Ac3093 Exc14

Examiners commentaries 2014

AC3093 Auditing and assurance
Important note
This commentary reflects the examination and assessment arrangements
for this course in the academic year 201314. The format and structure
of the examination may change in future years, and any such changes
will be publicised on the virtual learning environment (VLE).
Information about the subject guide and the Essential reading

references
Unless otherwise stated, all cross-references will be to the latest version
of the subject guide (2014). You should always attempt to use the most
recent edition of any Essential reading textbook, even if the commentary
and/or online reading list and/or subject guide refers to an earlier
edition. If different editions of Essential reading are listed, please check
the VLE for reading supplements if none are available, please use the
contents list and index of the new edition to find the relevant section.
General remarks
Learning outcomes
At the end of the course, and having completed the Essential reading and
activities, candidates should be able to:
explain why external audits and other types of assurance services are
conducted
discuss the duties of auditors and other assurance providers and how
these have changed over time
explain the meaning of concepts that are fundamental to auditing
and assurance services, such as independence, evidence, risk,
materiality
describe, in general terms, the processes involved in auditing and other
assurance services
distinguish between compliance and substantive testing and describe
various audit tests
discuss the form, content and importance of the reports provided at the
end of the audit or assurance service
discuss the issues of legal liability arising from audits and other
assurance services
discuss current developments in auditing and assurance services.
What are the Examiners looking for?

Once again, the examination in 2014 was sat by a large number of
candidates, many of whom showed a good working knowledge of
many aspects of auditing and assurance services. A significant number
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appeared to have taken particular note of the Examiners commentaries

from previous years and took pains to heed the advice in those reports.
For example, the vast majority of scripts were well presented and neatly
written. Nevertheless there are some candidates who seem not to bother
to divide their answers into paragraphs of separate points. Scripts written
as a large single block of text are very difficult to mark. Bear in mind that
Examiners are looking for particular points. If these are hard to spot then
there is a risk that you will lose the chance to gain credit. In addition, of
course, you should remember that this is an academic examination about
a professional service. Effective communication is a vital skill that both
Examiners and employers prize.
Presentation may seem to candidates to be a small point of detail but it
does make a very significant difference to the marking process. If you can
lay out your answers in a neat and methodical fashion, you stand more
chance of making a good impression on the Examiners and therefore
of securing a good mark. This is not to say that good presentation is a
substitute for content. A good answer must contain the relevant technical
points but in addition should be easy to read and coherently argued.
Presentation involves breaking answers into paragraphs a separate
paragraph for each point and starting a new question on a new page.
Some candidates feel duty-bound to include an introduction but where
this simply repeats or paraphrases the question itself, it is a waste of time.
For some unknown reason, more candidates this year chose to ignore this
advice. Introductions should be short and should do no more than set the
scene on which you immediately build the technical content of the answer.
Similarly with conclusions: if you feel you must end with a conclusion,
make sure that it adds something to your argument. Simply repeating
what you have previously said cannot gain you additional marks.
There are several general style points worth mentioning. A number of
candidates felt the need in answering essay questions to include diagrams,
for example, the pictorial representation of the expectation gap (Porter
et al., 2014, p.787) or the decision chart for the formulation of an
appropriate audit report (ISA 700). Such representations are designed to
help communicate complex ideas to candidates approaching the problem
for the first time. You may assume that the Examiners marking your
papers are already experts in the field your diagram will not help them
assess whether you really understand the problem. So avoid reproducing
diagrams.
Similarly, simply reproducing the audit risk model as a formula, complete
with mathematical proof, will not add anything to your answer. If the
question asks for factors that impact on the auditors assessment of
inherent risk then look at the case study and consider which aspects of
the company, its industry or its products might be more likely to lead
to misstatements. If the question refers to control risk, then think about
possible weaknesses in control procedures that might allow the financial
statements to be misstated.
The Examiners always encourage candidates to think of ways of answering
questions more efficiently and one way of dealing with certain (but not
all) Section A case study questions is to adopt a columnar approach with
answers to parts (a) and (b) being presented side by side. Certainly this
is preferable to the (a), (b), (a), (b), (a), (b) etc. approach which a few
candidates adopt this latter is very difficult and time consuming to mark.
Once again, some candidates chose to ignore this advice. But the columnar
approach is to be used only in certain cases (i.e. where part (b) relates
directly to part (a)). An example might be where part (a) of the question
asks you to identify weaknesses and part (b) asks you to suggest possible
consequences of these weaknesses or remedies to improve the control
system. The problem is that some candidates do not take the time to think
whether the columnar approach is appropriate but use it mechanistically
in every case this clearly helps neither the candidate nor the Examiners.
One common failing of a number of candidates in 2014 was an apparent
inability to attempt part (b) of one or more of the case studies they had
selected. Given that the marks available for part (a) are limited to 15,
failure to write anything at all for the related part (b) seriously limits the
candidates chances of getting more than a 2:2 classification at best. The
lesson to draw from this is that you need to be careful in choosing the case
study (Section A) questions you choose. Make sure that you can answer,
or at least attempt, both parts and, having made your selection, make sure
you write something in answer to both parts. The two parts of the case
study questions are related either directly or indirectly so it should be very
unlikely that candidates will be able to answer only one part.
In Section B the typical problems from past years recurred with the main
reasons for low marks being that candidates either wrote too little or did
not focus on answering the question that was set. Too many candidates
still believe that if they write three or four sides of material based on
what they have memorised from lecture notes, textbooks or the subject
guide, that will make a good answer. What they fail to realise is that
the Examiners want to see both knowledge of the technical subject and
the ability to address the particular question set. For example, if the
question asks you to discuss how the auditors report seeks to address the
expectations gap, it is not sufficient to talk only about the expectations gap
or the contents of the auditors report you need to be able to relate one
to the other.
A final few points on general writing style: since time is limited you should
not waste precious seconds with unnecessary words (e.g. last but not
least remains a common start to a final paragraph and sometimes is used
more than once in the final few paragraphs, suggesting that the candidate
was not clear as to which was the last point). You need to be precise
wherever possible, therefore, if asked to recommend audit procedures,
you should say the auditor should attend the inventory count rather than
the auditor might want to think about attending. Wherever possible try
to use technical terms, for example it is much better to say segregation
of duties than dividing up the work. The word ensure was often used
inappropriately for example, the auditors must ensure that every item
of stock is counted a moments thought should tell you that even if it
were the auditors responsibility to count stock, the auditor cannot ensure
anything of the sort. Auditors should ensure that they have assessed the
risks and reviewed the procedures and systems put in place to deal with
those risks but they cannot ensure that other people have carried out their
duties properly. Lastly, to rectify a common misconception: a walk-through
test is not a test of controls designed to provide compliance evidence;
a walk-through test is performed on a sample of one. A transaction is
followed through the system from start to finish so that the auditors can
reassure themselves that they understand the system (see Porter et al.,
2014, p.406).
Question spotting
Many candidates are disappointed to find that their examination
performance is poorer than they expected. This can be due to a number
of different reasons and the Examiners commentaries suggest ways
of addressing common problems and improving your performance.
We want to draw your attention to one particular failing question
spotting, that is, confining your examination preparation to a few
question topics which have come up in past papers for the course. This
can have very serious consequences.
We recognise that candidates may not cover all topics in the syllabus in
the same depth, but you need to be aware that Examiners are free to
set questions on any aspect of the syllabus. This means that you need
to study enough of the syllabus to enable you to answer the required
number of examination questions.
The syllabus can be found in the Course information sheet in the
section of the VLE dedicated to this course. You should read the
syllabus very carefully and ensure that you cover sufficient material in
preparation for the examination.
Examiners will vary the topics and questions from year to year and
may well set questions that have not appeared in past papers every
topic on the syllabus is a legitimate examination target. So although
past papers can be helpful in revision, you cannot assume that topics
or specific questions that have come up in past examinations will occur
again.
If you rely on a question spotting strategy, it is likely
you will find yourself in difficulties when you sit the
examination paper. We strongly advise you not to adopt
this strategy.

AC3093 Auditing and assurance Zone A
Important note

references
Comments on specific questions

Candidates should answer FOUR of the following EIGHT questions:
TWO from Section A, ONE from Section B and ONE further question
from either section. All questions carry equal marks.
Section A
Answer at least two questions, and no more than three questions from
this section. A total of four questions should be answered with at least one
from Section B.
Question 1
Boing plc was established in 2002 as a tour operator offering cut-price holidays.
The company grew slowly at first, but from 20062009, it managed to increase
its sales by an average of 20% per annum, much better than most of its
competitors. In 2011, the company was acquired by Cheap Trip plc.
On March 28, 2014, one of Boings planes crashed killing one hundred
passengers. The chief executive of Boing reassured the passengers relatives that
the company had adequate insurance cover. Almost immediately, a significant
number of other customers cancelled their holidays and demanded refunds. This
put the company in a serious financial situation. Its bankers, Tanbest, refused
requests for further loans since the company had used its borrowing facilities to
purchase new planes during 2013.
Boings financial accounting year ended on December 31, 2013. Thomas & Co.
has been Boings auditors since 2002. The audit took place during January 2014
and the auditors unqualified report was signed on February 5, 2014. A few days
before the report was signed one of the junior members of the audit team had
overheard Boing staff talking of concerns about short-cuts being taking in the
planes maintenance routines but the audit team member had been unable to
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corroborate the matter and therefore he had not reported it to the audit partner.
No one on the audit team had checked whether the insurance policy covered
death and injury caused by poor maintenance of the plane. Not being insurance
experts, the auditors relied on the directors reassurance that the insurance was
adequate this later proved to be false.
However, a consumer watchdog programme on national television on April
14, 2014 questioned the thoroughness of maintenance on the planes used by
Boing. Demand for Boing holidays collapsed immediately and on April 30, 2014,
the company was declared insolvent. As a result of Boings indebtedness to its
parent, Cheap Trip was also declared to be insolvent.
Thomas & Co. now faces law suits from (a) Tanbest (b) the creditors of Cheap
Trip, and (c) relatives of those killed in the crash on the basis that the financial
statements were wrongly prepared on a going concern basis, that the auditors
failed to ensure the planes were safe and failed to ensure that Boings insurance
cover was adequate.
Required:
a. From your knowledge of case law, assess the strength of the claims being
brought against the auditors, Thomas & Co.
Reading for this question
Subject guide, Chapter 8.
Gray, I. and S. Manson The audit process. (Andover: Cengage Learning EMEA,
2011) fifth revised edition [ISBN 9781408030493] Chapter 19.
Porter, B., J. Simon and D. Hatherly Principles of external auditing. (Chichester:
John Wiley & Sons, 2014) fourth edition [ISBN 9780470974452] Chapter 15.
Approaching the question

This was quite a tricky question and was attempted by only a minority of
candidates. The question deals with auditors liability to third parties, an
area which is covered extensively in Chapter 15 of Porter et al. (2014).
The third parties here are the bank which had lent money to the audit
client, the other creditors of the client (i.e. the customers who had paid
deposits but not had their holiday) and the relatives of the customers
who had died in a plane crash. The basis of the successful pursuit of any
claim by a third party is establishing a relationship of proximity or some
special relationship which ties parties in despite the lack of a contract. Part
of this test is the foreseeability principle could the auditors reasonably
have foreseen the consequences of their alleged lack of care? Then there
comes the question of negligence itself. Were the auditors negligent? Did
they fail to do what a reasonable auditor would have done in similar
circumstances? The third question would follow: if the auditors were
negligent, did their negligence cause the damage/injury being complained
about by those suing them. Lastly, can the loss be quantified? These steps
were laid out in the Caparo judgement.
Examiners will never expect candidates to be as knowledgeable of lawyers
and judges so you will never be asked to determine the outcome of these
hypothetical scenarios. But you might be expected to know the process
and the series of questions outlined above. In addition, discussion of the
main points linked to decided cases would be expected.
So rather than come to definite decisions on negligence, it is better to
focus on how the facts of the scenario are similar to other real-life cases.
For example, the difficulty of banks claiming to be owed a duty of care
is illustrated in Al-Saudi Banque, and yet banks have prevailed against
auditors as in RBS v. Bannerman.
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The fact that the crash occurred after the year end and after the audit is
possibly in the auditors favour. The crash was not reasonably foreseeable
at the time the audit was performed. The auditors cannot be expected to
have the benefit of foresight (Henry Squire).
However, the fact that an audit team member overheard talk of poor
maintenance might be an alert, which the auditors could be accused
of failing to pursue. Though not directly connected to the financial
statements, the risk of a plane crash is so critical to passenger confidence
that it might be expected that auditors should do more. Yet auditors are
not aircraft experts (although some candidates seemed to think that it is
part of an auditors job to test the airworthiness of aircraft) and what was
overheard might only have been groundless gossip.
It is likely that a competent audit would consider a clients insurance
cover and especially what the policy did not cover. Kingston Cotton Mill
might provide a defence of relying on management but probably a more
enquiring attitude of professional scepticism would be expected these days
(Selsdon Fountain Pen). If the auditors could not understand the policy,
they could hire their own lawyers/insurance experts to help them assess
the financial implications of the cover.
The claims of the relatives against the auditors look a little too remote.
The claim would have to show that their loss was directly attributable to
the negligence of the auditors. To do this they would have to show that
ordinarily auditors auditing financial statements of airlines would test
maintenance records and insurance policies.
b. Identify factors which you think would have been relevant to the auditors
risk assessment in doing the audit of the financial statements for the year
ended December 31, 2013.
Porter et al. (2014) Chapter 10.
Gray and Manson (2011) Chapter 5.

Candidates are not expected to be experts in a particular industry but the
application of some general knowledge might have produced some general
comments along the lines of:
Airlines are inherently risky.
Dependent on fuel from abroad they are vulnerable to exchange rate
fluctuations.
Economic downturns affect airlines more than most other companies.
Threats of terrorist action and natural disasters such as volcanic ash
clouds will affect airlines in ways that often cannot be predicted.
Airlines are highly competitive so the pricing strategy needs to be
sensitive to market conditions.
The industry is highly regulated and serious penalties can be handed
out if rules are breached.
Passenger safety is so important that planes can be grounded if a fault
is found in another airlines fleet.
Too many of those who started this question left out part (b) altogether.
You should not be intimidated by a question in a specialist area. Try to
have more confidence and give each part a thoughtful attempt.
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Question 2
Conrad is a young fashion designer who opened his first store in Manchester at
the start of 2013. His shop sells mainly high value designer dresses aimed at the
late-twenties-early thirties professional woman. However, he also stocks several
lines of low value accessories in order to tempt other potential customers into
the shop.
Conrad followed the bank managers advice and set up the business as a limited
company. Conrad is the only shareholder and the only director. He has invested
100,000 of his own money. The company has a borrowing facility of 100,000
from the bank. However, a condition of the bank loan is that he has to give a
personal guarantee on the loan.
You discover that there are four employees who work in the backroom making
the dresses and five who serve in the shop, at various times. The five sales ladies
are essentially casual workers who are paid by the hour. They try to fit the hours
around the demands of their home life and/or children. Often there is only one of
them in the shop. Conrad knows them all personally, he trusts them and is happy
for whoever is the last to leave to count up the cash, close up the shop and bank
the cash on their way home. He also allows them to make minor payments for
things like materials for window displays, tea, coffee and milk for the staff to be
paid out of the takings. However, he assures you that he has control of the bank
since he is the only one who has access to the cheque book and the internet
banking. He receives but never checks the bank statements. He says he is too
busy out on the road finding new outlets, attending trade shows and making
contacts.
Conrad engaged your firm to do the accounts and prepare the tax return. He has
no accounting experience and no knowledge of or interest in financial matters.
He expressed concern when you presented him with the accounts. His sales for
the year came to 900,000 and the cost of sales in the form of materials and
bought-in goods came to 500,000. He had done some rough costing in setting
his prices and aimed to make a mark-up of 200% on cost. So he would have
expected his gross profit on sales to be 600,000, not the 400,000 shown in
your accounts. He has no idea why the figures are different but wants you to
investigate and to conduct a full audit. He is also stunned to find that while
your accounts show that the company has made a 50,000 net profit, the bank
balance is now up to the limit of the permitted borrowing.
Required:
a. Set out in a letter to Conrad your concerns about the control environment,
the possible risks of his management style and what he might do to improve
control in his company.

This question required candidates to think about the potential
weaknesses in the controls over the business and its resources. As with
many examination questions the situation is almost too extreme to be
believable but you should not let that put you off. Do not refrain from
commenting on a particular aspect just because it looks ridiculous; for
example, the comment that Conrad never checks the bank statements
is an open invitation for some comment to him about the need to keep a
firm control over his own company. Banks can and do make mistakes with
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customer accounts and the only check upon this is to have the discipline of
examining the transactions which the bank claims to have processed.
Identifying various inherent and control risks in the scenario would be
expected in the context of this question. For example the fashion industry
is high risk and it would be worth the auditors finding out how Conrad
attempts to be aware of changing trends, etc.
Some explanation for Conrads benefit of the difference between cash and
profit (a Year One concept) was intended to be a gift for the sharp-eyed
candidate but too few candidates even mentioned this area of confusion in
the mind of the client.
The need for good internal control is essential in any business. In small
companies, formal systems are often not feasible but there are other
ways of reducing risks of loss and misappropriation namely a greater
involvement from the owner.
Setting out the answer as a proper memo or report would have improved
the appearance of some attempts.
b. Discuss the advantages and disadvantages for small companies voluntarily to
engage an external auditor to audit their annual financial statements.

There are certainly advantages to having an audit although in Conrads
case his lack of engagement in the detailed running of the business would
make an effective audit practically impossible.
It would be important to explain that some form of internal controls and
adequacy of accounting records are essential. Without these the auditors
report is likely to be so heavily qualified that any value in having an audit
is lost.
An audit can help to find some but cannot be expected to find all errors/
frauds/weaknesses that might save the business money in the long run.
In the real world, audits are carried out in small companies but the lack of
evidence can make them inordinately costly.
On the plus side, Conrad might find it easier to raise bank loans if he could
produce audited accounts.
Question 3
Internal controls are designed, amongst other things, in order to prevent
misstatement in the accounts caused by either fraud or error.
Maker Ltd is a high quality computer maintenance company. They pride
themselves on having staff with expertise in all the main computer
manufacturers and have service contracts with a number of high profile
companies nationwide.
The companys head office is based in Oxford. The engineers may be based
around the country and rarely visit head office.
Engineers vans must be stocked with as many parts as possible in order to
prevent delays when called in on a service contract. They have basic stock lists
which they are expected to maintain. In order to keep track of the stock held,
head office require the engineers to keep a running list of all stock items used
and this list may be requested at any time.
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Every Thursday, engineers should perform a stock take on their vans and place
an order on the pre-printed order pads for replacement stock. These are then
emailed to head office and the goods are despatched the next day to the
engineers home address.
If a part not kept in stock is required then the engineer has to telephone head
office to place the order. The goods are then ordered from head office and
requested to be sent direct to the engineer. If certain items are regularly being
requested as a special order then they often become an addition to the basic
stock held on the van.
At the companys year end the engineers are required to complete a stock take
on their vans and report back to head office. Random checks are carried out by
management at least once a year on engineers vans. The engineers are normally
given 24 hours notice that their van will be checked.
Required:
a. Identify the weaknesses in Maker Ltds purchases system for parts stock and
the van stock control. State what could go wrong as a consequence of each
weakness and recommend an internal control to prevent any error.
This question proved to be very popular with many candidates opting

to answer it. A large number of attempts were very well done with each
weakness being properly identified and fully explained in a separate
paragraph. In addition candidates were often able to come up with
inventive yet sensible solutions to deal with the problem identified. If
marks were lost anywhere, they were typically lost through not being able
to suggest a remedy for a weakness in effect only answering half of this
part of the question.
Once again it is important not to reject the chance of easy marks and the
simple solution to the problem of alerting employees to an impending
check, i.e. dont tell them that a check is coming, was sometimes
overlooked even though it seems a fairly obvious solution.
b. Explain the role of an internal auditors department in ensuring the
effectiveness of a companys control environment and to what extent the
work of an internal auditor may be of use to the external auditor when
assessing control risk.

If part (a) was generally well done with many candidates getting 15 out
of 15, part (b) was relatively poorly attempted. The overall knowledge
of internal auditing was quite low even at the basic level and knowledge
of the factors which might persuade an external auditor to rely on the
work of the internal auditors was patchy. It was expected that candidates
would think of considerations such as what are the internal auditors
qualifications and to whom do they report? Does anyone take any notice
of their reports? Are deficiencies which have been identified addressed by
senior management? If the answers to such questions are negative, then it
is less likely that the system of which the internal auditor is a part will be
reliable.
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Question 4
Your audit firm is planning the audit of the following five audits:
i. Peckham Ltds year end is 31st March 2014. You discover that during the year
the company has lost up to 50% of its customer base.
ii. Tottenham Ltds year end is 31st December 2013. Since the year end
the company has been approached by a competitor Acton Ltd which is
considering a takeover bid. Acton Ltd has informed the Board of Tottenham
Ltd that they will review the audited accounts before deciding on the
takeover bid.
iii. Greenwich Ltds year end is also 31st March 2014. During the year the Finance
Director of 8 years was asked to leave the company following a scandal
concerning the companys tax affairs. You are aware that the Finance Director
is suing the company for unfair dismissal. The Finance Director has yet to be
replaced.
iv. Covent Ltds year end is 31st January 2014. The company has recently
upgraded its accounting software and IT systems. The new systems were
installed in August 2013 and the company was running both the old and the
new systems in parallel until December 2013. The company has invested 1.4
million in the new system and has financed this through a short term loan
with the bank.
v. Piccadilly Ltds year end is 30th April 2014. The company is a manufacturer
of sports equipment and has recently expanded its operations into Europe
through the purchase of a new factory and warehouse in Holland.
Required:
a. What risks need to be considered in response to each of these audit issues
both for the financial statements as a whole and at the assertion level?

This question, it was thought, would be a reasonable test of candidates
perception of difficulties and their ability to suggest solutions. However,
all too often some of the most obvious problem areas were completely
overlooked. For example in the first case, the loss of half the customers
was supposed, immediately, to set alarm bells ringing about the possibility
of the client failing altogether, thus giving rise to a going concern problem.
Yet most candidates failed even to mention this as a risk. In addition, the
loss of a large customer base might have an impact on stock valuation
since inventory may have been ordered specifically for those customers
who have now been lost. Some candidates thought to broaden the
implications with the suggestion that the accounts receivable balance
might need to be reviewed but too often they failed to mention why.
Perhaps if the loss of the customers was due to their insolvency then
the concern with the valuation of accounts receivable would be justified
but this needed to be expressly stated. Furthermore, the reason for the
sudden decline in demand needs to be investigated; is it due to a problem
in product/service quality? Is there adverse publicity of a different type?
Is there a court case pending? These may have other implications for the
accuracy of the financial statements.
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b. For each of these audits, suggest an appropriate response for your firm to
make.

The aim of this question was to test the extent to which candidates might
appreciate that different audit findings might have different consequences
for the audit firm.
Candidates often showed that they were aware of different types of report
but were less likely to be able to identify which was appropriate. A few
tried to avoid the need to make distinctions by opting for the same audit
report for each of the five situations. Typically this was the emphasis of
matter paragraph which somehow is seen by some candidates as being
a compromise. If in doubt, give an emphasis of matter report seemed
to be the approach. Of course this is quite wrong. The emphasis of
matter is to be used only in certain circumstances, namely when there
is appropriate evidence to support the claims in the financial statements
and the statements include adequate disclosure of all major matters but
there remains the problem which shareholders and other readers must not
overlook.
In this question, candidates were expected to consider the bigger picture
not just the auditors report. What, for example, could be done in the
case of the company which has lost half its customers? Surely talk to
management to see what they are doing to make up lost ground? Look at
the order book for forthcoming sales. Is this showing signs of recovery?
Are new customers being sought out and are they ordering? To focus only
on the audit report was taking too narrow a view.
Section B
Answer at least one question, and no more than two questions from this
section. A total of four questions should be answered with at least two
from Section A.
Question 5
Auditors do not carry out 100% testing during their audit work and so must
select samples for testing. Explain how auditors choose a sample size and what
they must consider in order to minimise sampling risk.
Subject guide, Chapters 6 and 7.

Candidates generally avoided this question even though it was a relatively
straightforward exercise in discussing and explaining various approaches to
dealing with the problem of choosing which particular pieces of evidence to
examine. The topic is well considered in Chapter 12 of Porter et al. (2014).
An overall description should have been included, along the lines of:
sampling allows the auditor to carry out audit tests and then project the
results from the selected sample onto the whole population of the area
being tested.
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Candidates needed to discuss the problem of sampling risk the risk

that the sample will offer results that are not representative of the whole
population and so the auditors draw the wrong conclusion.
In addition, well-prepared candidates were able to explain the impact of
various factors such as:
population size
risk factors
tolerable error
materiality
availability of other audit evidence using alternative methods.
Candidates could have introduced discussion of different techniques such
as:
random selection
haphazard selection
statistical sampling techniques
sequence/block selection
systematic selection.
If there was a single weakness in answers to this question it was simply
not writing enough.
Question 6
Discuss the extent to which you believe the audit report gives the reader enough
information about the audit process, the findings made and the basis for the
opinion formed.
Subject guide, Chapters 2 and 5.

This question was designed to examine how much candidates understood
about the content of the modern audit report. The topic is covered
extensively in Chapter 14 of Porter et al. (2014).
The auditors report contains reference to auditing standards, accounting
standards and the legal framework under which the audit is conducted
and the financial statements are produced this gives some basis.
There is a reference to the responsibilities of directors for controls, going
concern and the financial records and financial statements.
There are hints about the auditors approach reasonable assurance,
material misstatements, true and fair view, etc. A candidate who had
done the reading and had done some thinking about these issues would
have added some comment to the effect that these are highly technical
terms and concepts and are unlikely to mean very much to the average
shareholder.
Candidates could also have described how in the past auditors reports had
become very standardised with every audit report looking the same, even
though each client must be unique.
The very best candidates would have been keeping up with current
developments and would have known that early in 2014 audit reports
began to appear which were highly customised. Discussions of particular
13
risks and even the materiality level used are included. This change in
approach is bound to make auditors reports more interesting and more
helpful to the reader.
Question 7
To what extent would a study of the history of company auditing from the late
nineteenth century suggest that the auditing profession has been slow to learn
from the mistakes of the past?

The history of auditing shows that problems such as expectations gap,
fraud detection procedures, lack of communication in reporting, too much
trust in management, lack of professional scepticism, auditors being too
close to management, failure to spot weaknesses in controls or in business
models have been around for a long time.
A well-read candidate may have been able to debate whether the
repeating of past mistakes demonstrates a lack of competence or an
element of human nature.
The fact that the problems which beset Victorian accountants still affect
modern day auditors may indicate that the solution does not lie in more
lengthy regulations.
In addition, we should recognise that while business is dynamic and
economic conditions change constantly, the essence of the auditing
environment remains the same.
The well-prepared candidate would have been able to draw parallels with
the past:
The frequency of employee fraud.
Senior management too concerned with the reported results rather
than the truth.
Auditors with too little time and too few resources and sometimes not
enough backbone to stand up to management.
Question 8
Assess the various ways in which an auditors independence can be
compromised and suggest methods for helping auditors remain independent.
The question of auditors independence has a long pedigree and should

not surprise candidates. The whole of Chapter 4 in Porter et al. (2014)
is devoted to this issue. At the very least the average candidate should
have been able to name and discuss the various threats to auditor
independence, each of which needs to be discussed coherently:
familiarity
self-interest
self-review
14
intimidation
management (in this sense, the problem is where auditors may occupy
a position as part of management as well as being the auditor).
They should also have been able to come up with some of the safeguards,
which have been included in the Code of Ethics of IFAC or the Ethical
Standards in the UK.
All too often candidates with a lot of knowledge of the topic squandered
the chance for really high marks by simply reproducing lists of bullet
points. Obviously, you make notes as part of your revision preparation
but examination essay answers need to be more than lists of points.
The Examiners are looking for good writing style and cogency of
argumentation, not just technical content. Repeating in note form what
has been memorised by rote is not an effective way of demonstrating
knowledge and understanding and is unlikely to be rewarded with high
marks no matter how many points are raised.
15

AC3093 Auditing and assurance Zone B
Important note

references
Comments on specific questions

Candidates should answer FOUR of the following EIGHT questions:
TWO from Section A, ONE from Section B and ONE further question
from either section. All questions carry equal marks.
Section A
Answer at least two questions, and no more than three questions from
this section. A total of four questions should be answered with at least one
from Section B.
Question 1
Internal controls are designed, amongst other things, in order to prevent
misstatement in the accounts caused by either fraud or error.
Merthyr Ltd is a high quality computer maintenance company. They
pride themselves on having staff with expertise in all the main computer
manufacturers and have service contracts with a number of high profile
companies nationwide.
The companys head office is based in Oxwich. The engineers may be based
around the country and rarely visit head office.
Engineers vans must be stocked with as many parts as possible in order to
prevent delays when called in on a service contract. They have basic stock lists
which they are expected to maintain. In order to keep track of the stock held,
head office require the engineers to keep a running list of all stock items used
and this list may be requested at any time.
Every Thursday, engineers should perform a stock take on their vans and place
an order on the pre-printed order pads for replacement stock. These are then
emailed to head office and the goods are despatched the next day to the
engineers home address.
16
If a part not kept in stock is required then the engineer has to telephone head
office to place the order. The goods are then ordered from head office and
requested to be sent direct to the engineer. If certain items are regularly being
requested as a special order then they often become an addition to the basic
stock held on the van.
At the companys year end the engineers are required to complete a stock take
on their vans and report back to head office. Random checks are carried out by
management at least once a year on engineers vans. The engineers are normally
given 24 hours notice that their van will be checked.
Required:
a. Identify the weaknesses in Merthyr Ltds purchases system for parts stock
and the van stock control. State what could go wrong as a consequence of
each weakness and recommend an internal control to prevent any error.
Gray, I. and S. Manson The audit process. (Andover: Cengage Learning EMEA,
2011) fifth revised edition [ISBN 9781408030493] Chapter 9.
Porter, B., J. Simon and D. Hatherly Principles of external auditing. (Chichester:
John Wiley & Sons, 2014) fourth edition [ISBN 9780470974452] Chapter 10.

This question contained a number of factors which could easily be seen
as weaknesses in the control system. Candidates who took their time to
read the question carefully would be able to identify each one. Really good
candidates not only spotted the weaknesses but were able to suggest the
possible consequences of the weakness going unchecked and thereby they
could propose a solution to the problem, i.e. they were well prepared to
provide a full answer to this part of the question.
The thoughtful candidate would quickly have realised that this is precisely
the sort of question to which a columnar style answer is best suited. For
example, a very good answer might take the following format:
Weakness
What could go wrong
Internal control
Engineers asked to keep

running list of stock held
and used but no mention
of it being checked to job
cards or sales invoices.
Risk of errors on stock

list causing misstatement
of stock in the financial
statements
Stock items bar coded and

engineers have system to
record when stock items
used which feeds back to
head office computer. Any
stock refills would then
be triggered automatically
by the system.
No ageing of stock items

required.
Stock may be held on the

van for several months
or years and its value
therefore depleted due
to obsolescence. If this is
not identified, stock could
be over valued in the
financial statements.
Stock sheets should

include date the engineer
acquired the item so that
slow moving stock can be
identified.
The very best candidates made sure that they identified as many
weaknesses as possible within the time available. The risk with this sort of
question is that it tempts the less disciplined candidate to spend too long
17
on constructing a complete or very full answer. You must try to avoid this
temptation. It is never worth going over time on any individual question.
You must be strict on yourself. 15 marks or 15% of the total available
translates into 27 minutes maximum. You must never go over the allotted
time.
b. Explain the role of an internal auditors department in ensuring the
effectiveness of a companys control environment and to what extent the
work of an internal auditor may be of use to the external auditor when
assessing control risk.

Good candidates made sure that their answers covered both parts of this
question whereas candidates who appeared to rush or not to read the
question carefully enough only made an attempt at the first part the
role of the internal audit function as part of the internal control system.
Answers were however quite good with candidates making effective points
stressing the importance of internal controls to the efficient running of a
company and the role of internal auditors in monitoring the effectiveness
of the internal control system and reporting to management having
carried out a review and monitoring assessment of the companys internal
controls.
Less well done was the issue of the degree of reliance that an external
auditor can place on the presence of an internal audit department. The
best answers mentioned the essential factors such as:
The measure of independence of internal auditors and the level of
management to which they report.
The expertise and competence of the internal audit team.
The conclusions drawn by the internal auditors, whether they are
consistent with the work done and with the external auditors
knowledge and experience.
Managements actions to any issues raised by the IA team.
Question 2
Your audit firm is planning the audit of the following five audits:
i. Ponty Ltds year end is 31st March 2014. You discover that during the year
the company has lost up to 50% of its customer base.
ii. Tredegar Ltds year end is 31st December 2013. Since the year end the
company has been approached by a competitor Anglesey Ltd which is
considering a takeover bid. Anglesey Ltd has informed the Board of Tredegar
Ltd that they will review the audited accounts before deciding on the
takeover bid.
iii. Goitre Ltds year end is also 31st March 2014. During the year the Finance
Director of 8 years was asked to leave the company following a scandal
concerning the companys tax affairs. You are aware that the Finance Director
is suing the company for unfair dismissal. The Finance Director has yet to be
replaced.
iv. Coity Ltds year end is 31st January 2014. The company has recently upgraded
its accounting software and IT systems. The new systems were installed in
August 2013 and the company was running both the old and the new systems
18
in parallel until December 2013. The company has invested 1.4 million in the
new system and has financed this through a short term loan with the bank.
v. Penylan Ltds year end is 30th April 2014. The company is a manufacturer
of sports equipment and has recently expanded its operations into Europe
through the purchase of a new factory and warehouse in Holland.
Required:
a. What risks need to be considered in response to each of these audit issues
both for the financial statements as a whole and at the assertion level?

This question, it was thought, would be a reasonable test of candidates
perception of difficulties and their ability to suggest solutions. However,
all too often some of the most obvious problem areas were completely
overlooked. For example in the first case, the loss of half the customers
was supposed immediately to set alarm bells ringing about the possibility
of the client failing altogether thus giving rise to a going concern problem.
Yet most candidates failed even to mention this as a risk. In addition, the
loss of a large customer base might have an impact on stock valuation
since inventory may have been ordered specifically for those customers
who have now been lost. Some candidates thought to broaden the
implications with the suggestion that the accounts receivable balance
might need to be reviewed but too often they failed to mention why.
Perhaps if the loss of the customers was due to their insolvency then
the concern with the valuation of accounts receivable would be justified
but this needed to be expressly stated. Furthermore, the reason for the
sudden decline in demand needs to be investigated; is it due to a problem
in product/service quality? Is there adverse publicity of a different type?
Is there a court case pending? These may have other implications for the
accuracy of the financial statements.
b. For each of these audits, suggest an appropriate response for your firm to
make.

The aim of this question was to test the extent to which candidates might
appreciate that different audit findings might have different consequences
for the audit firm.
Candidates often showed that they were aware of different types of report
but were less likely to be able to identify which was appropriate. A few
tried to avoid the need to make distinctions by opting for the same audit
report for each of the five situations. Typically this was the emphasis of
matter paragraph which somehow is seen by some candidates as being
a compromise. If in doubt, give an emphasis of matter report seemed
to be the approach. Of course this is quite wrong. The emphasis of
matter is to be used only in certain circumstances, namely when there
is appropriate evidence to support the claims in the financial statements
and the statements include adequate disclosure of all major matters but
19
there remains the problem which shareholders and other readers must not
overlook.
In this question, candidates were expected to consider the bigger picture
not just the auditors report. What, for example, could be done in the
case of the company which has lost half its customers? Surely talk to
management to see what they are doing to make up lost ground? Look at
the order book for forthcoming sales. Is this showing signs of recovery?
Are new customers being sought out and are they ordering? To focus only
on the audit report was taking too narrow a view.
Question 3
Chester Financials Ltd (Chester) is a company specialising in financial advice to
both individuals and companies. Chester has been audited by audit firm Findler
and Co for several years, having been introduced to the firm through their Sales
Director who is the brother of Findler and Cos tax partner.
The directors of Chester are keen to apply for a stock market listing within the
next few months and have asked if their engagement partner at Findler and Co
can suggest potential investors from his contacts and then attend the meetings
with potential investors. In addition, as the finance director of Chester is likely
to be quite busy with the listing, he has asked if Findler and Co can produce the
financial statements for the current year.
Should Chester obtain its stock exchange listing, it will require several
assignments to be undertaken, for example, obtaining advice about corporate
governance best practice. Findler & Co is very keen to be appointed to these
engagements. The sales director of Chester has informed his brother, the tax
partner, at a family dinner that the Board are relying on the completion of
a smooth and quick external audit. They are keen in order to proceed with
the application for a stock exchange listing. He more or less promises that if
Chester is successful then the Board would be keen to appoint Findler & Co
for the additional work required. As a token of the Boards gratitude, he plans
and would like to pay for the audit team to spend a weekend away at a luxury
hotel. In addition, the Board would be happy to offer all senior members of the
engagement team financial advice at significantly reduced rates.
Required:
a. Explain FIVE ethical threats which may affect the independence of Findler &
Cos audit of Chester Financials Ltd and for each threat explain appropriate
safeguards to reduce the threat to an acceptable level.

This was a straightforward question for the well-prepared candidate. The
ethical guidance issued by IFAC and/or the regulatory bodies in many
countries identifies a number of common threats to auditor independence.
The scenario in the question pointed in fairly obvious ways to a number of
these threats. Most candidates were able to produce a list of at least three
or four threats. What distinguished the very best candidates was their
knowledge of the safeguards which should be put in place. Whereas the
weaker candidates could perhaps mention one safeguard per threat, those
who had read the Essential reading were able to give very full descriptions
and explanations of the sorts of principles of which auditors should be
aware in order to preserve their independence.
20
b. Corporate governance best practice usually requires the formation of an

audit committee. Explain the role of the audit committee, how it should
be formed and the benefits to a company such as Chester Financials Ltd in
having an audit committee.

Again this is a relatively straightforward question. There are defined roles
for the various committees of the board of a large public interest company.
The audit committees roles include:
Monitoring the integrity of the financial statements.
Reviewing internal financial controls and risk management systems.
Monitoring and reviewing the effectiveness of the internal audit
function.
Making recommendations to the board in relation to the appointment,
re-appointment and removal of the external auditor and approve the
remuneration and terms of engagement of the auditor.
Reviewing the auditors independence and objectivity.
Developing and implementing the non-audit services policy.
But of course there were other aspects to this part of the question and
if candidates tended to lose marks on part (b) it was because they only
focussed on one aspect, such as the role of the audit committee. The best
answers went on to discuss how the committee is constituted it should
consist of at least three independent non-executive directors and at least
one of these should have some recent and relevant financial experience
and the benefits which having an audit committee can bring, viz:
It will help to improve the quality of the financial reporting.
The audit committee will assist by reviewing the financial statements.
The establishment of an audit committee can help to improve the
internal control environment of the company.
The audit committee is able to devote time and attention to areas such
as internal controls.
The requirement for non-executive directors will bring considerable
outside experience to the executive directors as well as challenging
their decisions and contributing to an independent judgement.
Question 4
Dime World plc is a listed company. Its sells only very low value items with each
item selling for 2. All sales are for cash only. The company has suppliers who
produce low quality goods. It also buys surplus stock at reduced prices from
main retailers which do not want stock which is very near to the end of its
shelf life. The buying is all done from the head office where goods are delivered
before being shipped to the stores.
Dime World has ten stores in the North West of Europe. Each store manager is
told what stock the store will receive. Each store manager is given a weekly
sales target which he must meet. Managers who meet their sales targets are
paid a bonus. Managers who miss three consecutive sales targets, they are
dismissed. The only discretion the store manager has is over stock placement
21
where in the shop various stock items are located. If a line of stock is slow
moving or is about to become out of date, the store manager may discount those
items as a two-for-one (buy-one-get-one-free) deal. At the end of the financial
year, every store carries out a detailed stock count where every item is counted.
The directors consider this to be a strong control it is the only time in the
whole year when the stores are closed. The store manager is not allowed to open
the store until the stock count has been completed.
Store managers have discretion over hiring and firing of staff. Each manager is
given a 2 hour training session on employment law. This is an attempt to avoid
the manager committing any serious breaches of employment law which might
cost the company significant sums in fines or penalties. The company directors
consider that this general overview is sufficient since the type of workers who
work for Dime World are highly unlikely to take legal action. The directors
believe therefore that little attention is paid to the finer details of employment
law. A similar approach is taken to environmental and social responsibility
concerns. The directors consider that as the company is not a national concern,
campaign groups and politicians are not going to waste time pursuing it.
Record-keeping at store level is minimal. The sales figure for the day is phoned
through to head office. Cash takings are counted by the store manager and
banked each day. The stores are all situated near banks so depositing the cash
at the end of the day is not difficult. The finance director of Dime World has
approached your firm to see if you would be interested in the audit since there
has been a disagreement with the existing auditors.
Required:
a. What concerns would you have about accepting the audit of Dime World?

There were so many things wrong in this scenario that the challenge was
to identify them all in the time available. By strict discipline, candidates
with good examination technique were able to produce a full list of the
faults or areas of concern whereas candidates who obtained lower marks
tended to focus at length on only three or four factors. Some of the points
that were often overlooked include:
A client which is a listed company is faced with extra regulations. While
this is not necessarily a problem, it might be if the audit firm does not
have experience of dealing with quoted companies.
The market for low value items is very competitive and tends to have
low profit margins which means that there is little room for error.
Often low quality goods enjoy little or no brand loyalty from customers
so that might make the company particularly susceptible to a shift in
consumer tastes.
Dealing in goods nearing the end of their shelf-life could involve health
risks or scares and potential liability issues.
The Draconian management style may produce short-term incentives
for staff to work hard but will engender no staff loyalty and the bonus
based on profits always creates the incentive to manipulate reported
profits.
22
b. If you were willing to accept the audit of Dime World, explain in detail what
further steps you would need to take before you could be formally appointed
as auditors of Dime World.

Technically this part of the question was not especially taxing and the best
candidates were able to explain the need for the new auditors to obtain
professional clearance from the existing auditors, the need to have done
background checks on the companys history and the directors previous
experience and records, the importance of performing some analysis of the
industry and the market conditions, perhaps a site visit in order to obtain a
clear picture of the client and, of course, completing and signing an audit
engagement letter or contract.
Section B
Answer at least one question, and no more than two questions from this
section. A total of four questions should be answered with at least two
from Section A.
Question 5
Closing the expectations gap is simply a case of educating the public on the
audit process. To what extent do you agree with this statement and why does
the expectations gap still exist?

Good essays were expected to have included:
Some explanation of what is meant by the expectation gap and its
different components (though the diagrammatic representation is not
needed and certainly would not be sufficient even for a third class
mark).
Candidates were required to identify other aspects of the confusion
about the role of the auditors and perhaps make some suggestions
about the historical roots of the gap, e.g. the early emphasis on fraud
detection.
Following from this basis, it might be suggested that the lack of
understanding of the role of the auditors is the result of poor
knowledge of accounting.
Although action can be taken by audit firms to close the gap such as
greater explanation in the auditors report, education alone is not likely
to be enough.
Poorly-prepared candidates appeared unable to talk about anything other
than the three aspects of the expectations gap and gave the impression
that they had not fully grasped the whole import of the question. Some
thought needed to be given to the reasons for the gaps existence and
the fact that all occupations suffer from some consumer disappointment
caused largely by the consumers lack of knowledge about the limitations
of the providers skills.
23
Question 6
Discuss the need for auditors to limit their liability with audit clients and the
opinion that if auditors concentrated on performing high quality audits then
there would be no need to fear litigation.

Very good essays included both the need for some form of protection for
the auditing profession and the opposite case. For example:
A discussion of the arguments put forward by auditors for limiting their
liability along the following lines:
Litigious nature of audit work
Deep pocket syndrome in the UK
Big money pay outs are a barrier to entry for smaller audit firms
who cannot afford the risk of being sued
Large increases in professional indemnity premiums
Unlimited liability increases the risk of audits and therefore the
costs to the audit client.
The popularity of out-of-court settlements by audit firms is skewing the
publics perception of the issue as they suggest guilt, the likelihood of
being successful when taking claims to audit firms and do not allow the
courts to protect the auditors when appropriate and therefore for the
law to develop.
Question 7
Explain the importance of the audit of financial statements in terms of its value
to the economy and suggest what might happen if the statutory audit were to
be abolished.
Porter et al. (2014) Chapters 1 and 2.
This essay produced some good answers which drew on material

from theoretical discussions concerning the role of auditors and the
value of having financial statements independently verified in order
to add reliability and thereby help improve the quality of information.
Beneficiaries of this added value would be investors of theory primarily
but also others such as banks and trade creditors.
The assertion that unaudited information cannot be trusted was explored
and the assumption that, without an audit, less reliable information would
impact on the cost of capital and the cost of doing business as a risk
premium would be added to transactions involving credit.
The next logical step was also suggested, i.e. that without a compulsory
audit for larger companies, investors might pressure management into
arranging a voluntary audit. Lenders with sufficient bargaining power
would be able to insist on potential borrowers undergoing an audit as a
condition for the loan. Without statutory audit, parties could negotiate
their own deals but this would result in inefficiencies.
24
Generally those who attempted this question made a pretty good go of

tackling the big picture of the economic importance of the audit industry.
These candidates were able to demonstrate that although a question may
look challenging, it can be approached sensibly if one is prepared to go
back to basic principles.
Question 8
Critically evaluate the effectiveness of the audit risk model as an approach to
the audit of financial statements.

A large number of candidates attempted this question but rather too
many thought that it required no more than a definition of the risk model
approach to auditing and a brief description of the component parts,
inherent, control and detection risks. While some knowledge of the basic
approach was clearly necessary, the question required a lot more thought
than simply reciting a formula.
A really good answer would have explained how the risk model focuses
attention on areas most prone to misstatement. The natural logic to this
approach seems unarguable. Auditors have to form an opinion on whether
financial statements are fairly stated so it makes sense to consider first
those areas where an error is most likely.
However, the better candidates were able to comment on the difficulty of
assessing the relative risk factors and especially of allocating numerical
values to each risk factor.
In reality, most practical auditors base their assessments on a simple range
of high, medium, low risks although this may be difficult to apply with
consistency at the margins.
Very good candidates also brought into the discussion the role of
management in dealing with the inherent risks facing a business. A
rational management will try to counter a perceived high level of risk by
putting in place controls to mitigate the risk.
Obviously, auditors need to assess the effectiveness of the controls as well
as the level of risks in deciding the extent to which a misstatement is likely.
This in turn determines the amount of work which is needed.
25

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Examiners commentaries 2014

Examiners commentaries 2014

Information about the subject guide and the Essential reading

What are the Examiners looking for?

AC3093 Auditing and assurance

appeared to have taken particular note of the Examiners commentaries

Examiners commentaries 2014

AC3093 Auditing and assurance

Examiners commentaries 2014

Examiners commentaries 2014

Information about the subject guide and the Essential reading

Comments on specific questions

AC3093 Auditing and assurance

Approaching the question

Examiners commentaries 2014

Approaching the question

AC3093 Auditing and assurance

Approaching the question

Examiners commentaries 2014

Approaching the question

AC3093 Auditing and assurance

This question proved to be very popular with many candidates opting

Approaching the question

Examiners commentaries 2014

Approaching the question

AC3093 Auditing and assurance

Approaching the question

Approaching the question

Examiners commentaries 2014

Candidates needed to discuss the problem of sampling risk the risk

Approaching the question

AC3093 Auditing and assurance

Approaching the question

The question of auditors independence has a long pedigree and should

Examiners commentaries 2014

AC3093 Auditing and assurance

Examiners commentaries 2014

Information about the subject guide and the Essential reading

Comments on specific questions

Examiners commentaries 2014

Approaching the question

What could go wrong

Engineers asked to keep

Risk of errors on stock

Stock items bar coded and

No ageing of stock items

Stock may be held on the

Stock sheets should

AC3093 Auditing and assurance

Approaching the question

Examiners commentaries 2014

Approaching the question

Approaching the question

AC3093 Auditing and assurance

Approaching the question

Examiners commentaries 2014

b. Corporate governance best practice usually requires the formation of an

Approaching the question

AC3093 Auditing and assurance

Approaching the question

Examiners commentaries 2014

Approaching the question

Approaching the question