Question 28 Vital Enterprises deals in motor cars.

. The cars are received on consignment from the manufacturer with a clause that unsold cars will be returned to the manufacturer after a specified period. The past practice reflects that Vital never returns any cars. The dealer bears the risk of slow moving and obsolescence. Vital in its book has included the cost of unsold cars in the inventories. What will be the impact of above treatment on your audit report t assuming that the amounts involved are a material? Answer 28 Although the legal form of the transaction is a consignment, in substance it is sale by manufacturer to Vital. The client, Vital should include unsold cars in the inventory. Unqualified report will be in order. Question 29 Calico Enterprises had acquired an equipment on January 1, 2005 for Rs. 30 million with a useful life of 6 years. The company has been using straight line method. On January 1, 2009, the remaining useful life was estimated to be 6 years You are the auditor of Calico for year ended December 31, 2009 You have noted that the company has passed following entry on January 1, 2009 Equipment Retained Earnings = = 8 8 Rs in million Cost Accumulated depreciation to 31/12/08 Depreciation to 31/12/08 on the basis of 10 years life Excess depreciation The amount involved are considered to be material
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30 20 12 8

During 2009, the company charged depreciation Rs. 3 million What will be the impact on you7r audit opinion? Answer 29 IAS 16 provides that a change in useful life is change in accounting estimate. The change of accounting estimate is to be accounted for in the current and future periods. Opening retained earnings should not be adjusted. Depreciation for 2009 and future year should be Rs. 1.67 million (Rs. 10 million / 6) If the management does not adjust the accounts qualified opinion should be issued. Question 30 You are the auditors of Kerr Corporation for year ended December 31, 20x8. On December 10, 20x8, the management decided for restructuring and closing down a division. The decision was communicated to those affected on January 15, 20x9 and no other steps were taken to implement the decision. Kerr has made provision of Rs. 5 million representing approximate cost for closure of division. Your independent estimate of cost works out to Rs. 9 million. What will be the impact on audits report? Answer 30 At December 31, 20x8 there was no obligating event and no provision should have been made. IAS37, Provision, contingent assets and cotangent liabilities provides that a provision is recognized only when there is present obligation as a result of past events. A Provision for restructuring may be made only when as entity has announced the main features to those affected by it. If the management does not reverse the provision, a qualified opinion will be issued. Question 31 Year end of one of your client is December 31, 20x8. In February 20x9, before the accounts were approved, the Government announced increase in tax rates by 10%. The liability for deferred tax has been adjusted by the increase in tax rates. The amount involved is material. What will be the impact on you audit report for year ended December 31, 20x8? Answer 31

One of the examples of no adjusting events per IAS 10 states: Changes in tax rates of tax laws enacted or announced after the balance sheet date and has a significant effect on current and differed tax assets and liabilities. Since there is no present obligation at year end, no provision should have been made. The report will be qualified if the client does not reverse the provision. Question 32 Years are the auditors of Good Dealers Limited for year ended December 31, 20x8. The Company was defendant in a law suit alleging infringement of certain patent refights. Preliminary hearing was in progress and at year end. The ultimate outcome of the matter could not be determined at year end. The case was decided against the company of February 27, 20x9 before the accounts were approved. The company has made a disclosure in notes to accounts What type of audit report will you issue? Answer 32 This is an adjusting even under IAS 10. A mere disclosure is not adequate. Provision should have been made in the accounts. If the amount is material, a qualified report should be issued. Question 33 Give an example of a matter which has material and pervasive effect on financial statements. Answer 33 An error, correction of which converts reported significant profits into significant loss. Question 34 You are the auditor Matz Pharmaceutical for year ended December 2009. You have already signed the audit report on March 20, 2010. On March 21, you have read a report of a Government agency for quality control that Matz Pharmaceutical is in breach of the regulatory requirements for quality control and a fine of Rs. 27 million (which is material to the financial statements) has been levied. The breach of the law took place in a production batch commenced on January 23, 2010. How would you deal with the matter in audit report?
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Answer 34 The event occurred after year end and does not provide further evidence as to the conditions existed at the balance sheet date. However a disclosure of the penalty should be made in the financial statements. Question 35 You have competed the audit of financial statements of Pride Limited showing profit before tax and total assets of Rs. 74 million and Rs. 582 million respectively. Following issues are still unresolved: (i) Subsequently to year end, an employee left the company without settling a loan of Rs. 0.5 million. Management has refused to make provision but ready to give a disclosure. The company imported a plant of deferred payment management. No forward exchange cover was taken by the company. At year end the liability was valued at Rs. 83.0 million and reported accordingly. However, it as finally settled for Rs. 88.5 million. The revenue recognition policy is not consistent with the relevant Intonations Accounting Standard (IAS). Had it been in accordance with the IAS, the profit before tax would have been Rs. 79.2 million. The contract with a major customer is about to expire after three years. Certain internal documents show that the company might have to face a very difficult situation thereafter. Personal files of many senior executives do not contain any documentary evidence of their qualification. Salaries paid to such executives are Rs. 24 million.

(ii)

(iii)

(iv)

(v)

Required Discuss the impact of each of the above matters on your audit report. Answer 35 (i) (ii) Amount involved Rs. 0.5 million is immaterial and would not have any impact on audit report. Subsequent change in foreign exchange rate is not an adjusting event. The decision to take or not to take forward cover is based on managements understanding and assessment of the underlying business environment and the auditor has no right to interfere unless the matter is very material and involves an unduly high degree of risk as regards the viability of entity.

(iii)

(iv)

Non compliance with IFRS is one of the causes of disagreement with the client, science the effect of the error is 7% of net profit before tax, this material. A qualified report is to be issued. Non availability of personnel files does not require a modification in the report.

Question 36 You are manager in charge for the audit of Sehwan Marbles Limited. During audit you noticed that company was sued for breach of contract by a customer claiming damages of Rs. 200 million. Based on the lawyers opinion ( received through management), the management asserted that there would be no significant liability at the balance sheet date in respect of the said breach and accordingly, no provision was made in the financial statements. However, while studying the case file you found a memorandum from the head of the legal department addressed to the managing director in which he had opined that the company will have to pay at least 50% of the damages claimed. You concluded that this note was strong evidence indicating the existence of this liability, which should be provided for. Management considers that such note was nullified by the opinion of the companys legal advisor and as such there was no need to make any provision in respect of this contingent liability that was considered to be remote. Therefore, the CFO advises you that at the most there may be a disclosure of this contingent liability in the financial statement of perhaps an emphasis of matter paragraph in the auditors report without qualification. Required Write a memorandum containing your conclusion and recommendation for the decision of the partner as to the type of opinion that should be issued and why. Answer 36 From Manager in charge Shewans Marbles Limited To Partner Subject Date xxx Breach of contract by a customer claiming damages Rs. 200,000.

----------------------------------------------------------------------------------------------------------------------------------------Kindly refer to attached detailed note on the subject. My conclusion and recommendation are:
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1. A provision is required under the circumstances as outflow of economic resources is probable and the amount can estimated reliably. 2. A qualified opinion is required on the grounds of disagreement with management. Question 37 Under what circumstances the effect on audit opinion is considered to be pervasive? Explain with examples. Answer 37 A matter is considered to be pervasive if: (a) The effect of misstatement or inability to obtain audit evidence (b) The effect of misstatement on inability to obtain audit evidence is material, affects only specific elements of financial statements but represents a substantial proportion of financial statements (c) Inadequate or misleading disclosures are fundamental to the understanding of financial statements. Examples: (1) Receivables account for 8% of total assets. The client restricted the auditor to send confirmation letters. No alternative procedures could be use to verify the year end balances of receivables. There were no problems in the rest of financial statement accounts. The effect is not considered to be pervasive. (2) Inventories account for 85% of total assets, Physical inventory could not be carried out at year end. No alternative procedures count be used to verify the year end balances of inventories. There were no problems in the rest of financial statement accounts. The effect is considered to be pervasive Question 38 Explain the circumstances when audit opinion is modified on the grounds of material misstatement. Answer 38 The audit report is modified on the grounds of material misstatement under following circumstances: 1. Inappropriate accounting policies, theism adoption of policies that is adoption of policies in contradiction to IFRS.

2. Misapplication of accounting policy resulting in incurred amounts. This also includes violation of consistency principle 3. Inadequate disclosure or presentation of disclosures in contradiction with the requirements of IFRS. Question 39 In ability to obtain audit evidence is also reefed to as scope limitation. Such limitation arises from following matters: (1) Circumstances beyond the control of entity, for example, entitys accounting recodes have been destroyed. (2) Nature and timings of the auditors work; for example the auditors appointment was made after year end. As a result the auditor could not observe physical inventory and no alternative procedures could be applied. Also, in an IT environment, if an entitys controls are ineffective and substantive procedures alone cannot provide sufficient appropriate audit evidences. (3) Limitation imposed by management For example, management does not allow the auditor to send confirmation letters to debtors. Question 40 State circumstances when a modified opinion is issued. Answer 40 Audit opinion is modified if the opinion is: (a) Qualified opinion Qualified opinion is issued when the effect of misstatement or inability to obtain audit evidence is material but not pervasive. (b) Adverse opinion Adverse opinion is issued when the effect misstatement to obtain audit evidence is material and pervasive. (c) Disclaimer Disclaimer is issued when the effect of inability to obtain evidences material and pervasive.

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Question 41 The auditor has accepted an audit engagement. Subsequent to acceptance the management has imposed some restriction the work of the auditor. Discuss possible consequences in such a case. Answer 41 If after acceptance of audit, the management has imposed some restrictions the auditor should: (a) Carry out alternative audit procedures. For example, is the management has prevented auditor to count inventories at year end, carry out physical count at ante native date, and work back with verification of transaction in intervening period. (b) If due to the nature of recodes, alternative procedures could not be applied, and the matter is not pervasive issue a qualified opinion. (c) If the matter is pervasive, consider withdrawal from engagement or issue a disclaimer of opinion. Withdrawal may not be appropriate if the audit is substantially complete or the auditor has statutory duty to complete the audit. Question 42 A company has acquired a piece of land on 99 years lease. The company classifies the lease as operating lease. How would it affect your audit opinion? Answer - 42 In the case of leasehold land the risk and rewards are not transferred to the lessee. Accordingly, IAS 17 classifies leasehold land as operating lease. However for the schedule of the companies ordinance, 1984 requires that leasehold land should be classified under fixed assets. As the companies ordinance, 1984 prevails over IFRS; the leasehold is accounts for as part of fixed assets and not as operating lease.

If the financial statements as not amended, a qualified opinion will be issued on the grounds of disagreement with management.

Chapter 26 Emphasis of matter paragraphs and other matter paragraphs in the independent auditors report CHAPTER 26 EMPHASIS OF MATTER PARAGRAPHS IN THE INDEPENDENT AUDITORS REPORT (ISA 706) 1. INTRODUCTION ISA 706 deals with two type of additional communication in the auditors report. (a) Emphasis of matter paragraph (b) Other matters paragraph 2. EMPHASIS OF MATTER Emphasis of a matter paragraph is necessary under following circumstances: (a) Significant uncertainly relation to litigation (b) Early application of a new accounting standard (c) A major catastrophe which may have a significant effect on entitys financial position. Emphasis of a matter paragraph is included in audit opinion only when the management has fully disclosed the relevant facts in the notes to the accounts. 3. OTHER MATTERS PARAGRAPH Examples of other matter paragraph in audit opinion are: (a) Where the inability to obtain sufficient and appropriate evidence is so material due to rest restriction imposed by the management is no material and pervasive that the auditor considers that a withdrawal from engagements is necessary, but unable to do so, there auditor may include an other matters paragraph. The paragraph should explain why is not possible for the auditor to withdrawal from engagements. (b) Responsibilities of auditor in addition to those set out in ISAs. (c) Where an entity has prepared two set of financial statements, for example one in compliance with local regulations and another in accordance with IFRS, if the auditor s opinion is required on both set of financial statements, the auditor may include another matter paragraph in the audit report. The paragraph will state that another set of financial statements has been prepared in accordance with another general purpose framework and that the auditor has issued a report on these financial statements. (d) Restriction on distribution of audit report. Question and answers
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Question 1 Under what circumstances an emphasis of a matter paragraph is included in the audit opinion? Answer 1 Refer to paragraph2 of the text Question 2 Why a widespread use of emphasis of matter paragraph is discouraged by the auditing standard? Answer 2 Wide spread use of emphasis of matter paragraph is discouraged by the auditing standards because: (a) Emphasis of a matter paragraph diminishes the effectiveness of the auditors communication of such matters. (b) Additional information (not disclosed in financial statements) may imply that information in financial statements in not appropriately disclosed. (c) Emphasis of matter paragraph is not a substitute for qualified, adverse or disclaimer of opinion, or inadequate disclosure. Question 3 Give some examples of other matter paragraph in other matters paragraph. Answer 3 Refer to paragraph 3 of the text Question 4 Give five examples in instances which are excluded from other matter paragraph in audit opinion. Answer 4 Give five examples in instances which are excluded from other matter paragraph in audit opinion are: (a) Proper books of accounts have been kept. (b) Expenditure was incurred for the propose of business

(c) Investments made, expenditure incurred and business conducted was in accordance with objects of the company. (d) Ethical standards relating to confidentiality of information (e) Information that is required to be provided by management. Question 5 Identify the situations in which an auditor may modify his report without affecting his opinion. Also explain how such a modification should be presented in the audit report. Answer 5 The situations in which a report in modified without affecting the auditors opinion are as follows: (i) (ii) If the use of going concern assumption is appropriate but a material uncertainty exists which has been adequately disclosed in the financial statements. In there is a significant uncertainty (other than going concern) the resolution of which is dependent upon future events and which may affect the financial statement. In case, other information attached with the financial statements are inconsistent with information in the financial statements.

(iii)

How modification is presented: (i) By adding an emphasis of matter paragraph to highlight an important matter affecting the financial statements. (ii) The above paragraph is required to refer to the note to the financial statements that more extensively discussed the matter. (iii) The paragraph should preferably by include after the paragraph containing the auditors opinion but before the section on any other reporting responsibilities. (iv) The emphasis of matter paragraph should ordinary refer to the fact that the auditors opinion in not qualified in this respect.

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CHAPTER 27 THE AUDITORS RESPONSIBILITIES RELATING TO OTHER INFORMATION IN DOCUMENTS CONTAINING AUDITED FINANCIAL STATEMNTS (ISA 720) INTRODUCTION The auditor should read the other information included in annual report. The objective is to identify contradictions if any, between the audited accounts and other information. Other information generally included in Pakistani annual reports is: Companys basic information Directors report Review by the chairman 10 Years highlight Financial ratios Pattern of holding of the shares Incorrect reporting in any of the above information resulting in contradiction with the accounts would unnecessarily affect the reliance on the audited accounts INCONSISTENCY BETWEEN OTHE INFORMAITON AND AUDITED ACCOUNTS If the auditor identifies a material inconsistency between other information and audited accounted and he concludes that the financial statements need amendment, which the management does not agree to correct, he would issue a qualified or adverse opinion on the grounds of disagreement with the management. However, if the amendment is required in other information, he should pursue the management to amend the other information. In rare circumstances, the management may refuse to amend the other information. In such a case the auditor should add a paragraph emphasizing the matter describing the inconsistencies.

Chapter 28 SPECIAL CONSIDERATIONS-AUDITS OF FINANCIAL STATEMENTS PREPARED IN ACCORDANCE WITH SPECIAL PURPOSE FRAMEWORKS (ISA 800) INTRODUCTION ISA 800 provides guidance in connection with special purpose audit engagements including: a) Financial statements prepared in accordance with a comprehensive basis of accounting other than International Accounting Standards or National Standards; b) Specified accounting, element of accounts, or items in a financial statement; c) Compliance with contractual agreements; and d) Summarized financial statement In Pakistans context, the auditors are also required to issue opinion on certain matters required by the companys ordinance, 1984. Two more commonly reports are: a) Statutory report b) Report on prospectus Statutory report Section 157 requires that every company limited by shares and every company limited by guarantee and having a share capital shall, within a period of not less than three months, not more than six months, from the date at which the company is entitled to commence the business, to hold a general meeting of the members of the company, which is called the statutory meeting. The directors shell, at least 21 days before the date on which the meeting is held, forward a report, referred to as the statutory report The contents of the report have been set out in sub sections (3) and (4) of section 157. Section 157 (5) of the Companies Ordinance, 1984 requires that statutory report shall, so far as it relates to the shares allotted by the company, be accompanied by a certificate of the auditors of the company as to the correctness of such allotment, receipts of cash, and receipts and payments. The auditors certificate on statutory report may take following form: We the undersigned, being the auditors of XYZ limited, hereby certify that so much of this report as to the shares allotted the cash received in respect of such shares, and the receipts and payments of the company is correct. AB & Co. Chartered Accountants Karachi. May 31, 20x7. Audit procedures to verify report include:
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1. Check that no allotment is made of any share capital of the company unless the amount stated in the prospectus as the minimum amount which in the pinion of directors must be raised by the issue of share capital has been subscribed. 2. Ensure that all moneys received from applicants is deposited and kept in a separate bank account in a scheduled bank until retuned or until certificate to commence the business is obtained. 3. Verify the amount received on application. 4. Ensure that the amount payable on application is the full nominal amount of the share. 5. Check that the company has taken a decision within ten days of the closure of the subscription lists as to what applications have been accepted or are 6. Successful and that a refund has been made in the case of the unaccepted or unsuccessful applications within ten days of such decision. 7. Verify the return of allotment filed with the registrar 8. Check terms of issue with the memorandum and articles of association and prospectus. 9. Inspect the minutes of the directors meeting for the allotment of shares. 10. Reconcile register of members to share capital control account. 11. Ensure that the summary of receipts and payment of the company has been prepared up to a date within seven days of the report. 12. Ensure that the company within 90 days after the allotment of shares and within 45 days after the application of the transfer of any shares has ready for delivery the share certificates. 13. Ensure that commission has been paid to any person in consideration of his subscribing or agreeing to subscribe, for any shares in or debentures of the company, or procuring or agreeing to procure subscription, whether absolute or conditional for any shares in or debentures of the company if: (a) The payment of the commission is authorized by the articles; (b) The commission paid on agreed to be paid does not exceed such rate-cent of the amount as may generally or in a particular case be fixed by the Authority; and (c) The amount or rate per-cent of the commission paid or agreed. 14. Check that separate disclosure has been made for receipts from shares, redeemable capital, other sources, commission or discount on the issue or sale of shares and preliminary expenses. 15. Vouch in detail other receipts and payments not covered above. 16. Count cash and check with the summary of receipts and payments. 17. Reconcile bank accounts.

Contents of the report on prospectus 1. A report by the auditors of the company with respect to: (a) Profits and losses and assets and liabilities; and (b) The rates of the dividends, if any, paid by the company, in respect of each class of shares in the company for each of the five financial years immediately preceding the issue of the prospectus, giving particulars of each class of shares on which such dividends have been paid and particulars of the cases in which no dividends have been paid in respect of any class of shares for any of those years; and, if no accounts have been made up in respect of any part of the period of five year ending on a date three months before the issue of the prospectus, containing a statement of the fact. 2. If the company has no subsidiaries, the report shall: (a) So far as regards profits and losses, deal with the profits or losses of the company (distinguishing items of non-recurring nature) for each of the five financial years immediately preceding the issue of the prospectus; and (b) So far as regards assets and liabilities, deal with the assets and liabilities of the company at the last date to which the accounts of the company were made up. If the company has subsidiaries, the report shall: So far as regards profit and losses, deal separately with the companys profits or losses as provided by sub-clauses (2) and in addition, deal either: Individually with the profits or losses of each subsidiary, so far as the concern member of the company; Or instead of dealing separately with the companys profit or losses, deal as a whole with the profit or losses of the company, and so far as they concern members of the company, with combined profits or losses of its subsidiaries, and so far as regards assets and liabilities, deal separately with the companys assets and liabilities as provided by sub -clause (2) and in addition, deal either: As a whole with the combined assets and liabilities, of its subsidiaries, with or without the companys assets and liabilities; or individually with the assets and liabilities of each subsidiary; And shall indicate as respects the assets and liabilities of the subsidiaries, the allowances to be made for persons other then members of the company. If any shares have been or are to be issued or the proceeds or any part of the proceeds, of the issue of the shares or debentures are or is to be applied directly or indirectly: i) In the purchase of any business; or ii) In the purchase of an interest in any business; and by reason of that purchase or anything to be done in consequence thereof, or in connection therewith, the company will become entitled to an interest, as respects either the capital or profits and losses or both, in such business exceeding fifty percent, thereof; A report made by auditors (who shall be named in prospectus) upon:
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a) The profit or losses of the business for each of the five financial years immediately preceding the issue of the prospectus; and b) The assets and liabilities of the business at the last date to which an account of the business were made up, being a date not more than one hundred and twenty days before the date of the issue of the prospectus. If: a) The proceeds; or any part of the proceeds, of the issue of the shares or debentures are or is to be applied directly or indirectly in any manner resulting in the acquisition by the company of shares in any other body corporate; and b) By reason of that acquisition or anything to be done in consequence thereof or in connection therewith that body corporate will become a subsidiary of the company;