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Audit & Assurance - Professional Stage December 2011

MARK PLAN AND EXAMINERS COMMENTARY


The marking plan set out below was that used to mark this question. Markers were encouraged to use
discretion and to award partial marks where a point was either not explained fully or made by implication.
More marks were available than could be awarded for each requirement. This allowed credit to be given for a
variety of valid points which were made by candidates.
General comments
It was pleasing to note a significant improvement in the standard of answers to the written test questions and,
in particular, answers to the question on audit reports. However, the improvement in the standard of answers
to the short form questions (SFQ), noted in recent sessions, was not sustained. This was mainly due to poor
performances on SFQs 1, 2 and 3. In addition, some candidates are still failing to take advantage of the
facility to present the short-form answers in note form. There is an increasing trend in candidates who hedge
their answers, to questions requiring a conclusion, by providing a number of different scenarios to their
answer in the expectation that one of these will be the correct one. This was particularly evident on SFQ 2
and questions 7b and 9a in this examination. Candidates are advised that the examiners take account of the
way in which answers are presented and where hedging is evident candidates will lose marks.

SFQ 1

Management threat
Arises if a member of the firm is expected to make decisions
E.g. selection of accounting policies or making accounting estimates
Firm may become too closely aligned with the views and interests of management
Auditors objectivity and independence may be impaired or perceived to be impaired
Mitigate threats
Not prohibited in UK as company not listed.
Member of the firm must have no involvement in the audit of the financial statements.
No initiating of transactions.
No taking decisions or making judgements.
Accounting services are of a technical, mechanical, informative nature.
i.e. where management takes all decisions requiring the exercise of judgement and has prepared the
underlying accounting records.
Accounting services are reviewed by a partner or other senior staff member with appropriate expertise
Independent review of audit work
Ensure the existence of informed management.
i.e. designated members of management have the capability to make judgements and decisions on the basis
of the information provided.
Refer to ethics partner.
Responsibilities set out in separate engagement letter.
Answers to this question were mixed. Stronger candidates focused on the management threat, as set out in
the requirement, and were able to explain that, whilst assistance with preparing the financial statements was
not prohibited for a non-listed client, the firm may be expected to make judgements that are properly the
responsibility of management. Such candidates were then able to state a number of appropriate safeguards
to mitigate the threat. Weaker candidates failed to answer the question, which was restricted to the
management threat, and instead offered detailed explanations of other threats to independence and
objectivity such as familiarity and self-interest. These points scored no marks.
Maximum marks ( mark per point)
Total available

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Audit & Assurance - Professional Stage December 2011

SFQ 2

Business relationships are permitted under ES 2 as long as the arrangement is:


- in the ordinary course of business
- on an arms length basis
- not material to either party
Leasing properties is in the ordinary course of business for both parties
Market rate implies arms length basis
As both parties are large,
Transaction is unlikely to be material to either
Robinia has numerous properties and firm has 25 other offices
Appropriate to accept
Answers to this question were poor. Many candidates failed to appreciate that the business relationship was
appropriate given that the leasing of property was in the ordinary course of business for both parties. Some
candidates identified that the transaction was to be carried out at market rate, and hence appeared to be on
an arms length basis but few candidates identified that it was unlikely to be material to either party. Many
candidates believed that the threats to independence and objectivity were insurmountable and wasted time
detailing those threats for which there were no marks. A number of candidates hedged their answers by
providing reasons unrelated to the circumstances set out in the question as to why it was both acceptable and
unacceptable to lease the property.
Maximum marks ( mark per point)
3
Total available
5

SFQ 3

Senior person/partner within the firm or a suitably qualified external person


Experience of the pharmaceutical industry
Experience of listed companies
Independent of the engagement team
Not connected to Pharma
Answers to this question were mixed. A high proportion of candidates understood that the requirement asked
for attributes required of an individual appointed to undertake the engagement quality control review. Of
these candidates, those that provided specific points such as needing experience in the pharmaceutical
industry tended to score very well, often attaining full marks. However, others failed to be as specific, simply
stating that experience was necessary and did not score as highly. A minority of candidates failed to read the
question properly and provided a list of the activities that would be undertaken as part of an engagement
quality control review and consequently scored no marks.
Maximum marks (1 mark per point)
3
Total available
5

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Audit & Assurance - Professional Stage December 2011

SFQ 4

Obtain the clients permission to contact the previous auditor for professional clearance.
- if the client refuses, it may be an indication that management has something to hide.
- the outgoing auditor may provide information in respect of unpaid fees, unlawful acts or disagreements.
Obtain references from reliable third parties such as professional advisors or credit agencies
- to identify deficiencies in the character or behaviour of the directors
Undertake searches of relevant databases including those at Companies House
- to ascertain whether the directors are listed as undesirable characters or disqualified directors
Undertake internet/press cuttings searches
- for evidence of scandals, adverse publicity, failed companies involving the directors which may provide
evidence about unscrupulous behaviour
Hold discussions with the directors
- which may provide evidence of a cavalier attitude towards business ethics or lack of social responsibility for
example willingness to pay taxes
Undertake client identification procedures
- to establish that the directors are who they say they are
Inspect prior year audit reports
- for evidence of disagreements or inappropriate accounting policies
Answers to this question were generally good. Candidates tended to be stronger at outlining the procedures
that would be undertaken to assess the integrity of management, such as obtaining professional clearance
from the previous auditor, but weaker at explaining how those procedures assisted in assessing
managements integrity. Some candidates simply explained each procedure by restating that it would help
assess management integrity no marks were awarded for such explanations.
Maximum marks ( mark per procedure, 1 mark per explanation)
Total available

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SFQ 5

Fees should be determined with reference to:


- seniority and professional experience of the members of the team;
- number of staff required/time expended by each;
- greater amount of time required in first year;
- risk which the work entails;
- inherent risk likely to be high in oil and gas sector
- nature of the clients business and complexity of its operations
- priority and importance of the work to the client
- expenses properly incurred such as overseas travel
- extent to which firm can rely on work of component auditors
- extent to which reliance can be placed on internal audit
- whether an auditors expert is required
This question was generally well answered with many candidates scoring full marks. The most commonly
overlooked factors were those relating to the first-year audit, the higher inherent risk in the oil and gas
industry and the extent to which the firm might rely on the clients internal audit function.
Maximum marks ( mark per point)
Total available

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Audit & Assurance - Professional Stage December 2011

SFQ 6

Consequences
May not obtain the best price and/or value for money
Nature and quality of items acquired may not be fit for purpose
Use of friends/relatives/suppliers who give gifts/kickbacks or provide hospitality
May result in budgets being breached
Adverse impact on profits and cash flow
Recommendations
Communicate company policy to relevant employees
Employees to confirm in writing that they understand company policy
Employees in breach of company policy to be informed in writing
Authorisation controls when placing orders to include ensuring three quotes obtained
Monitor procedures to ensure compliance
This question was generally well answered with a high proportion of candidates scoring full marks. Most
candidates appropriately identified that the failure to adhere to the company policy of obtaining three quotes
before purchasing property, plant and equipment may lead to the company not achieving the best value for
money. However, few candidates identified that it may result in budgets being breached. Most candidates
were then able to cite appropriate recommendations such as communication of the policy to employees and
disciplinary action for non-compliance. Monitoring of compliance with the company policy was the most
commonly overlooked recommendation.
Maximum marks (1 mark per point)
Total available

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Audit & Assurance - Professional Stage December 2011

Question 7

Total Marks: 40
General comments
Answers to this question attained the second highest average on the written test questions. Answers to parts
(b) and (c) were generally stronger than answers to parts (a) and (d).
Part (a)
Explain the self-interest and self-review threats arising from the provision of due diligence services to
Fitco and outline how your firm should respond to those threats.
Self-interest threat
Arises when the audit firm has interests, which might cause it to be reluctant to take actions that would be
adverse to the interests of the firm. As the due diligence services involve regular work, fear of losing the
lucrative fees may impair the firms objectivity resulting in the firm issuing an inappropriate audit opinion.
Safeguards
The firm should monitor the fees from all regular services provided to Fitco to ensure they do not exceed 15%
of the gross fee income of the firm. If the fees from Fitco are between 10% and 15% of gross fee income,
additional safeguards should be implemented. These safeguards should include disclosure of the situation to
those charged with governance and an external independent quality control review of the audit. If the
company becomes listed in two years time, the above fee thresholds will reduce to 10% for the maximum fee
and between 5% and 10% for the additional safeguards.
Self-review threat
Arises when the product of a non-audit service performed by the auditor will be included in the financial
statements or when a previous judgement has to be re-evaluated. This could arise in relation to target
companies that are subsequently acquired and their financial statements are consolidated with Fitcos. In
addition, the firm may have to review the financial statements of target companies previously audited by the
firm if the target company is an existing client. The engagement team may rely too heavily on the work
undertaken by their firm or may be reluctant to notify the client of errors in relation to the due diligence work or
the previous audits.
Safeguards
There should be separate personnel involved in the audit and due diligence work and an independent quality
control review should be undertaken on the audit work. The firm may consider rejecting the due diligence
work if the target company is a client.
The ethics partner should be consulted in respect of both threats.
Generally answers to the self-interest threat arising from the provision of due diligence services were better
than the answers to the self-review threat. In respect of the self-interest threat, many candidates often
overlooked the need to monitor fees as a safeguard. Where this was correctly identified some candidates
gave the incorrect fee thresholds for listed and unlisted companies. Many candidates were able to provide
general explanations of the self-review threat. However, only a minority was able to appreciate that the threat
arises if the firm reviews the financial statements of target companies that have already been audited by the
firm. Even fewer appreciated that if target companies are acquired following due diligence reviews, their
financial statements would be included in Fitcos consolidated financial statements that are audited by the
firm. A number of candidates digressed and provided explanations of management and familiarity threats
which were not a requirement of the question.
Maximum marks
Total available

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Audit & Assurance - Professional Stage December 2011


Part (b)
State, with reasons, how your firm should respond to the directors request for a partner in your firm
to join the board of Fitco as a non-executive director.
Response
The firm must refuse the request for the partner to join the board as a non-executive director as well as
continuing as a partner in the firm.
Reasons
Dual employment is prohibited by Ethical Standard 2 (and also by the Companies Act 2006).
As a board member, the partner will be involved in approving strategy and consequently, the management
threat is insurmountable. Furthermore, there is the threat that the audit firm would become closely aligned
with the views and interests of management and the auditors objectivity and independence may be, or
perceived to be, impaired.
Answers to this part of the question were good. Those candidates that knew that Ethical Standard 2 and the
Companies Act 2006 prohibited dual employment usually went onto score full marks by successfully
explaining the reasons why the request for a partner to join the board of directors should be refused. A
number of candidates hedged their answers and suggested that the partner could join the board of directors if
appropriate safeguards were in place but should resign if the management threat became too great. These
answers did not score any marks. Disappointingly, some candidates thought it was acceptable for the partner
to join the board whilst continuing as a partner of the firm.
Maximum marks
Total available

3
5

Part (c)
Justify why the items 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.
Opening balances
Justification
Opening balances are based upon the
closing balances of the prior period and
reflect the effect of transactions and
events of prior periods and accounting
policies applied in the prior period.
The firm has recently been appointed
and is not familiar with the events or
transactions of prior periods and
consequently may not identify
misstatements in opening balances.

Opening balances
Procedures
Compare the opening balances to the audited prior
year closing balances
Determine whether the opening balances reflect the
application of appropriate accounting policies
Review the predecessor auditors working papers to
obtain evidence regarding opening balances
Evaluate whether audit procedures performed in the
current period provide evidence relevant to the
opening balances

Inventory
Justification
Inventory has increased by 16% while
purchases and revenue have increased
by 9.8% and 8.2% respectively. The
inventory movement is out of line with
the movements in purchases and
revenue, which may indicate an
overstatement of inventory.
The inventory figure is extracted from
records, which may not reflect the
physical quantities if there is inadequate
control over the periodic counts or if the
records are not adjusted for differences
between book and physical inventory.
The costing system may not reflect
appropriate direct costs coupled with the
fact that the allocation of production
overheads involves the exercise of
judgement.

Inventory
Procedures
Review and evaluate the results of the periodic
inventory counts throughout the year
Obtain and evaluate the inventory count instructions
Attend one of the inventory counts and observe and
assess procedures: perform two-way test counts;
and note slow-moving/damaged items
Perform cut-off tests by vouching entries in the
component inventory records to goods received
records and vouching entries in the finished goods
inventory records to despatch records
Components:
Vouch cost of components to purchase invoices
If applicable, reperform translations, checking rates
to a reliable external source
Finished goods
Inspect specification costings and vouch to invoice
and payroll details

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Audit & Assurance - Professional Stage December 2011

The use of overseas suppliers may give


rise to translation errors in respect of
components if the overseas suppliers
are paid in their local currency.
The returned faulty blood pressure
monitors may be inappropriately
included in inventory and, if included,
inappropriately valued.

Discuss with management the basis of allocation of


production overheads and ensure it is based on the
normal level of activity
Reperform calculations
Review post year-end inventory listing for items
which have a selling price below cost and ensure
those items are included at net realisable value
Review post year-end aged inventory report for
slow-moving items and discuss provision with
management
Discuss with management their intentions regarding
the returned faulty monitors. Where returned
monitors are to be repaired and returned to
customers, ensure they are excluded from
inventory. Where customers are refunded or
returned monitors replaced with new monitors,
ascertain whether faulty monitors are included in
inventory and the basis of managements valuation.

Trade payables
Justification
The trade payables payment period has
fallen from 40.9 to 37.9 days, which may
indicate understatement. This is out of
line with expectation as one would
expect the balance to be higher as the
company is using a more expensive
supplier.
The use of overseas suppliers may give
rise to translation errors if the overseas
suppliers are paid in their local currency.

Trade payables
Procedures
Evaluate and test controls over the recording of
suppliers invoices and payments to suppliers
Reconcile payables balances in the purchase
ledger with suppliers statements or consider direct
confirmation where supplier statements are not
available.
Perform cut off tests by tracing goods received
records to invoice entries in the purchase day book
and nominal ledger and vouch invoices recorded in
the subsequent period back to goods received
records.
Inspect after-date payments/invoices for items
relating to the current year
Inspect the new supplier's contract for credit terms
as tighter credit terms may explain the fall in
payables days

Provision for warranties


Justification
The provision is estimated by the finance
director and by nature is at greater risk
of misstatement.
The provision represents 1% of revenue.
This is the same percentage as the
previous year and is out of line with
expectation as one would expect it to be
higher due to the product recall.

Provision for warranties


Procedures
Obtain the finance directors workings and discuss
the basis of the provision and reperform any
calculations
Ensure the provision includes anticipated costs
relating to the 40% of monitors not yet returned
Inspect customer correspondence to identify
complaints relating to any of the companys
products
Inspect board minutes for an indication of problems
with any of the companys products
Inspect returns records to ascertain the level of
returns after the year end
Inspect records of repair costs post year end to
assess amounts involved
Ascertain whether Fitco has insurance and assess
impact on provision
Obtain a written representation from management
stating that the assumptions used in the calculation
are reasonable

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Audit & Assurance - Professional Stage December 2011


This part of the question was generally well answered in respect of opening balances and trade payables, but
the answers relating to inventory were mixed and the provision for warranties was generally not well
answered. Many candidates were able to correctly interpret the extracts from the financial statements
provided and use this information to help justify why inventory, trade payables and provision for warranties
were identified as areas of audit risk. Disappointingly, a number of candidates did not make use of the
extracts from the financial statements, whilst others drew incorrect conclusions from their analytical
procedures. Previous examiners commentaries have noted that procedures used to address the audit risks
were often vague and markers found this was common in this examination. For example, in respect of
inventory, audit procedures such as verify the completeness of inventory or test whether inventory is stated
at the lower of cost and net realisable value were too vague to be awarded any marks.
Opening balances
Those candidates familiar with the audit procedures set out in ISA 510, Initial audit engagements opening
balances, provided strong answers. A number of candidates incorrectly cited in detail the procedures for
obtaining professional clearance from the previous auditor as an audit procedure to address the risk. The
audit procedures most commonly overlooked were those relating to determining whether the opening
balances reflected the application of appropriate accounting policies and the evaluation of current period audit
procedures.
Inventory
Most candidates were able to provide a number of reasons to justify why inventory was an area of audit risk
and provide some relevant audit procedures. Very few candidates described relevant audit procedures in
respect of the valuation of finished goods. Many failed to consider testing the reliability of the system and
failed to use information provided in the scenario such as the inventory listing and aged inventory report to
generate audit procedures.
Trade payables
Those candidates that correctly identified that the trade payables payment period had fallen by 3 days and
that this may indicate understatement of trade payables went on to score well. A number of candidates did
not calculate payable days or consider the accounts payable balance alongside the increase in purchases.
They cited that trade payables had increased by 2% but incorrectly believed that this was indicative of an
overstatement of trade payables or an inability of the business to settle its liabilities as they fell due resulting
in an uncertainty over going concern. Points most commonly overlooked were the evaluation and testing of
controls over the recording of invoices and payments to suppliers and the inspection of the new suppliers
contract to identify if there had been any change in terms that may explain the fall in payable days.
Provision for warranties
This part of the question was poorly answered with many brief answers. Many candidates correctly calculated
that the provision had increased by 8.2% but failed to appreciate that revenue had increased by a similar
amount. Consequently these candidates believed, incorrectly, that the provision for warranties was overstated
and provided inappropriate audit procedures. Many candidates failed to appreciate that the design fault
relating to the blood pressure monitors was likely to result in a need to increase the provision. Audit
procedures commonly overlooked were those relating to post year-end correspondence and returns and the
inspection of board minutes for an indication of problems with other products. Weaker candidates strayed
beyond the requirement and attempted to deal with the former suppliers claim for damages, failing to
appreciate that this was nothing to do with the warranty provision.
Maximum marks
Total available

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Part (d)
Explain why the legal claim by Comp should be considered by your firm in respect of the audit of the
financial statements for the year ended 30 November 2011 and describe the audit procedures to be
undertaken in respect of this matter.
Reasons
The claim arises from an obligating event prior to the year end and, depending on its materiality and
expected outcome, it may impact on the financial statements and/or the audit report. If it is probable that the
claim is successful, then a provision will be required and if it is possible then it needs to be disclosed by way
of note as a contingent liability. If the claim is successful and damages are awarded against Fitco, it may
affect its going concern status.
Procedures
Consult, with the clients permission, Fitcos lawyers about the expected outcome of the claim.
Inspect the contract with Comp to ascertain whether there are penalties for early termination of the contract.
Inspect board minutes for evidence of developments such as an out of court settlement.
Discuss with management their intentions regarding accounting treatment.
Obtain a written representation regarding managements intention to fight the claim or settle out of court.
Consider events after the year end that indicate the likely outcome of the claim such as negotiations
regarding an out of court settlement.
Examine cash flow forecasts to ensure Fitco can continue to pay its debts as they fall due if damages are
awarded against them
Answers to this part of the question were mixed. The majority of candidates identified that the claim gave rise
to an uncertainty and, if material, this had implications for the financial statements and possibly the audit
report. Many also identified that, if the claim was successful, there may be going concern implications. Most
candidates described one or two audit procedures to be undertaken. However a number of candidates lost
marks by giving very short descriptions of standard audit procedures such as inspect minutes, discuss with
management or inspect cash flow forecasts without providing any further detail of the procedure to be
undertaken.
Maximum marks
7
Total available
12

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Audit & Assurance - Professional Stage December 2011

Question 8

Total Marks: 20
General comments
Answers to this question attained the lowest average on the written test questions. Answers to part (c) were
stronger than answers to parts (a) and (b).
Part (a)
From the information provided in the scenario, identify the key receipts and payments that you would
expect to be included in the cash flow forecasts prepared by the directors of Gourmet. For each
receipt and payment, identify the specific matters you would consider when reviewing the
reasonableness of the assumptions in forecasting that receipt or payment.
Receipts
Sales receipts
These should include sales from the new outlets and delivery service which should be staged to reflect the
roll out. The inflow should reflect prior years patterns and, in respect of the new outlets, commence after the
completion of the refurbishment. Consideration should be given as to whether amounts are prudent in light of
the economic conditions and whether the introduction of the delivery service may impact on take away sales.
Loan from bank
The amount should be consistent with any negotiations, as evidenced by bank correspondence, be sufficient
to cover the expansion costs and the inflow should be included prior to commencement of the new business.
Payments
Expenditure on refurbishment and vehicles including logo painting
These should be based on suppliers price lists or quotes and the outflow should be reflected prior to the
commencement of the new business.
Payments to suppliers for ingredients and packaging
These should reflect the level of forecast sales and payments for items other than fruit and vegetables should
reflect the suppliers terms of trading.
Vehicle running costs
These should be based on the proposed number of vehicles and the anticipated usage following the
introduction of the delivery service.
Premises running costs
These should include the extra costs (e.g. rent and utility costs relating to the two new outlets). The rent
should reflect the terms of any lease agreements such as up-front premiums and rental periods (e.g.
quarterly) and rent reviews.
Wages and salaries
These should reflect the increased number of staff for the new outlets, the drivers for the delivery service and
rates above the industry sector. Any bonus should be based on the forecast profit.
Sundry payments
These should include advertising, training and recruitment costs relating to the new business and the outflow
should be reflected prior to the commencement of the new business. Professional fees should include
payments to the legal advisers and the reporting accountant.
Loan repayments and finance costs
Loan instalments should reflect the repayment terms being negotiated with the bank and finance costs should
reflect market rates and the level of borrowings. All outflows in respect of these items should be reflected on
the anticipated due dates.
Tax payments
PAYE, VAT and corporation tax should be consistent with the relevant figures in the profit forecast and paid
on due dates.
Dividend payments
These should be in line with prior years policies or take into account any anticipated changes in policy which
should be confirmed by the directors.
General
Sensitivity analysis should be undertaken on key variables e.g. customer receipts, finance costs and
ingredients.

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Audit & Assurance - Professional Stage December 2011


Answers to this part of the question were mixed. Weaker candidates incorrectly discussed non-cash related
items such as accounting for depreciation, the distinction between capital and revenue items and cut-off
issues. Another common error was to overlook the fact that the work involved examining a forecast and
consequently cite verification procedures that would be undertaken on historical cost financial information
such as checking amounts to invoices and bank statements. Some candidates, whilst identifying relevant
receipts and payments, were unable to identify matters to be considered when reviewing the reasonableness
of the assumptions underlying those receipts and payments and simply made comments such as check if
reasonable. or check if they accounted for it correctly. These points are too vague to be awarded any
marks.
Maximum marks
Total available

10
23

Part (b)
Explain the role of written representations in the examination of and reporting on forecast
information.
Role of written representations
When conducting an engagement to examine forecast information, written representations are obtained from
management regarding:
- the intended use of the forecast information;
- the completeness of significant management assumptions; and
- managements responsibility for the forecast information.
The representations provide evidence that management accepts its responsibility regarding the assumptions
and will reduce the risk of any misunderstanding regarding respective responsibilities (i.e. narrow the
expectation gap). The representation regarding the intended use of the forecasts may protect the reporting
accountant from claims for damages from unforeseen third parties.
Answers to this part of the question were disappointing as many candidates were unaware of the requirement
of ISAE 3400 The Examination of Prospective Financial Information to obtain such representations. Many
candidates wasted time and wrote about the role of written representations in an audit of financial statements
instead of their role in examining and reporting on forecast information. Although many identified
managements responsibility for the forecast information, surprisingly few mentioned reduction of the risk of
misunderstanding regarding respective responsibilities. A small number of candidates mistakenly thought that
written representations were produced by the reporting accountant and tended to confuse them with the
contents of a letter of engagement.
Maximum marks
Total available

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Part (c)
Describe the differences between the conclusion expressed in an assurance report on forecast
information and the opinion expressed in an audit report on financial statements. Give reasons for
these differences.
Forecast information
The conclusion of the assurance report on the forecast information will include a statement of negative
assurance (i.e. limited/moderate assurance) in the form of nothing has come to our attention which causes
us to believe that the assumptions do not provide a reasonable basis for the forecast. It will also include an
opinion on whether the forecast information is properly prepared on the basis of the assumptions and is
presented in accordance with the relevant financial reporting framework.
Audit of financial statements
The opinion in the audit report on financial statements will provide reasonable assurance that the financial
statements:
- give a true and fair view;
- have been properly prepared in accordance with relevant generally accepted accounting practice; and
- have been prepared in accordance with the requirements of the Companies Act 2006.
Reasons
Financial statements are mainly based on historical information whereas forecast information is based on
assumptions about future events. The historical information can be verified to a greater degree whereas the
forecasts are subject to uncertainty.
This part of the question was generally well answered as the majority of candidates cited the basic points
regarding the different levels of assurance provided by the conclusions within each report and gave an
example of each. However, only a minority of candidates could provide plausible reasons why the
conclusions were different. Many failed to indicate that audits of financial statements are based on historical
information while forecasts are based on assumptions about future events and that consequently the figures
in forecast information could not be corroborated to the same extent as with historical information. Weaker
candidates strayed beyond the requirement and wasted time writing about the differences between the
reports as a whole, instead of focusing on the conclusions in each of the reports.
Maximum marks
7
Total available
10

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Audit & Assurance - Professional Stage December 2011

Question 9
Total Marks: 20
General comments
Answers to this question attained the highest overall average mark on the written test questions. This was
generally due to very strong answers on part (a) as answers to part (b) were generally disappointing,
particularly in respect of the quality control procedures.
Part (a)
For each of the three situations outlined, state whether you would modify the audit opinion. Give
reasons for your conclusion and describe the modification(s), if any, to each audit report.
Southerndown
An unmodified opinion should be issued as the circumstances do not arise from an inability to obtain sufficient
appropriate audit evidence (a limitation on scope) or a material misstatement (disagreement). There is a
significant uncertainty regarding the going concern status of the company that is fundamental to users
understanding of the financial statements. As the situation is appropriately disclosed in the financial
statements, an emphasis of matter paragraph should be added to the audit report, following the opinion
section. The paragraph should explain the issue giving rise to the uncertainty, draw the users attention to the
note and include a specific statement our opinion is not qualified in respect of this matter.
Belfry
A modified opinion should be issued and the modification should be a qualified (except for) opinion. As the
auditor is unable to obtain sufficient appropriate evidence, there is a limitation on the scope of the auditors
work. The amount is material as it represents 6.6% of total assets and 19.6% of profit before tax. It 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. The company is not reliant on the cash to continue operations as it has
positive cash flow. There should be an explanation of the issue (reason and the amount involved)
immediately above the opinion. The auditor should report by exception, after the opinion, that all information
necessary for the audit has not been received.
Turnberry
A modified opinion should be issued and the modification should be a qualified (except for) opinion. As the
managing director refuses to disclose the transaction there is a material misstatement (disagreement). The
amount of the transaction is not material by size as it is only 0.25% of total assets and 1.5% of profit before
tax. However, it is material by nature as it is a related party transaction due to the managing directors
controlling interest in Valderama. It is not pervasive as it is confined to a specific item in the financial
statements. There should be an explanation of the issue (reason and amount involved) immediately above
the opinion.
Many candidates scored high marks on this part of the question by identifying the issues (i.e. significant
uncertainty, limitation on scope and material misstatement), calculating and commenting on materiality and
reaching a conclusion on whether or not the opinion should be modified. However, a significant number of
candidates lost marks by failing to reach a conclusion as to whether the opinion should be modified. The
common shortcomings are detailed below.
Southerndown
Many candidates ignored the information in the scenario indicating that the issue had been fully disclosed, to
the engagement partners satisfaction, in a note to the financial statements and wasted time discussing the
options if the issue had not been disclosed. There were no marks for discussing such options.
Belfry
A significant number of candidates failed to appreciate that the issue was not pervasive and stated,
incorrectly, that the report should be modified with an adverse opinion. Of those who identified that the matter
was not pervasive, many identified that the amount involved was confined to a specific item and did not
represent a substantial portion of the financial statements. However, few appreciated the fact that the
company was not reliant on the cash to continue in operation and therefore this was not a going concern
issue.
Turnberry
A number of candidates hedged their bets and discussed the possibility of the issue being pervasive, thereby
demonstrating a lack of understanding of what constitutes a pervasive issue.
Maximum marks
14
Total available
23

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Audit & Assurance - Professional Stage December 2011


Part (b)
Describe the possible consequences for your firm if an inappropriate audit opinion on financial
statements is issued and outline the quality control procedures your firm should implement to reduce
the risk of issuing an inappropriate audit opinion.
Consequences
The firm may be subject to professional negligence claims from the audited entity and its shareholders and/or
third parties where it can be demonstrated that the auditor owed the party a duty of care. Although damages
awarded against the firm may be covered by professional indemnity insurance, the cost of future insurance
will increase.
The firm may be investigated by the regulatory bodies, which may result in penalties such as fines or
withdrawal of registered auditor status.
The adverse publicity associated with legal claims and disciplinary procedures may result in the loss of clients
and in extreme cases financial collapse of the firm.
Quality control procedures
The firm should allocate competent and experienced staff to each engagement team. Junior members of the
team should be supervised and all team members work should be subject to a review by a more senior
member of the team.
Consultation should take place on contentious issues and all such matters, including their resolution, should
be documented.
An engagement quality control review should be performed on audits of all listed companies and other audits
where audit risk is considered higher than normal.
The firm should undertake monitoring procedures to ensure that its policies and procedures relating to the
system of quality control are relevant, adequate and operating effectively.
The firm should undertake due diligence procedures prior to accepting new clients and deciding whether to
continue with existing clients.
The majority of candidates correctly identified a number of potential consequences for the audit firm,
However, a significant number of candidates lacked an understanding of the quality control procedures
required to reduce the risk of issuing an inappropriate audit opinion. Weaker candidates cited the objectives
of quality control instead of the procedures to be exercised by the firm. A significant number of candidates
stated, incorrectly, that agreeing liability caps and including a Bannerman paragraph in the audit report would
reduce the risk of issuing an inappropriate audit opinion. These candidates failed to appreciate that such
actions would only reduce the auditors exposure to damages in the event of an inappropriate opinion being
issued and would not reduce the risk of issuing an inappropriate opinion. Some answers to this part of the
question were short or not attempted indicating that those candidates had not managed their time across the
paper.
Maximum marks
6
Total available
12

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