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CONFIDENTIAL AC/JULY 2011/AUD610/560

SUGGESTED SOLUTION
AUDITING AND ASSURANCE SERVICES (AUD 610)
JULY 2011

Answer 1

A. a) Advertising is the communication to the public of facts about a professional


accountant with a view of procuring professional business. Publicity is the
communication to the public of facts about a professional accountant which is not
designed for the deliberate promotion of the professional accountant. Solicitation is the
approach by any means, to a potential client for the purpose of offering professional
services.
(3 x 1 mark = 3 marks)

b) Professional fees should be a fair reflection of the work performed and determination
of the fee should take into consideration the following factors:
i) The skill and knowledge required for the type of work
ii) The level of training and experience of the persons required for the work
iii) The time required by each person engaged on the work
iv) The degree of responsibility and urgency that the work entails
(4 x 1 mark = 4 marks)

c) Three (3) examples of acts that are considered discreditable to the profession under
the MIA By-Laws are:
i) Retention of client records
ii) Making false entries in financial statements
iii) Advise client of any tax evasion scheme
iv) Any relevant answers
(3 x 1 mark = 3 marks)

B. An accounting firm may provide such service but should avoid making the
management decisions as to whom to hire. The firm can assist in reviewing the
professional qualification of the applicants and provide advice on their suitability for
the position. The firm may also provide a short-list of candidates for the interview
provided that the list is drawn up based on criteria specified by the client.
(3 marks)

C. a) If the engagement involves the design and implementation of IT systems that will
generate information for the preparation of the client’s financial statements, a self-
review threat to independence will arise.
(3 marks)

b) The firm should not accept such an assignment unless the following safeguards
are available:
i) The client is fully responsible for establishing and monitoring the system of
internal controls
ii) The client makes all management decisions regarding the design and
implementation of the IT processes
iii) The client has a designated competent employee responsible for all management
decisions relating to the design and implementation of the system
iv) The client is responsible for the operation of the system and the data generated
by the system.
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CONFIDENTIAL AC/JULY 2011/AUD610/560

(4 x 1 mark = 4 marks)
Total : 20 marks

Answer 2

A. To establish that the auditor’s negligence has caused the loss of the company, the
liquidators of Jati Berhad can claim that if the auditor had performed their work with due
care, the company would have caused a receiver to be appointed earlier, instead of
carrying on the business until 2009. It can claim that the overstatement in investments
and receivables had presented a very misleading picture of the true financial position of
the company. If the company had appointed a receiver when the non-existence of the
assets was discovered, the company would have avoided the subsequent trading losses
and the increase in the deficiency in the shareholders’ funds.
(6 marks)

B.
a) The elements required for establishing an auditor’s liability for negligence to clients are:
i) The duty to conform to a required standard duty of care
ii) Failure to act in accordance with that duty
iii) A causal connection between the negligent action and the client’s damage, and
iv) Actual loss or damage to the client
(4 marks)

b) The Caparo case seems to be a reversal of the principle found in cases such as Hedley
Byrne, Haig v. Bamford, and JEB Fasteners. In the case, it was stated that the purpose
of statutory accounts was for the company and the shareholders and not to assist
investors making investment decisions. Accordingly, the auditors do not owe a duty of
care to investors making investment decisions on the strength of auditor accounts. It was
held in the case that it was unreasonable to establish a relationship of proximity between
the auditors and the third party who was not intended recipient of the auditor’s report.

(4 marks)

c) The following steps can be taken to minimize legal liability against auditors:

At the professional level


i) Establishing stronger auditing and assurance standards
ii) Continually updating the code of professional conduct and ethics and sanctioning
members who do not comply with it
iii) Educating users

At the firm level


i) Instituting sound quality control and review procedures
ii) Ensuring that members of the firm are independent
iii) Following sound client acceptance and retention procedures
iv) Being alert for risk factors that may result in lawsuits
v) Performing and documenting work diligently
vi) Pushing for tort reform
(6 × 1 mark = 6 marks)
Total : 20 marks

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CONFIDENTIAL AC/JULY 2011/AUD610/560

Answer 3

A. a) The responsibilities of auditors regarding the going concern of an entity are:


i) To consider the appropriateness of the management’s use of the going concern
assumption in the preparation of the financial statements
ii) To consider whether there are any material uncertainties about the entity’s ability
to continue as a going concern that should be disclosed in the financial
statements
iii) To remain alert throughout the audit for indications and business risks that may
give rise to going concern uncertainties
(3 x 2 marks = 6 marks)

b) The following explain the steps an auditor should follow in assessing going concern:
i) Evaluate whether the results of audit procedures performed during the course of
the audit provide any indication of events or conditions which may cast
substantial doubt about the entity’s ability to continue as a going concern for a
reasonable period of time
ii) If there is substantial doubt, the auditor should obtain information about the
management‘s plans to mitigate the going concern problem and assess the
likelihood that such plans can be implemented
iii) If the auditor concludes after evaluating management’s plan, that there is
substantial doubt about the entity’s ability to continue as a going concern, the
auditor should consider the adequacy of the disclosures with respect to such
uncertainty and include an explanatory paragraph in the audit report.
(3 x 2 marks = 6 marks)

B. Tom has the responsibility to plan and perform the audit to obtain reasonable assurance
about whether the financial statements are free of material misstatements, whether caused
by error or fraud. If Tom’s risk factor assessment indicates that fraud may be present, he
might respond as follows:
i) Increase professional skepticism by using an attitude that includes a questioning
mind and critical assessment of audit evidence
ii) Assign more experienced auditors who have the knowledge, skill, and ability
commensurate with the increased risk of the engagement
iii) Consider management’s selection and application of significant accounting policies,
particularly those related to revenue recognition, asset valuation, or capitalizing
versus expensing.
iv) Modify the nature, timing and extent of audit procedures to obtain more reliable
evidence and use increased sample sizes or more extensive analytical procedures.
(8 marks)
Total : 20 marks

Answer 4

A. Four (4) types of audit opinions with the appropriate circumstances are:

1. An unqualified opinion
2. An unqualified opinion with emphasis of matter
3. A qualified opinion ‘except for’
4. An adverse opinion
5. A disclaimer opinion
(any 4 types x 1 mark with 1 mark for each appropriate circumstance = 8 marks)
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B. The effect of those circumstances on the auditors’ report is as follows:

a) This is a disagreement with management. The audit report would have an


explanatory ‘Qualification’ section with an ‘except for’ opinion (unless it was a small
company – then it may be an adverse opinion).

b) This is a scope limitation. The audit report would have an explanatory ‘Qualification’
section with an ‘except for’ opinion.

c) This is an inherent uncertainty and may result in one of the following audit opinions.
i) If the matter of litigation is not adequately disclosed then this constitutes a
disagreement with management, and the appropriate form of qualification is
‘except for’ or adverse.
ii) If the matter of litigation is adequately disclosed, an emphasis of a matter is
added.

d) This is a scope limitation. The audit report would have an explanatory ‘Qualification’
section with an ‘except for’ opinion.

e) This is a going concern uncertainty and may result in one of the following audit
opinions.
i) If there is adequate disclosure of the going concern uncertainty, the audit
report would have an unqualified opinion with an emphasis of a matter
paragraph after the opinion section.
ii) If there is inadequate disclosure, the audit report would have a qualification
paragraph with an ‘except for’ opinion after the scope section, but before the
opinion section.
iii) If it is highly probable that the entity will not continue as a going concern, the
audit report would express an adverse opinion.

f) This is a scope limitation. The audit report would have an explanatory ‘Qualification’
section with an ‘except for’ opinion. However, it is unlikely that a matter such as this
would result in a qualification, as the threat of a qualification would probably be
enough for the auditor to see the minutes.

(6 × 2 marks = 12 marks)
Total : 20 marks

Answer 5

A. a) The element of materiality implies importance relative or absolute and the materiality
of an item may be dependent upon its nature, its size, or both. Materiality is not a
universally quantifiable concept; it must be determined in light of professional judgement
on a case-by-case basis. There is some general agreement that materiality should be
based on what would influence the decisions of the users of the financial statements.
Materiality may depend on either quantitative or qualitative characteristics, often a
combination of both. Auditors generally view materiality in terms of its importance in the
context of presenting fairly, primarily in quantitative terms, the financial position, results of
operations, and changes in cash flows for an enterprise, in conformity with approved
accounting standards. In assessing a matter’s importance, auditors consider its nature
as well as its relative magnitude and relative financial effect either singly or cumulatively
in light of the surrounding circumstances.
(3 marks)
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b) Some usual common relationships and other considerations used by the auditor in
judging materiality are:
i) Total assets
ii) Total revenues
iii) Income before tax
iv) Average of three years’ net income
v) Fraud or irregularities
vi) Small amounts that might violate covenants in a contract
vii) Amounts that might affect the trend in earnings
(any 3 x 1 mark = 3 marks)

c) The scope of the audit will be affected by the auditor’s concept of materiality because
there should be stronger evidence to support an opinion with respect to financial
statement accounts that are relatively more important and financial statement accounts
in which the possibilities of material misstatement accounts of lesser importance or
financial statement accounts in which the possibility of material misstatement is remote.
Materiality is used as a criterion for determining the items that are to receive limited
attention in terms of either the conclusiveness of evidence gathered or the extent of the
items examined. In the execution of the audit program, materiality is used to evaluate
any misstatements discovered.
(3 marks)

B.

(a) Assertions tested by Junior (b) Assertions for further testing by Audit
Auditor Manager

Trade creditors
The primary assertion tested is A further test needs to undertake to verify
existence, i.e. that each of the recorded completeness. This requires tracing from
amounts exists. The test also contributes goods received notes to invoices, having first
to the rights and obligations and established the numerical continuity of GRNs.
valuation assertions in providing Additionally the junior auditor should agree
evidence that the amounts are owed to suppliers' statements with recorded
the creditor and are recorded in the amounts investigating items appearing on the
correct amount. statements but not in the creditors' ledger.

(3 marks) (2 marks)

Non Current Assets

The primary assertion tested is that of A further test needs to be performed to verify
occurrence of additions to fixed assets. completeness, i.e. that no addition to fixed
The test also contributes to the rights assets has been omitted. This usually arises
and obligations assertion in that the through the purchase being recorded as an
sales invoice records the transfer of title expense and not as an asset. This occasionally
and to measurement at the cost happens with repairs and maintenance where a
recorded on the invoice. 'repair' constitutes an addition to an existing
fixed asset. The junior auditor should analyse
postings to repairs and maintenance
expense to verify that none should have been
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capitalised. Another test is to obtain a schedule


of authorised fixed asset additions such as
from the directors' minutes or capital
expenditure budget and inquiring into any items
not appearing on the list of fixed asset
additions.

(3 marks) (3 marks)

Note: Any relevant answers are acceptable

(6 marks (a) + 5 marks (b) = 11 marks)


Total : 20 marks

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