sequence checks
in the input of transactions into the computer system to ensure
completeness and accuracy.
(vii) The appointment of a credit controller who limits the credit available to
customers, together with restricted access to those sections of the system
that contain credit limits.
(viii) The use of exception reporting to highlight overdue accounts and accounts
where the credit limits have been exceeded, together with a system for
investigating and dealing with such accounts.
(ix)
The regular review by the financial controller of amounts receivable and the
independent authorisation of the write-off of bad debts.
118
(d)
41
(ii)
If the auditors tests showing that internal controls are operating properly,
the volume of substantive testing on transactions and balances can be
reduced.
(iii)
Granger
(a)
(i)
Possible
misstatement
Reassignment
Checking the
numerical continuity of
invoices, determining
the total cash sales
and entering the cash
receipts journal.
This should be
assigned to Clerk 1.
(See additional
procoedure 1.)
An invoice could be
deliberately omitted
and the subsequent
cash receipt
misapprpriated if done
by the same person.
Errors, such as
transaction errors,
made in entering the
sales journal are likely
to be repeated in
entering the accounts
receivable ledger.
Cash receipts could be
temporarily
misappropriated and
the shortgage
119
Function to be
reassigned
Possible
misstatement
concealed by delaying
recording the receipt.
(See the answer to
part (b)).
Reassignment
If payments by
customers have been
misappropriated and
not credited to the
customer account,
customers suspicions
would not be aroused
by chasing apparent
overdue balances.
Reconciling accounts
receivable with the
control account in the
general ledger.
120
(ii)
(b)
(i)
2.
3.
4.
5.
Control all cash funds until completion of the count to prevent cash
from a counted fund being transferred to an uncounted fund to
conceal a deficiency.
Count funds in the presence of the custodian to prevent any
suggestion, in the event of a shortage, that the funds were complete
when released to the auditors.
List each item in the fund, such as the denominations of notes, details
of cheques and, for petty cash funds, of vouchers so that the count
can subsequently be agreed with the deposit slip and other
accounting records.
(ii)
121
42
Nobel
The audit evidences which may be gathered in the cases referred to in the question
are as follows:
(i)
(ii)
43
Legal Opinion.
The terms and conditions of the contract related to defective material and
liability thereof.
Industry standards.
Masoom Limited
Using the work of an expert
An auditor may need the opinion of an expert on matters which require professional
expertise, other than accounting and audit.
Example of such circumstances are:
Legal opinions.
Obtain sufficient appropriate audit evidence that the scope of the experts work
is adequate;
Resolve the inconsistency, if any, between results of the expert and other audit
evidence.
122
44
Sky blue
The investigation of unusual fluctuations and relationships ordinarily begins with
inquiries of management, followed by:
45
(a)
(b)
Direct confirmations 1
(a)
(b)
(c)
(ii)
(iii)
(iv)
123
46
Chill
When planning to use the report the auditor should evaluate the professional
competence of the expert.
This will involve considering the experts:
Experience and reputation in the field in which the auditor is seeking audit
evidence.
The auditor should also evaluate the objectivity of the expert. The risk that the
experts objectivity will be impaired increases when the expert is in some way
related to or dependent on the entity.
47
Sales sampling
(a)
(i)
(ii)
By product
Geographically
124
(b)
48
when there is a significant risk and other means do not provide sufficient
appropriate audit evidence; or
PQR
(a)
For the purpose of determining the extent of reliance that may be placed on the
work of internal auditor in specified areas, it may be evaluated by:
(i)
Inspecting the adequacy of the scope of the work and related programs.
(ii)
125
49
(b)
(ii)
(iii)
(iv) Attend inventory counts at period end and ensure that physical differences
are appropriately recorded and resolved and damaged items if any are
identified.
(v)
(vi) Identify slow moving items and discuss/determine the impact thereof.
126
50
Related parties
Procedure to identify Related Parties
The auditor may perform the following audit procedures to ensure the completeness of
the information provided by management about related parties:
51
(i)
Review prior year working papers for names of known related parties;
(ii)
(iii)
Inquire as to the affiliation of those charged with governance and officers with
other entities;
(iv)
(v)
(vi)
(vii)
Review the entitys income tax returns and other information supplied to
regulatory agencies.
Direct confirmations 2
(a)
(b)
The auditor may consider not to circulate the direct confirmation to the
customers where:
(i)
(ii)
(iii)
(iv)
(v)
vi)
While designing the confirmation request, the auditor considers the following
factors:
(i)
(ii)
(iii)
(iv)
(v)
(vi)
127
(c)
52
(ii)
When there is no receipt from customers after balance sheet date, the
auditor should consider the following audit procedures:
(iii)
(iv)
Examine sales near the period end to provide audit evidence about cutoff assertion.
Working papers
The auditor should consider the following factors while determining the form, content
and extent of audit working papers.
(i)
(ii)
(iii)
The extent of judgment required in performing the work and evaluating the
results;
(iv)
(v)
(vi)
The need to document a conclusion or the basis for a conclusion not readily
determinable from the documentation of the work performed or audit evidence
obtained; and
53
Al-Shams
(a)
(i)
(ii)
(iii)
128
(iv)
Identify all employee benefit plans and the names of the officers and
trustees thereof.
(v)
(vi)
(vii)
(viii) Review significant contracts re-negotiated by the entity during the period.
(b)
54
(ix)
(x)
(xi)
(xii)
Significant transactions are referred to the related party for final approval.
(ii)
(iii)
Transactions involving the related party (or a close family member of the
related party) are rarely independently reviewed and approved.
(iv)
Auditors expert
Information regarding the competence, capabilities and objectivity of an auditors
expert may come from a variety of sources, such as:
Discussions with other auditors or others who are familiar with that
experts work.
129
55
ADL
(a)
(i)
(ii)
(b)
(i)
That the auditor should attempt to ensure that all items in the
population have a chance of selection.
In stratification, the audit efforts are directed towards larger value items.
However, the audit planning documentation should explain why the only
10 debtors out of 50 largest debtors were selected.
(ii)
130
56
Guava & Co
(a)
After the assembly of the final audit file has been completed, the auditor shall
not delete or discard audit documentation of any nature before the end of the
retention period.
The firm should establish its own policies and procedures for the retention of
engagement documentation. The retention period for audit engagement
ordinarily is no shorter than five years from the date of auditors report.
(b)
(c)
Changes in the audit documentation during the final file assembly process may
only be made if they are administrative in nature. Examples of such changes
include:
(i)
(ii)
(iii)
(iv)
The auditor must respond appropriately to facts that become known to the
auditor after the date of the auditors report, that, had they been known to the
auditor at that date, may have caused the auditor to amend the auditors report.
Examples might include:
-
(ii)
(iii)
131
57
RP planning
The steps that I as an auditor would consider as part of the audit planning to ensure
that all related party relationships and transactions are identified and disclosed in the
financial statements are as follows:
(a) Obtaining an understanding of the controls, if any, that management has
established to identify, account for, and disclose related party relationships and
transactions in accordance with the applicable financial reporting framework.
(b) Inquiring of the management regarding:
(i)
The identity of the entitys related parties, including changes from the prior
period;
(ii) The nature of relationships between the entity and these related parties; and
(iii) Whether the entity entered into any transactions with these related parties
during the period and, if so, the type and purpose of the transactions.
(c) Inspecting the following documents for indications of the existence of related party
relationships or transactions that management has not previously identified or
disclosed:
(i)
(f)
58
Once related parties have been identified, the client should provide the details of
transactions with such parties. I as auditor would ensure that these transactions
are disclosed appropriately in the financial statements as per applicable financial
reporting framework.
Manufacturing inventories
Substantive Procedures
Physical verification:
(i)
(ii)
(iii)
Ascertain whether the staff members are carrying out the physical
inventory count as per approved instructions issued to them.
(iv)
132
(v)
Observe the physical inventory count and identify the matters for
appropriate follow-up during the audit. These matters may include the
following:
Excess/ Shortages found in test count performed by the auditors.
Items of inventory identified as obsolete, slow moving, damaged or
defective.
Details of instances where the approved inventory count procedures
are not followed by the staff members of the client.
Instances where the stock records (bin cards, stock and stores ledger
etc.) do not contain adequate details relating to balance of inventory in
hand, minimum level, maximum level, ordering level, specification of
inventory and location of inventory etc.
Cut-off procedures and adherence thereto.
(vi)
Check that the adjustments arising out of the physical count have been
made in the stock count sheets.
(vii)
Finished Goods:
(i)
(ii)
(iii)
(iv)
(v)
Work in Process:
(i)
(ii)
Compare the list with physical count sheet balances and with stock ledger
balances
(iii)
Check the quantity and items included in the list with the production reports
and job cards etc.
(iv)
(v)
Raw material:
(i)
Obtain a list of items shown as Raw material, with full particulars, quantity
and value.
133
(ii)
Compare the list with physical count sheet balances and with stock ledger
balances.
(iii)
Valuation of Inventories:
(i)
Ensure that stock has been valued in accordance with the valuation policy.
(ii)
Ensure that inventories have been valued at the lower of cost and net
realizable value.
(iii)
(iv)
Check that the following costs have not been included in the cost of
inventories:
Administrative overheads
Financial charges
(v)
(vi)
Where the inventories are valued at net realizable value, check that
valuation is correct and is based on the most reliable evidence.
(vii) Check that the cost of obsolete and damaged items is properly written
down.
(viii) Test arithmetical accuracy of the calculation of the stock sheets.
Disclosure:
Ensure that inventories have been disclosed in accordance with the requirements
of International Financial Reporting Standards and the Companies Ordinance,
1984.
General:
(i)
(ii)
134
59
Wedge & Co
(a)
Factor
(i)
No effect, as the
factor is not related to
test of details.
(ii)
Number of debtors
has increased from
4,500 to 5,000.
Negligible effect, as
for large population,
the actual size of the
population has little, if
any, effect on sample
size.
(iii)
(iii)
(iv)
A decrease in the
amount of
misstatements and
increase in the
monetary amount in
respect of which the
auditor requires an
appropriate level of
assurance will
decrease the sample
size as both the factor
will reduce the audit
risk. Hence the
sample size of the test
of details will
decrease.
(b) Following factors are relevant to the auditors consideration of the expected rate of
deviation:
(i)
Auditors understanding of the business, in particular, risk assessment
procedures undertaken to obtain an understanding of internal control.
(ii) Changes in personnel or in internal controls
(c) (i)
135
60
MWL
(a)
The debtors listing will be stratified in accordance with the different market
segments (Super markets, whole sellers, retailers and five star hotels)
(ii)
All twelve super markets, as well as the seven five star hotels will be
purposely selected (59% of the total debtors balance will be covered in
this manner).
Debtors with nil and credit balances, as well as overdue debtors should
also be selected.
136
61
(i)
Timing difference
(ii)
Misstatement
In case of timing differences, the auditor will need to reconcile the amount
confirmed by the confirming party and the amount sent for confirmation.
In either case, the auditor will consider whether he needs to revise his risk
assessment and audit procedures.
BPR
(a)
(b)
Trace and agree balances per books of accounts (ledger or bank book) as
appearing in the bank reconciliation statement with the general ledger/
bank book.
Trace and agree balances per bank statement as appearing in the bank
reconciliation statement with the bank statements.
Select a sample of newly appointed staff and check their salaries with
the appointment letter.
In both the above cases check that allowances and deductions are in
accordance with the companys policies or the relevant legal
requirements.
137
(c)
Compare net payroll after deductions with transfer letter issued to the
bank.
Ensure that payroll costs have been properly disclosed in the financial
statements.
Match invoices with goods receiving notes to ensure that goods have
been received for all billings made by supplier.
62
Taskeen Co
(a)
Sampling risk
Sampling risk is the possibility that the auditors conclusion, based on a sample,
may be different from the conclusion reached if the entire population were
subjected to the audit procedure.
The auditor may conclude from the results of testing that either material
misstatements exist, when they do not, or that material misstatements do not
exist when in fact they do.
Sampling risk is controlled by the audit firm ensuring that it is using a valid
method of selecting items from a population and/or increasing the sample size.
138
Non-sampling risk
Non-sampling risk arises from any factor that causes an auditor to reach an
incorrect conclusion that is not related to the size of the sample.
Examples of non-sampling risk include the use of inappropriate procedures,
misinterpretation of evidence or the auditor simply missing an error.
Non-sampling risk is controlled by providing appropriate training for staff so they
know which audit techniques to use and will recognise an error when one occurs.
(b)
The population is relatively small and it is likely to be quicker to test all the
items than spend time constructing a sample.
All the transactions are not large but could be considered material in their
own right, e.g. compared to project. As all the transactions are material,
then they all need to be tested.
The audit senior suggests using statistical sampling. This will mean selecting a
limited number of sales invoices from the population using probability theory
ensuring a random selection of the sample and then applying audit tests to those
invoices only. This approach may be appropriate because:
The audit junior suggests using random sampling, which the junior auditor
appears to understand as manually choosing which invoices to look at. The
approach therefore involves an element of bias and is not statistical or true
random sampling.
While this approach appears to save time, it is not appropriate because:
(c)
The sample selected will not be chosen randomly but on the whim of the
auditor. Human nature will tend to avoid difficult items for testing.
Also, as invoices will not have been chosen using statistical sampling, no
valid conclusion can be drawn from the results of the test. If an error is
found it will be difficult extrapolating that error on to the population.
Materiality
Information is material if its omission or misstatement could influence the
economic decisions of users taken on the basis of the financial statements.
Materiality depends on the size of the item or error judged in the particular
circumstances of its omission or misstatement.
It is important that the auditors of Tam ensure that the financial statements are
free from material error for the following reasons:
139
63
There are only two owner/directors who will be the initial users of the
financial statements. While the owners/directors maintain the accounting
records, the directors will want to know if there are material errors resulting
from any mistakes financial statements are materially correct
There are also other users of the financial statements who will include the
taxation authorities and the bank who have made a loan to the company.
They will want to see true and fair accounts. The auditors must therefore
ensure that the financial statements are free from material misstatement to
avoid any legal liability to third parties if they audit the financial statements
negligently.
Wings
(a)
The sales function is likely to be integrated with the accounting and internal
control system used to produce the figure in the financial statements for
revenue, on which the external auditor reports.
(ii)
The internal auditors' work on the ticketing system is less likely to be useful
because it relates to an operational area which does not have a direct
impact on the financial statements. There are, however, regulatory matters
that may need to be considered by the external auditor. Ticketing may also
have an indirect effect, because it is likely to be integrated with the sales
system and there is likely to be some crossover between the controls over
ticketing and controls over sales generally. The work of the internal auditors
is therefore likely to be of some use to the external auditor.
(iv)
(v)
It is also possible that the internal auditors' work may involve some
verification of the income statement/statement of comprehensive income
and statement of financial position entries at the year-end. Given the likely
materiality of the amounts involved, this work will also be of interest to the
external auditors.
140
(vi)
It is possible that the internal auditors' work may also relate to the quality of
aircraft, and other operational aspects of fleet management. These issues
may also be relevant to the external auditors, at least insofar as they relate
to compliance with laws and regulations.
(b)
(c)
(ix)
(x)
The quality of the internal audit function will have a significant effect on the
extent of the external auditor's reliance. If the quality of work is not
adequate, reliance will not be possible, regardless of the extent and
relevance of the work performed.
(ii)
The firm will seek to ensure that there is an appropriate structure within the
department itself, with appropriate reporting lines outside the department,
preferably reporting to the audit committee.
(iii)
The internal audit function has recently been expanded and there are likely
to be changes in the way that it is organised. The function should have
operational independence within the organisation and formal terms of
reference that encompass the recent changes made.
(iv)
(v)
141
64
(ii)
(iii)
Glasses2Go
(a)
(b)
To record the audit evidence resulting from the audit work performed to
support the auditors opinion.
Documentation
Information obtained
142
(b)
(c)
Documentation
Information obtained
Working paper
The audit working paper does not meet the standards normally expected in a
working paper because:
The page reference is unclear making it very difficult to either file the
working paper in the audit file or locate the working paper should there be
queries on it.
It is not clear what the client year end date is the year is missing. The
working paper could easily be filed in the wrong years audit file.
There is no signature of the person who prepared the working paper. This
means it is unclear who to address queries to regarding the preparation or
contents of the working paper.
The test objective is vague it is not clear what correct means for
example, it would be better to state the objective in terms of assertions
such as completeness or accuracy.
The test objective is also stated as an audit assertion. This is not the case
as no audit assertions are actually listed here.
It is not clear how the number for testing was determined. This means it will
be very difficult to determine whether sufficient audit evidence was obtained
for this test.
Information on the results of the test is unclear the working paper should
clearly state the results of the test without bias. The preparer appears to
have used personal judgement which is not appropriate as the opinion
should be based on the facts available, not speculation.
The conclusion provided does not appear to be consistent with the results
of the test. Five errors were found therefore it is likely that there are some
systems weaknesses.
143
65
ISA 620
Reliance on the work of an auditors expert
(i)
(ii)
Legal opinions, for example, the experts view on the likely outcome of an
ongoing court case.
confidentiality requirements
66
Cuddly World
(a)
Procedures
(i)
144
Analytical procedures
Review of sales income year on year 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.
(2)
Inquiry
Obtain statements from suppliers to check the completeness of
liabilities at the end of the year. As there is no control over
purchases, invoices could have been misplaced resulting in a lower
purchases and suppliers figure.
(3)
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.
(4)
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.
(5)
Recalculation
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)
Analytical procedures
This method of collecting evidence will be useful in Cuddly World because
it will help to identify unusual changes in income and expenditure. As
Cuddly World is a relatively small company, monitoring gross profit will
show relatively small changes in sales margin or purchasing costs.
Decisions by Mr Kabir 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.
(2)
Inquiry
Inquiry evidence will be very useful in the audit of Cuddly World, 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 statement
145
Inspection
Inspection of documents within Cuddly World will be useful, particularly
regarding checking whether expenses are bona fide. All purchase invoices,
for example, should be addressed to Cuddly World and relate to purchases
expected from that company e.g. cuddly toys for resale, office expense etc.
Inspection of documents can take a long time, however, given the poor
internal control system within Cuddly World, 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.
(4)
Observation
Observation may be useful because it will show how the assistants check
documents. However, no information is provided on any internal controls
with Cuddly World 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 Kabir.
(5)
Recalculation
Recalculation 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 Cuddly World can be confirmed.
The main weakness of recalculation 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.
67
146
(ii)
(iii)
(b)
Materiality
Concept
Information is material if its omission or misstatement could influence the
economic decisions of users taken on the basis of financial statements.
Materiality depends on the size of the item or error judged in the particular
circumstances of its omission or misstatement. So what might be material in one
year might not be material the next, and what might be material to one company
might not be to another.
Effect on audit work
The quantitative aspects of materiality are often, in practice, calculated as
percentage of revenue, profit before tax or assets, or a particular class thereof.
Auditors calculate materiality for the financial statements as a whole and calculate
performace materialty for individual account areas. They look at the aggregate
(net) effects of misstatements and omissions for the financial statements as a
whole. Companies sometimes adjust the accounting records and financial
statements for immaterial items, sometimes they do not.
Materiality is related to risk and used in the calculation of sample sizes and
tolerable misstatement, and in the performance of analytical procedures. Less
work is performed in immaterial areas than in material areas, although some work
is always performed because an area that may appear to be immaterial may,
when tested, provide to be material.
147
68
Tahira Transporters
(a)
Audit test
Discuss with booking clerk how orders
are recorded from the customer.
148
(b)
Audit work
Obtain non-current asset register from client. Cast the cost, depreciation
and net book value columns of the register and agree to the financial
statements of TT.
Agree to the physical asset to confirm existence of the vehicle. Where the
vehicle is on hire during the audit visit, obtain alternative evidence of
existence such as payment from customer near year end for hire
(Existence assertion)
Check the physical condition of the vehicle to ensure that repairs and
renewal expenditure is not being understated. (Existence of repair
expenditure)
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
assertion).
Compare sales income to sale of similar vehicles with similar mileage and
ensure comparable.
For a sample of vehicles purchased durin the year, agree details to purchase
invoice and purchase day book (PDB) ensuring details recorded in the correct
year. (Occurrence assertion)
For a sample of vehicle purchases in the PBD, agree details to the non-current
asset register. (Completeness assertion)
Agree totals in non-current asset register to the financial statements, ensuring
vehicles are disclosed separately in the non-current asset note (material item).
(Disclosure assertion)
Ensure that the accounting policy for depreciation is clearly stated in the financial
statements and is the same as last year. (Disclosure assertion)
149
69
Willow
(a)
verify the schedule to and from accounts recorded in the nominal ledger
and with the draft financial statements;
The basis for this procedure is that of professional scepticism which requires
making no presumption as to the accuracy of information provided by
management.
Opening balances
I would check that the opening balances are in agreement with the balances in
the previous years audit file. This is for two reasons:
(b)
Completeness
150
Valuation
(c)
Ensure that the items properly meet the definition of plant and equipment
and are properly recorded as such.
Revaluation
Competence and objectivity of the valuer
My prime concern would be that the valuer is an employee of the entity.
Nevertheless, I may be prepared to accept the valuation although I would need to
be satisfied that the valuation has been performed with sufficient objectivity that it
represents sufficient, appropriate audit evidence. This depends on factors such
as the materiality of the amounts involved and the available of corroboratory
evidence. The revaluation is certainly substantial representing a gain of Rs 144m
on property, plant and equipment having a written down value of Rs.603m.
It is a common practice for interim valuations to be undertaken by valuers
employed by the entity providing they are confirmed by less frequent independent
valuations, such as every five years. If this is the practice I would examine the
record of past valuations to see if the employees valuations tended to be
confirmed by the independent valuations.
I would also enquire into the professional qualifications and experience of the
valuer to ensure that he or she is both suitably qualified to perform valuations and
sufficiently experienced in valuations of the type undertaken.
Scope of work
I would obtain a copy of the valuers report and:
check that the valuation given in the report is consistent with the valuation
recorded in the financial statements;
form a view as to how thoroughly the valuer has undertaken his or her
work.
Although the valuer was an employee of the company I would need to ensure
that no undue restriction was placed on the valuers access to relevant
information having a bearing on the valuation.
Assessing the work of the valuer
When reviewing the work of the valuer I would expect to see the basis of the
valuation explained and justified in the report. Where practicable I could confirm
any data used such as recent transactions involving similar property. I could also
consider the reasonableness of any assumptions made concerning which I have
some knowledge, such as the effect of recent changes in legislation or in the
economic climate.
151
Conclusion
If I find that:
Accumulated depreciation
According to IAS 8 the correction of errors which are the natural result of
estimates inherent in the accounting process are normally dealt with in the
income statement in the period in which they are identified. This would appear to
be the accountants argument.
An alternative view is that this is a fundamental error and the cumulative
adjustments applicable to prior periods have no bearing on the results of the
current period. In this case, as a prior period adjustment, the benchmark
treatment required by IAS 8 is to adjust the opening balance of retained earnings
of retained earnings and to amend the comparative figures for the previous
accounting period. However, the accountants proposed treatment is consistent
with the allowed alternative treatment providing it is accompanied by additional
pro forma information as required by the benchmark treatment.
70
Sparkle Forever
(a)
Reason
152
(b)
Audit procedure
Reason
153
(c)
71
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.
Bubbles
(a)
each item of inventory was counted at least once a year (in practice
items are likely to be counted more often that this as such systems
are often relied on to produce figures for management accounts).
(ii) I would ask management about the procedures for inventory counting and
review the related documentation, including inventory counting instructions,
and form a view as to whether the system was adequate in principle. I
would also review the results of any internal audit work on the system
design (assuming that I considered the internal audit function to be
adequate).
(iii) I would need to obtain evidence relating to the three items noted in (i)
above. I would therefore visit the warehouses during the year, possibly on
a rotational basis, to ensure that the system was being operated in the
manner prescribed.
(iv) I would perform certain preliminary analytical procedures to establish which
warehouses to visit (such as those where the records indicated that large
volumes of inventories were held, warehouses that were experiencing
problems or had experienced problems in the past, or warehouses that
were considered high risk or other reasons). I might use different offices of
my own firm for these purposes, and/or I would enlist the help of internal
audit. I would review the results of the work already performed by internal
audit.
154
(v)
I would ask local staff about the procedures performed, especially about
any variations from the procedures prescribed. I would observe procedures
being performed.
(vi)
I would test check records of goods received and goods despatched and
trace them through the Stockpop system to ensure that records were
accurate and input on a timely basis. I would ensure that the correct
corresponding entries for costs had been made in the purchases and sales
systems.
(vii) I would perform my own test checks of inventory and trace my counts
through the Stockpop, sales and purchases systems.
(viii) I would consider using CAATs (computer assisted audit techniques),
including test data and audit software to establish whether, for example, the
system is rejecting entries outside certain pre-determined parameters (cost
per unit for example), and that the system highlights any old inventory, or
any exceptions such as negative inventory quantities.
(ix)
(b)
I would review all exception reports produced by the system to see if there
were any recurring or old items and to ensure that all errors and exceptions
were being dealt with on a timely basis.
(ii)
I would ask management about any problems experienced with the system
at, or close to, the period-end and about how they had been dealt with to
ensure that they had been appropriately resolved.
(iii)
I would also ask management about the likely level of write-down of either
raw materials or finished goods (inventory being of inadequate quality or
spoiled, for example). I would compare this with prior years and form an
opinion as to its appropriateness. I would check the calculation of the
allowance for damaged inventory and review exception reports close to the
period-end.
(iv)
(v)
(vi)
155
72
ISA 500
(a)
(b)
Solicitor letter
Assertions achieved and not achieved by each example (only one example of
each required).
Accounts receivable letter
This letter provides evidence of the existence of the receivable when a reply is
returned from that receivable direct to the auditor.
The letter provides evidence on cut-off because sales or cash receipts recorded
in the incorrect accounting period will have to be reconciled to the balance
provided by the receivable.
The letter does not provide evidence of completeness of the receivables balance
because receivables may not query balances which are understated.
The letter does not provide evidence of the valuation of the receivables balance
because the receivable cannot be expected to list all outstanding balances and
external confirmation of the debt does not mean it will be paid.
Solicitor letter
A solicitor letter provides evidence as to the existence of claims at the period end
as the solicitor will confirm specific claims.
However, the letter does not necessarily confirm the valuation of claims due to
uncertainty about the future or the completeness of any legal claims as solicitors
do not normally provide a list of all claims they prefer to comment only on
claims they are actually asked about.
Bank report letter
A bank confirmation letter provides good evidence on the existence of the
companys bank accounts as the bank has confirmed this information in writing.
A bank letter cannot necessarily be relied on to provide complete or accurate
information. Most banks place a disclaimer on the letter of errors and omissions
excepted indicating that the auditor must review this evidence against other cash
and bank evidence obtained.
Inventory held by third parties
A letter from the third party holding the inventory will provide evidence of the
existence of that inventory because the third party has confirmed this in writing.
However, the letter does not provide evidence regarding the valuation of the
inventory; confirming something exists does not necessarily mean it is in good
condition.
156
73
Javeria Co
(a)
(b)
Agree the balances for each bank account to the relevant bank
reconciliation and the year-end balance in the financial statements.
Agree total interest charges on the letter to the interest expense account in
the general ledger.
For any details of loans, ensure repayment terms are correctly disclosed in
the financial statements between current and non-current liabilities.
(2)
157
74
Porridge
(a)
(b)
(i)
(ii)
(iii)
(iv)
(v)
(ii)
(iii)
(v)
(vi)
158
(vii) I have reasons to suspect that the company, or a member of the companys
staff, may be deliberately understating liabilities and there is a possibility
that some of the suppliers statements may be forgeries given the ease of
replicating documents with modern scanning and desk top publishing
technology. Assessment of control risk as slightly less than high, the limited
segregation of duties, and the failure to routinely reconcile all statements
with the accounts payable ledger mean that this is not necessarily a remote
possibility.
(c)
Obtain a list of such accounts payable and test its accuracy by testing it to
and from the computer records and adding it and agreeing it to the control
account. (If production payables are not segregated from other payables
this procedure will apply to all payables.)
Analytical procedures
(ii)
Ascertain cut-off data for goods received notes (GRNs) (probably obtained
during attendance at the physical inventory count).
(iv)
Check cut-off by obtaining GRNs for two weeks prior to the year end and:
(v)
(vi)
For a sample of the closing accruals I would verify the amount of the
accrual by vouching the amount to a subsequently received suppliers
invoice.
all suppliers from whom the entity bought more than 1% of its
purchases during the year;
(viii) For each supplier in the sample I would compare the balance with the
suppliers statement and investigate differences.
(ix)
159
(d)
there are no goods received notes to determine the date of receipt of the
goods;
(ii)
invoices are not recorded until after approval by the department manager
which could cause considerable delay and even a failure to record liability
for invoices mislaid or even lost before being recorded;
(iii)
suppliers statements are not reconciled which would otherwise detect most
delayed or missing invoices.
My audit procedures would be centred on cut-off and the search for unrecorded
liabilities.
(i)
(ii)
Vouch larger purchases recorded in the first two weeks of the subsequent
year to invoices to ensure that they are properly recorded after the yearend.
(iii)
Obtain suppliers statements from major suppliers and reconcile them with
the balance in accounts payable for evidence of invoices missing or
mislaid.
(iv)
(v)
Similarly vouch cash payments for the first two weeks after the end of the
reporting period for payments for goods and services received before the
year-end not processed as payables.
(vi)
Review both purchases and cash payments for items that may relate to
goods or services received prior to the end of the reporting period. This
review should be continued up to the date of signing the auditors report.
(vii) Compare prepayments and accruals with the previous year for items such
as rent or utility bills normally paid in advance or arrears of receipt of goods
and services and investigate differences.
(viii) Analyse expense accounts for significant differences either in absolute
amounts or relative to sales. Any unexpected difference could be due to
unrecorded purchases at the end of the reporting period.
75
Trembridge Engineering
(a)
Assess the system of control in the purchases system and its reliability. If
discrepancies are found in the audit tests, increase the sample of items
checked.
If the company's staff regularly perform checks on the supplier's statements
then perform fewer checks and instead rely on their work as evidence.
160
(ii)
(iii)
(iv)
goods in transit;
(v)
Goods in transit are invoices on the supplier's statement which are not on
the customer's purchase ledger. If these differences have been included in
purchase accruals no further checks are necessary. However, for large
value items, check the goods received note (GRN) to ensure they were
received before the year-end.
(vi)
(vii) Other differences, such as discounts, need only be investigated if they are
material.
(b)
(ii)
(iii)
the purchase ledger should include the purchase invoice before the year
end.
A cut-off error will exist if the items are not recognised in the correct accounting
period.
(c)
(ii)
161
76
(iii)
The sales tax payable is verified by agreeing the amount to the tax return
and then agreeing the tax return calculation by checking input tax to the
purchase day book, output tax to the sales day book and any sundry
amounts to either cash book or petty cash book
(iv)
Accrued interest on the bank loan and overdraft will be checked to the bank
letter.
(v)
Other accruals will be checked to invoices received after the year-end (or if
no invoices have been received after the year end, then invoices received
before the year end will be used).
(vi)
Consider whether there are any circumstances which have arisen in the
year which may result in new accruals, and check if these accruals have
been included.
The experience and reputation of the expert in the area in which the auditor
is seeking audit evidence.
The independence of the expert from the client company. The expert
should not normally be employed by the client.
(b) Auditor rights
Right to receive notice of and attend meetings of the company in the same
way as any member of the company.
Completeness ensure that all non-current assets are recorded in the noncurrent asset register by agreeing a sample of assets physically verified
back to the register.
Rights and obligations ensure the company owns the asset by seeing
appropriate document of ownership for example, a purchase invoice.
162
77
Heidi Co
(a)
(i)
(ii)
The relative cost of using audit software decreases the more years that
software is used. Any cost overruns this year could be offset against the
audit fees in future years when the actual expense will be less.
Problems on the audit of Heidi
Timescale six week reporting deadline audit planning
The audit report is due to be signed six weeks after the year end. This means
that there will be considerable pressure on the auditor to complete audit work
without compromising standards by rushing procedures.
This problem can be overcome by careful planning of the audit, use of
experienced staff and ensuring other staff such as second partner reviews are
booked well in advance.
Timescale six week reporting deadline software issues
The audit report is due to be signed about six weeks after the year end. This
means that there is little time to write and test audit software, let alone use the
software and evaluate the results of testing.
This problem can be alleviated by careful planning. Access to Heidi Co.s
software and data files must be obtained as soon as possible and work
commenced on tailoring Cal & Co.s software following this. Specialist computer
audit staff should be booked as soon as possible to perform this work.
First year audit costs
The relative costs of an audit in the first year at a client tend to be greater due to
the additional work of ascertaining client systems. This means that Cal & Co may
have a limited budget to document systems including computer systems.
This problem can be alleviated to some extent again by good audit planning. The
manager must also monitor the audit process carefully, ensuring that any
additional work caused by the client not providing access to systems information
including computer systems is identified and added to the total billing cost of the
audit.
163
Staff holidays
Most of the audit work will be carried out in July, which is also the month when
many of Cal & Co staff take their annual holiday. This means that there will be a
shortage of audit staff, particularly as audit work for Heidi Co is being booked
with little notice.
The problem can be alleviated by booking staff as soon as possible and then
identifying any shortages. Where necessary, staff may be borrowed from other
offices or even different countries on a secondment basis where shortages are
acute.
Non-standard systems
Heidi Co.s computer software is non-standard, having been written specifically
for the organisation. This means that more time will be necessary to understand
the system than if standard systems were used.
This problem can be alleviated either by obtaining documentation from the client
or by approaching the software house (with Heidi Co.s permission) to see if they
can assist with provision of information on data structures for the inventory
systems. Provision of this information will decrease the time taken to tailor audit
software for use in Heidi Co.
Issues of live testing
Cal & Co has been informed that inventory systems must be tested on a live
basis. This increases the risk of accidental amendment or deletion of client data
systems compared to testing copy files.
To limit the possibility of damage to client systems, Cal & Co can consider
performing inventory testing on days when Heidi Co is not operating e.g.
weekends. At the worst, backups of data files taken from the previous day can be
re-installed when Cal & Co.s testing is complete.
Computer systems
The client has 25 locations, with each location maintaining its own computer
system. It is possible that computer systems are not common across the client
due to amendments made at the branch level.
This problem can be overcome to some extent by asking staff at each branch
whether systems have been amended and focusing audit work on material
branches.
Usefulness of audit software
The use of audit software at Heidi Co does appear to have significant problems
this year. This means that even if the audit software is ready, there may still be
some risk of incorrect conclusions being derived due to lack of testing, etc.
This problem can be alleviated by seriously considering the possibility of using a
manual audit this year. The manager may need to investigate whether a manual
audit is feasible and if so whether it could be completed within the necessary
timescale with minimal audit risk.
(b)
Ensuring that the department has staff who have appropriate qualifications.
Provision of a relevant qualification e.g. membership of a computer related
institute would be appropriate.
164
Ensuring that the documentation is actually used during internal audit work
and that problems with documentation are noted and investigated as part of
that work. Being given access to internal audit reports on the inventory
software will provide appropriate evidence.
78
Using part of the documentation to amend Cal & Co.s audit software, and
then ensuring that the software processes inventory system data
accurately. However, this stage may be limited due to the need to use live
files at Heidi Co.
Zeedin Co
(a)
165
(b)
Procedure
166
(c)
(i)
Aims
The aim of a test of control is to check that an audit clients internal control
systems are operating effectively.
(ii)
(d)
How to overcome
weakness:
Inventory sheets
stated the quantity
of items expected
to be found in the
store
Count teams
allowed to decide
which areas to
count
Inventory not
marked to indicate
it has been
counted
Inventory should be
marked in some way to
show that it has been
counted to avoid this
error.
167
79
Weakness
How to overcome
weakness:
Recording
information on the
count sheets in
pencil
Sahito Co
(a)
(b)
Tests of control
Test of control
168
(c)
(d)
Test of control
Assertions receivables
Assertion
Existence
Cut-off
(i)
169
(ii)
80
2.
3.
4.
5.
Bashir Co
(a)
(b)
Employees are only paid for work that they have done
Gross pay has been calculated correctly
Gross pay has been authorised
Net pay has been calculated correctly
Gross and net pay have been recorded accurately in the general ledger
Only genuine employees are paid
Correct amounts are paid to taxation authorities.
The Directors
Bashir Co
1701 Any Street
Big Town 12345
Pakistan
3 December 20X3
Dear Sirs
Management letter
We write to bring to your attention weaknesses in your companys internal control
systems and provide recommendations to alleviate those weaknesses.
(i) Weakness:
(iii) Recommendation:
The logging in
process for
employees is not
monitored.
170
(i) Weakness:
(iii) Recommendation:
the number of employees
logged in for work each
shift.
Overtime is not
authorised by a
responsible official.
Dummy employees
payments that do not
relate to any real
employee could be
added to the payroll
payments list in the
accounts department.
Details of employees
leaving the company
are sent on an email from the
personnel
department to
payroll.
There is no check to
ensure that all e-mails
sent are actually received
in the payroll department.
There needs to be a
control to ensure all emails are received in
personnel prenumbering of e-mails or
tagging the e-mail to
ensure a receipt is sent
back to the personnel
department will help meet
this objective.
In the accounts
department, the
accounts clerk
authorises payment
of net wages to
employees.
It is inappropriate that a
junior member of staff
should sign the payroll; the
clerk may not be able to
identify errors in the
payroll or could even have
included dummy
employees and is now
authorising payments to
those people.
171
If you require any further information on the above, please do not hesitate to
contact us.
Yours faithfully
Global Audit Co.
(c)
Expectation
Compare total salaries cost this year Assuming that the number of shift
to total salaries cost last year.
managers has remained unchanged,
the total salary expenditure should
have increased by inflation only.
Ascertain how many shift managers Total salary should be approximately
are employed by Bashir and the total number of managers multiplied by
salary from the personnel department. average salary.
Calculate total salary and compare to
the salary disclosed in the financial
statements.
Obtain a listing of total
payments made each month.
(d)
Audit procedure
Confirmation
Confirmation is the process of
obtaining a representation of
information or of an existing condition
directly from a third party.
Observation
This procedure involves watching a
procedure being performed by others
in this case watching shift-workers
using the time recording system.
172
Inquiry
Inquiry involves obtaining information
from client staff or external sources.
Recalculation
Recalculation means re-checking the
arithmetical accuracy of the clients
records; in this case the hours worked
by the time-recording system.
Reperformance
This is the auditors independent
execution of procedures or controls
that were originally performed as part
of the entitys internal control.
Analytical procedures
Analytical procedures involve
comparing financial or non-financial
data for plausible relationships.
81
Analytical procedures
(a)
(i)
Between
173
(iii)
The auditor should apply analytical procedures at or near the end of the
audit in order to
form an overall conclusion as to whether the financial statements as a
whole are consistent with the auditors understanding of the entity.
Corroborate the conclusions drawn through other procedures.
To identify unusual or unexpected balances (if any) in order to identify
a previously unrecognized risk of material misstatement. In such
circumstances, the auditor may need to re-evaluate the planned audit
procedures.
(b)
Date:
Signature:
Contents:
174
82
Auditor responsibility
The statement of responsibility should state the following:
(i)
(ii)
(iii)
the auditor plans and performs the audit to obtain reasonable assurance
whether the financial statements are free from material misstatement.
(iv)
That an audit involves performing procedures to obtain audit evidence about the
amounts and disclosures in the financial statements.
(v)
(vi)
In making the risk assessment the auditor considers internal controls relevant to
fair presentation of financial statements in order to design audit procedures that
are appropriate in the circumstances but not for the purpose of expressing an
opinion on the effectiveness of the entitys internal control.
(vii)
(viii) The auditor believes that the audit evidence the auditor has obtained is sufficient
and appropriate to provide a basis for the auditors opinion.
83
Al-Badr
(i)
(ii)
In the introductory paragraph and opinion paragraph, the word cash flow
statement has been omitted.
(iii)
In the opinion paragraph, the words its cash flows have been omitted.
(iv)
(v)
After the statement We conducted our audit in accordance with the auditing
standards in the audit responsibility paragraph, the words as applicable in
Pakistan have been omitted.
(vi)
In the auditors responsibility paragraph, the words on test basis have been
omitted.
(vii)
175
(viii) The opinion paragraph whether proper books of account have been kept by the
company as required under the Companies Ordinance, 1984, has been omitted.
84
(ix)
In paragraph (b) of the opinion, the financial statements have incorrectly been
referred to have been drawn up in accordance with International Financial
Reporting Standards instead of the requirement i.e. approved accounting
standards as applicable in Pakistan.
(x)
In the introductory paragraph the word Income and expenditure account should
be replaced with profit and loss account".
(ii)
In the introductory paragraph the phrase to the best of our knowledge and
belief is to be inserted before the phrase were necessary for the purpose of an
audit.
(iii)
(iv)
(v)
(vi)
In the scope paragraph the phrase and limited is incorrect and be omitted.
(vii)
In the scope paragraph the word material be added before the word
misstatement.
(viii) In the scope paragraph the phrase on a test basis should be added before the
phrase evidence supporting the amounts and disclosures in the above said
statements.
(ix)
(x)
In para (b) point (ii) the phrase was in accordance with the objects of the
Company be replaced with was for the purpose of the Companys business
(xi)
In para (b) point (iii) the phrase was for the purpose of the Companys
business be replaced with were in accordance with the objects of the
Company
(xii)
In para (c) the phrase of the profit or loss, its cash flows and changes in equity
for the year then ended; be added at the end.
(xiii) The place of signing of accounts is to be mentioned after the signature of the
firm
(xiv) Name of the engagement partner has not been mentioned.
176
85
86
(b)
(c)
The auditor will include an other matter paragraph in the auditors report,
referring to the fact that the financial statements of Samarkand Limited for the
Previous year, were audited by another auditor, who expressed an un-modified
opinion on those financial statements.
Two significant uncertainties exist for ZTL i.e. recoverability of balance due
from SEL and whether the going concern assumption is appropriate in light
of the possible termination of the contract by SEL.
The Accounts receivable balance is material to the financial statements as it
is 12.48% of profit after tax.
The possible loss of contract from SEL is material to the financial
statements as the revenue from SEL contributes about 25% of total
revenue.
It appears that the uncertainty relating amount receivable balance and
termination of contract will not be resolved till the time of signing off the
financial statements and audit report.
If uncertainties are adequately disclosed in the financial statements then an
unqualified opinion can be given, however an emphasis of matter paragraph
is to be included in the auditors report to draw users attention to the
significant uncertainties. In case appropriate disclosure is not given a
qualified opinion or adverse opinion as appropriate.
(b)
(c)
A provision of Rs. 30 million has been made in the financial statements and
it represents 37.5% of the profit after tax and is material to the financial
statements.
A constructive obligation to restructure arises only when an entity has a
detailed formal plan for the restructuring identifying at least the principal
locations affected.
In this case it is unlikely that a constructive obligation exists in respect of
third factory because the factory which is to be closed is not identified.
177
87
(b)
(c)
(i)
(ii)
(iii)
(iv)
(v)
(vi)
(vii)
(i)
(ii)
With respect to job in progress ,if the auditor can satisfy himself that
management would be able to recover the cost of work in process from
another customer, he may conclude that a provision is not required in this
respect.
(iii)
In making the above decision the auditor should also consider the
expenses that are required to be incurred on the job, subsequent to year
end.
(iv)
The auditor should ask the management to provide for the loss of Rs. 9.6
million or any part thereof depending upon the estimated amount of
default, plus any further provision that may be necessary in respect of the
work in process. In case of managements refusal, the auditor shall qualify
his report.
The auditor shall qualify the audit report by mentioning that investment of Rs.
150 million was not in accordance with the objects of the company with a
clarification that the object clause was amended a week before the issuance of
audit report, to include the said objective.
178
88
Hafiz Limited
(i)
In this case of reporting on more than one set of financial statements,the auditor
will need to determine that whether the reporting requirements of other
framework are acceptable to the auditor in the prevailing circumstances.
Impact on Audit Report
If the framework is acceptable then the auditor will include an other matter
paragraph in the auditors report, which will include a reference that he has also
issued an audit report on another set financial statements which has been
prepared as per the reporting requirements of a different accounting framework.
(ii)
That the amount paid was not for the purposes of the companys
business.
In either case, the auditor should consider the impact thereof on his initial
risk assessment and to revise the audit procedures accordingly.
The indication of non-compliance with laws and regulations may require the
auditor to consider the potential financial consequences of the noncompliance, on the financial statements including, the imposition of fines
and penalties and the impact thereof on the companys ability to carry out its
business.
The auditor may discuss his findings with those charged with governance if
the auditor considers that they will be able to provide with additional audit
evidence in relation to the transaction.
The auditor may also consider whether it is necessary for him under the
relevant laws and regulations to report the matter to the concerned
authorities.
179
89
(b)
(i)
90
Revaluation of Properties:
(i)
(ii) Since compliance with (i) above is not possible, the auditor should advise
the client to not to change the accounting policy and state the values of the
property at cost.
(iii) In case of disagreement the auditor may consider issuing a qualified report.
180
(b)
(c)
(d)
(ii)
(iii)
The auditor should analyze the situation, in the light of IAS 37, Provisions,
Contingent Liabilities and Contingent Assets, and assess whether a
disclosure of the event as a contingent liability is required or not.
(iv)
Warranty Provision:
(i)
(ii)
If a provision is not made for the warranty then if the amount of provision
is material to the financial statements then the audit report should be
qualified
91
Ranjha Limited
(a)
(i)
Significant matter
In view of the decline in production capacity, it has become necessary
to recalculate the value in use and recoverable amount in order to
assess the impairment in the value of plant.
The value of plant is material to the financial statements in terms of
total assets as well as profit before tax of the company.
Impact on audit report
If the impairment test indicates a decline in the value of plant, the
management should be advised to make appropriate adjustments.
In case of disagreement with the management, the auditor should give
a qualified opinion.
181
(ii)
Significant matter
Amount claimed by the customer is material to the financial statements
in terms of total assets as well as profit before tax of the company.
Impact on audit report
If management agrees to explain the issue in the note on contingent
liabilities, the report will not be qualified but in view of the material
uncertainty an emphasis of matter paragraph would have to be added
to the auditors report to draw the users attention to the note in the
financial statements.
In case of disagreement on making appropriate disclosure, the auditor
should give a qualified opinion.
(iii)
Significant matter
It is a fundamental error within the meaning of IAS-8 and its effect
should be taken into account retrospectively. All comparatives figures
should be restated accordingly.
The managements decision to adjust the short amortization in the
future years is in contravention to the requirements of IAS-8.
Impact on audit report
Since the error is material in terms of profit after tax, it should be
discussed with the management. They should be advised to make
appropriate adjustment and disclosure in accordance with the
requirements of IAS-8.
In case of disagreement, the auditor should give a qualified opinion.
92
Pervasive effects
(a)
(b)
(i)
(ii)
(iii)
(i)
Issuance of bank guarantee after the year end does not require any
adjustment or disclosure. Therefore, there will be no effect on the audit
report on this issue.
182
(ii)
The audit report shall state that Zakat deductible at source under the
Zakat & Ushr Ordinance, 1980, was deducted and deposited in the
Central Zakat Fund established under section 7 of that Ordinance.
(iii)
The auditor should consider the materiality of the amount. If the amount is
material, the auditor should express a qualified or adverse opinion.
(iv)
93
(b)
(ii)
(iii)
(iv)
(v)
(vi)
(vii)
(viii)
The auditor believes that the audit evidence the auditor has obtained is
sufficient and appropriate to provide a basis for the auditors opinion.
The situations in which a report is modified without affecting the auditors opinion
are as follows:
(i)
183
(ii)
(iii)
94
(i)
(ii)
(iii)
(iv)
The emphasis of matter paragraph should ordinarily refer to the fact that
the auditors opinion is not qualified in this respect.
184
96
(iii)
that the balance sheet and the profit and loss account together with notes
thereonare in conformity with the Companies Ordinance, 1984 and in
agreement with the books of accounts and are further in accordance with the
accounting policies consistently applied.
Opinion as regards the following:
whether expenditure incurred during the year was for the purposes of the
companys business and
whether the business conducted, investments made and expenditure
incurred during the year were in accordance with the objects of the
company.
(iv)
97
Written representations
Under the following situations, the auditor would have doubt as to the reliability of written
representation:
(a)
When the auditor has concerns about the competence, integrity, ethical values or
diligence of management, or about its commitment to or enforcement of these.
(b)
When written representations are inconsistent with other audit evidence obtained.
The auditor shall determine the effect that such concerns may have on the
reliability of representations and audit evidence in general.
(ii)
The auditor may consider whether the risk assessment remains appropriate and, if
not, revise the risk assessment and determine the nature, timing and extent of
further audit procedures to respond to the assessed risks.
(ii)
If the matter remains unresolved, the auditor shall reconsider the assessment of
the competence, integrity, ethical values or diligence of management, or of its
commitment to or enforcement of these, and shall determine the effect that this
may have on the reliability of other representations and audit evidence in general.
(iii)
If the auditor concludes that the written representations are not reliable, the auditor
shall take appropriate actions, including determining the possible effect on the
opinion in the auditors report.
185
98
Shahrukh and Co
(i)
(ii)
In the introductory paragraph the phrase to the best of our knowledge and
belief is to be inserted before the phrase were necessary for the purpose of
an audit.
(iii)
(iv)
(v)
(vi)
In the scope paragraph the phrase and limited is incorrect and be omitted.
(vii) In the scope paragraph the word material be added before the word
misstatement.
(viii) In the scope paragraph the phrase on a test basis should be added before
the phrase evidence supporting the amounts and disclosures in the above
said statements.
(ix)
(x)
In para (b) point (ii) the phrase was in accordance with the objects of the
Company be replaced with was for the purpose of the Companys business
(xi)
In para (b) point (iii) the phrase was for the purpose of the Companys
business be replaced with were in accordance with the objects of the
Company
(xii) In para (c) the phrase of the profit or loss, its cash flows and changes in equity
for the year then ended; be added at the end.
(xiii) The place of signing of accounts is to be mentioned after the signature of the
firm
(xiv) Name of the engagement partner has not been mentioned.
99
Kazmi-Wassan
(a)
186
In the latter situation, other forms of audit evidence are normally unavailable
because knowledge of the facts is confined to management and the matter is one
of judgement or opinion.
Obtaining representations does not mean that other evidence does not have to
be obtained. Audit evidence will still be collected and the representation will
support that evidence. Any contradiction between sources of evidence should,
as always, be investigated.
(b)
Matters
(i) Tigers Purr
The amount of the claim is material being 50% of profit before taxation.
There is also a lack of definite supporting evidence for the claim. The two
main pieces of evidence available are the claim from Tigers Purr itself and
the legal advice from Kazmi-Wassans solicitors. However, any claim
amount cannot be accurately determined because the dispute has not been
settled.
The directors have stated that they believe the claim not to be justified,
which is one possible outcome of the dispute. However, in order to obtain
sufficient evidence to show how the treatment of the potential claim was
decided for the financial statements, the auditor must obtain this opinion in
writing. Reference must therefore be made to the claim in the
representation letter.
Paragraph for inclusion in representation letter.
A legal claim against Kazmi-Wassan by Tigers Purr has been estimated at
Rs 4 million by Tigers Purr. However, the directors are of the opinion that
the claim is not justified on the grounds of breach of product specification.
No provision has been made in the financial statements, although
disclosure of the situation is adequate. No similar claims have been
received or are expected to be received.
(ii)
Depreciation
This matter is unlikely to be included in the letter of representation because
the auditor appears to have obtained sufficient evidence to confirm the
accounting treatment. The lack of profit or loss on sale confirms that the
depreciation charge is appropriate large profits would indicate overdepreciation and large losses, under-depreciation. The amount also meets
industry standards confirming the Kazmi-Wassans accounting policy is
acceptable. Including the point in the representation letter is inappropriate
because the matter is not crucial and does not appear to be based on
judgment or opinion. The only opinion here appears to be that of the auditor
unless the feelings can be turned into some appropriate audit evidence,
the matter should be closed.
(c)
Discuss the situation with the directors to try and resolve the issue that the
directors have raised. The auditor will need to explain the need for the
representation letter again (and note that the signing of the letter was
mentioned in the engagement letter).
187
(ii)
Ascertain exact reasons why the directors will not sign the letter. Consider
whether amendments can be made to the letter to incorporate the directors
concerns that will still provide the auditor with appropriate and sufficient
audit evidence.
(iii)
The discussion must clearly explain the fact that if the auditor does not
receive sufficient and appropriate audit evidence, then the audit report will
have to be qualified.
The reason for the audit qualification will be uncertainty regarding the
amounts and disclosures in the financial statements.
(iv)
Even if the letter is subsequently signed, the auditor must still evaluate the
reliability of the evidence. If, in the auditors opinion, the letter no longer
provides sufficient or reliable evidence, then a qualification may still be
required.
100 RK Resourcing
(a)
Obtaining and reading the companys latest interim accounts as well as any
budgets and cash flow forecasts.
(b)
Checking whether any events have occurred that could call into question
the validity of the going concern assumption.
Adjusting or non-adjusting?
The bankruptcy of a major customer provides additional evidence of
conditions existing at the end of the reporting period. The customer will not
be able to pay debts due, therefore receivables are overstated and the bad
debt expense in the profit and loss account is understated. An adjustment
for the amount of the receivable should be made in the financial
statements.
188
(ii)
Confirming that the customer will not pay to a letter from the receiver
or similar authorised person.
Confirming the amount due from the customer to invoices raised prior
to the year end, and if possible to a positive confirmation request.
1 November 20X3
(i)
Adjusting or non-adjusting?
The accidental release of toxic chemicals occurred after the reporting
period. Assuming that the inventory was not on the statement of financial
position at the year end, then the spill is indicative of conditions that arose
subsequent to 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.
(ii)
189
Date the new auditors report no earlier than the date of the amended
financial statements and update active subsequent events review to
that date.
30 November 20X3
(i)
Adjusting or non-adjusting?
The fire at an oil well means that RK Resourcings 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 as at this time there was no indication that
this would occur. The event is therefore non-adjusting in the financial
statements. However, disclosure of the event should be made so that the
financial statements do not give a misleading position.
(ii)
190
(ii)
(iii)
Disclosure
The directors must ensure that there is adequate disclosure of all matters
required by statute or IASs/IFRSs in the financial statements. The auditor
will check that disclosure provisions have been complied with, and where
certain disclosures have not been made (e.g. ISA 550 regarding related
party transactions) provide this information in the audit report.
(iv)
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
or opinion may be modified to bring the situation to the attention of the
members of the company.
(b)
Errors
The auditors responsibility paragraph does not meet the requirements of ISA 700
for the following reasons:
(i)
It does not follow the standard wording set out in ISA 700. For example, it
does not state at the outset that the auditors responsibitly is to express an
opinion on the financial statements based on his audit.
(ii)
The use of the term Auditing Standards is not clear, because the report
does not state which auditing standards have been used (e.g. ISAs). This
provides uncertainty regarding the actual standard of work performed.
(iii)
191
(iv)
Stating that time was a factor in obtaining information and explanations for
the audit is not correct as this implies some factor which could have been
avoided and that the audit may therefore be incomplete. The auditor has to
plan the audit carefully and ensure that all the information and explanations
considered necessary are obtained to form an opinion, not simply stop work
when time runs out.
(v)
The auditor does not confirm that the financial statements are free from
material misstatement as this implies a degree of accuracy that the auditor
simply cannot provide. Making the statement could also leave the auditor
liable to claims from members or third parties should errors be found in the
financial statements later. Rather than make such a categorical statement,
the correct wording from ISA 700 states that the auditor provides
reasonable assurance that the financial statements are free from material
misstatement, which clearly implies that audit techniques are limited.
(vi)
audit: this may be external audit, internal audit or a combination of the two;
and
review.
An audit provides a high, but not absolute, level of assurance that the audited
information is free from any material misstatement. This is often referred to as
reasonable assurance. The opinion is usually expressed as positive assurance
that, in the opinion of the auditors, the financial statements do present fairly the
financial position and performance of the company.
A review is a voluntary investigation. In contrast to the reasonable level of
assurance provided by an audit, a review into an aspect of the financial
statements would provide only a moderate level of assurance that the information
under review is free of material misstatement. The resulting opinion is usually
(although not always) expressed in the form of negative assurance. Negative
assurance is an opinion that nothing is obviously wrong: in other words, nothing
has come to our attention to suggest that the information is misstated.
192
(b)
Review procedures
decisions taken at board meetings and other meetings of the entity that
may affect the financial statements;
103 Karim
In the above situation the auditor should carry out the following procedures:
(i)
He should inquire whether the management has changed its assessment of the
entitys ability to continue as a going concern.
(ii)
Inquire the management about its future plans, the feasibility of these
plans and whether management believes that the outcome of such plans
will improve the situation.
(iii)
The auditor should consider whether the note given by the management
adequately discloses the uncertainty as regards the entitys ability to continue
as a going concern.
(iv)
If he assesses that the note is adequate, the auditor should give an emphasis
of the matter paragraph.
(v)
193
104 IFI
Procedures which an auditor may perform to update the understanding of the entity
and its environment for an engagement to review interim financial information
includes the following:
(a)
(b)
(c)
Reading the most recent annual and comparable prior period interim financial
information.
(d)
(e)
(f)
(g)
Considering the results of any audit procedures performed with respect to the
current years financial statements.
(h)
Considering the results of any internal audit performed and the subsequent
actions taken by management.
(i)
(j)
(k)
(l)
194
!" !## $
% !!!& '( !" ! ) info@icap.org.pk
!! * * + ,- %/ 01 23 2 4
&" #!!! $
% !!!& ) lahore@icap.org.pk
5 6!7& 8
9):
$
% !!!& '( !" ! ) ):;<=1=<-
# ' - ,3 DEF + % G 6 3- 3 2 8
=
!" !!!!!! '( !" !&!! ) )
;<=1=<-
!"
' 6
?3 0
D<<= ): C )) 8 6=,= 2 6
?3=
" #! ) 1
?3;<=1=<-
#$$
) 0- 5
--
90
< 2 5
--
!" B! ) sukkur@icap.org.pk
%&
2015
AUDIT AND
ASSURANCE
QUESTION BANK