Вы находитесь на странице: 1из 233
ACCA P7 ADVANCED AUDIT & ASSURANCE Tuition Note For exams in DEC 2013 © Lesco

ACCA P7 ADVANCED AUDIT & ASSURANCE

Tuition Note

For exams in DEC 2013

© Lesco Group Limited, April 2014 All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior written permission of Lesco Group Limited.

1

Accounting Practise Center (A.P.C)

www.accaapc.com

CONTENTS

CHAPTER1BEFORE THE ENGAGEMENT SERVICES:

5

CHAPTER 1 ADVERTISING: (DEC2010 Q4)

6

CHAPTER 1 ADVERTISING: (JUNE 2004)

8

CHAPTER 1 TENDERING+FEES (JUNE09 Q2)

9

CHAPTER 1 FACTORS TO BE CONSIDERED JUNE2008Q1(C)

14

CHAPTER 1 QUALITY CONTROLDEC2007 Q1(C)

20

CHAPTER 1 ETHICS THEORY:

23

CHAPTER 1 JUNE2008 Q4 (SMITH & CO)

25

CHAPTER 1 DEC2008 Q4(BECKER & CO)

29

CHAPTER 1 ENGAGEMENT LETTER Q:

34

CHAPTER 1 MONEY LAUNDERING (DEC2009 Q2(C))

35

CHAPTER 1 ISA250

37

CHAPTER2 PERFORM AN ENGAGEMENT SERVICE:

38

CHAPTER 2 Q1: WHAT DOES AN AUDIT FLOWCHART LOOK LIKE?

38

CHAPTER 2 Q2:JUNE2009 Q1(A)

39

CHAPTER2 Q3:DEC2009 Q1(A)(B)

42

CHAPTER2 Q4: JUNE2008 Q1 (A+B)(BUSINESS RISKS)

44

CHAPTER2 Q5:JUNE2012 Q1(RISK OF MATERIAL MISSTATEMENT/AUDIT RISKS)

50

CHAPTER2 Q6: SATGE 3:JUNE2010 Q2

55

CHAPTER2 Q7: BIG ACCOUNTING QUESTIONS

60

Chapter2 Q7: 1, conceptual framework:

61

Chapter2 Q7: 2,IAS1 Presentation of Financial Statements

63

Chapter2 Q7: 3,IAS2 Inventories

64

65

66

Chapter2 Q7: 5,IAS8 Accounting Policies, Changes in Accounting Estimates and

errors

67

69

Audit Question [ DEC2009 Q2] IAS2

Chapter2 Q7: 4, IAS7 Statement of cash flows

Audit question [DEC2011 Q3 ] IAS 8

Chapter2 Q7: 6,IAS10 Events after the Reporting Period

Audit question ISA560 [DEC2009 Q5]

Chapter2 Q7: 7,IAS 11 Construction Contracts

Audit question [june2011 Q2] IAS11:

Chapter2 Q7: 8,IAS12 Income Taxes

Audit question: [Q11:DEC2008 Q1] IAS 12

71

72

75

77

79

83

Chapter2 Q7: 9,IAS16 Property, Plant and Equipment

84

Chapter2 Q7: 10,IAS17 Leases

88

Audit question1: [June2009Q3] leases

Chapter2 Q7: 11,IAS 18 Revenue

92

94

Audit questions: (IAS18 revenue recognition)

95

Q Harrier (June2004) (IAS18 revenue recognition)

96

2

Accounting Practise Center (A.P.C)

www.accaapc.com

Chapter2 Q7: 12,IAS 19 Employee Benefit

97

Audit question (June2012 Q5(b)) IAS19

99

Chapter2 Q7: 13,IAS 20 Accounting for Government Grants and Disclosure of

Government Assistance

101

103

Chapter2 Q7: 14,IAS 21 The effects of Changes in Foreign Exchange Rates

104

105

106

108

110

112

116

118

119

Chapter2 Q7: 16,IAS 24 Related Party Transactions

Audit Question [june2010 Q1 (c)(ii)] IAS 20

Audit question: Grissom Co (June2010 Q1 extract)

Chapter2 Q7: 15,IAS 23 Borrowing Costs

Audit question:[june2012 Q5] IAS23 Borrowing cost

Audit question:[Q15june2008 Q3]related party transactions

Chapter2 Q7: 17,IAS28 Investments in Associates

Audit Question [June2010 Q1] IAS28

Chapter2 Q7: 18, Financial instruments IAS32,37,39 IFRS9

Audit question [Q17] IAS32,39 IFRS7

Audit question:[DEC2011 Q3(b)] Financial instruments(relating to 3rd party work)

125

Chapter2 Q7: 19,IAS33 Earnings Per share

Audit question

[june2009 Q5 Pluto] IAS 33: (Ajusted)

Chapter2 Q7: 21,IAS 36 Impairment of Assets

126

127

130

131

Audit question: [Q] impairment IAS36

133

Audit question [DEC2010 Q3 Clooney]impairment IAS36

135

Chapter2 Q7: 22,IAS 37 Provisions, Contingent liabilities and Contingent Assets

137

139

Chapter2 Q7: 23,IAS38 Intangible Assets

Audit question [ DEC2007 Q1(b)] provision

141

Audit question IAS 38 [ june2008 Q5] Blod

144

Audit question [ DEC2011 Q1] IAS 38

146

Chapter2 Q7: 24, IAS40 Investment Property

Audit question [DEC2008 Q3] IAS40

Chapter2 Q7: 25, IFRS2 Share-based Payment

Audit question [ DEC2008 Q1(b)(i)] IFRS2 share based payment:

147

149

152

155

Chapter2 Q7: 26, IFRS5 Non-current Assets Held for Sale and Discontinued

Operations

157

Audit question1 IFRS 5 [ DEC2007(a) ]

160

Audit question2 [june2011 Q1a]IFRS 5

162

Chapter2 Q7: 27, IFRS8 Operating Segments

Audit question1 IFRS8 [ DEC2009 Q1(d)]

Chapter2 Q7 :28, IFRS10,11,12

Audit question [Shire DEC2005] IFRS11 Joint Arrangements

Chapter2 Q7 :29, IFRS13 Fair Value Measurement

Audit question [DEC2008 Q3(a)]fair value

Chapter2Group audit

3

Accounting Practise Center (A.P.C)

www.accaapc.com

165

167

169

172

173

175

176

June2012 Q1(a(i+iii)): Group audit

177

STAGE 5 OF AUDIT FLOWCHART

181

DEC2012 Q2 AUDIT FINDINGS

182

CHAPTER 2 JUNE2011 Q3 OPENING BALANCES (ISA510&ISA710)(B)

189

CHAPTER2 :DEC2010 Q2 NEWMAN & CO(C) [ISA720 OTHER INFORMATION]

191

STAGE 6 AUDIT REPORT

193

CHAPTER 2 JUNE2012 Q5(B)

193

CHAPTER 2 JUNE2011 Q5 NASSAU GROUP

195

NON AUDIT ENGAGEMENT SERVICES

199

INTERIM FINANCIAL INFORMATION DEC2012 Q5(B)

200

PROSPECTIVE FINANCIAL INFORMATION CHAPTER 2 JUNE2012 Q2(A)

202

DUE DILIGENCE REVIEW CHAPTER 2 JUNE2008 Q2

207

FORENSIC AUDIT CHAPTER 2 DEC2008 Q2

211

SOCIAL AND ENVIRONMENTAL AUDIT DEC2008 Q1(C)

216

JUNE2012 Q2(B)(II): SOCIAL AND ENVIRONMENTAL AUDIT

218

CHAPTER 2 DEC2010 Q2(B) SOCIAL AND ENVIRONMENTAL AUDIT

220

CHAPTER3 CURRENT ISSUES

221

CHAPTER3 JUNE2009 Q2(D) TRANSNATIONAL AUDIT

222

CHAPTER3 DEC2009 Q4

225

JUNE2008 Q2(C) JOINT AUDIT

227

CHAPTER3 Q5 DEC2010 NEESON&CO(B) Q4

229

CHAPTER3 JUNE2010 Q5(B) AUDITORSLIABILITY

231

4

Accounting Practise Center (A.P.C)

www.accaapc.com

Chapter1Before the engagement services:

In this chapter we will be going through:

1. Advertisement issues

2. How to draft a tendering document

3. Professional appointment issues

4. Quality control issues

5. Regulatory issues

The best way to learn these knowledge is to copy note from tuition video.

5

Accounting Practise Center (A.P.C)

www.accaapc.com

Chapter 1 Advertising: (DEC2010 Q4) Neeson&Co

An advertisement could be placed in national newspapers to attract new clients. The draft advertisement has been given to you for review:

Neeson & Co is the largest and most professional accountancy and audit provider in the country. We offer a range of services in addition to audit, which are guaranteed to improve your business effi ciency and save you tax.

If you are unhappy with your auditors, we can offer a second opinion on the report that has been given.

Introductory offer: for all new clients we offer a 25% discount when both audit and tax services are provided. Our rates are approved by ACCA.

Required:

Evaluate each of the suggestions made above, commenting on the ethical and professional issues raised. 8marks

6

Accounting Practise Center (A.P.C)

www.accaapc.com

Answer to Neeson&Co:

Back up Any comments made by the advertisement should be backed up with evidence. For example it says Neeson&Co is the largest and most professional accountancy provider in the country so sales revenue and number offices should be made to back up this evidence.

Definitely clear The advertisement should be definitely clear.The business efficiency can not be guaranteed by the firm and this seems that it’s not honest by Neeson.

The second opinion offered by Neeson&Co may imply that the audit work done by Neeson&Co is low and as a result client would not be happy with the first opinion given and hence second opinion would be issued again. And this comment in the advertisement is not professional.

Ensure to comply with laws and regulation The advertisement should comply with laws and regulation. The guarantee to save tax means maybe Neeson would use some tricks to help client save time which may not comply with laws and regulation because not in every circumstance that the tax can be saved.

Fundamental ethics Neeson&Co can’t quote rates are approved by ACCA because ACCA does not approve any rates and this would be seen as unprofessional.

Legal obligation It seems that if taxes can’t be saved and also business efficiency hasn't been improved so that client may take potential legal action against Neeson&Co resulting in further future cash outflow from Neeson&Co.

Low balling The 25% of introductory fees is low balling and it’s not prohibited but Neeson&Co should need to make sure by charging such a low amount of fees the quality of the work should be maintained, ie, following ISAs to do the audit work.

7

Accounting Practise Center (A.P.C)

www.accaapc.com

Chapter 1 (June 2004)Hawk Assocaite

Displaying business cards alongside those of local tradesman and service providers in supermarkets and libraries. The cards would read:

Hawk ACCA Associates For PROFRSSIONAL Accountancy, Audit, Business Consultancy and Taxation services Competitive rates. Money back guarantees.

Answer to June2004 Hawk Associate:

(4marks)

Advertisement in the super markets and libraries is not professional and they should advertise their firm using eg, financial magazines.

Professional is in capital and this implies only their firm is professional while others are not and firms shouldn’t criticize others.

Competitive rate is vague and compare to whom? So this information is misleading.

Money back guarantees may mean they can help company save tax and if not they would give money back to them and this will:

Firstly involving some illegal techniques to help company save tax and hence its a breach of laws and regulations.

Secondly it implies that the quality of services provided to the company may not be good and hence give their money back.

8

Accounting Practise Center (A.P.C)

www.accaapc.com

Chapter 1 tendering+Fees (June09 Q2)

The Dragon Group is a large group of companies operating in the furniture retail trade. The group has expanded rapidly in the last three years, by acquiring several subsidiaries each year. The management of the parent company, Dragon Co, a listed company, has decided to put the audit of the group and all subsidiaries out to tender, as the current audit firm is not seeking re-election. The financial year end of the Dragon Group is 30 September 2009.

You are a senior manager in Unicorn & Co, a global firm of Chartered Certified Accountants, with offices in over 150 countries across the world. Unicorn & Co has been invited to tender for the Dragon Group audit (including the audit of all subsidiaries). You manage a department within the firm which specialises in the audit of retail companies, and you have been assigned the task of drafting the tender document. You recently held a meeting with Edmund Jalousie, the group finance director, in which you discussed the current group structure, recent acquisitions, and the group’s plans for future expansion.

Meeting notes Dragon Group Group structure The parent company owns 20 subsidiaries, all of which are wholly owned. Half of the subsidiaries are located in the same country as the parent, and half overseas. Most of the foreign subsidiaries report under the same financial reporting framework as Dragon Co, but several prepare financial statements using local accounting rules.

Acquisitions during the year Two companies were purchased in March 2009, both located in this country:

(i) Mermaid Co, a company which operates 20 furniture retail outlets. The audit opinion expressed by the incumbent auditors on the financial statements for the year ended 30 September 2008 was qualified by a disagreement over the non-disclosure of a contingent liability. The contingent liability relates to a court case which is still on-going.

(ii) Minotaur Co, a large company, whose operations are distribution and warehousing. This represents a diversification away from retail, and it is hoped that the Dragon Group will benefit from significant economies of scale as a result of the acquisition.

Other matters The acquisitive strategy of the group over the last few years has led to significant growth. Group revenue has increased by 25% in the last three years, and is predicted to increase by a further 35% in the next four years as the acquisition of more subsidiaries is planned. The Dragon Group has raised finance for the

9

Accounting Practise Center (A.P.C)

www.accaapc.com

acquisitions in the past by becoming listed on the stock exchanges of three different countries. A new listing on a foreign stock exchange is planned for January 2010. For this reason, management would like the group audit completed by 31 December

2009.

Required:

(a)Recommend and describe the principal matters to be included in your firm’s tender document to provide the audit service to the Dragon Group. (10 marks)

(b)

Explain FOUR reasons why a firm of auditors may decide NOT to seek re-election as auditor. (6 marks)

(c)

Using the specific information provided, evaluate the matters that

should be considered before accepting the audit engagement, in the event of your firm being successful in the tender. (7 marks) Professional marks will be awarded in part (c) for the clarity and presentation of the evaluation. (4 marks)

10

Accounting Practise Center (A.P.C)

www.accaapc.com

Answer to June2009 Q2a-c:

(a)

Recourses Detailed background of our firm should be included for example the expertise and clients we serve.

Clients needs Because Dragon group is going to go listed onto the stock exchange and so we can provide non audit services such as corporate governance advice relating to the listing.

We have offices in over 150 countries across the world so we can deal with audit with your subsidiaries all around the world more effectively.

Way to do the audit We should include how we perform the audit service to ensure appropriate quality of work maintained such as following ISA to do the risk assessment.

Also we ensure quality during the audit by having appropriate quality control procedures during the audit such as hot review on the audit work we have done.

Extra benefit We can provide recommendation to address internal control weakness to management in the management letter as an extra service for example.

Fees Fees should be broken down into how it’s calculated by clearly laying out different classes of staff involved, such as hourly rate for audit manager and partner.

11

Accounting Practise Center (A.P.C)

www.accaapc.com

(b)

Overdue fees Where a client hasn't paid their fees there has been outstanding for some time and such overdue fees would be seen as loan to client which may cause a self interest threat, ie, in order to keep the loan auditor may issue whatever opinion that client wants so that a safeguard for this is not to seek re-election.

Resources

As the company expands the audit firm may not have enough resources to do the audit any more. Such as the company is listing on a stock exchange and the audit firm is a lack of relevant experts who know the regulation of the stock exchange and so the firm may not seek re-election.

Integrity When the management doesn't comply with specific accounting standards such as a deliberate failure to provide a provision in the financial statements and this action would be seen as a lack of integrity. So in order for the audit firm to remain good reputation they should not seek re-election.

Conflict of interest Such as the existing company we are auditing is damaging the environment and didn't disclose the fact. Another company is waiting for out firm’s tendering but they are competitors and if we audit both companies which would cause a conflict of interest so we should resign the first company as by continuing to be an auditor for this would damage our firm’s reputation.

12

Accounting Practise Center (A.P.C)

www.accaapc.com

(c)

Evaluation of matters to be considered:

Recourses

As dragon group has expanded rapidly in the last three years so we must ensure we have enough audit staff to audit those components.

Management integrity As a qualified opinion issued by previous auditor over a deliberate non-disclosure of contingent liability we should question management’s integrity and if they not integrate then we should not accept the engagement service because if after conducting the service and we find information we obtained is fake then it will still have an impact on our audit opinion.

Previous auditor

It would be necessary to contact previous auditor to gather information regarding the non disclosure of contingent liability with client’s permission of whether it should be disclosed in the individual financial statements of Mermaid Co, and at group level.

Experiences Given Minotaur Co is involved in distribution and warehousing but this is not a very complicated industry for Unicorn&Co because it has its offices over 150countries and it should have relevant experience into auditing this eg, bringing in staff from a different department more experienced in clients with distribution operations

Time

There will be only 3months for Unicorn&Co to complete the audit and Unicorn&Co should consider whether to allocate more recourses to this engagement given this client is large and it needs to spend more time into it.

13

Accounting Practise Center (A.P.C)

www.accaapc.com

Chapter 1 June2008Q1(c)

You are a senior audit manager in Mitchell & Co, a firm of Chartered Certified Accountants. You are reviewing some information regarding a potential new audit client, Medix Co, a supplier of medical instruments. Extracts from notes taken at a meeting that you recently held with the finance director of Medix Co, Ricardo Feller, are shown below:

Meeting notes meeting held 1 June 2008 with Ricardo Feller Medix Co is a provider of specialised surgical instruments used in medical procedures. The company is owner managed, has a financial year ending 30 June 2008, and has invited our firm to be appointed as auditor for the forthcoming year end. The audit is not going out to tender. Ricardo Feller has been with the company since January 2008, following the departure of the previous finance director, who is currently taking legal action against Medix Co for unfair dismissal.

Company background Medix Co manufactures surgical instruments which are sold to hospitals and clinics. Due to the increased use of laser surgery in the last four years, demand for traditional metal surgical instruments, which provided 75% of revenue in the year ended 30 June 2007, has declined rapidly. Medix Co is expanding into the provision of laser surgery equipment, but research and development is at an early stage. The directors feel confident that the laser instruments currently being designed will eventually receive the necessary licence for commercial production, and that the laser product will replace surgical instruments as a leading source of revenue. There is currently one scientist working on the laser equipment, subcontracted by Medix Co on a freelance basis. The building in which the research is being carried out has recently been significantly extended by the construction of a large laboratory.

A considerable revenue stream is derived from agents who are not employed by Medix Co. The agents earn a commission based on the value of sales they have secured for Medix Co during the year. There are many suppliers into the market and agents are used by all manufacturers as a means of marketing and distributing their products.

The company’s manufacturing facility is located in another country, where operating costs are significantly lower. The facility is under the control of a local manager who visits the head office of Medix Co annually for a meeting with senior management. Products are imported via aeroplane. The overseas plant and equipment is owned by the company and was constructed 12 years ago specifically for the manufacture of metal surgical instruments.

The company has a bank overdraft facility and makes use of the facility most months. A significant bank loan, which will carry a variable interest rate, is currently being negotiated. The terms of the loan will be finalised once the audited financial statements have been viewed by the bank.

14

Accounting Practise Center (A.P.C)

www.accaapc.com

After receiving permission from Medix Co, you held a discussion with the current audit partner of Medix Co, Mick Evans, who runs a small accounting and audit practice of which he is one of two partners. Mick told you the following:

‘Medix Co has been an audit client for three years. We took over from the previous auditors following a disagreement between them and the directors of Medix Co over fees. As we are a small practice with low overheads we could offer lower fees than our predecessors. We could also do the audit very quickly, which pleased the client, as they like to keep costs as low as possible.

During our audits we have found the internal systems and controls to be quite weak. Despite our recommendations, there always seemed to be a lack of interest in making improvements to the accounting systems, as this was seen to be a ‘waste of money’. There have been two investigations by the tax authorities, which we did not deal with, as we are not tax experts. In the end the directors sorted it all out, and I believe that the tax matter is now resolved.

We never had a problem getting access to accounting books and records. However, the managing director, Jon Tate, once gave us what he described as ‘the wrong cash book’ by mistake, and replaced it with the ‘proper version’ later in the day. We never found out why he was keeping two cash books, but cash was an immaterial asset so we didn’t worry about it too much.

We are resigning as auditors because the work load is too much for our small practice, and as Medix Co is our only audit client we have decided to focus on providing non-audit services in the future.’

You have also found a recent press cutting regarding Medix Co:

Extract from local newspaper business section, 2 June 2008 It appears that local company Medix Co has breached local planning regulations by building an extension to its research and development building for which no local authority approval has been given. The land on which the premises is situated has protected status as a ‘greenfield’ site which means approval by the local authority is necessary for any modification to commercial buildings. A representative of the local planning office stated today: ‘We feel that this is a serious breach of regulations and it is not the first time that Medix Co has deliberately ignored planning rules. The company was successfully sued in 2003 for constructing an access road without receiving planning permission, and we are considering taking legal action in respect of this further breach of planning regulations. We are taking steps to ensure that these premises should be shut down within a month. A similar breach of regulations by a different company last year resulted in the demolition of the building.’

15

Accounting Practise Center (A.P.C)

www.accaapc.com

Required:

Prepare briefing notes, to be used by an audit partner in your firm, assessing the professional, ethical and other issues to be considered in deciding whether to proceed with the appointment as auditor of Medix Co. Note: requirement (c) includes 2 professional marks. (12 marks)

16

Accounting Practise Center (A.P.C)

www.accaapc.com

Answer: June2008 Q1(c)

Briefing notes

To: Audit partner From: Audit manager Date: exam date Subject: Factors to consider regarding appointment as auditor of Medix Co Introduction:

This briefing note summarises the main factors we should consider in deciding whether to take the appointment further.

Time to build up knowledge Because this is the last month before the financial statement year end we would questions whether we have enough time to quickly build up the knowledge of Medixcompany.

Expertise Given Medix company operates in a very sophisticated industry so we need to question whether we should refer to expertise when doing the audit and if yes this will increase audit fees charged to client and given client wants to keep the audit costs as low as possible this may not be acceptable.

Control system Given Medix company has a weak internal control system so we should not rely on its system but rather we should use full substantive testing approach and this increases the costs and also time spent as well and it may not be acceptable by client given he wants to keep the costs down.

Opening balance Because this is a new audit client and we should consider extra work done on the opening balance of its financial statement given a weak internal control system exists.

Management style Medix company is being sued by previous finance director and previous auditor resigned as a result of a disagreement with the management so the history shows we may find it difficult to maintain the good relationship with management.

Fee pressure Medix company is now struggling to raise finance and so there would be a risk that after we become its auditor we can’t collect our money back as audit fee and as a result this creates lots of threats to objectivity, ie, intimidation threat by threatening not to pay for us unless to give a wrong audit opinion satisfying client.

17

Accounting Practise Center (A.P.C)

www.accaapc.com

Reputation Medix company has been in breach of laws an regulation and this has impair its reputation within the industry and if we were to become its auditor then it will impact on our reputation as well.

Advocacy threat Medixcompany has in breach of laws and if we were to become an auditor of them then we would be seen as promoting its status saying client’s breach of laws is right and hence this will impair our objectivity in expressing an audit opinion.

Competence Medixcompany is in such a sophisticated industry and we should question ourselves whether we have competence in carrying out such an audit, eg, experience before in auditing the work in progress in a similar industry.

Public interest Medix company has in breach of laws before involving in activities damaging the environment and its doing harm to public interest so we would be better not to become its auditor.

Time It seems that there would be only 1 month before we start our audit and given the complexity of client’s business activities we may not have enough time to carry out such an audit service.

Integrity Given there are two cash book presented by managing director and we can reasonably assume that fraudulent transactions may occur here and hence we should question the integrity of management and if they are lying then we shouldn't accept as an auditor.

Staff and resources We should consider whether we have enough staff and recourses to carry out the audit given part of its Medixcompany’s operations are overseas and if no we shouldn't accept as an auditor.

Easy It seems that medix company is going to raise finance from the bank and the audit report may be relied on by bank as well and this creates higher risk for us because given time, recourses, expertise analysis maybe we don't have time to carry out this audit as expected.

18

Accounting Practise Center (A.P.C)

www.accaapc.com

Conclusion:

So from the above analysis it would be better for us not to be as an auditor for Medixcompany.

19

Accounting Practise Center (A.P.C)

www.accaapc.com

DEC2007 Q1(c)

(e) (i) Identify and describe FOUR quality control procedures that are applicable to the individual audit engagement; and (8 marks)

(ii) Discuss TWO problems that may be faced in implementing quality control procedures in a small firm of Chartered Certified Accountants, and recommend how these problems may be overcome. (4 marks)

20

Accounting Practise Center (A.P.C)

www.accaapc.com

Answer to DEC2007 Q1(c):

(i)

Pre appointment checks Auditors should check the client before accepting this engagement such as:

Obtaining professional clearance from previous auditors to ensure there’s no problem to accept this engagement letter from previous auditors’ perspective.

Considering any conflict of interest among its existing clients.

Due diligence in client whether they are involved in money laundering activities.

Planning Auditor should plan their audit before it’s actually implemented by clearly setting up appropriate audit strategy and detailed audit plan.

Planning meeting Auditors should hold a planning meeting before audit is implemented by clearly stating the responsibility of members for example.

Documenting the work During the audit auditors should document the work properly according to ISA.

Direction, supervision and review of work During the audit there should be an audit supervisor or manager directing the audit work, eg, act as a mentor during the audit and if any problems arise from audit junior they can come to supervisor or manager for a solution.

Audit work should be reviewed after the work has been done, ie, hot review on the work before audit report is signed to identify any mistakes within the audit work.

Delegate work based on knowledge and experience Auditors should be delegated work based on knowledge and experience this means for example audit junior should not be delegated the work to audit fair value.

21

Accounting Practise Center (A.P.C)

www.accaapc.com

(ii)Competence

Problem:

In order to keep up to date with the knowledge particularly for ISA and IFRS staff should be trained but it’s too expensive to set up an inhouse training within the small firm.

Recommendation:

So this can be outsourced to an external training company to do so because due to economic of scale within that external training company a lower cost incurred comparing to setting up in house.

Review

Problem:

It may not be possible to hold an independent review of an engagement within the firm because of the small number of senior and experienced auditors.

Recommendation:

An external review service may be purchased.

22

Accounting Practise Center (A.P.C)

www.accaapc.com

Chapter 1 Ethics:

Basic knowledge:

ACCA particularly identifies there are 5 principles we need to follow:

Professional behavior:

We shouldn’t do anything that discredits ACCAs reputation.

Integrity:

Both accountant and auditor should lie to others.

Competence and due care:

Professional accountants should pass ACCA exams and accumulate relevant experience and do annual continues professional development.

They should also follow rules to do the work and finish the work within the reasonable amount of time.

Confidentiality Professional accountants should keep clients confidential information and should not disclose them to 3 rd parties.

If clients company is involved in illegal activities and we can:

1. Seek legal advice

2. Disclose those to appropriate authority.

Objectivity This means audit opinion should be trustable.

23

Accounting Practise Center (A.P.C)

www.accaapc.com

And there are 6 threats to objectivity:

1. Self interest threat

In order for auditor to keep benefit then auditor helps to cover up the fraud by

client making its opinion not objective.

2. Self review threat

Checking auditors own work would mean auditor will lose profeesional skepticism when trying to audit client and the opinion given wouldn’t be

objective.

3. Advocacy threat

It may seem that auditor is trying to promote the status of clients company

making any audit opinion subsequently issued not objective.

4. Familiarity threat

This means there is a close relationship between auditor and Client Company

and this would mean:

a. auditor will cover up fraud made by clients company;

b. auditor may lose professional skepticism when auditing the clients company.

So it will make audit opinion not objective.

5. Intimidation threat

Clients Company threatens auditors and in order to keep benefit auditor would issue whatever opinion that clients wants and making it not objective.

6. Management threat

Audit form makes a management decision on behalf of clients company and this may run a risk that clients company would fail.

In order not being affected by clients company audit firm would issue an audit opinion which is not trustable.

24

Accounting Practise Center (A.P.C)

www.accaapc.com

Chapter 1 June2008 Q4 (Smith & Co)

You are an audit manager in Smith & Co, a firm of Chartered Certified Accountants. You have recently been made responsible for reviewing invoices raised to clients and for monitoring your firm’s credit control procedures. Several matters came to light during your most recent review of client invoice files:

Norman Co, a large private company, has not paid an invoice from Smith & Co dated 5 June 2007 for work in respect of the financial statement audit for the year ended 28 February 2007. A file note dated 30 November 2007 states that Norman Co is suffering poor cash flows and is unable to pay the balance. This is the only piece of information in the file you are reviewing relating to the invoice. You are aware that the final audit work for the year ended 28 February 2008, which has not yet been invoiced, is nearly complete and the audit report is due to be issued imminently.

Wallace Co, a private company whose business is the manufacture of industrial machinery, has paid all invoices relating to the recently completed audit planning for the year ended 31 May 2008. However, in the invoice file you notice an invoice received by your firm from Wallace Co. The invoice is addressed to Valerie Hobson, the manager responsible for the audit of Wallace Co. The invoice relates to the rental of an area in Wallace Co’s empty warehouse, with the following comment handwritten on the invoice: ‘rental space being used for storage of Ms Hobson’s speedboat for six months she is our auditor, so only charge a nominal sum of $100’. When asked about the invoice, Valerie Hobson said that the invoice should have been sent to her private address. You are aware that Wallace Co sometimes uses the empty warehouse for rental income, though this is not the main trading income of the company.

In the ‘miscellaneous invoices raised’ file, an invoice dated last week has been raised to Software Supply Co, not a client of your firm. The comment box on the invoice contains the note ‘referral fee for recommending Software Supply Co to several audit clients regarding the supply of bespoke accounting software’.

25

Accounting Practise Center (A.P.C)

www.accaapc.com

Required:

Identify and discuss the ethical and other professional issues raised by the invoice file review, and recommend what action, if any, Smith & Co should now take in respect of:

(a)

Norman Co; (8 marks)

(b)

Wallace Co; and (5 marks)

(c)

Software Supply Co. (4 marks)

26

Accounting Practise Center (A.P.C)

www.accaapc.com

(17 marks)

Answer to June2008 Q4:

(a)

Matters to consider:

In order to secure the payment, audit firm would issue a wrong audit opinion to maximize its benefit and hence creating self interest threat to objectivity.

Audit firm is not chasing money from client company would suggest there is a good relationship between them and a familiarity threat exists meaning audit firm may help company conceal some mistakes in the financial statements but still issue a clean audit report.

Because Norman is suffering poor cash flows and is unable to pay for audit firm and this may create intimidation threat meaning Norman may threaten not to pay the firm unless a clean audit report is given.

Before accepting an engagement letter to Norman company auditors should do a detailed pre-appointment check to ensure this client is a going concern entity.

Actions:

1. Auditor should raise this issue to audit committee to secure payments.

2. Auditors should quickly invoice management about the audit work service fees.

3. Auditor should have a detailed pre-appointment check client in the future before working for them.

4. Auditors should perform an independent partner check for last year audit work as well since they haven’t paid the firm in the last year.

27

Accounting Practise Center (A.P.C)

www.accaapc.com

(b)

Matters to consider:

In order to keep the cheap rental expense of $100 auditor would issue a wrong audit opinion and hence leads to self interest threat.

The $100 nominal value would suggest theres a good relationship between client and audit firm and hence familiarity threat would exist meaning auditors would lose professional skepticism when doing the audit and hence giving a wrong audit opinion.

The nominal $100 would create an intimidation threat as well because client would threaten to withdraw this offer unless a clean audit report is given by auditors.

This is about managers work and hence its senior so all its work done would have a big impact onto the overall opinion given.

Actions:

1. Partners should perform an independent review on work done by audit manager.

2. When necessary report to ACCA about this issue.

3. Remove managers from the audit team for this client.

4. Carefully check whether there are any relationships that manager with other

clients and if yes then remove him/her from other services as well.

(c)

Matters to consider:

This will increase business risk because if the software quality is bad then it would be seen that audit firms work quality would be bad as well and hence leads to an impairment of audit firms reputation.

Actions:

1. Tell client about the referral fees.

2. Make written confirmation that client knows about referral fees.

3. Make sure that other audit staff involved in audit have no further interest in

software company because if yes then any other threats to objectivity would be created.

28

Accounting Practise Center (A.P.C)

www.accaapc.com

Chapter 1 DEC2008 Q4(Becker & Co)

You are a senior manager in Becker & Co, a firm of Chartered Certified Accountants offering audit and assurance services mainly to large, privately owned companies. The firm has suffered from increased competition, due to two new firms of accountants setting up in the same town. Several audit clients have moved to the new firms, leading to loss of revenue, and an over staffed audit department. Bob McEnroe, one of the partners of Becker & Co, has asked you to consider how the firm could react to this situation. Several possibilities have been raised for your consideration:

1. Murray Co, a manufacturer of electronic equipment, is one of Becker & Co’s audit clients. You are aware that the company has recently designed a new product, which market research indicates is likely to be very successful.

The development of the product has been a huge drain on cash resources. The managing director of Murray Co has written to the audit engagement partner to see if Becker & Co would be interested in making an investment in the new product. It has been suggested that Becker & Co could provide finance for the completion of the development and the marketing of the product. The finance would be in the form of convertible debentures.

Alternatively, a joint venture company in which control is shared between Murray Co and Becker & Co could be established to manufacture, market and distribute the new product.

2. Becker & Co is considering expanding the provision of non-audit services.

Ingrid Sharapova, a senior manager in Becker & Co, has suggested that the firm could offer a recruitment advisory service to clients, specialising in the recruitment of finance professionals. Becker & Co would charge a fee for this service based on the salary of the employee recruited. Ingrid Sharapova worked as a recruitment consultant for a year before deciding to train as an accountant.

3. Several audit clients are experiencing staff shortages, and it has been

suggested that temporary staff assignments could be offered. It is envisaged that a number of audit managers or seniors could be seconded to clients for periods not exceeding six months, after which time they would return to Becker & Co.

29

Accounting Practise Center (A.P.C)

www.accaapc.com

Required:

Identify and explain the ethical and practice management implications in respect of:

(a)

A business arrangement with Murray Co. (7 marks)

(b)

A recruitment service offered to clients. (7 marks)

(c)

Temporary staff assignments. (6 marks)

(d) I heard one of the audit managers say that our firm had lost an audit client to a competitor because of lowballing. What is lowballing and is it allowed?

(3 marks)(DEC2009 Q4)

30

Accounting Practise Center (A.P.C)

www.accaapc.com

(23 marks)

Answer to DEC2008 Q4:

(a)

In order to make investment in the product more successful audit firm would issue a favorable audit opinion to client’s company even though its financial statements are wrong and this creates self interest threat.

By starting up a joint venture it may suggest audit firm and Murray Company are close friends and hence this creates familiarity threat meaning Audit firm would lose professional skepticism when doing the actual audit.

The finance is in the form of convertible loan meaning it can be converted into cash or equity at the end of the life of project and an intimidation threat exists meaning if audit firm is not going to issue a clean audit report then Murray Company may not pay for audit firm for cash/equity.

A management threat arises as well because a joint venture is set up and any management decision made by the audit firm may result in company failure and hence there is a risk that audit firm may get sued and hence in order not being sued by Murray company, audit firm would issue whatever opinion that they want.

By investing in such a project there is a business risk that audit firm reputation would be impaired if the project goes badly and hence there might be less future clients go to Becker&Co.

Audit firm would have 2 choices including:

1.

Accept the offer but IFAC code of ethics says the threats to objectivity

making opinion not objective to be so significant and no safeguard would put in place to minimize the threat and hence audit firm would be better not doing audit services for this client.

2. Reject the offer and continue to provide audit service to this client.

31

Accounting Practise Center (A.P.C)

www.accaapc.com

(b)

By receiving more income from the audit client would creates a self interest threat because in order to keep this interest audit firm would issue whatever opinion that client wants.

Because Becker & Co would charge a fee for this service based on the salary of the employee recruited so the higher salary that Becker&co argues then higher income stream would flow into audit firm and hence greater self interest threat.

By recruiting members to do the financial work the employees and audit firm would become friends and hence familiarity threats is created because by subsequently checking work done by those staff auditor would lose professional skepticism.

Intimidation threat would be created because if the quality of recruited staff is poor then client would sue us or require a clean audit report even though the financial statements are not true and fair.

If the staff recruited is poor quality then there would be an impairment on audit firms reputation and hence future client may not go to Becker&Co for those services including audit service any more.

(c)

Audit firm would have an incentive to send higher level staff to the company and hence earn more fees and this creates a higher self interest threat.

After auditor working on this company they may have a good relationship with staff there and hence a familiarity threat is created meaning auditor would lose professional skepticism when doing the actual audit or ignore the mistakes staff have made as well.

If quality of auditor sent to clients company is poor then an intimidation threat would create meaning client would choose to sue us for negligence or we give a clean audit report in order not get sued.

Audit manager or partner sent would be so senior and hence they would have a big impact on the audit work so this needs to be carefully checked.

32

Accounting Practise Center (A.P.C)

www.accaapc.com

(d)

Low balling means audit firm would charge a low fee to attract audit service from client in the hope to win the tender contact and provide future services to client.

This is not banned by ACCA as long as audit firm can demonstrate they would complete the work with competence and due care.

But as the fees is cut back then auditor may not spend enough time doing the work and stick to auditing standards and hence quality of the audit work would be lowered down.

33

Accounting Practise Center (A.P.C)

www.accaapc.com

Chapter 1 Engagement Letter Q:

State 6 items that could be included in an engagement letter.(3marks) Fee cover note: how the fees are calculated. Address to directors. Responsibilities of auditors and directors. Scope of audit. Extra services provided to client Signature and date.

34

Accounting Practise Center (A.P.C)

www.accaapc.com

Chapter 1 Money Laundering (DEC2009 Q2(c))

There are specific regulatory obligations imposed on accountants and auditors in relation to detecting and reporting money laundering activities. You have been asked to provide a training session to the new audit juniors on auditors’ responsibilities in relation to money laundering.

Required:

Prepare briefing notes to be used at your training session in which you:

(i)Explain the term ‘money laundering’. Illustrate your explanation with examples of money laundering offences, including those which could be committed by the accountant; and

(ii)Explain the policies and procedures that a firm of Chartered Certified Accountants should establish in order to meet its responsibilities in relation to money laundering.

(10 marks)

Professional marks will be awarded in part (c) for the format of the answer, and the quality of the explanations provided.

(2 marks)

35

Accounting Practise Center (A.P.C)

www.accaapc.com

Answer to DEC2009 Q2(c):

(i)

Definition:

Money laundering is to convert crime money into a legitimate form.

3 stages:

Placing

It seems that Heron co receives cash from customer and this is placing and cash

may be illegal from customers.

Layering

$2m of electronic bank transfer to an overseas financial institution would be a layering, ie, creating transactions to cover the true source of money.

Integration

Then getting money out from the financial institution of $2m then the source of money would become legitimate.

Offences:

Auditor committee money laundering activities.

Auditor helps client to establish money laundering system.

Doing tipping off meaning auditors would inform client about the potential investigation of money laundering activities by other departments and hence interrupt the investigation process.

(ii)

Train all relevant staff to money laundering issues.

Appoint a money laundering reporting officer to deal with money laundering activities and this will often be a senior audit partner.

Due diligence review of clients company including their address, directors register etc.

Review procedures would be put in place to review working papers of clients company to see if they are involved in money laundering activities.

Quality control procedures would be put in place like pre appoint check of the clients company whether it would involve in money laundering activities.

36

Accounting Practise Center (A.P.C)

www.accaapc.com

Chapter 1 ISA250

The purpose of ISA250 Consideration of Laws and regulations in an audit of financial statements is to establish standards and provide guidance on the auditor’s responsibility to consider laws and regulations in an audit of financial statements.

Required:

Explain the auditor’s responsibilities for reporting non-compliance that comes to the auditor’s attention during the conduct of an audit. (5marks)

Answer to ISA250:

Auditors are not responsible for the non-compliance with laws by client.

But if the non-compliance with laws would result in a material misstatement in the clients financial statements then auditors should modify its audit report.

Before that auditors should raise this issue to audit committee.

If this is not applicable then auditor should seek legal advice first.

If Client Company is involved in money laundering issues then auditor should report this to relevant authority.

37

Accounting Practise Center (A.P.C)

www.accaapc.com

Chapter2 Perform an engagement service:

Chapter 2 Q1: What does an audit flowchart look like?

38

Accounting Practise Center (A.P.C)

www.accaapc.com

Chapter 2 Q2:June2009 Q1(a)

Required:

(a)

(i) Identify and explain the aspects of a client’s business which should be considered in order to gain an understanding of the company and its operating environment; and

(6 marks) (ii) Recommend the procedures an auditor should perform in order to gain business understanding.

(4 marks) Professional marks will be awarded in part (a) for the clarity, format and presentation of the briefing notes.

(2 marks)

39

Accounting Practise Center (A.P.C)

www.accaapc.com

Answer to June2009 Q1(a):

(i)

Internal control system Auditors need to review clients internal control system including its control environment, internal control procedures etc to better understand whether a control testing approach or full substantive testing approach to audit would be used.

External factors Auditors need to review the level of competition within the industry because for example if the industry is so competitive then in order for the company to keep up with the industry average profit then company would have an incentive to manipulate the financial statements.

Auditors need to review the laws and regulations as well because if clients companys activity is not fulfilling the current laws and regulations then there might be risks that financial statements would be misstated, eg, failure to disclose contingent liability to the note of the Financial statements.

Performance measurement Auditors need to review companys performance measurement as well because for example if manager is measured based on profit then profit would be overstated in order to earn more bonus.

Companys structure and its accounting policy Auditors need to review its structure and its accounting policy and if the company’s structure is so complicated then during the actual consolidation there would be potential misstatements to the financial statements as well.

Company’s strategy, plan and its related business risks For example company’s strategy would be a market leader in the industry so its plan would be launching a new product and there is a business risk that this may fail resulting in the financial statements being misstated.

40

Accounting Practise Center (A.P.C)

www.accaapc.com

(ii)

Perform analytical procedure to identify any unusual transactions and this can help auditors to identify whether trends for the financial statements would be reasonable, ie, consistent with growth in economy.

Enquire with internal auditors about internal control system of company to understand its its effectiveness.

Inspect business plan by management to understand its potential business risks.

Observe internal control operations physically to verify internal control procedures are working effectively.

Recalculate some material balances to verify its accuracy.

41

Accounting Practise Center (A.P.C)

www.accaapc.com

Chapter2 Q3:DEC2009 Q1(a)(b)

ISA 520 Analytical Procedures requires that the auditor performs analytical procedures during the initial risk assessment stage of the audit. These procedures, also known as preliminary analytical review, are usually performed before the year end, as part of the planning of the final audit.

Required:

(i) Explain, using examples, the reasons for performing analytical procedures as part of risk assessment; and

(ii) Discuss the limitations of performing analytical procedures at the planning stage of the final audit.

(6 marks) (b) Explain and differentiate between the terms ‘overall audit strategy’ and ‘audit plan’.

(4 marks)

42

Accounting Practise Center (A.P.C)

www.accaapc.com

Answer to DEC2009 Q1(a)(b):

(i)

It can help auditors better understand the client.

Eg, perform analytical procedures for new client by comparing its profit with its competitor would provide the auditor with a better picture about the relative performance of the entity within its business environment.

It can help auditors better identify high risk areas.

Eg, preform analytical procedures by comparing its financial information,eg200% increase in profit with the non- financial information such as economic recession happens outside the market would clearly show that revenue may be overstated and hence this is a high risk area.

(ii)

It may not reflect the whole year figure because this is done based on interim financial information.

Because it’s not done at the year-end so some figures such as impairment should be ignored.

For some companies internal control system would be weak during the year and hence the analytical procedure on these results may not be correct.

(b)

Audit strategy sets out the scope, timing, nature and direction of the audit and it tells auditor which audit approach should be used, ie, system based or full substantive approach and how the recourses would be allocated.

Audit plan sets out the risk assessment, materiality and potential audit procedures to be used.

Audit strategy leads to audit plan meaning that audit plan, ie, if system based approach is used then less audit procedures would be included in the audit plan.

Any changes in the audit plan should lead to a change in the audit strategy as well, eg, during the audit a material risky balance is omitted so further procedures should be planned and recourses allocation schedule would also be changed.

43

Accounting Practise Center (A.P.C)

www.accaapc.com

Chapter2 Q4: June2008 Q1 (a+b)(business risks)

You are a senior audit manager in Mitchell & Co, a firm of Chartered Certified Accountants. You are reviewing some information regarding a potential new audit client, Medix Co, a supplier of medical instruments. Extracts from notes taken at a meeting that you recently held with the finance director of Medix Co, Ricardo Feller, are shown below:

Meeting notes meeting held 1 June 2008 with Ricardo Feller Medix Co is a provider of specialised surgical instruments used in medical procedures. The company is owner managed, has a financial year ending 30 June 2008, and has invited our firm to be appointed as auditor for the forthcoming year end. The audit is not going out to tender. Ricardo Feller has been with the company since January 2008, following the departure of the previous finance director, who is currently taking legal action against Medix Co for unfair dismissal.

Company background Medix Co manufactures surgical instruments which are sold to hospitals and clinics. Due to the increased use of laser surgery in the last four years, demand for traditional metal surgical instruments, which provided 75% of revenue in the year ended 30 June 2007, has declined rapidly. Medix Co is expanding into the provision of laser surgery equipment, but research and development is at an early stage. The directors feel confident that the laser instruments currently being designed will eventually receive the necessary licence for commercial production, and that the laser product will replace surgical instruments as a leading source of revenue. There is currently one scientist working on the laser equipment, subcontracted by Medix Co on a freelance basis. The building in which the research is being carried out has recently been significantly extended by the construction of a large laboratory.

A considerable revenue stream is derived from agents who are not employed by Medix Co. The agents earn a commission based on the value of sales they have secured for Medix Co during the year. There are many suppliers into the market and agents are used by all manufacturers as a means of marketing and distributing their products.

The company’s manufacturing facility is located in another country, where operating costs are significantly lower. The facility is under the control of a local manager who visits the head office of Medix Co annually for a meeting with senior management. Products are imported via aeroplane. The overseas plant and equipment is owned by the company and was constructed 12 years ago specifically for the manufacture of metal surgical instruments.

The company has a bank overdraft facility and makes use of the facility most

44

Accounting Practise Center (A.P.C)

www.accaapc.com

months. A significant bank loan, which will carry a variable interest rate, is currently being negotiated. The terms of the loan will be finalised once the audited financial statements have been viewed by the bank.

After receiving permission from Medix Co, you held a discussion with the current audit partner of Medix Co, Mick Evans, who runs a small accounting and audit practice of which he is one of two partners. Mick told you the following:

‘Medix Co has been an audit client for three years. We took over from the previous auditors following a disagreement between them and the directors of Medix Co over fees. As we are a small practice with low overheads we could offer lower fees than our predecessors. We could also do the audit very quickly, which pleased the client, as they like to keep costs as low as possible.

During our audits we have found the internal systems and controls to be quite weak. Despite our recommendations, there always seemed to be a lack of interest in making improvements to the accounting systems, as this was seen to be a ‘waste of money’. There have been two investigations by the tax authorities, which we did not deal with, as we are not tax experts. In the end the directors sorted it all out, and I believe that the tax matter is now resolved.

We never had a problem getting access to accounting books and records. However, the managing director, Jon Tate, once gave us what he described as ‘the wrong cash book’ by mistake, and replaced it with the ‘proper version’ later in the day. We never found out why he was keeping two cash books, but cash was an immaterial asset so we didn’t worry about it too much.

We are resigning as auditors because the work load is too much for our small practice, and as Medix Co is our only audit client we have decided to focus on providing non-audit services in the future.’

You have also found a recent press cutting regarding Medix Co:

Extract from local newspaper business section, 2 June 2008 It appears that local company Medix Co has breached local planning regulations by building an extension to its research and development building for which no local authority approval has been given. The land on which the premises is situated has protected status as a ‘greenfield’ site which means approval by the local authority is necessary for any modification to commercial buildings. A representative of the local planning office stated today: ‘We feel that this is a serious breach of regulations and it is not the first time that Medix Co has deliberately ignored planning rules. The company was successfully sued in 2003 for constructing an access road without receiving planning permission, and we are considering taking legal action in respect of this further breach of planning regulations. We are taking steps to ensure that these premises should be shut down

45

Accounting Practise Center (A.P.C)

www.accaapc.com

within a month. A similar breach of regulations by a different company last year resulted in the demolition of the building.’

Required:

(a) Using the information provided, identify and explain the principal business risks facing Medix Co.

(12 marks) (b) (i) Discuss the relationship between the concepts of ‘business risk’ and ‘risk of material misstatement’; and

(4 marks)

46

Accounting Practise Center (A.P.C)

www.accaapc.com

Answer to June2008Q1(a+b):

(a)

Demand Demand of traditional market is declining. There is a risk that continues decline in demand in the traditional market will result in less profit made by company.

R&D The research and development would be costly for company. There is a risk that given poor liquidity position of company because company seems to make uses of the facility most months and because R&D expenses are huge cost to company so company may not have enough money to invest in this area hence making this unsuccessful.

License Management is confident that licence is received for commercial production in the future. There is a risk that license may not be received by company given this is a highly regulated country and hence this will make the future production not successful decreasing shareholders wealth as a result.

Scientist There is just one scientist working in the company. There is a risk that this scientist may leave the company and hence stop researching and developing of products process and this will result in company suffering greater loss given huge expenses input in the R&D process.

Scientist is subcontracted not employed by the company. There is a risk that scientist may bring his knowledge and research results out from company to its competitors and if this is the case company’s financial position will be again threatened resulting in decrease in profit and shareholders wealth.

Agent A large amount of revenue is from agent. There is a risk that if the agent is not successful in selling products which may result in a further decrease in profit and cash flow from company.

There is a risk that agent may try to overstate the sales revenue in order to maximize commission received and given a weak internal control system exists within company and this may not be easily detected.

47

Accounting Practise Center (A.P.C)

www.accaapc.com

Oversea The manufacturing facility is located overseas. There is a risk that quality of product may not be guaranteed and if the quality of product is poor then it will impact on the demand of products and hence impair the profitability of company.

There is a risk that company will have to pay high expenses in importing goods from other country and hence this will decrease the profit of company.

There is a risk that company will have to suffer foreign exchange rate risk and hence it will decrease it profit given an increase in the expenses.

Old asset The overseas plant and equipment were built 12 years ago. There is a risk that given the assets are too old and it may not have sufficient future capacity to produce new products in the future and hence decrease profit of company.

Bank overdraft Company relies very much on the bank overdraft and this is more expensive than other bank loans. There is a risk that it will further impair its profitability because company has to pay more as a result of the expensive expense.

Weak internal control system The internal control system of client’s company is so weak. There is a risk that fraudulent transactions happened which can’t be detected and it may lead to company suffering a loss.

Tax authority Two tax investigations into company happened. There is a risk that company may not comply with tax regulations which would result in further penalties paid by company as a result and hence impair its profitability position.

Shut down The building has no local authority approval. There is a risk that building may be shut down and as a result company needs to find another place to building the building which may be expensive to company and hence impair its profitability position.

48

Accounting Practise Center (A.P.C)

www.accaapc.com

Regulations Company has been in breach of local planning regulations. There is a risk that company will need to pay related penalty which would impair its liquidity position.

Reputation Company breaches the regulation. There is a risk that demands for the product by customers will decrease as a result of the bad publicity company creates, ie, breaches in regulation.

Impairment of building The building has been impaired last year. There is a risk that company may find it more difficult to raise finance because of a worsen position in its non-current assets.

(b)

(i)

Business risk is the risk that business fails, ie, as a result of this risk company will have to pay more expenses.

Risk of material misstatement is the risk that the financial statement of client’s company may be misstated.

Business risk will lead to risks of material misstatement, ie, in Medix Co the decline in demand of products by customers is a business risk and this would lead to risk of material misstatement in financial statement, ie, risk of inventory being overstated.

Business risk would relate to going concern status of company as well. Ie, in Medix Co it is struggling to raise finance given poor quality assets it has and as a result of the lack of finance it would impact on its going concern status, ie, doesn't have enough cash flow to operate its business.

49

Accounting Practise Center (A.P.C)

www.accaapc.com

Chapter2

June2012 Q1(Risk of material misstatement/Audit risks)

You are a manager in Magpie & Co, responsible for the audit of the CS Group. An extract from the permanent audit file describing the CS Group’s history and operations is shown below:

Permanent file (extract) Crow Co was incorporated 100 years ago. It was founded by Joseph Crow, who established a small pottery makingtableware such as dishes, plates and cups. The products quickly grew popular, with one range of products becominghighly sought after when it was used at a royal wedding. The company’s products have retained their popularity overthe decades, and the Crow brand enjoys a strong identity and good market share.

Ten years ago, Crow Co made its first acquisition by purchasing 100% of the share capital of Starling Co. Both companies benefited from the newly formed CS Group, as Starling Co itself had a strong brand name in the pottery market. The CS Group has a history of steady profitability and stable management.

Crow Co and Starling Co have a financial year ending 31 July 2012, and your firm has audited both companies for several years.

Acquisition of Canary Co

The most significant event for the CS Group this year was the acquisition of Canary Co, which took place on 1 February 2012. Crow Co purchased all of Canary Co’s equity shares for cash consideration of $125 million, and further contingent consideration of $30 million will be paid on the third anniversary of the acquisition, if the Group’s revenue grows by at least 8% per annum. Crow Co engaged an external provider to perform due diligence on Canary Co, whose report indicated that the fair value of Canary Co’s net assets was estimated to be $110 million at the date of acquisition. Goodwill arising on the acquisition has been calculated as follows:

$m

Fair value of consideration:

Cash consideration Contingent consideration Less: fair value of identifiable net assets acquired Goodwill

Cash consideration Contingent consideration Less: fair value of identifiable net assets acquired Goodwill
Cash consideration Contingent consideration Less: fair value of identifiable net assets acquired Goodwill
Cash consideration Contingent consideration Less: fair value of identifiable net assets acquired Goodwill

125

30

155

(110)

45

To help finance the acquisition, Crow Co issued loan stock at par on 31 January 2012, raising cash of $100 million. The loan has a five-year term, and will be repaid at a premium of $20 million. 5% interest is payable annually in arrears. It is Group accounting policy to recognise financial liabilities at amortised cost.

50

Accounting Practise Center (A.P.C)

www.accaapc.com

Canary Co manufactures pottery figurines and ornaments. The company is considered a good strategic fit to the Group, as its products are luxury items like those of Crow Co and Starling Co, and its acquisition will enable the Group to diversify into a different market. Approximately 30% of its sales are made online, and it is hoped that online sales can soon be introduced for the rest of the Group’s products. Canary Co has only ever operated as a single company, so this is the first year that it is part of a group of companies.

Financial performance and position The Group has performed well this year, with forecast consolidated revenue for the year to 31 July 2012 of $135 million (2011 $125 million), and profit before tax of $8·5 million (2011 – $8·4 million). A breakdown of the Group’s forecast revenue and profit is shown below:

Crow Co

Starling Co

Canary Co

CS Group

$ million

$ million

$ million

$ million

Revenue

69

50

16

135

Profit before

3·5

3

2

8.5

tax Note: Canary Co’s results have been included from 1 February 2012 (date of acquisition), and forecast up to 31 July 2012, the CS Group’s financial year end.

The forecast consolidated statement of financial position at 31 July 2012 recognises total assets of $550 million.

Other matters Starling Co received a grant of $35 million on 1 March 2012 in relation to redevelopment of its main manufacturing site. The government is providing grants to companies for capital expenditure on environmentally friendly assets. Starling Co has spent $25 million of the amount received on solar panels which generate electricity, and intends to spend the remaining $10 million on upgrading its production and packaging lines.

On 1 January 2012, a new IT system was introduced to Crow Co and Starling Co, with the aim of improving financial reporting controls and to standardise processes across the two companies. Unfortunately, Starling Co’sfinance director left the company last week.

Required:

Evaluate the risks of material misstatement to be considered in the audit planning of the individual and consolidated financial statements of the CS Group

51

Accounting Practise Center (A.P.C)

www.accaapc.com

(18 marks)

Answer to June2012 Q1:

Contingent consideration

Step1:Contingent consideration is $155m. Step 2:According to IFRS3 business combination that contingent consideration should include the probability of payment and also should discount to present value. Step 3:There’s a risk that $155m hasn't included the probability of being paid and hasn't been discounted to its present value resulting in over/understatement of goodwill figure.

Net assets

Step 1:Fair value of identifiable net assets is $110m. Step 2:According to IFRS3 business combination that this should net of deferred tax implication. Step 3:There is a risk that $110m hasn't included deferred tax implication, ie, net of deferred tax liability resulting in misstatement in identifiable net assets figure.

Goodwill

Step 1:Goodwill is $45m. Step 2:According to IAS36 impairment of assets management should conduct an impairment test for goodwill at the year-end by comparing its carrying value and its recoverable amount. Step 3:There is a risk that an impairment test has not been done resulting in overstatement of goodwill in statement of financial position and understatement of expenses in the statement of profit or loss.

Loan stock

Step 1:Crow co issued a loan stock at par. Step 2:According to IFRS9 financial instrument when calculating the fair value of financial liability at inception the repayment at premium of $20m should be included. Step 3:There is a risk that this is not done which would impact on the calculation of finance cost and hence resulting in understatement of expenses in statement of profit or loss and financial liability in the statement of financial position.

Financial cost

Step 1:Interest is paid annually and to its year end it’s half a year now. Step 2:Finance cost should be accrued at the year end, ie, half a year amounts to $2.5m($100mX5%X1/2) by DR I/S $2.5m, CR interest payable $2.5m. Step 3:There is a risk that this is not done which would result in understatement of expenses in the statement of profit or loss and liability in the statement of financial position.

52

Accounting Practise Center (A.P.C)

www.accaapc.com

Online sales

Step 1:30% of sales are made online. Step 2:According to IAS18 revenue recognition sales revenue is recognized when the risks and rewards of products have been transferred from seller to buyer; no managerial involvement on the goods; related expenses can be measured reliably. So company should recognize a sales revenue when the above conditions are met. Step 3:There is a risk that company may not record the sales revenue correctly given complexity in online sales system which would result in revenue figure being misstated in statement of profit or loss and relating assets such as

receivable or cash being misstated in statement of financial position.

Canary revenue and profit before tax

Step 1:Canary Co revenue and profit before tax are $16m and $2m. Step 2+3:There is a risk that Canary Co may overstate its revenue and profit

before tax figure in order to argue for a better price.

Group position

Step 1:The forecast revenue without including Canary co is $119m($135m-$16m) and the profit before tax is $6.5m ($8.5m-$2m) which are less than the actual 2011 figure of $125m and $8.4m. Step 2+3:There is a risk that both revenue and profit before tax figures are understated given a new incorporation of Canary Co into the group happens.

Grant

Step 1:Starling Co received a grant of $35m. Step 2:According to IAS20 Government Grant the receipt of grant should be deferred and released over the life of the asset to recognize income in statement of profit or loss. Step 3:There is a risk that Starling Co may recognize the full $35m at inception and hence this would result in overstatement of revenue in statement of profit

or loss and understatement of liability in statement of financial position.

Grant repayment

Step 1:Starling Co has not spent the rest of grant of $10m. Step 2:If Starling Co hasn't spent this $10m onto the qualifying assets then it may become repayable and According to IAS37 provision, contingent liability and contingent assets if the cash outflow is possible then a contingent liability should be disclosed to the financial statement and if the repayment becomes probable then a provision should be recognized. Step 3:There is a risk that this is not done resulting in either under disclosure or understatement of expenses in statement of profit or loss and liability in the statement of financial position.

53

Accounting Practise Center (A.P.C)

www.accaapc.com

New IT system

Step 1:New IT system as introduced to both companies. Step 2:Because of the unfamiliarity of the system there would be a risk that errors may occur in transferring data from old to new system. Step 3:This would result in the overall financial statement being misstated.

Finance director

Step 1:Finance director left Starling Co last week. Step 2+3:This would increase the likelihood of misstatement in the individual financial statement because of a lack of expertise in the financial reporting process.

54

Accounting Practise Center (A.P.C)

www.accaapc.com

Chapter2 Q7: June2010 Q2

Mac Co is a large, private company, whose business activity is events management, involving the organisation of conferences, meetings and celebratory events for companies. Mac Co was founded 10 years ago by Danny Hudson and his sister, Stella, who still own the majority of the company’s shares. The company has grown rapidly and now employs more than 150 staff in 20 offices.

You are a manager in the business advisory department of Flack & Co. Your firm has just been engaged to provide the internal audit service to Mac Co. In your initial conversation with Danny and Stella, you discovered that currently there is a small internal audit team, under the supervision of Lindsay Montana, a recently qualified accountant. Before heading up the internal audit department, Lindsay was a junior finance manager of the company. The members of the internal audit team will be reassigned to roles in the finance department once your firm has commenced the provision of the internal audit service.

Mac Co is not an existing client of your firm, and to gain further understanding of the company, you held a meeting with Lindsay Montana. Notes from this meeting are shown below.

Notes of meeting held with Lindsay Montana on 1 June 2010 The internal audit team has three employees, including Lindsay, who reports to the finance director. The other two internal auditors are currently studying for their professional examinations. The team was set up two years ago, and initially focused on introducing financial controls across all of Mac Co’s offices. Nine months ago the finance director instructed the team to focus their attention on introducing operational controls in order to achieve cost savings due to a cash flow problem being suffered by the company. The team does not have time to perform much testing of financial or operational controls.

In the course of her work, Lindsay finds many instances of management policies not being adhered to, and the managers of each location are generally reluctant to introduce controls as they want to avoid bureaucracy and paperwork. As a result, Lindsay’s recommendations are often ignored.

Three weeks ago, Lindsay discovered a fraud operating at one of the offices while reviewing the procedures relating to the approval of new suppliers and payments made to suppliers. The fraud involved an account manager authorizing the payment of invoices received from fictitious suppliers, with payment actually being made into the account manager’s personal bank account. Lindsay reported the account manager to the finance director, and the manager was immediately removed from office. This situation has highlighted to Danny and Stella that something needs to be

55

Accounting Practise Center (A.P.C)

www.accaapc.com

done to improve controls within their organisation.

Danny and Stella are considering taking legal action against Mac Co’s external audit provider, Manhattan & Co, because their audit procedures did not reveal the fraud.

Danny and Stella are deciding whether to set up an audit committee. Under the regulatory framework in which it operates, Mac Co is not required to have an audit committee, but a disclosure note explaining whether an auditcommittee has been established is required in the annual report.

Required:

(a) Evaluate the benefits specific to Mac Co of outsourcing its internal audit

function. (6 marks)

(b) Explain the potential impacts on the external audit of Mac Co if the

decision is taken to outsource its internal audit function. (4 marks)

(c) Recommend procedures that could be used by your firm to quantify the

financial loss suffered by Mac Co as a result of the fraud. (4 marks)

(d) Prepare a report to be presented to Danny and Stella in which you:

(i) Compare the responsibilities of the external auditor and of management in relation to the prevention and detection of fraud; and (4 marks)

(ii) Assess the benefits and drawbacks for Mac Co in establishing an audit

committee. (4 marks)

Professional marks will be awarded in respect of requirement (d) for the presentation of your answer, and the clarity of your discussion. (4 marks) (26 marks)

56

Accounting Practise Center (A.P.C)

www.accaapc.com

Answer to June2010 Q2:

(a)

Roles assigned After outsourcing the internal audit function the role of financial manager may be reassigned to other parts of the company and this will benefit the company for having extra resources for having such employees.

External expertise Because currently there are two internal auditors within the client’s company not being qualified so a decision of outsourcing the internal audit function will have extra expertise to do the internal service for client and this will improve the overall internal audit quality as well.

Focus It seems that the team currently lacks a consistent focus. They are directed by the finance director, who has changed the focus from financial reporting controls to operational controls, and it seems the team is too small to do both. Outsourcing the function will provide as many staff as necessary to cover a range of activities.

Time Because currently there are two internal auditors within the client’s company so for outsourcing the internal audit function that it will have extra resources to focus on other areas of the company.

(b)

Audit strategy If after outsourcing its internal audit function then the internal control system off client company improved and so the external audit firm may rely on the

internal control system and hence spent less time doing the full substantive testing and this would result in less audit fees charged.

Assessable of the working papers by outsourcing firm If the outsourcing firms working papers are accessible by external auditor and this will reduce the work done by external auditor and hence reduce the fees charged.

Internal control system changes If the internal control system changes and this will impact on the amount of work done by audit firm and hence impact on its fees as well.

57

Accounting Practise Center (A.P.C)

www.accaapc.com

Report

If external auditor replies on type2 report then this will decrease its work load and hence fees charged as well.

(c)

Enquire with the police and lawyer to verify if the amount can be reimbursed ith client’s permission.

Inspect the insurance policy to verify if it covers this situation and the losses can be reimbursed.

Compare a list of unapproved suppliers to a list of actually approved suppliers by the company to identify the discrepancies of suppliers and its related amount.

Use computerized assisted audit techniques to identify the suppliers with the same bank account to the accountant manager.

(d)

Report to: Danny and Stella Hudson Content: Responsibilities in respect of fraud Audit committees: benefits and drawbacks Introduction: The objective of the report is to compare the responsibilities of the external auditor and of management in relation to the detection of fraud, and also to outline the benefits and drawbacks for Mac Co of establishing an audit committee.

(i) Responsibilities of the external auditor and of management in relation to the detection of fraud

Management has a primary responsibility in establishing a sound internal control system to prevent and detect of fraud.

Management should assess the internal control system continuously.

Auditor would be responsible for the fraud happened within company if they are material to the financial statements. This means auditors would focus more on the fraud impact on the accounts rather than its operational issues.

Auditor would assess the internal control system at the planning stage of audit to determine its audit strategy.

58

Accounting Practise Center (A.P.C)

www.accaapc.com

(ii)

Benefits This can improve the overall internal control system which client’s company because originally Lindsay reports internal control system weaknesses to the finance director and if the control environment is weak then it will have an impact on the quality of internal control system if finance director refuses to change the internal control system required by Lindsay.

Audit committee would have more power and status not like Lindsay who is just the current junior financial manager then they may adopt the internal control recommendations more easily.

Drawbacks

It’s difficult in the real world to recuitstaff who are independent and with relevant skills. They may not have time to devote to their role as a member of the committee. This could be a problem for Mac Co, whose business activities are quite specialised.

The audit committee members should expect to receive a fee commensurate with their level of experience and knowledge, so the fees may be significant. This could be an issue for Mac Co due to its cash flow problem.

59

Accounting Practise Center (A.P.C)

www.accaapc.com

Chapter2 Q7: Big Accounting questions

Please outline all the accounting standards contents in ACCA paper and related audit work to it.(35 accounting standards outlined below)

60

Accounting Practise Center (A.P.C)

www.accaapc.com

Chapter2 Q7: 1, conceptual framework:

Its objective is to provide useful information to users of financial statements but how?

We need to make sure information in the FS is:

Relevant To help users making their economic decisions like using fair value; Reliable To ensure financial statement figures are correct(audited);

From past event(shown in the contract);

Free from bias(no window dressing); not overstating value(prudence);

Showing substance of transaction like recognize finance lease rather than operating lease(substance over form);

Comparable

Understandable

No missing information(complete). Disclosing diluted EPS and its comparative figures to help users to make their decisions. Information should be translated in easy language to be

understood by to users with reasonable business and accounting knowledge and should be clear and precise as well.

61

Accounting Practise Center (A.P.C)

www.accaapc.com

Of course when preparing the financial statements the underlying assumptions would be:

1.Going concern.

This means company can operate its business for more than 12 months and hence non-current assets and liabilities would need to be recognized. When a company is not a going concern entity any more then company needs to prepare its financial statements under break up basis and this means to reclassify its non-current assets and liabilities into current assets and liabilities.

If there is significant uncertainties about the going concern status of the company then company should disclose those uncertainties in the note of the financial statement as per IAS1 presentation of financial statements. Auditor should bring shareholders attention by adding emphasis of matter paragraph after the actual opinion paragraph as well.

2. Accruals. This means company should recognize its revenue provided the expenses can be matched against each other like in IAS20 government grant.

This is also against cash basis where looking at sales revenue-we will not recognize sales revenue until we receive the cash but rather we would DR receivable CR sales revenue even if we haven’t received cash payment.

62

Accounting Practise Center (A.P.C)

www.accaapc.com

Chapter2 Q7: 2,IAS1 Presentation of Financial Statements

Accounting Issues:

Statement of Financial Position(not balance sheet); Statement of profit or loss and other comprehensive income; Statement of changes in equity.

Audit Works:

Inspect the financial statements to ensure company has used break up basis, ie, to reclassify all non-current assets and liabilities into current assets and liabilities if company is not a going concern entity.

Inspect disclosures made by management regarding certainties about going concern status of the company is adequate.

Obtain a written representation from management to confirm company is a going concern entity at the review stage.

63

Accounting Practise Center (A.P.C)

www.accaapc.com

Chapter2 Q7: 3,IAS2 Inventories

Accounting Issues:

1,what’s the difference between inventory and property, plant and equipment? Aim:

The aim of inventory is “held for sale”; The aim of PP&E is to hold for production of goods or delivery of services or for administrative purposes. Period:

Inventory is within 1 year; while PP&E is more than 1 year.

2, How can we measure inventory? Initial measurement:

The initial cost of inventory would be including all costs of purchase, plus the costs of conversion and other costs incurred in bringing the inventories to their present location and condition. Subsequent measurement:

Value at the lower of Cost and Net Realizable Value(Estimated selling price-Estimated costs to sell) Costs are usually measured using FIFO, Weighted average cost.(LIFO is banned)

Audit Works:

1, initial measurement:

Costs should be agreed to invoices and purchase agreement and bank statement and cash book;

If manufactured, costs should be agreed to material requisitions, timesheets, personnel records;

2, subsequent measurement:

NRV should be agreed to post year-end selling prices and invoices.

Inspect inventory condition and if it’s damaged then it should be valued using NRV.

64

Accounting Practise Center (A.P.C)

www.accaapc.com

Audit Question [ DEC2009 Q2] IAS2

Banana Co designs specific items for customers according to contractually agreed specifications. And you are at the review stage of audit.

After the year end, Cherry Co, a major customer with whom Banana Co has several significant contracts, announced its insolvency, and that procedures to shut down the company had commenced.

The amount of contract is $50,000 while the total asset within statement of financial position is $500,000.

Required:

Comment on the matters to be considered relating to the above inventory.

Answer:

Materiality The inventory of $50,000 accounts for 10% of total asset and it's material to statement of financial position.

Accounting treatment Because the inventory is for specific use and Cherry Co is in insolvency and hence inventory can’t be used by Cherry co and they are with no use any more so according to IAS2 the value should be written down to lower of cost and net realizable value according to IAS2.

Audit opinion If this is not done properly then a qualified audit opinion with an except for qualification due to material misstatement should be given.

(Tutor tips: this is at the review stage of audit and hence any matters to be considered should be taking into account the impact on audit report if the adjustment is not done properly)

65

Accounting Practise Center (A.P.C)

www.accaapc.com

Chapter2 Q7: 4, IAS7 Statement of cash flows

Accounting Issues:

It incorporates operating cash flows, investing cash flows and financing cash flows.

In operating cash flows element, non-cash flow items should be added it back.

Audit works:

Agree opening cash flows to last year end cash flow to verify its accuracy.

Review and verify the non-cash item such as depreciation is added back to the operating cash flows.

(Statement of cash flow is often in the form of prospective financial information (forecast) and it requires audit work to be performed to verify its reasonableness, eg, check the assumptions. )

66

Accounting Practise Center (A.P.C)

www.accaapc.com

Chapter2 Q7: 5,IAS8 Accounting Policies, Changes in
Chapter2 Q7: 5,IAS8 Accounting Policies, Changes in

Chapter2 Q7: 5,IAS8 Accounting Policies, Changes in

Chapter2 Q7: 5,IAS8 Accounting Policies, Changes in Accounting Estimates and errors

Accounting Estimates and errors

Chapter2 Q7: 5,IAS8 Accounting Policies, Changes in Accounting Estimates and errors

Accounting Issues:

If the company is going to use another accounting policy this year and find an error relating to last year’s account then the company should adjust for this year and last year’s financial statements.(retrospective adjusting)

If the company is going to use another accounting estimate this year and the company should adjust for current year financial statements and future one.(prospective adjusting)

But how to determine whether this is a change in accounting policy or estimate? Well, if there’s a change in

Measurement basis of the figure, eg, value the inventory using FIFO but now use weighted average method; use replacement cost rather than historic cost.

Recognition basis of the figure, eg, recognize as an expense before but now for asset(eg,IAS 23 borrowing costs)

Presentation basis of the figure, eg, recognize the depreciation expense into cost of sales now rather than in administrative expenses before.

You are going to change in the accounting policy only if:

1, a change in laws / accounting standards and you are required to do so; 2, gives a fairer presentation to the users of FS.

And

presentation of figures are deemed to be a change in accounting estimate such as:

Allowance for receivables;

is not changing the measurement, recognition or

anything

that

Useful life/ depreciation method of the non-current assets;

Warranty provision relating to return of goods from customers.

An error may happen if there’s a

Misuse of the accounting standard last year;

Fraud happened last year;

Omit some figures in last year’s account.

67

Accounting Practise Center (A.P.C)

www.accaapc.com

Summary:

Changes in accounting policy this year:

Assume it happens in last year as well and of course this year happens; Adjust for last year closing retained earnings taken into account in the changes to be brought forward in this year’s statement of changes in equity.

Material prior period errors found:

Correct last year’s material errors; Adjust for last year closing retained earnings taken into account in the error effect to be brought forward in this year’s statement of changes in equity.

Changes in accounting estimate:

Use the new one to continue the calculation.

Audit works:

1, Inspect the changes in accounting policy and ensure it’s consistent and properly disclosed.

2, Inspect the changes in accounting estimate and verify the nature and the amount have been disclosed properly.

68

Accounting Practise Center (A.P.C)

www.accaapc.com

Audit question [DEC2011 Q3 ] IAS 8

Pine Co Pine Co operates a warehousing and distribution service, and owns 120 properties. During the year ended 31 July 2011, management changed its estimate of the useful life of all properties, extending the life on average by 10 years. The financial statements contain a retrospective adjustment, which increases opening non-current assets and equity by a material amount. Information in respect of the change in estimate has not been disclosed in the notes to the financial statements.

Required:

Identify and explain the potential implications for the auditor’s report of the accounting treatment of the change in accounting estimates. (5 marks)

69

Accounting Practise Center (A.P.C)

www.accaapc.com

Answer to audit question [DEC2011 Q3 ] IAS 8:

Pine Co

Materiality The increase in non-current asset amount is material by question.

Accounting treatment This is a change in accounting estimate not change in accounting policy so this does require prospective adjustment not retrospective adjustment.

This means management shouldn't restate the opening balance of non current asset and retained earnings.

Audit report implication If management has corrected this mistake then an unmodified audit report would be given.

If management still insist to restate the opening balance of non-current asset and retained earnings then an modified audit report with qualified audit opinion would be given with an except for material misstatement in the financial statement.

Auditor should explain the reasons why a qualified audit opinion would be given in the basis of opinion paragraph.

And this paragraph would be placed before the actual opinion paragraph.

70

Accounting Practise Center (A.P.C)

www.accaapc.com

Chapter2 Q7: 6,IAS10 Events after the Reporting Period

Accounting Issues:

Time line: Audit FS report authorized YR start YR end signed to issue
Time line:
Audit
FS
report
authorized
YR start
YR end
signed
to issue

This is the event happened between financial statement year end and the financial statements are authorized to be issued to the shareholders to be discussed at the AGM(annual general meeting).

They will be either adjusting events or non-adjusting events

Magical way to distinguish the adjusting events and non-adjusting events:

Is it because of this event then it will affect the figure as at the year end?

-Adjusting events Change in judgments, estimate or assumptions after the year end. Eg, 1, inventory sold at a loss? Change in assumptions that closing inventory should be valued at the lower of cost and net realizable value (IAS 2); 2, Customers go bankruptcy so that recoverability of the receivable balance at the year end has been changed. 3, If company is involved in going concern problems after the year end and because the financial statement should be prepared under going concern basis and now this is changed. -Non-adjusting events There’s no link between financial statement figures at the year end and events after the FS year end. Eg, 1, fire destroyed the inventory after the year end (cant’s predict!) 2, dividends are declared after the year end or share issues after the year end (no link between figures and events)

Audit works:

Can be active responsibility; passive responsibility. And this is according to ISA560 subsequent events.

71

Accounting Practise Center (A.P.C)

www.accaapc.com

Audit question ISA560 [DEC2009 Q5]

Subsequent events

(a) Guidance on subsequent events is given in ISA 560 (Redrafted) Subsequent

Events.

Required:

Explain the auditor’s responsibility in relation to subsequent events. (6 marks)

(b) You are the manager responsible for the audit of Lychee Co, a manufacturing

company with a year ended 30 September 2009. The audit work has been completed and reviewed and you are due to issue the audit report in three days. The draft audit opinion is unmodified. The financial statements show revenue for the year ended 30 September 2009 of $15 million, net profit of $3 million, and total assets at the year end are $80 million.

The finance director of Lychee Co telephoned you this morning to tell you about the announcement yesterday, of a significant restructuring of Lychee Co, which will take place over the next six months. The restructuring will involve the closure of a factory, and its relocation to another part of the country. There will be some redundancies and the estimated cost of closure is $250,000. The financial statements have not been amended in respect of this matter.

Required:

In respect of the announcement of the restructuring:

(i) Comment on the financial reporting implications, and advise the further audit procedures to be performed; and (6 marks)

(ii) Recommend the actions to be taken by the auditor if the financial

statements are not amended. (4 marks)

(16 marks)

72

Accounting Practise Center (A.P.C)

www.accaapc.com

Answer to ISA560 [DEC2009 Q5]Subsequent Events

(a)

Events between FS year end and audit report is signed:

Auditor would have active responsibility to identify any subsequent events.

Procedures would include for example:

Enquire with management to verify any subsequent events have occurred.

Reading minutes of meetings of shareholders and management to verify any subsequent

events have occurred.

Reviewing the latest interim financial statements to verify any subsequent events have

occurred.

Events between audit report signed and the FS are issued:

Auditor would have a passive responsibility to identify any subsequent events.

Ie, they don't need to perform procedures actively to identify those events.

But management would have the responsibility to tell auditors any subsequent events.

If any events occurred which would materially affect the FS then this matter should be

discussed with management.

If this matter has been dealt with by management either disclose or amend it then auditors

should perform additional audit procedures relating to this issue and a new audit report would

be issued.

If management refuses to deal with this event and it is material to the FS then a qualified

audit opinion should be issued by auditors.

Events after financial statements are issued:

Auditor would have a passive responsibility to identify any subsequent events.

Ie, they don't need to perform procedures actively to identify those events.

If any events occurred which would materially affect the FS then this matter should be

discussed with management.

If this matter has been dealt with by management either disclose or amend it then auditors

should perform additional audit procedures relating to this issue and a new audit report would

be issued.

If management refuses to deal with this event and it is material to the FS then a qualified

audit opinion should be issued by auditors.

73

Accounting Practise Center (A.P.C)

www.accaapc.com

(b)

(i)

Materiality:

Based on revenue: $250,000/15 million = 1·67%

Based on profit: $250,000/3 million = 8·3%

Based on assets: $250,000/80 million = <1%

So this is material to statement of profit or loss and other comprehensive income.

Accounting:

A note detailing the nature of the event and the amount should be provided according to

IAS10.

Company needs to determine the probability of cash outflow to see whether provision or

contingent liability should be accounted for disclosed to the note of the financial statement.

Audit procedures:

Enquire with management and read board minutes relating to this to gain an understanding

about the reason for the restructuring.

Inspect the note to financial statements which should disclose the non-adjusting event,

providing a brief description of the event, and an estimate of the financial effect.

Inspect detail copy of the announcement about the nature of the restructuring, ie, the

number of employees to be affected.

Agree the $250,000 potential cost of closure to supporting documentation like a schedule

showing the number of staff to be made redundant and these should be supported by payroll

details.

(ii)

Auditor should raise this issue to those charged with governance, ie, audit committee to

persuade them to correct this misstatement.

If misstatement still exists then auditor should modify his audit report by giving a

qualification of audit opinion due to material misstatement in the fiancnial statement.

Auditor should explain the reasons for the qualification in the basis of opinion paragraph

and this is before the actual opinion paragraph.

Auditor can choose to raise this issue to the annual general meeting to shareholders.

74

Accounting Practise Center (A.P.C)

www.accaapc.com

Chapter2 Q7: 7,IAS 11 Construction Contracts

Accounting Issues:

1,When you’re trying to build this tower it may take you more than 1 year to finish. After finishing off this tower and you may try to sell off to the client. So before finishing off this tower will you keep it as a inventory?(IAS2) The answer is no! Remember inventory is current asset which is less than 1 accounting year.

2,Next question is because the contractor is building this tower so he may have to pay for material, labor costs etc. So when is the cost being recognized? The contractor can get the sales revenue only when after selling off this tower to client. So before selling off this tower, the contractor gets no cash from the client. So does the contractor recognize no revenue at all? To answer this question:

According to Prudence concept, the sales revenue should be recognized after this tower has been sold off to the client. According to Accruals concept, the expenses relating to the building of the tower should be matched with the revenue from the tower. So one is contradict with another. But here in this case, Accruals concept wins.

3,But how much does the revenue and expenses should be recognized? IAS 11 Construction Contract gives us the guidance.

4,

Guidance by IAS 11 construction contract (Diagram)

Fixed Price or Mark up?

11 construction contract ( Diagram ) Fixed Price or Mark up? yes Profit making contract? yes

yes

Profit making contract?

yes) Fixed Price or Mark up? yes Profit making contract? Outcome is certain? yes Recognize based

Outcome is certain?

Mark up? yes Profit making contract? yes Outcome is certain? yes Recognize based on stage of

yes

Recognize based on stage of completion

75

Accounting Practise Center (A.P.C)

www.accaapc.com

Mark up No
Mark up
No
No
No

Profit=price(cost+mark up)-cost

Recognize loss in full

Revenue=costs(no profit/loss)

5, Stage of completion

Sales basis method (work certified method):

Cost method:

76

Accounting Practise Center (A.P.C)

www.accaapc.com

work certified to date Contract price

Costs incurred to date Total contract costs

Audit question [june2011 Q2] IAS11:

Construction Contract(attachment1)

In the last week, two significant issues have arisen at Bill Co. The first issue concerns a major contract involving the development of an old riverside warehouse into a conference centre in Bridgetown. An architect working on the development has discovered that the property will need significant additional structural improvements, the extra cost of which is estimated to be $350,000. The contract was originally forecast to make a profit of $200,000. The development is currently about one third complete, and will take a further 15 months to finish, including this additional construction work. The customer has been told that the completion of the contract will be delayed by around two months. However, the contract price is fixed, and so the additional costs must be covered by Bill Co.

Forecast profit before tax is $2·5 million.

Hello Thanks for taking on the role of audit manager for the forthcoming audit of Bill Co. (i) I have just received some information on two significant issues that have arisen over the last week, from Sam Compton, the company’s finance director. This information is provided in attachment 1. I am asking you to prepare briefing notes, for my use, in which you explain the matters that should be considered in relation to the treatment of these two issues in the financial statements, and also explain the risks of material misstatement relating to them. I also want you to recommend the planned audit procedures that should be performed in order to address those risks.

(8 marks)

77

Accounting Practise Center (A.P.C)

www.accaapc.com

Answer to [june2011 Q2] IAS11

Matters to be considered

Materiality:

The loss on the contract of $150,000 represents 6% of the forecast profit before tax and is

therefore material to the statement of profit or loss.

Accounting treatment:

1. The $150,000 loss needs to be recognized immediately to the statement of profit and loss

and other comprehensive income.

2. the delay completion of contract would result in penalties and this should be accounted for

under IAS37 provision, contingent liabilities and contingent asset.

Risks of material misstatement:

There is a risk that loss of $150,000 has not been recognized in the statement of profit or loss

and hence overstate the profit figure by $150,000.

There is also a risk that a failure to provide for a provision or disclose contingent liability in the

note of the FS and this would result in understatement of liability and expense or under

disclosure.

Audit procedures:

Inspect the customer-signed contract to verify the fixed price and any penalty clauses

relating to late completion.

Recalculate the budget for the Bridgetown development to verify the accuracy of the

schedule and confirm the expected loss of $150,000.

Inspect report made by the architect regarding the structural improvements to verify the

estimate of the additional costs.

Discuss the additional costs with contractors to assess if the estimate appears

reasonable.

Review Bill Co’s cash flow forecast to ensure adequate funds to cover the additional costs.

78

Accounting Practise Center (A.P.C)

www.accaapc.com

Chapter2 Q7: 8,IAS12 Income Taxes

Accounting issues:

In the statement of profit or loss and other comprehensive income:

$

Sale revenue

1,000

Cost of sales

(300)

Gross profit

700

Expenses

(100)

Profit before tax

600

Tax expense (@30%)

(50)

Profit after tax

550

You can see although tax rate is 30% but we use 30%Xprofit before tax which does not equal to 50, why?

The reason being within the tax expense there are 3 components: (mnemonics: CPD)

Current tax payable (based on last year taxable

profit)

Provision (under/(over)) Deferred tax movement

Because of permanent and temporary difference which leads to the difference in taxable

profit calculation and accounting profit calculation.

Permanent differences are the amounts which represent income or expense for accounting

purposes but are not taxable/allowable for tax purposes. Example: client entertaining.

Temporary differences are amounts which represent income or expense for accounting

purposes and tax purposes but in difference periods. Example: depreciation and capital

allowances.

Notice: The deferred tax transfer is not cash flow!!!

Before we look at deferred tax, why not start off by looking at current taxation? (this is what

you have already learnt in F3, just a recap.)

79

Accounting Practise Center (A.P.C)

www.accaapc.com

Current tax:

Companies have to pay tax on taxable profits. The tax charge is normally ESTIMATED at the end of the financial year and charged to the statement of comprehensive income, and paid in the following year.

The double entry for taxation would be:

DR Taxation expense CR Taxation liability

(Statement of comprehensive income) (Statement of financial position)

The double entry for when the tax is paid a few months later:

DR Taxation liability CR Bank

(Statement of financial position) (Statement of financial position)

Since the amount paid is likely to differ from the estimated tax charge originally recognized, a balance will be left on the taxation liability account being an under or over provision of the tax charge.

80

Accounting Practise Center (A.P.C)

www.accaapc.com

Deferred tax:

What is deferred tax?

Illustrate with an example:

Imagine you have a building with a carrying value of $1000. During the year you have revalued this building to $1,100 then you make a profit from it of $100 which is not realized yet.

DR NCA 100 CR revaluation reserve 100

So for the tax man’s perspective, because you will somehow in the future realized this profit when sold so they may require you to provide for a future tax obligation(deferred tax) of $100Xtax rate although you are not paying money now but you will in the future.

Concept:

So we know that deferred tax is a future obligation to be settled by company depending on the future tax law. So deferred tax does not necessarily fulfill the liability definition (present obligation).

Deferred tax arises because of temporary differences (TD). Temporary difference is the difference between CV and TB.

DT=TD* X CT% *TD=CV - TB

TD:

Temporary difference between carrying value and tax base

CV:

Carrying value of asset/liability.

TB:

tax base in the tax man’s book.(in real practice we will try to refer to

DT:

different tax regulations to calculate the tax base) Deferred tax liability/asset

CT%: Corporation tax rate

Deferred tax is a future liability recognized today. And deferred tax is based on temporary difference (timing difference between accounting and tax law). So the amount we owe to the tax authority will be finally paid back to them in the subsequent years.

Typically, in P7, Deferred Tax Asset is most commonly tested. The recoverability of Deferred Tax Asset will be limited depending on the forecast profit company will make.

81

Accounting Practise Center (A.P.C)

www.accaapc.com

Audit Works:

[Q11:DEC2008 Q1] Income taxes IAS 12

So we usually focus on the profit forecast, management accounts for the company performance to estimate the company future profit making ability to establish if it can utilize the deferred tax asset (unutilized losses) to set against the future profit.

82

Accounting Practise Center (A.P.C)

www.accaapc.com

Audit question: [Q11:DEC2008 Q1] IAS 12

(b) Describe the principal audit procedures to be carried out in respect of the following:

(ii) The recoverability of the deferred tax asset.

(4 marks)

Answer to [Q11:DEC2008 Q1] Income taxes IAS 12

(ii) Principal audit procedures recoverability of deferred tax asset

Agree figures in the current and deferred tax calculation to tax correspondence.

Inspect profitability forecast to agree there is enough forecast taxable profit to offset

against the loss.

Perform analytical procedure by evaluating assumptions used in the forecast to ensure

it’s in line with auditors’ business understanding.

Perform analytical procedure by assessing time taken to generate profit to recover tax

losses and if it takes many years to generate such profit and the recognition of deferred

tax asset would be restricted.

Inspect tax correspondence to verify there’s no restriction for company to carry forward

and use losses against future taxable profits.

83

Accounting Practise Center (A.P.C)

www.accaapc.com

Chapter2 Q7: 9,IAS16 Property, Plant and Equipment

Accounting Issues:

Initial measurement:

Capital expenditure

Capital expenditure is the costs of acquiring non-current assets. According to IAS 16 the following costs may be capitalised in the statement of financial position on acquisition of a non-current asset:

(Mnemonic: IIIID) Initial cost (purchase price) Import duty not refundable(if asset is bought from other country) Installation costs Intended use relating costs (lawyer, surveyor costs) Delivery costs

Finance cost (IAS 23 see F7 & P2)

Revenue expenditure Revenue expenditure is expenditure on maintaining the capacity of noncurrent assets. Costs that are regarded as revenue expenditure should be expensed in the statement of comprehensive income and may not be capitalised according to IAS 16 are:

(Mnemonic: RIM) Repairs expenses Insurance expenses Maintenance expense

After we’ve purchased the non current asset the accountant needs to record that non current asset into the non- current asset register. A non-current asset register is generally maintained in the finance department. Companies can purchase specifically designed packages or a register can simply be maintained on an Excel spreadsheet. And this is used to reconcile the NCA in the NCA register to the individual asset in place, ie, an example of control procedure by company.

84

Accounting Practise Center (A.P.C)

www.accaapc.com

Sample of Non-current asset register:

Asset type

Date purchased

Description

Cost

Depreciation

Carrying

Disposal

Disposal date

 

value

proceeds

Machine

1 July 2013

Drink

$7m

 

machine

 

Year ended 31 DEC 2013

$700,000

$6.3m

Year ended 31 DEC 2014

$3m

Jan-2014

Subsequent measurement

Cost model: cost-accumulated depreciation*=carrying value

Depreciation method should be reviewed each year to see whether or not it is reasonable. A change in depreciation method should be treated as a change in accounting estimate and prospective adjusting method according to IAS 8 should be applied. Ie, disclose the depreciation method in the note of the financial statements.

Revaluation Model: revalued amount

IAS 16 the test was whether the expenditure was Capital or Revenue e.g. an improvement could be capitalised but maintenance or repair could not be capitalized.

The following circumstances should be capitalized:

(mnemonics: LOSE)

L: Life extension O: major overhaul cost S: separate component, eg, new enguine for an aircraft E: energy saving, eg, improving production capacity

Basic idea:

1, economic benefits are excessed 2, component treated seperatly 3, major overhaul cost

85

Accounting Practise Center (A.P.C)

www.accaapc.com

Revaluation

Basic Idea:

As time goes by initial costs of asset may be very different from their market value.

Eg, if a company purchased a property 35 years ago and therefore subsequently charged depreciation for 35 years, it would be safe to assume that the carrying value of the asset would be significantly different from today’s market value.

If revaluation policy per IAS 16 may be adopted (i.e. the business has a choice), and if so the following rules must be applied per the standard: (mnemonic:

CRRR)

1, No Cherry picking(If a company chooses to revalue an asset they must revalue all assets in that

category.)

2, Regular (Revaluations must be regular but IAS 16 doesn't specify how often)

3, Revalued amount(Subsequent depreciation must be based on the revalued amounts.)

4, Revaluation Reserve (Gains from revaluations are taken to revaluation reserve rather than retained earnings unless they are sold)

Calculation:

 

$

Revalued amount

X

CV of asset on revaluation date

(X)

Revaluation gain/(loss)

X/(X)

DR Asset cost DR Accumulated depreciation CR Revaluation reserve

86

Accounting Practise Center (A.P.C)

www.accaapc.com

Journal (Statement of financial position) (Statement of financial position) (Statement of financial position)

Audit work:

IAS16 PP&E does not test it much, but if the asset involves finance cost and then make sure it’s capitalized correctly.

Also, if it involves impairment issue ,then make sure an impairment test is properly conducted by management. Also the discount rate used by management to determine value in use of the asset should be verified for reasonableness.

87

Accounting Practise Center (A.P.C)

www.accaapc.com

Chapter2 Q7: 10,IAS17 Leases

Accounting issues:

Introduction

You want to have a photocopier and you have two choices:

1, you can buy it and then you become the owner of the photocopier; 2, you can lease it from the lessor and then you would become the lessee. Long term-finance lease Short term-operating lease

But the key to differentiate between them is not just the time length it takes but rather “substance over form”.

IAS 17 leases describes two types (forms) of leases:

*Finance lease: lease that transfers the risks and rewards of the asset from the lessor to the lessee. *Operating lease: any leases other than finance lease.

5 senarios

So the substance over form concept behind it can be summarized as follows:

IAS 17 prescribes there are 5 common scenarios that the lease is a finance lese. (one of them fulfilled then it’s a finance lease and if none of them fulfills then it’s an operating lease.)

1, ownership of asset has been transferred from lessor to lessee. 2, lessee has the option to purchase asset at a price which is sufficiently lower than its FV. 3, lease term is almost the same as the major part of economic life of asset. (IFRS doesn't specify the period but US GAAP has given us guidance of >75%.) 4, at the start of the lease, PV of minimum lease payment is close to FV of asset. (again, IFRS doesn't specify the percentage but US GAAP has given us a guidance of >90%.) 5, leased assets are specified nature and can only be used by lessee and they can be used by others if any significant modification to assets occurs.

88

Accounting Practise Center (A.P.C)

www.accaapc.com

Risks and rewards

But the idea behind it is when the majority risks and rewards has been transferred from the lessor to lessee then it’s considered to be a finance lease. So the typical risks and rewards may include:

Risks:

costs of repairing, maintaining and insuring the assets. Risk of obsolescence Risks of losses from idle capacity of the asset (if machine breaks down then lessee bears the loss)

Rewards:

Use of assets for almost all of its useful life. Use of the assets is not disrupted.

Accounting Treatment: