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Audit & Assurance Professional Stage December 2010

MARK PLAN AND EXAMINERS COMMENTARY


General comments
It was pleasing to note an improvement in candidates performance regarding the short-form questions,
continuing the improvement identified in recent sessions. However, a significant number of candidates are
failing to take advantage of the facility to present the short-form answers in note form. A small number of
candidates failed to follow the instruction to answer each short-form question on a separate page and to
submit the short-form questions in numerical order. It was also pleasing to note that there was evidence
that candidates were managing their time better than in previous sessions as there were notably fewer
unfinished last questions.
SFQ1
Proposal represents lowballing
Threat to the fundamental principle of professional competence and due care
Risk that the firm may cut corners to stay within the budget
If non-audit services obtained objectivity may be impaired due to:
self-interest/fee dependency threat
- fear of losing fee may cause reluctance to report unfavourably
self-review threat
- over reliance on colleagues work
- reluctance to notify firms errors to clients management
management threat
- may be expected to make decisions
ES4 (Revised) states that audit fee must not be influenced by the provision of other services.
This question was generally well answered with most candidates identifying and adequately explaining selfinterest, self-review and management threats. Although many candidates identified that the firm may cut
corners to stay within the budget, few cited that this posed a threat to the fundamental principle of
professional competence and due care. Furthermore, the majority of candidates did not make the point that
Ethical Standard 4 Fees Remuneration and Evaluation Policies, Litigation, Gifts and Hospitality (Revised),
states that the audit fee must not be influenced by the provision of other services. A minority of candidates
wasted time citing safeguards for each of the threats which were not required.
Maximum full marks
Marks available

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SFQ2

As the background information can be pooled (i.e. knowledge spillover)


- services can be provided at a lower overall cost
- convenient/less disruptive to client/one-stop shop
As the firm has a greater knowledge and understanding of the client
- services are likely to be of higher quality
Client derives a greater degree of comfort from having the services provided by a trusted source.
This question was well answered with the majority of candidates appreciating the benefits that a firms
existing knowledge would bring when external auditors provide non-audit services to a client. Some
candidates failed to read the question properly and gave benefits from the firms perspective (such as
attracting higher calibre staff through offering a varied portfolio of work) or the general benefits of some
non-audit or assurance services (such as increased credibility when raising finance). These points were
outside the scope of the question and did not score any marks.
Maximum full marks
Marks available

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Audit & Assurance Professional Stage December 2010


SFQ 3
Rights
Outgoing auditors may
- make written representations and request directors to circulate to members
- attend and speak at general meeting
Responsibilities
Prepare statement of circumstances
- specifying reasons for ceasing to hold office
- to be deposited at Pisces registered office and copy to be sent to Registrar of Companies
As Pisces is listed, there is no option to state there are no circumstances
Obtain permission from client to reply to prospective auditors communication
Return promptly all books and records of the company
Maintain client confidentiality after ceasing to act
Maintain money laundering identification records.
This question was well answered but some answers were very disappointing, particularly given that this
question tested candidates basic knowledge of external auditors rights and responsibilities when not being
re-appointed. Candidates often demonstrated an inability to distinguish between a written representation (a
right) and the statement of circumstances (a responsibility) and often were unable to give these documents
their correct titles. Candidates did not appreciate that the written representation is circulated to
shareholders by the directors, rather than the auditor. A significant minority of candidates included,
incorrectly, the rights and responsibilities of the auditor on resignation, such as requisitioning an
extraordinary general meeting. A few candidates misread the question and answered it from the
perspective of the new firm of auditors about to be appointed.
Maximum full marks
Marks available

4
10

SFQ4
Tasks
Discussion of significant matters with engagement partner
Review of financial statements and proposed audit report
Review of selected documentation relating to significant judgements/conclusions
Evaluation of conclusions reached and appropriateness of audit report
For audits of listed entities consider
Engagement teams evaluation of the firms independence
Whether consultation has taken place on difficult or contentious matters
Whether audit documentation selected for review reflects the work performed and supports the conclusions.

This was the most poorly answered short-form question, with only a minority of candidates appreciating that
the answer could be found in International Standard on Auditing 220, Quality Control for an Audit of
Financial Statements (ISA 220) and International Standard on Quality Control 1(ISQC1). Those candidates
aware of the requirements of ISA 220 or ISQC1, or who knew where to look in the open text, often scored
full marks. However, the majority of candidates failed to distinguish the tasks associated with an
engagement quality control review from those required by review procedures undertaken as part of routine
engagement performance. In addition, many confused it with monitoring procedures (cold review) designed
to provide an audit firm with assurance that its own system of quality control is operating effectively. Others
just listed the six elements of a system of quality control as set out in paragraph 16 of ISQC1.
Maximum full marks
Marks available

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Audit & Assurance Professional Stage December 2010


SFQ 5
Increased risk of window dressing/misstatement/bias
In order to increase purchase consideration
Reduce materiality thresholds
Increase the level of testing
Emphasis on
- testing assets and income for overstatement
- testing liabilities and expenses for understatement
Increase the level of professional scepticism
Look carefully at judgement areas
Place less reliance on management representations
Use more experienced staff
Arrange a quality control review.
Answers to this question were mixed. Whilst the majority of candidates correctly identified that the pending
purchase of shares increased the risk of material misstatement due to management bias, many candidates
did not appreciate the impact this would have on the overall audit strategy. Points commonly missed by
candidates included: arranging a quality control review, reducing materiality thresholds and placing less
reliance on management representations. A number of candidates focussed, incorrectly, on the prospective
owner of the business discussing issues such as client identification procedures and issuing new
engagement letters and consequently scored no marks.
Maximum full marks
Marks available

3
5.5

SFQ 6
Likely to have material impact on financial statements
- refunds for returns
- provision for faulty inventory
- increase in provisions for warranties
- provisions/contingencies relating to legal claims
Adverse publicity may impact on going concern status.
This question was very well answered with many candidates scoring the full two marks available.
Candidates correctly identified the impact the product recall would have on the financial statements, such
as provisions for legal claims and warranties, and the impact of adverse publicity on the going concern
presumption. A minority of candidates wasted time by going on to explain, often in detail, the nature of the
audit procedures that should be employed. This was not required within the two marks available for this
question.
Maximum full marks
Marks available

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Audit & Assurance Professional Stage December 2010

Question 7

Total marks: 40

General comments
There were some very good answers to this question which attained the highest average mark on the written
test section of the paper. In general, candidates provided strong answers to part (b) but struggled with part (d).
Part (a)
Explain why an auditor should consider whether a company is a going concern. Your answer should
consider the implications for both the financial statements and the audit report.
ISA 570 Going Concern (ISA 570) requires the auditor to consider whether there are events or conditions that
may cast significant doubt on the entitys ability to continue as a going concern.
If the going concern basis of preparation of the financial statements is not appropriate, then the break-up
basis will have to be used and this will have to be disclosed in the notes to the financial statements. This has
implications for the amounts at which items are included in the financial statements, in particular,
assets may need to be written down to recoverable amounts;
assets and liabilities should be reclassified as current; and
additional liabilities for losses/redundancies may arise.
If the auditor agrees with the use of the break-up basis and this is adequately disclosed in the notes to the
financial statements, the audit report will be issued with an unmodified opinion. The audit report will be
modified with an emphasis of matter paragraph drawing the users attention to the basis of preparation and
the note in the financial statements.
If the financial statements are prepared using an inappropriate basis the audit opinion will be modified with an
adverse opinion.
If there is uncertainty about the going concern status, the financial statements should be prepared on the
going concern basis, but there should be a note in the financial statements explaining the situation. If the
note is adequate, then the auditor can give an unmodified opinion but the audit report will be modified with an
emphasis of matter paragraph.
If the note is inadequate, then the audit opinion will be modified, either with a qualified opinion (except for) if
considered material but not pervasive or an adverse opinion if considered material and pervasive.
Although there were some very comprehensive answers to this part of the question, a number struggled with
the requirement. Most candidates were able to explain why an auditor should consider whether a company is
a going concern and the implications of this for the financial statements. However, fewer candidates were
able to explain the implications for the audit report and some candidates provided very brief answers to this
aspect of the question and consequently lost marks. A number of candidates incorrectly stated that when
financial statements are prepared on a break-up basis then the audit opinion should be modified.
Consequently, they failed to appreciate as long as the basis of preparation was adequately disclosed in the
financial statements the audit report would be modified with an emphasis of matter paragraph and the
opinion would be unmodified. Weaker candidates were unable to explain the implications for the audit
report when there are doubts over the going concern status of the company. Others failed to appreciate the
distinction between doubt over the going concern status and the situation where a company was definitely
ceasing to trade. A small number of candidates confused the going concern and break-up basis and stated,
incorrectly, that the going concern basis should be used when a company was ceasing to trade. Weaker
candidates strayed beyond the requirement and wasted time citing the audit work to be undertaken.
Maximum full marks
Marks available

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Audit & Assurance Professional Stage December 2010

Part (b)
Justify why the items listed have been identified as key areas of audit risk and, for each item,
describe the procedures that should be included in the audit plan in order to address those risks.
Going concern
Justification
The company is experiencing cash flow
difficulties as evidenced by the need to
increase the overdraft facility, the delayed
payments to HMRC and the overdue
amount from a major customer. There is a
risk that the overdraft facility may not be
extended, or even withdrawn. If the
company fails to meet its payments to
HMRC, the latter may seek to place the
company into administration.
The cash flow problem is further
exacerbated by a decline in demand from
the construction sector coupled with
undercutting of prices by competitors.
Both of these have an adverse impact on
profitability and impede the companys
ability to generate cash from operations.
The company is under investigation by the
industry regulator and as a result may be
subject to large fines or even have its
licence to operate revoked.

Receivables
Justification
A material amount is overdue and if its
recoverability is in doubt, receivables may
be overstated if a provision is not made.

Work in progress
Justification
The work in progress figure is extracted
from the job costing records which are
integrated with the purchases and payroll
systems. If the system is unreliable, it
could result in under or overstatement of
work in progress. The allocation of
overheads involves the use of judgement
which increases the risk of misstatement.
Cost overruns on fixed-price contracts
could result in losses which, if not
provided for, will result in the
overstatement of work in progress.

Going concern
Procedures
Examine profit and cash flow forecasts for at least 12
months from the year end. In respect of the forecasts,
consider the:
- reasonableness of the assumptions upon which the
forecasts are based;
- results of sensitivity analysis on key components of the
forecasts; and
- companys ability to meet its debts as they fall due,
including the arrears to HMRC
Review post year-end management accounts to assess
the companys performance
Inspect borrowing agreements and assess the companys
ability to comply with covenants and other terms and
conditions
Obtain a written representation on the feasibility of
managements future plans
Enquire of the companys legal advisors to assess the
impact of potential fines imposed by the regulator
Inspect correspondence with regulators to assess the
likely outcome of the investigation
Inspect bank correspondence for evidence of any
deterioration in the relationship with the bank or
alternative sources of finance
Inspect correspondence with HMRC to confirm the
payments plan has been agreed

Receivables
Procedures
Inspect correspondence with the customer for evidence of
a dispute
Discuss the situation with the directors and request a
provision if recoverability in doubt
Examine cash book, bank statements or remittance
advice up to audit completion to ascertain whether the
amount is paid after date
Work in progress
Procedures
Evaluate and test the controls exercised over the posting
of purchases and payroll costs
For a sample of contracts underway at the year end:
- vouch entries for labour to payroll
- vouch entries for components to suppliers invoices
Trace payroll costs/invoices to job costing records
Ascertain the basis of overhead allocation and review it
for reasonableness, in particular, ensure only attributable
overheads are included
Reperform overhead calculation based on the figures in
the management accounts
Compare actual costs to budget to identify cost overruns
which may indicate potential losses
Compare receipts after date to total costs for contracts in
progress at the year end to ascertain whether provision
for losses required

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Audit & Assurance Professional Stage December 2010

Non-current assets
Justification
The valuation of the property involves
judgement which increases the risk of
misstatement. There is a risk that
revaluation adjustments may not be
accounted for correctly. There is also a
risk that management has used the
revaluation to strengthen the statement of
financial position by window dressing (for
example, the valuation may be
deliberately overstated or all properties in
the class may not be revalued).

Non-current assets
Procedures
Obtain a copy of the valuers report and consider the
reliability of the valuation after taking account of:
- the basis of valuation;
and in respect of the valuer:
- independence/objectivity;
- qualifications;
- experience/competence/expertise; and
- reputation
Compare the value attributed to Laggs property to the
value of other similar properties in the locality
Reperform the calculation of the revaluation adjustments
and ensure that they have been accounted for correctly
Ensure the depreciation is based on the revalued amount
Inspect the notes to the financial statements to ensure
appropriate disclosures
Ensure all assets in the class are revalued (i.e.no cherry
picking)

The Institute of Chartered Accountants in England and Wales 2010.

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Audit & Assurance Professional Stage December 2010

This part of the question was very well answered in respect of going concern and trade receivables.
However, work in progress and property, plant and equipment were generally not well answered. As in
previous exams, almost all candidates followed the examiners guidance to use a columnar format to layout
their answers. Those candidates who worked methodically through the question justifying why each item had
been identified as a key area of audit risk and then describing procedures to address that risk scored
particularly well, with a significant number scoring maximum marks. On the whole, candidates performed
better on the justification of the risks identified in the question, than on the procedures to be performed to
address the risks.
Going concern
The vast majority of candidates were able to justify why going concern was an area of audit risk and provide
some relevant audit procedures involving examination of forecasts and correspondence with the companys
bank, lawyers and the industry regulator. As noted by examiners in previous commentaries, a number of
candidates lost marks by being too vague e.g. many candidates cited obtain cash flow forecasts or inspect
correspondence but did not specify what they should be looking for in the cash flow forecasts or why they
should inspect the correspondence. The point most commonly overlooked was that relating to the
examination of post year-end management accounts.
Receivables
Generally well answered as most candidates appreciated that the overdue receivable may not be collectable
and therefore receivables may be overstated if a provision is not made. However, many candidates failed to
identify procedures to address that specific risk, i.e. inspecting evidence of payment after the year end, and
included a number of general audit procedures in respect of receivables as a whole. Weaker candidates
wasted time on income recognition which was beyond the scope of the requirement as revenue was not
listed as an area of audit risk.
Work in progress
Many candidates provided very weak answers to justify why work in progress had been identified as a key
audit risk. Some candidates discussed, at length, why raw materials inventory was a key audit risk and
described procedures to verify such inventory instead of focusing on work in progress as required by the
question. Very few candidates described how to test the reliability of the job costing records used in the work
in progress valuation by vouching payroll and component entries back to source documentation and tracing
source documentation into the costing records. Most candidates failed to appreciate that cost overruns on
fixed price contracts could result in losses requiring provision and consequently affecting the work in progress
valuation.
Property, plant and equipment
Some answers dealing with the property, plant and equipment risk were brief, particularly in relation to the
audit procedures. Many candidates appreciated that the valuation might have been overstated in order to
strengthen the statement of financial position. However, a significant minority failed to appreciate that
valuations involved judgement and that in itself posed a risk of misstatement. In addition, a significant number
of candidates overlooked the possibility that the revaluation adjustments may not have been recorded
correctly. Although the majority of candidates considered the competency and independence of the valuer,
many failed to consider inspecting the valuers report.
Maximum full marks
Marks available

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Audit & Assurance Professional Stage December 2010

Part (c)
Explain the matters that should be considered, including any actions to be taken, by you and your
firm, if during the course of the audit you discovered that the directors of Lagg had authorised the
illegal disposal of hazardous waste in order to save costs.
The directors actions indicate a lack of integrity and cast doubt on the reliability of their representations and
hence the degree of reliability that can be placed on them. There is also an increased risk of misstatement
as the directors may fail to provide for probable fines or disclose possible fines.
International Standard on Quality Control 1 (ISQC1) and International Standard on Auditing 220 Quality
Control for an Audit of Financial Statements (ISA 220) require the engagement partner to consider the
integrity of the directors when deciding whether to continue with an existing engagement. Furthermore,
association with cavalier directors could impact adversely on the reputation of the audit firm. In light of this,
the firm should consider whether it is appropriate to offer itself for re-appointment.
Breaking the law to save costs represents money laundering and as such needs to be reported to the firms
money laundering reporting officer who should decide whether to report to the Serious Organised Crime
Agency. The audit firm should take care not to tip-off the client.
This part of the question was generally well answered. Most candidates identified that there was an
increased risk of misstatement in the financial statements arising from a failure to provide for fines and
explained why the integrity of the directors needed to be considered. Although many identified that the
engagement partner should consider whether it was appropriate to continue to act, few appreciated that this
is a requirement of ISQC1 and ISA 220. Stronger candidates went on to score full marks by explaining that
the illegal dumping of hazardous waste to save costs represented money laundering and set out the actions
that needed to be taken by themselves and their firm once money laundering is identified.
Maximum full marks
Marks available

6
10

Part (d)
Identify and explain the principal threats to objectivity which arise from a member of your firms
staff assisting with the preparation of the financial statements as requested by the finance director
of Lagg. State how your firm should mitigate these threats.
Threats
The self-review threat arises when the results of a non-audit service performed by the engagement team or
others within the firm are reflected in the amounts included or disclosed in the financial statements. Audit
staff may be reluctant to identify shortcomings in their colleagues work or may place too much reliance on
that work without checking it.
The management threat arises if members of the firm are expected to make decisions on behalf of
management. The firm may become too closely aligned with the views and interests of management.
Assistance with the preparation of the financial statements is not prohibited in the UK as Lagg is not listed,
therefore assistance with the preparation of the financial statements can be given as long as appropriate
safeguards are in place.
Mitigate threats
The staff member assisting with the preparation of the financial statements must have no involvement in the
audit of those financial statements. In addition, the staff member should not be involved in initiating
transactions, taking decisions or making judgements. Any such services should be of a technical,
mechanical and informative nature. Laggs management should take all decisions requiring the exercise of
judgement and should have prepared the underlying accounting records.
The accounting services should be reviewed by a partner or other senior staff member, with appropriate
expertise, who is not a member of the audit team. The audit of the financial statements should be
independently reviewed to ensure that the accounting services performed have been properly and
effectively assessed in the context of the audit of the financial statements.
The firm should ensure that the management of Lagg are informed, i.e. designated members of the
management have the capability to make management judgements and decisions on the basis of the
information provided. The respective responsibilities should be set out in a separate engagement letter.

The Institute of Chartered Accountants in England and Wales 2010.

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Audit & Assurance Professional Stage December 2010

Answers to this part of the question were mixed. Most candidates correctly identified the threat of selfreview but fewer candidates identified the management threat. Of those who did identify the management
threat, few were able to state how it could be mitigated. A number of candidates wasted time by discussing,
at length, a number of other threats including familiarity, intimidation and self-interest that were not relevant
to the answer. For example, many cited the self-interest threat in respect of fee dependency and failed to
appreciate that fee dependency only applied to regular income and, as this assignment was likely to be a
one-off, was not applicable in this situation. On the other hand, having correctly identified the self-review
threat most candidates stated, correctly, that it could be mitigated by the loan staff having no involvement
on the audit and by independent review. A number of candidates stated that provision of accounting
services is prohibited in the UK for listed companies but then failed to apply this to the question by stating
that Lagg was not listed and therefore the services could be provided.
Maximum full marks
Marks available

The Institute of Chartered Accountants in England and Wales 2010.

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Audit & Assurance Professional Stage December 2010

Question 8

Total marks: 20

General comments
Answers to this question attained the second highest average mark on the written test section of the paper.
In general, answers to parts (c) were better than answers to parts (a) and (b).
Part (a)
Prepare briefing notes on matters which you wish to discuss with the management of Bambi in
respect of the information provided in the scenario. Your notes should include reference to the
results of your preliminary analytical procedures.
Briefing notes on matters to be discussed with the management of Bambi
Revenue
Increase of 10.8% is out of line with previous years, how much of this increase is due to:
- the new retail outlet in Paris
- the expansion of the product range
- increases in selling prices
The point at which revenue is recognised in respect of:
- the accessories which have to be ordered
- the internet sales of items which are subject to stockouts
Method used to translate sales made by the Paris retail outlet
Gross profit margin
Increase of 2% is significant in light of significant increase in revenue. Would not have been surprised to see
the margin fall. Is the increase due to:
- higher margin on accessories
- beneficial effect of movement in exchange rates
- cheaper goods from Portuguese suppliers
- possible understatement of purchases
- possible overstatement of inventory.
Operating margin
The reason for the significant fall of 4%, which is surprising in light of increase in gross margin. Is the fall
due to:
- misclassification of costs between cost of sales and operating expenses
- marketing costs of the new range and overseas expansion
- depreciation relating to the new IT infrastructure
- running expenses associated with the new Paris retail outlet
- leasing costs of the purpose-built warehouse facility (any up-front leasing costs accounted for
incorrectly)
- misclassification of expenditure by expensing items which should have been capitalised
Inventory days
Inventory days have increased by 14 days which is surprising in view of the companys policy of holding
limited inventory for the more expensive items. Is this increase due to:
- slow moving or obsolete items which need to be written down
- build up of new range of less expensive accessories
- translation errors in respect of items purchased from overseas suppliers
Whether the book figure is supported by a physical count
Payables days
Payables days have fallen by 6 days. Is the fall due to:
- understatement of payables due to unrecorded invoices
- tighter credit terms with new suppliers
- translation errors
General
The controls exercised over data transfer to the new IT system and whether the old and new systems were
subject to parallel running.

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Audit & Assurance Professional Stage December 2010

Answers to this part were mixed. Those candidates who dealt with each of the given ratios in turn, stating a
plausible matter to be discussed with management, tended to score high or full marks. However, many lost
marks by being too vague and just stating obtain reason for the increase instead of demonstrating an
understanding of what might be the cause of the significant increase. The points most commonly
overlooked were: in respect of gross profit margin, the possibility of understated purchases and cheaper
suppliers, in respect of inventory days, the possibility of translation errors and in respect of payables days
the possible understatement of payables. Furthermore, only a minority of candidates appreciated that an
increase in gross margin coupled with a fall in operating margin may result from a misclassification of costs.
Weaker candidates digressed into the consideration of the business risks such as failing to deliver goods or
failing to comply with overseas laws and regulations.
Maximum full marks
Marks available

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Part (b)
Identify the financial information, in addition to the interim financial information, that would be
useful when undertaking analytical procedures in respect of Bambis performance for the six
months ended 30 November 2010.
The following financial information would be useful when undertaking analytical procedures:
Schedules supporting the figures included in the financial statements for example, a breakdown in
operating expenses.
Management accounts for the corresponding six-month period
Profit forecasts for the corresponding six-month period
Segmental information, including:
- mail order v retail outlets
- accessories v clothing
- outlet by outlet basis
Industry sector and competitor financial information
The full financial statements for the whole previous year
The cash flow statement for the corresponding six-month period
Answers to this part of the question were mixed. Strong candidates identified additional information such as
management accounts, budgets and forecasts, industry information and full financial statements for the
previous year. Some candidates ignored the requirement in addition to the interim financial information
and identified items that would be available in the interim statement of financial position. For example, many
cited figures needed to calculate ratios such as the quick ratio and other liquidity ratios which would already
be available in the interim statement of financial position. The points most commonly overlooked were those
in respect of the segmental information.
Maximum full marks
Marks available

4
10

Part (c)
Comment on the level of assurance provided by the report on the financial information of Bambi
and explain how and why it differs from the level of assurance provided by an audit report on
annual financial statements.
A review of the financial statements provides limited/moderate assurance as to the credibility of the financial
information. A limited assurance engagement reduces the risk to a level that is acceptable in the
circumstances. The conclusion is expressed negatively in the form of nothing has come to our attention
that causes us to believe that the accompanying financial statements do not give a true and fair view.
A statutory audit provides reasonable assurance as to the credibility of the financial statements. A
reasonable assurance engagement reduces the risk to an acceptably low level. It provides a high, but not
absolute, level of assurance that the financial statements are free from material misstatement. The
conclusion is expressed positively in the form of in our opinion the financial statements give a true and fair
view of the state of the companys affairs
A review provides less assurance than an audit because the scope of the work is less.

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Audit & Assurance Professional Stage December 2010

This part was very well answered by the majority of candidates with many scoring full marks. The point
most commonly overlooked was that in respect of the scope of the work being less in an engagement to
review financial information. A small minority of candidates stated, incorrectly, that the level of assurance
provided by such a review engagement was low.
Maximum full marks
Marks available

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6.5

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Audit & Assurance Professional Stage December 2010

Question 9

Total marks: 20

General comments
Answers to this question attained the lowest average mark on the written test section of the paper. In general
answers to part (a) were better than answers to part (b). This was mainly due to poor performance on
Pembroke in part (b).
Part (a)
Prepare extracts suitable for inclusion in your firms report to the management of Conco. For both
internal control deficiencies identified, you should outline the possible consequences of the
deficiency and provide recommendations to remedy each of the deficiencies.
(i) Failure to compare costs with budgeted on fixed-price contracts
Consequences
Failure to compare actual costs to budgeted costs on a weekly basis may result in cost overruns on individual
contracts not being identified at an early stage. This may result in loss-making contracts which have an
adverse impact on cash flow and could impede the companys ability to continue to trade. Work in progress
may be overvalued if provisions for losses are not recognised.
The lack of control may encourage the misappropriation of raw materials and failure to identify contracts
behind schedule may trigger penalty clauses for late completion.
Recommendations
Senior management should write to contract managers, informing them of their responsibility to compare
actual costs with budget on a weekly basis and that the comparison should be evidenced by signature. A
progress report should be submitted to senior management on a monthly basis. Contract managers should
also be informed that disciplinary procedures will be implemented for breaches of company policy.
A system of monitoring should be implemented to ensure that procedures are being followed.
(ii) Failure to reconcile non-current asset register
Consequences
Failure to reconcile the property plant and equipment register with the physical assets may result in failure to
identify the following:
- assets recorded in the register which have been stolen;
- acquisitions or disposals which have not been recorded;
- assets which are fully written down but still in use;
- assets which are impaired; and
- inappropriate useful lives and consequently inappropriate depreciation charges
Unrecorded acquisitions may result in incorrect claims for capital allowances.
Recommendations
Senior management should introduce a policy requiring a designated employee to undertake checks which
involve comparison of the:
- physical assets to the register to ensure completeness of recording; and
- assets recorded in the register to the physical asset to confirm existence and condition.
The reconciliation should be performed by an employee independent of the custodian of the assets and
differences should be reported to senior management and investigated.
A system of monitoring should be implemented to ensure that procedures are being followed.

The Institute of Chartered Accountants in England and Wales 2010.

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Audit & Assurance Professional Stage December 2010


On the whole, the failure to compare costs against budget was dealt with better than the failure to reconcile
the non-current asset register.
Failure to compare costs with budgeted
Most candidates identified that failure to apply the companys policy could result in failure to control costs and
possibly result in losses which, in turn, would have an adverse impact on cash flow. However, few candidates
identified that work in progress may be overvalued if losses were not provided for or that contracts behind
schedule may trigger penalty clauses for late completion. Most candidates identified the importance of making
managers aware and disciplining those who failed to comply with company policy but only a minority identified
the need to monitor company procedures. A small number of candidates failed to score highly on
recommendations as a result of simply reiterating that budgets should be reviewed regularly this control
was already in place but was not operating effectively and therefore did not address the issue.
Failure to reconcile non-current asset register
The consequences were generally well covered with the exception of the point relating to incorrect capital
allowances. The recommendations were generally poorly covered as many candidates failed to provide
recommendations in a manner that would be understood by the client. Statements such as undertake
physical checks on the assets on a regular basis were common and too general to be awarded marks. A
number of candidates wasted time citing other control procedures in respect of non-current assets, for
example physical controls, which did not address the control deficiency identified.
Maximum full marks
10
Marks available
23

Part (b)
In each of the two situations outlined, state whether you would modify the audit opinion. Give
reasons for your conclusions and describe the modifications, if any, to each audit report.
Pembroke
The opinion should be modified due to the limitation on scope imposed by the directors, as the auditor is
unable to obtain sufficient appropriate evidence. International Standard on Auditing 580 Written
Representations (ISA 580) requires the auditor to disclaim an opinion on the financial statements when the
directors refuse to provide representations regarding the fulfilment of their responsibilities in relation to the
preparation of the financial statements.
Consequently, as the matter is material and pervasive, the auditor should specify in the opinion section of the
report that we do not express an opinion or we are unable to express an opinion. Immediately above the
opinion, there should be an explanation of the reasons for the disclaimer of opinion.
In the matters on which auditors are required to report by exception section of the report, the auditors should
refer to the fact that they:
- have not received all information and explanations considered necessary for the audit; and
- were unable to determine whether adequate accounting records had been kept.
Snowdonia
The opinion should be modified, due to disagreement over accounting treatment. The transaction should be
accounted for in the year ended 30 September 2010 because it was received and in use prior to the year
end. As a result, non-current assets, liabilities and depreciation are understated.
As the equipment represents 14.5% of total assets and the depreciation of 40,000 represents 5.3% of profit
before tax, the matter is material and the opinion should be qualified (except for). The matter is not pervasive
as it is confined to specific items in the financial statements and does not represent a substantial proportion
of the financial statements.
Immediately above the opinion, there should be an explanation of the issue including the reasons and the
amounts involved.

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Audit & Assurance Professional Stage December 2010


It was pleasing to note an improvement in candidates understanding of the terminology used in respect of
modified reports, but some candidates still struggle with distinguishing between modified reports and
modified opinions. In addition, a significant number of candidates continue to use the term qualified opinion
to cover all types of modified opinion, failing to appreciate that this term refers to a modified opinion in
respect of a matter which is material but not pervasive. In general, the answers to Snowdonia were better
than the answers to Pembroke.
Pembroke
The majority of candidates correctly identified the situation as a limitation on scope and many of those
appreciated that it would warrant a disclaimer of opinion. However, many students lost marks by hedging
their bets and cited that if the matter is considered material, but not pervasive, it would result in a qualified
opinion (except for). These candidates failed to appreciate that there was no choice regarding the type of
modification, because ISA 580 paragraph 20 requires the auditor to disclaim the opinion on the financial
statements if management refuses to provide written representations on the matters cited in the question.
Many candidates also failed to identify that these matters are required by the Companies Act 2006 to be
reported on by exception.
Snowdonia
Many candidates correctly identified that the situation represented a material misstatement due to
disagreement over accounting treatment and that it would warrant a qualified opinion (except for). Again,
candidates lost marks by hedging their bets and cited that if material and pervasive it would be an adverse
opinion, failing to appreciate that the matter was not pervasive as the issue was confined to specific items
and did not represent a substantial proportion of the financial statements. Some candidates considered the
materiality of the non-current asset in the context of profit before tax, failing to appreciate that it was the
depreciation of 40,000 that should have been benchmarked against profit before tax.
Maximum full marks
10
Marks available
16.5

The Institute of Chartered Accountants in England and Wales 2010.

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