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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
4
8
Page 1 of 14
SFQ 2
SFQ 3
Page 2 of 14
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
4
11
SFQ 5
2
5
Page 3 of 14
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
4
10
Page 4 of 14
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
8
12
Page 5 of 14
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
Page 6 of 14
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
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Page 9 of 14
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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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
3
6
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Page 12 of 14
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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