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Examination Papers
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E XT
RN
AL PROG RA
Auditing
Economics, Management, Finance
and the Social Sciences
2790093
93 Auditing
advising the client of a possible need to increase the audit fee. If there are
insurmountable difficulties in obtaining sufficient audit evidence, the auditors may
need to consider qualifying the audit opinion.
In answer to part b), many attempts were too general. Marks were only awarded for
raising circumstances specific to Highlife Ltd. Better answers correctly identified that
the stock valuation may be a problem area, especially if gliders have been built
without orders. Foreign currency exposure, liquidity and going concern issues are also
relevant. It was disappointing that only a few answers noted the possible creation of a
duty of care if Highlife Ltd.s bank were to place reliance on the audited accounts.
The risk is increased by the tight reporting deadline.
Question 2
This was a straightforward question and again was generally answered well. Some
answers to part a) were far too long given that this part was worth only five marks.
A number of students lost marks because they described internal controls but did not
mention why they are significant for auditors. If auditors can rely on internal controls
they may be able to reduce the level of substantive testing.
In part b) a mark was awarded for identifying each weakness and a further mark for
discussing the risks. Those students who identified all the weaknesses and commented
on risks therefore obtained a higher mark than those who did not identify as many
problems or who did not consider risks. The errors in a number of answers showed
that the question had not been read with sufficient care; whereas in other cases,
imaginary details (which could not reasonably be inferred from the question) were
introduced. Marks were not awarded for including recommendations because these
were not required.
Segregation of duties is clearly one of the problems here. Other issues include: the
risk of error, fraud, fraudulent collusion, stock shortages, accepting defective stock,
unrecorded liabilities and overpayment for goods.
Question 3
There were only five marks for each part of this question. Some students wrote far
more than was required and others too little.
Part a) was generally answered well. The key points to be raised regarding the
different roles of external and internal auditors could include:
1. The role of external auditors is to arrive at an opinion as to whether or not the
financial statements disclose a true and fair view.
2. Externals have an independent role.
3. Internal auditors conduct an objective review but cannot be truly independent
because they are salaried employees.
4. Internal auditors identify weaknesses in controls and formulate action plans with
heads of department for improvement and to effect change.
In part b), the scope of many answers was too narrow. Some aspects of external and
internal work may be similar, including documenting and understanding systems, risk
assessment and compliance testing/substantive testing. However, external auditors set
materiality levels that impact on their audit approach and work performed. The audit
scope of internal auditors may be restricted or extended by management to Value For
Money auditing and special investigations. Internal auditors are interested in all risks
and not just those that have an impact on the effectiveness of the control environment.
Part c) is a straightforward question but answers were often far too brief or simply
incorrect. The external auditors report on the financial statements is addressed to
shareholders and not to the directors as some answers suggested. A management letter
is usually produced that reports weaknesses in systems to management.
Internal auditors normally report to the chief executive and the audit committee if
applicable. Most answers just mentioned reporting to management, which is not
specific enough. Some mentioned the finance director but this could compromise the
objectivity of the internal audit department. Internal auditors also prepare reports for
different departmental heads.
Marks were also awarded to students who discussed respective responsibilities for
reporting fraud.
In part d), good answers applied general points to the situation outlined in the case
study.
The extent of reliance by the externals on the internals will depend on:
Whether the work of assistants has been properly supervised, reviewed and
documented. This has been a problem in the past. Conclusions reached about
work performed and reports need to be appropriate in the circumstances. Any
exceptions or unusual matters disclosed by internal audit must be properly
resolved and may have an impact on the external audit work programme.
Competence and qualifications of staff morale has been low in the past, possibly
because of staff shortages and the resulting pressure. Such circumstances can have
an impact on the quality of work performed.
There is always a need to test the work of internal audit to confirm its adequacy.
Question 4
This question was answered fairly well. A main weakness in answers to part a) was a
tendency to write a short essay on general audit risk, whereas the majority of marks
were available for identifying risks specific to Racewell plc. This was a new audit
client, with a new management team, following a reorganisation. The bonus scheme
could be manipulated if it is profit-based. A new product has been introduced but
there is no warranty provision in spite of a three-year guarantee. Production has been
sub-contracted resulting in a possible loss of control over quality.
Students were also asked to suggest internal control procedures that might reduce
these risks. Again, many answers were too general and talked generically about types
of control such as authorisation, without explaining why this control would be helpful
in the context of the case study. Recommendations about internal control procedures
should have focused on monitoring the quality of sub-contracted stock, controlling
stock movements and on the implementation of monitoring controls over refunds
under warranty. Authorisation controls over sales and reasonableness checks
regarding management bonuses would also be helpful.
Part b) was answered well. Weaker answers focused only on stock count procedures
and lacked breadth. Better answers showed awareness of procedures to test
presentation, ownership, valuation and existence and included analytical procedures.
93 Auditing
Section B
Given the small number of students sitting this paper, it is difficult to produce
meaningful observations about the range and distribution of marks or general
comments on the essay answers presented. Instead, the key points that the examiners
expected to be covered are listed below.
Question 5
Few students attempted this question but those who did answered it well. Part a)
requires knowledge of the current responsibilities of auditors regarding the prevention
and detection of fraud. Students who were well prepared scored high marks for
repeating factual information and for stressing the point that auditors are responsible
only for detecting material fraud.
Most students described types of management fraud in part b) but some did not
explain which procedures could be performed to detect such irregularities, thereby
restricting the number of marks that could be obtained.
Students should have demonstrated awareness of the requirements of SAS 110 and
610. Examples of typical management frauds could include misstatement of profit
through manipulation of sales, debtors, creditors, stock, recognition of expenditure.
Question 6
Students should have demonstrated awareness of quantitative as well as qualitative
issues, e.g. the nature of item, whether factual, whether or not a matter of judgement,
under- or over-statement, importance of heading in financial statements, size,
incidence trends, suspicion of fraud, legality, cumulative impact and the impact on
financial statements.
The advantages of quantitative guidelines for materiality include:
The disadvantages:
materiality levels may differ between industries or even within the same
industry with companies of different size
Question 7
Analytics may be used at three main stages of the audit: planning, evidence gathering
(substantive testing) and the final review of financial statements.
Use of analytics depends on auditors judgement about their expected effectiveness
and efficiency. Auditors usually enquire of management as to the availability and
reliability of information and the results of any such procedures performed by the
entity.
Auditors consider:
the knowledge gained during previous audits, the effectiveness of the accounting
and internal control systems and the types of problems encountered in the past.
Greater reliability of results is obtained by using data from sources independent of,
rather than internal to, the entity. Internal data are more reliable if produced
independently of the accounting system or if subject to controls to verify reliability.
Limitations: There are three main factors which will determine the value of the
results of the analytics: first and foremost, the reliability of the information being
subjected to the analytics and the quality of the system which produced it. Second, the
quality of the analytics themselves, which in turn will be determined by the degree of
knowledge of the business, imagination and skill of the person conducting the
analytics. Third, the thoroughness of the investigation of any differences revealed by
the analytics.
Question 8
Regulation can play a number of roles:
quality control
education
disciplinary benchmarks
legal benchmarks
93 Auditing
Final comments
The examiners were pleased with the general standard of examination scripts. There
were some outstanding papers and students were well prepared for the examination.
Encouragingly, only a small number of students answered questions this year by
reproducing memorised essays, bearing little relation to the question requirements.
The demonstration of knowledge, the ability to apply ideas and analytical skills are of
much more importance in an examination at this level. It is these qualities that enable
students to produce an above average script. A short, well-planned and well-structured
essay will obtain better marks than a long, rambling essay that does not focus on the
question and includes irrelevant details. Also, when preparing an essay or answer
plan, students should make sure that they have addressed all parts of the question;
failure to do so will inevitably limit the number of marks that can be obtained.
The importance of time allocation cannot be over-emphasised. If students do,
however, run out of time, then marks can still be obtained for noting down key points
in bullet format. The reduction in the number of questions required to be answered
from 2004 onwards may make it easier for students to keep to the appropriate time
allocation.
Examination paper in 2004
In the 2004 examination paper, the number of questions students will be required to
answer will be reduced from five 20-mark questions to four 25-mark questions. The
structure of the paper, however, will remain the same, with four case study questions
in section A and four essays in section B. The reduction in the number of questions to
be answered is intended to reduce time pressure on students. It will also afford wellprepared students the opportunity to demonstrate depth of understanding and
knowledge. Studying previous case study questions on past examination papers will
continue to be the best way to prepare for next years paper.
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