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SUGGESTED SOLUTION

AUD 589 AUDITING 1


JUNE 2019
QUESTION 1

A. Audit Planning:

i. Benefits of conducting analytical procedures at the planning stage:


 assist in planning the nature, timing, and extent of auditing
procedures.
 enhance the auditor's understanding of the client's
business and the transactions and events that have
occurred since the last audit date.
 identify areas that may represent specific risks relevant to
the audit.
 identify the existence of unusual transactions and events,
and amounts, ratios and trends that might indicate matters
that have financial statement and audit planning
difficulties.
C1 (any 3 answers X 1 mark each = 3 marks)

ii. Examples of analytical procedures that could be performed at the planning stage
for account receivables:

 Compare account balances in account receivables with the preceding


year or years. Investigate significant changes in amounts or deviations
from trends.
 Investigate large and/or unusual balance classified as other account
receivables.
 Compute the number of days net revenues in accounts receivable
 Compute year-end receivables as a percent of gross revenues

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 Compute bad debts as a percentage of gross revenues
 Compute allowance for doubtful accounts as a percentage of account
receivables
 Compute aged accounts as a percentage of total accounts
 Compute interest income as a percentage of the average balance of
account receivables
C1 (Any 3 answers X 1 mark each = 3 marks)

B. Qualitative factors which may affect the materiality of an audit item:

 First-year engagement.
 Internal control weaknesses.
 Management turnover.
 High market pressures.
 High fraud risk.
 Higher than normal risk of bankruptcy.
C2 (Any 2 answers with explanation X 2 marks each = 4 marks)

C. Audit risk:

i. Difference between inherent risk and control risk:

 Inherent risk – Inherent risk is the risk posed by an error or omission in a


financial statement due to a factor other than a failure of control. In a
financial audit, inherent risk is most likely to occur when transactions are
complex, or in situations that require a high degree of judgment in regard to
financial estimates.

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 Control risk – Control risk, which is the risk that a misstatement due to error
or fraud that could occur in an assertion and that could be material,
individually or in combination with other misstatements, will not be
prevented or detected on a timely basis by the company's internal control.
C4 (2 marks each = 4 marks)

ii. Procedures that auditor could perform to obtain an understanding of the client
business and its environment, including its internal control:
 enquiries of those charged with governance, management and others
within the entity.
 analytical procedures of key figures in the financial statements.
 observation and inspection of client’s business premises.
 inquiries from former auditor.
 read company’s previous annual reports especially the Chairman’s
Statement and Directors’ Report.
 discussion with internal audit personnel and review of internal audit
files/report.
 review minutes of meetings.
 Any other relevant answers.
C4 (Any 4 answers with explanation X 1.5 marks each = 6 marks)
(Total: 20 marks)

QUESTION 2

A. Audit evidence:
i. Examples of audit evidence:

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 Physical examination
 Confirmation
 Documentation
 Analytical procedures
 Inquiries of the clients
 Reperformance
 Observation
C1 (Any 2 answers X 1 mark each = 2 marks)

ii. Term ‘sufficient and appropriate audit evidence’:

 Sufficiency is the measure of quantity of audit evidence i.e. the


amount of evidence obtained must be enough that it can be used and
considered by the auditor. The quantity of audit evidence required
depends on the assessment of risk conducted by the auditor. If the
risk of material misstatement is high then higher quantity of audit
evidence is required to establish (confirm) by the application of audit
procedures.

 Appropriateness on the other hand is the measure of quality of audit


evidence. Audit evidence is said to be appropriate if it is relevant and
reliable in the given set of circumstances. However, the
appropriateness of audit evidence is affected by the time, source and
the circumstances under which such evidence is obtained.
C1 (2 marks each = 4 marks)

iii. Internal vs. external evidence:

 Internal evidence such as sales invoices duplicate copy, employees’


time reports, inventory reports, counterfoils of receipts, purchase
requisitions
 External evidence such as bank statement, supplier Invoice, insurance
policies
C1 (1 mark each = 2 marks)

B. Engagement letter:

i. Purpose of an engagement letter:


 The engagement letter documents and confirms the auditor’s
acceptance of the appointment, the objective and scope of the audit,
the extent of the auditor’s responsibilities to the client and the form of
any reports that should be submitted upon completion of an audit. It is
in the interest of both client and auditor that the auditor sends an
engagement letter, preferably before the commencement of the
engagement, to help in avoiding misunderstandings with respect to
the engagement.
C3 (2 marks)

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ii. Principal contents of an engagement letter:
 The objective of the audit of financial statements.
 Management’s responsibility for the financial statements as
described in ISA 200.
 The financial reporting framework adopted by management in
preparing the financial statements, i.e., the applicable financial
reporting framework.
 The introduction of the audit, including description about the client
and financial year end of the client.
 The form of any reports or other communication of results of the
engagement.
 The fact that because of the test nature and other inherent
limitations of an audit, together with the inherent limitations of
internal control, there is an unavoidable risk that even some material
misstatement may remain undiscovered.
 Unrestricted access to whatever records, documentation and other
information requested in connection with the audit.
 Management’s responsibility for establishing and maintaining
effective internal control.
C3 (Any two answers with explanation X 2 marks = 4 marks)

C. Audit working papers:


i. Distinguish between permanent file and temporary file:
• Permanent files - contain data of historical or continuing nature
• Current files – includes all audit documentation applicable to the year
under audit
C4 (1 mark each = 2 marks)

iii. Examples of documents kept in the permanent file and current file
respectively:

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Permanent  Copies of, or excerpts from, the memorandum and articles
file of association of the company
 Charts of accounts
 Organisation chart
 Accounting manual
 Copies of important contracts (pension contracts, union
contracts, leases, etc)
 Documentation of internal control (flow charts)
 Terms of debenture and bond issues
 Prior years’ analytical procedure results
Current file  Copy of financial statements and auditor’s report
 Audit plan and audit programs
 Copies or, or excerpts from, minutes of important
committee meetings
 Working trial balance
 Adjusting and reclassification journal entries
 Working papers supporting financial statement amounts
C4 (1 mark X 2 examples each = 4 marks)
(Total: 20 marks)
QUESTION 3

A. Internal control weaknesses relating to material purchase system of Apex Berhad.


B. Possible effect of each of the weaknesses identified in part (A) above on the
operations of Apex Berhad:

Part A. Weaknesses Part B. Possible effect

1. Material issued on verbal request Can result in fictitious or


unauthorized request of materials
and theft of goods

2. Plant foreman approved material purchase No proper authorization can lead to


requisitions misappropriation of materials
3. Duplicate invoices are not marked “paid” to
prevent double processing and payment Can result in overpayment for
goods or theft of cash
4. The employee who placed the order gave
approval on the invoice for payment Possibility of falsified transactions,
overcharging or overpayment
5. No checking is performed on the material
received whether the quantity and type of The materials received may differ
material is correct as ordered from the materials ordered
resulting in delayed production.

+ Any other relevant answers


Part A – C4 (2 marks X 3 points = 6 marks)
Part B – C5 (with explanation X 2 marks each = 6 marks)

C. Segregation of duties:
i. Sets of incompatible functions that need to be segregated in an effective internal
control system for material purchase cycle:
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 Separation of the custody of assets√ and accounting/recording√
 Separation of authorization of transactions√ from custody of related
assets√
 Separation of operational responsibilities√ from record-keeping
responsibilities√
C6 (2 sets = one mark for every √ = 4 marks)

ii. Reasons for maintaining proper segregation of duties in the material purchase
cycle:
 It ensures that there is oversight and review to identify errors/frauds.
 It helps to prevent fraud or theft because it requires two people to collude
in order to hide a transaction.
C6 (2 points with explanation X 2 marks each = 4 marks)
(Total: 20 marks)

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QUESTION 4

A. Petty cash is relatively small in amount but often at the centre of auditors’ attention:
- Although petty cash is small in amount, it is relatively risky due to:
 Unauthorized use of money for personal expense
 Inflated expense bills
 Theft
 Improper accounting [leading to shortage or excess cash]
 Collusion between employees
 misappropriation of cash by responsible staff
 Overriding of controls over petty cash by management
C2 (2 marks)

B. Audit of long-term liabilities:


i. Audit procedures to verify long-term liabilities:
 Review all debt covenants
 Review all leases for correct classification as capital or operating
 Confirm all significant debts with the lenders
 Determine if all liabilities are classified appropriately (as current or
non-current)
 Agree the end-of-period balances on the balance sheet to the
amortization schedule
 Review any significant accrued interest at period-end
C3 (For every point X 1.5 marks = 6 marks)

ii. Assess the importance of auditing long-term liabilities:


 Long term liabilities are normally big in quantum, hence if materially
misstated, would materially affect the financial statement true and fair
view.
 Long term debts most of the times would be attached with debt
covenants, which are legally binding – if not properly
presented/accounted for in the financial statements, it can lead to
legal risk.
C3 (2 marks)

C. Audit of inventory:
i. Substantive procedures that could be employed to audit inventory:
 Perform cutoff tests for purchases, sales, purchase returns, and sales
returns and tie to movement of inventory.
 Verify the clerical and mathematical accuracy of inventory listings.
 Reconcile physical inventory amounts with perpetual records.
 Reconcile physical counts with general ledger control totals.
 With respect to tagged inventory, perform tests for omitted
transactions and tests for invalid transactions.
C5 (For every point X 1.5 marks = 6 marks)

ii. The need for the auditors to attend the stock taking process carried out by the
client company.

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 While the principal reason for attendance at a stock take is to obtain
evidence to substantiate the existence of the stocks, attendance can
also enhance the auditor’s understanding of the business by providing
an opportunity to observe the production process and/or business
locations at first hand and providing relevant evidences.
 Attendance at stocktaking can provide evidence to the auditor in
respect of the existence, completeness and valuation assertions
(including a consideration of possible obsolescence and deterioration).
The auditor attending a stock take considers whether the checking of
stocks as a whole is effective in confirming that accurate records of
stocks are maintained. If the entity’s records of stocks are not reliable
the auditor may need to request management to perform alternative
procedures which may include a full count at the year end.
C5 (4 marks)
(Total: 20 marks)

QUESTION 5

A. Elements of audit report:


i. Elements that should be included in the auditor’s report.
 Title
 Addressee
 Introductory paragraph
 Management’s responsibility for the financial statements
 Auditor’s responsibility
 Signature of the auditor
 Date of the audit report
 Auditor’s address
C3 (any 2 with explanation X 2 marks each = 4 marks)

ii. The importance for the auditing profession to adopt conventional and uniform
wordings in the auditor’s report:
 To avoid confusion to the readers/users of financial statement.
 To avoid misunderstanding in the message contained in the audit
report being communicated to the readers/users of financial
statements.
C3 (any one answer with explanation = 2 marks)

B. Deficiencies of audit report:


 Not addressed to the members/shareholders of Kesatria Berhad
 Reference was made to only statements of financial position as at 31 July
2018 and the statements of comprehensive income for the financial year
ended 31 July 2018. Audit report should cover other documents in the
financial statements such as statement of cash flow, statement to the
changes of equity, notes to the account.
 It mentioned ‘true view’. It should be ‘true and fair view’
 Management’s and auditor’s responsibilities not stated.
 Not signed by the engagement partner.
 Not dated.
 No address of the auditor.

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C4 (any four with explanation X 2 marks each = 8 marks)

C. Types of audit opinion classified as departure from the unqualified audit report.

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Types of audit
Explanation
opinion

1. Qualified opinion There are two circumstances that could result


with except for in this type of opinion:
1. Where there is material misstatement that
materially affects the financial statement true
and fair view. However, the effect of the
material misstatement is not pervasive to the
financial statement.
2. Where there is insufficient evidence on
certain material audit item and lead to auditor
not able to form conclusion. However, other
items are satisfactory.

The qualified opinion is issued can be due to


inherent uncertainty, limitation of scope and
disagreement between client and auditors, but
the impact is viewed as not so material and
pervasive.

2. Disclaimer of Auditor is not able to obtain sufficient and


opinion appropriate audit evidence for majority of the
items in the financial statements. Thus, auditor
cannot draw conclusion on the financial
statement true and fair view.

The disclaimer of opinion is issued can be due


to inherent uncertainty and limitation of scope,
and the impact is viewed as material and
pervasive.

3. Adverse opinion Thee ae material misstatements that render


the whole financial statements not achieving
true and fair view.

The adverse opinion is issued can be due to


disagreement between client and auditors,
and the impact is viewed as not so material
and pervasive.

C6 (three types of audit opinion with explanation X 2 marks each = 6 marks)


(Total: 20 marks)

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