Audit & Assurance

Suggested Answers
Certificate in Accounting and Finance – Mock Spring 2015

Answer Q. 1 (a)
(i) This situation does not contain any threat.
(ii) Self-Interest Threat: (M= ½ )
Subsequent employment with the assurance client is of personal interest to the audit management
which will impair the independences and objectivity of the audit manager in the professional
matter. (M= ½ )
(iii) Intimidation Threat: (M= ½ )
The CEO of the client has actually threatened of replacement in case there is a disagreement by the
auditor over the issues. (M= 1½ )
(iv) Familiarity Threat: (M= ½ )
The prolonged period of time during which partner has been the engagement partner could lead to a
close relationship with the company. This could affect his objectivity as he may decide not to a
discuss contentious matters with the management, to maintain good relationship. (M= 1½ )

Answer Q. 1 (b)
ABC & Co. should take the following steps before acceptance of the engagement:
1. Ensure that all legal requirements regarding their appointment have been fulfilled.
2. Determine that pre-conditions relating to audit are being met regarding financial statement and
information to be provided to them by the management.
3. No ethical threat arises which cannot be reduced to an acceptance level by implementation of adequate
safeguards.
4. It must communicate with the outgoing auditor before acceptance of the engagement.
(1 mark for each point accept other logical answers including that given in the book)

Answer Q. 1 (c)
Carvan Ltd.
Performing accounting services for a non-listed client is permitted. However, a management threat may
arise as the estimation of the year-end allowance against receivables and warranty provisions are likely to
involve judgement.
A self-review threat will also arise as the external audit team may be insufficiently questioning of the
work performed by the secondee and may be reluctant to highlight errors or omissions in the work.

Safeguards
The firm cannot accept the engagement in its current form. It may be able to accept an engagement which
involves a reduced scope, i.e. services that do not involve judgements or the taking of management
decisions but are of a technical, mechanical or informative nature only.
If such an engagement is accepted the secondee should not form part of the audit team and the assignment
should be for a short period only.

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 Audit & Assurance
Suggested Answers
Certificate in Accounting and Finance – Mock Spring 2015

Answer Q. 2
Risk Indicator
a) The investee companies have different year
end than the investor company
b) One of the investee is a foreign operation;
c) Significant transactions between the
investees and investor companies;
d) Poor operating results and financial
condition of one of the investee company;
e) The investor has guaranteed the debts of
one of the investee company
f) The investees’ financial statements are
audited by another firm.
Answer Q. 3
(a) General Controls
These are general controls which cover the environment in which the computer system is operating. Broadly
speaking, this category covers organisational controls, system development and maintenance controls, access
controls and other general controls.
Significance / Possible Implication
a) Failure to account for or disclose significant
transactions occurring between the
investees’ and investor’s year end.
a) Due to Foreign currency fluctuations,
translations may not have been done
accurately.
b) Potential expropriation of assets Potential
lack of reliable information regarding the
investee’s operations c-different basis of
accounting.
a) improper elimination of intercompany
profits, (in case of consolidation)
b) increased risk of inadequate disclosure of
related party transactions
c) Risk of non-arms length transactions
a) Uncertainty regarding the realizibility of
investment in such company.
a) Inadequate disclosure of guarantees.
b) Failure to disclose or provide for any
liability that may have been due under the
guarantee agreement.
a) Misstatement due to the audit team’s
reliance on these financial statement and
failure of the other auditor to follow the
appropriate standards.
(2 mark for each implication)

Application Controls

These are controls which seek to ensure the accuracy and completeness of input processing, processing
controls and output controls. These application controls are designed to detect errors before, during and after
processing.
(2 mark for each type)

(b) Some of the benefits associated with the use of CAATs include:

• The ability to test the entire population or a much greater part of the population than using a sample
approach.

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 Audit & Assurance
Suggested Answers
Certificate in Accounting and Finance – Mock Spring 2015

• Common tests can be designed and programmed so that they can be repeated several times and thus
increase audit efficiency.

• Using most data analysis tools so that data once imported to the system cannot be changed thus reducing
the risk of accidental change or deletion of the data. (1 mark for each benefit)

Answer Q. 4
Deficiency Audit significance
Ordering of goods • There is no central control over reorder levels
No authorisation is required in order for employees to and therefore efficiency of the business may
order goods. be lost. In addition the best prices may not be
achieved without a central buying policy.
Order forms are not sent directly to responsible person
for authorisation.

The order forms are not prenumbered. • Difficult to check that all goods ordered are
for the purpose of the business.

No evidence of lists of authorised suppliers to be used.
Receipt of goods
No physical check of goods received to purchase
order or goods received note.
• Difficult to check that all commitments have
been recorded and, as a result, that liabilities
are not understated.
• The quality of goods received may not be
satisfactory with the consequence that
inventory valuation and liabilities may be
overstated.

No check of goods received note to purchase order. • Liabilities could be overstated if the goods
received are less than the goods received note.

Goods inward clerk has receipt of both goods received
note and the retained copy of the order form giving
her the capacity to misappropriate inventory by
altering the goods received note and order form.
Receipt of invoice
No checks exist to agree quantities invoiced to
quantities ordered or received or on quality of goods.
• The effect on year-end inventories of under
supply of goods or misappropriation will
depend upon how the year-end inventory is
calculated. As it will most likely be based
upon a year-end count the statement of
financial position value will be unaffected.
However purchases will be overstated with a
consequential reduction in profit
• Purchases and liabilities may be misstated by
Javed, being over or under invoiced.

Authorisation
No reliable evidence exists to ensure all invoices are • Possible overstatement of purchases and
authorised by management (i.e. invoices not initialed). liabilities by invoices not being passed for
authorization by person ordering the goods.

No procedures to ensure safekeeping and return of • Loss of invoices in transit could occur which
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 Audit & Assurance
Suggested Answers
Certificate in Accounting and Finance – Mock Spring 2015

invoices. may result in understatement of liabilities in

Recording
No segregation of duties between recording in the
nominal ledger and purchase ledger.
the nominal ledger account which would not
be picked up until the purchase ledger control
account reconciliation was done. At the
yearend reconciling differences should be
watched for.
• Loss of invoices would mean loss of
underlying documentation, with consequential
loss of audit trail.
• Non-detection of erroneous purchase entries.

No arithmetic check on input of purchase invoices.

Payments to suppliers and reconciliation

No segregation of duties in either function. Although • Again the validity of the purchases, inventory
the cashier pays suppliers, she does so only on the and liabilities balances in the financial
advice of the purchase ledger clerk. statements is called into question.

General
Where a deficiency has an impact on the business but
does not necessarily have an impact on the financial
statements, the auditor would still consider reporting
the matter in a letter of deficiency.
(1 mark for each deficiency, 1 mark for each Audit Significance; accept any six from each)

Answer Q. 5
ICAP Book, Page 317 (Reporting req of CO 1984)

Answer Q. 6 (a)
(a)
(i) This letter from the tax authorities provides further information about a liability which existed at 31
December 2012 and hence is an adjusting event and should be included in the financial statements.
This is also a material amount ( as materiality is set at Rs.50,000) therefore if management do not
adjust for this amount then it would impact on the annual report in that we would disagree with
management on accounting treatment and therefore, the appropriate modification to the audit report
would be ‘except for’ on the basis of disagreement on this accounting treatment The necessary
adjustment would be to Dr Income Tax Expense Rs.51,400 and Cr Income Tax Payable ( in Statement
of Financial Position Rs.51,400)
(ii) This is not an adjusting event. Investments were correctly valued at 31 December (Companies have a
choice as to whether to value them at Cost or Fair Value) this additional information will have no
bearing on the annual report.
(iii) On 1 February, a dividend of Rs. 0.05 per share was declared. This is not an adjusting event. If the
amount is material then a disclosure should be made in the financial statements about the amount of the
dividend. Assuming that this disclosure is made then there would be no impact on the annual report.

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 Audit & Assurance
Suggested Answers
Certificate in Accounting and Finance – Mock Spring 2015

(iv) A customer who owed Rs.100,000 was declared bankrupt in Jan 2013. This information highlights that
the Accounts Receivable balance is currently overstated by Rs.100,000 in the year end accounts. This is
an adjusting event and we would recommend to Sahar to adjust their accounts (Dr. Bad Debts 100K Cr
Accounts Receivable 200K) This is also a material amount so if an adjustment is not made then this
would have an impact on our audit report.
(v) Inventories which had a carrying value of Rs.300,000 were disposed of on 7 February for Rs.180,000.
This is an adjusting event. In accordance with IAS 2 Inventories are valued at the lower of cost and Net
realisable value. The details obtained on 7 Feb give an indication as to the NRV of inventories so
inventory is currently overstated in the accounts. Thus as auditors we would recommend that inventory
be restated to reflect this. This will require an adjustment of Rs.120,000 to be made both to the Closing
Inventory figure and to the COS figure ( Dr COS 120K, Cr Inventory 120K) As this is a material
adjustment a failure to make the amendment would result in a qualification to our report on the grounds
of the accounting treatment for inventories.

(2 marks for dealing with each event correctly and providing appropriate discussions up to a
maximum of 10 marks)

Answer Q. 6 (b)
(i) (1) I would instruct my staff to examine the evidence available with the management to substantiate
their contention that they have supplied air conditioners in good quality and that the defect was due to
mishandling by MML’s technicians. Such evidence may include:
(a) Lab test report of the air conditioners supplied.
(b) “Handing over” report duly signed by MML’s representatives as the air conditioners are claimed to
be working properly.
(c) Examination report of ACs by the experts to substantiate that these were mishandled during or after
installation. (2 marks)
(2) I would also ask them to verify the basis of provision of Rs. 2 million made by Nobel Ltd. (1 mark)
(3) I would ask them to obtain enquire from the legal advisor of Nobel Ltd. About the possible outcome of
the litigation. (1 mark)
(4) I would also ask them to consider status of the pending case upto the date of my report. (1 mark)
(ii) Again in this case management’s representation should not be considered as sufficient and appropriate
audit evidence. The amount of significant loss is an indicator of under provision of depreciation.
(2 mark)
Therefore, I would instruct my staff to perform the following procedures:
(i) Review useful life of assets and method of depreciation being used.
(ii) Assess risk of impairment of assets.
(iii) If any indication of impairment loss is present, enquire from management whether assets have
been tested for impairment.
M½
(iv) Examine working of any such testing.
each
(v) Ensure that proper adjustment is made to the carrying amount of asset, if required.
(vi) Consider appropriateness of policy of carrying the assets at cost model. proce
dure

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 Audit & Assurance
Suggested Answers
Certificate in Accounting and Finance – Mock Spring 2015

Answer Q. 7 (a)
Accounts,
Classes of Audit Procedure Directed at Assertion Marks
Transactions
(i) All Inquire who controls passwords for IT Control
access.
(ii) Sales, Examine document packages for items that Control Accuracy,
Receivables, have been shipped for inclusion of a Occurrence
Inventory customer order, credit approval, and shipping
document. Make sure the documents are
properly matched and complete, with all
required signatures and trace amounts to the
sales journal, accounts receivable subsidiary
ledger, and inventory files.
(iii) Payroll For the Hourly Payroll Expense account, Amount Accuracy
multiply the average number of workers Completeness
times the average number of hours worked
per year times the average hourly rate.
Compare to the total posted annual amount.
(iv) Cash Inspect the client-prepared bank Control Valuation
reconciliation for each month of the year,
recalculate the amounts, examine the
supporting bank statements, and trace the
cash amount to the general ledger.
(v) Fixed Assets Obtain a list of fixed assets and physically Amount Existence Right
look at the assets.
(vi) Long-term Read the contract related to each of the Disclosures Accuracy
debt company’s long-term borrowings and agree Understandability
the terms of the contracts to the financial
statements notes.
(vii) Cash, Long- For each item of long-term debt that existed Amount Valuation
term debt both at the beginning and end of the year, obligation
inspect the debt contracts and the company’s completeness
analysis of the discounted debt amount and
its analysis of violation of debt covenants
and look for whether the details agree.
Recalculate the amounts, and examine
recorded entries and bank statements for cash
disbursements for debt repayments. Using

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 Audit & Assurance
Suggested Answers
Certificate in Accounting and Finance – Mock Spring 2015

that information, determine whether the

company has been in violation of any debt
covenants during the year.
(viii Prepaid rent Using the beginning financial statement Amount Valuation,
) amount, cash receipts and cash Occurrence,
disbursements evidence, and the lease Completeness
agreement, calculate year-end prepaid rent
and agree that amount to what is shown in
the journal ledger.
(ix) Inventory At the end of the last day in the fiscal year, Amount Cut-off
go to the client’s shipping area and record the
last shipment; trace the shipment into the
client’s records.
(1/2 mark for each point)

Answer Q. 7 (b)
 Inspect the underlying contracts or agreements to evaluate whether:
 the contracts etc. were entered into in order to engage in fraudulent financial reporting or to hide the
misappropriation of assets (a lack of business rationale might indicate this.
 the terms of the contracts etc. are consistent with management’s explanations, and
 the transactions have been properly accounted for and disclosed.
 Obtain evidence that the transactions were properly authorised.
 If management has made a statement in the notes to the financial statements that a related party transaction
was made on the same terms as an arm’s length transaction, the auditor must obtain evidence to support this
assertion.
 Obtain written representation from management.
(1/2 mark for each point)

Answer Q. 8 (a)
Whether all sales returns have been recorded. If percentage of sales returns does not match with previous year’s
pattern, it would indicate that sales returns have not been completely recorded. Auditor should review sales returns
recorded in the subsequent period and note the date of actual return of goods. If goods have actually been recorded
in the current period, these should be recorded in the period of return. (3 marks)

Answer Q. 8 (b)
A decline in bad debt as a percentage of credit sales indicates that bad debts have not been identified completely
and thus not provided.
Auditor should identify long outstanding debt and see whether these are recoverable. (1 mark)

Answer Q. 8 (c)
A change in age-wise debt amount or percentage as compared to previous year is indicative of irrecoverability of
debtors.
Auditor will have to ascertain actual recoverability of debtor specially which have been outstanding for quite some
time. (1 mark)

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 Audit & Assurance
Suggested Answers
Certificate in Accounting and Finance – Mock Spring 2015

Answer Q. 9 (a)
Internal audit is an appraisal or monitoring activity established within an entity as a service to the entity. It
functions by examining, evaluating and reporting to management and the directors. It reports on the
adequacy and effectiveness of components of the accounting and internal control systems. (1 mark)
Internal audit is broader in scope than the investigation of financial systems and records. IA dept. may be
asked to look into any aspect of the organisation including financial and operational areas.

Internal audit can improve the organisation by:

● Assisting with risk management, establishing and maintaining good systems of internal control.
● Helping with implementation of new accounting standards.
● Reviewing all policies and procedures.
● Liaising with external auditors and therefore potentially reducing their fees.
● Independently reporting to Audit Committee
● Adding value by strengthening the system within the organisation and improving its efficiency and
effectiveness.
(1 mark for each point maximum marks 6)

Answer Q. 9 (b)
Before using specific work of internal audit the external auditor is then required to evaluate whether:
 the work was performed by internal auditors with adequate technical training and proficiency
 the work was properly supervised, reviewed and documented
 adequate audit evidence was obtained
 appropriate conclusions were reached, consistent with any reports prepared
 any exceptions or unusual matters were properly resolved
(1 mark for each point)

Procedures to achieve this might include:

 examining items already examined by internal audit
 examining other similar items
 observing procedures performed by internal audit.
(1/2 mark for each point maximum 5)

(THE END)
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