AUD589 – DEC 2018

SUGGESTED SOLUTION
AUD 589 DECEMBER 2018
QUESTION 1

A. Sources of information commonly required by auditors that can provide knowledge

about the client’s business and industry:

• Inquiry from management.

• Tour the plant and office.
• Read trade journal.
• Read procedural manual and code of conducts.
• Read minutes of board of directors meeting.
• Read contracts and other legal documents.
• Read regulatory requirements.
• Perform ratio analysis.
• (Other relevant sources from which information comes).
C1 (Any 6 sources x 1 marks each = 6 marks)

B. Factors that can cause material misstatements to the financial statements:

• Error – unintentional misstatement of the financial statements.

o Misapplication of accounting policies.
o Mistakes in extending prices times quantity on sales invoices.
o Overlooking older raw materials in determining the lower of cost and
market value for inventory.
• Fraud – intentional misstatement of the financial statements.
o Manipulation, falsification or alteration of documents and records.
o Intentional misappropriated cash collection by the cashier at the time a
cash sale is made and not entering the sale in the cash register
machine.
o Intentional overstatement of sales near the balance sheet date to
increase reported earnings.
C2 (2 factors x 2 marks each = 4 marks)

C. Risks of material misstatement in the financial statements of Deroyan:

• First year audit – The auditor ordinarily does not have the previous
experience with the client company. This may influence the auditor judgment
when considering the audit risk at the overall financial statement level.
• Owner-managed business – The close involvement of the owners (i.e. the
shareholders and directors are the same people) enables them to override
the controls and purposely exclude transactions from the records. Therefore,
the auditor may not be able to obtain reasonable assurance on the
completeness of the transactions and the records.
• Granting of credit – The nature of the business as sole-proprietors are that
they do not remain at one place. As the demand for fruits is required
elsewhere they will move to that location. This will give rise to doubtful and
eventually bad debts.

1
 AUD589 – DEC 2018

• Extend of credit term – The matter on bad and doubtful debts is further
aggravated by extending the credit term in order to help the retailers to cope
with the cash flow.
• Dependent on short-term financing – This is a symptom of going concern
difficulties. There is uncertainty as to whether the company is viable as an
ongoing entity in the foreseeable future.
• Uploading of fruit containers – The inventory could easily go missing due to
theft, since containers could be uploaded without pay. Here, there is no
adequate independent checking over the inventory.
• Workers – The workers could have given generous discount and have the
possibility to steal the cash collection.
• General clerk – The clerk might lack the competency to prepare a complete,
accurate and valid set of accounts.
C4 (Any 5 risks X 2 mark each = 10 marks)
(Total: 20 marks)

QUESTION 2

A. Audit evidence:
i.Different types of audit evidence:
• Physical examination
• Confirmation
• Documentation
• Analytical procedures
• Inquiries of the client
• Recalculation
• Re-performance
• Observation
C1 (Any 4 X 1 mark each = 4 marks)

ii.Example for each type of audit evidence identified in (i) above:

• Physical examination – count by the auditor of tangible assets such as
inventory, cash and tangible fixed assets, securities and notes receivable.
• Confirmation – confirmation send to debtors, bankers, creditors
• Documentations- check client’s documents such as sales invoices,
payment vouchers, etc.
• Analytical procedures: looking at trends, plausible relationship, compare
last & current year figures, financial data and non- financial date etc.
• Inquiry – obtaining of written or oral information from client in response to
questions from auditors
• Recalculation – rechecking a sample of calculations, check arithmetical
accuracy in sales invoices.
• Re-performance – the auditor compare the price on an invoice to an
approved price list
• Observation – tour the plant, watch individual perform accounting task,
stock observation.
C1 (Any 4 X 1 mark each = 4 marks)

2
 AUD589 – DEC 2018

B. Importance of having good documentation of audit work:

• To aid auditor in providing reasonable assurance that an adequate audit

was conducted in accordance with auditing standards
• To provide a basis for planning current year audit. For example, by
making reference to previous year’s internal control system
• To provide a record of evidence accumulated
• To provide data for deciding the proper type of audit report
• To provide basis for review by partners/supervisors
C3 (Any 3 X 2 marks each = 6 marks)

C. Communication between clients and auditors:

i. Differentiate between engagement letter and management letter:

Engagement letter – Engagement letter establishes an understanding between

the auditor and client about the scope of services to be performed. Typically,
this understanding is obtained during the planning phase of the audit, before
the auditor performs any significant audit procedures. It may need to be
updated during the course of the audit if the scope of the audit changes.

Management letter – Management letter is issued by the auditor to

communicate less-significant internal control issues as well as opportunities for
the client to make operational improvements.
C4 (1.5 marks each = 3 marks)

ii. Identify two (2) 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 scope of the audit, including reference to applicable legislation,
regulations, or pronouncements of professional bodies to which the
auditor adheres.
• 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.
C4 (1.5 marks each with brief explanation = 3 marks)
(Total: 20 marks)

3
 AUD589 – DEC 2018

QUESTION 3

A. Purposes of designing good internal control systems:

• Reliability of financial reporting – management has both legal and professional
responsibility to be sure that the information is fairly presented in accordance with
reporting requirements of accounting frameworks such as GAAP and IFRS.
• Efficiency and effectiveness of operations – Controls within a company
encourage efficient and effective use of its resources to optimize the company’s
goals.
• Compliance with laws and regulations – All companies are required to follow laws
and regulations especially those related to accounting.

C4 (3 points with explanation X 2 marks each = 6 marks)

B. Weaknesses in the internal control systems of Mozares Kitchen:

C. Control procedure that should be implemented by Mozares Kitchen for each answer
in part (B):

B. Weaknesses C. Control procedures

1. Datuk Zul has never conducted any
spot check.
2. Workers’ attendance was recorded
in an attendance register without
proper monitoring.
3. The cashier has total control of the
physical cash and updating of cash
receipt register. There is no
segregation of duties between
physical control over cash and the
updating of cash receipts register.
4. There is no person responsible for
the custodian of the raw inventory
items.
+ Any other relevant answers
Datuk Zul should assign someone to do a
regular check, perhaps twice or thrice in a
week. Workers will be more alert if there
is a person who regularly monitors their
work. Datuk Zul’s brother-in-law alone is
not sufficient to perform check and
balance.
Datuk Zul should appoint a person
responsible for reviewing the attendance
records in the register on a daily basis.
There should be proper segregation of
duties between physical control over cash
and recording of the cash receipt register.
Two of the chefs should be appointed as
joint custodian responsible for the safe
keeping of the inventory items.

Part B – C5 (1.5 marks X 4 points = 6 marks)

Part C – C6 (with explanation X 2 marks each = 8 marks)
(Total: 20 marks)

4
 AUD589 – DEC 2018

QUESTION 4

A. Purpose of preparing bank reconciliation statement by the client:

• Bank reconciliation is the practice of comparing company’s records against
the bank’s records. A monthly reconciliation helps in identifying any unusual
transactions that might be caused by fraud or accounting errors.
C2 (2 marks)

B. Audit procedures that auditor could conduct in verifying acquisition and disposal of
property, plant and equipment:

• Select a sample of entries in the acquisitions journal and trace to capital asset
master file.
• Select a sample of entries in the acquisitions journal and trace to vendor
invoices and receiving reports.
• Select a sample of entries in the acquisitions journal and physically examine
the related assets.
• Review whether newly acquired assets replace existing assets.
• Analyze gains, losses and miscellaneous income from the disposals of
assets.
• Review plant modifications and changes in product line, property taxes, or
insurance coverage of the assets.
• Make inquiries of management and production personnel about the possibility
of the disposal of assets.
C3 (Any 4 answers with explanation X 2 marks each = 8 marks)

C. Auditing of inventory:

i. Responsibilities expected of the auditors during the observation of stock

taking process:

• Determining that all inventory owned by the client is included in the

count.
• Inventory taking instructions are complied with.
• Be alert of inclusion of any obsolete or damaged inventory.
• Record serial number of the final receiving and delivery documents
issued before taking of inventory so that accuracy of the count cut off
can be determined at a later date.
• Closely observe delivery and or receipt of goods taking place during the
counting process and any reconciliation made.
• Observe that the client is controlling the inventory sheets or tags
properly.
• Test count selected inventory items, both from physical to count sheets
and from count sheets to physical.
• For test count of work in process, the auditor must ascertain percentage
or stage of completion indicated on inventory tag if appropriate.
• Ascertain that numerical control is maintained over both inventory.tags
and inventory sheets.

5
 AUD589 – DEC 2018

• Make inquiries to ascertain whether any of the materials or goods on

hand are the property of others, such as goods held on consignment or
customer – owned materials sent in for machine work or other
processing.
• Prepare working papers indicating the extent of test counts, any
deficiencies noted and conclusion as to whether the physical inventory
appeared to have been properly taken in accordance with client’s
instructions.
C5 (Any 2 points with explanation X 2 marks = 4 marks)

ii. key issues that auditors may face in verification of inventory

• Existence - Inventories are susceptible to theft and pilferage.

• Valuation - Adequacy provision for slow moving and obsolete
inventories.
• Cut-off - Stock purchased/sold before and after year end should
recorded in the correct accounting period.
C5 (2 answers X 2 marks each = 4 marks)

iii. Justify the importance of auditor’s attendance during the stock taking process.

• Auditor’s attendance during stock taking process can 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 evidence in relation to the completeness and valuation of
stocks, ‘cut-off’ for recording stock inwards and outwards movements,
the resultant impact on revenues and costs and the design and
operation of an entity’s internal control relating to stocks.
C5 (2 marks)
(Total: 20 marks)

QUESTION 5
A. Circumstances that are required for a standard audit report with an unmodified opinion:

• The balance sheet, income statement, statement of retained earnings, and

statement of cash flows are all included in the financial statements.
• The three basic concepts of standards (general standards, standards of fieldwork
and standards of reporting) have been followed in all respects on the engagement.
• Sufficient appropriate evidence has been accumulated and the auditor has
conducted the engagement in a manner that enables him or her to conclude that
the standards of fieldwork have been met.
• The financial statements are presented in accordance with the principles governing
an audit of financial statements. This also means that adequate disclosures have
been included in the footnotes and other parts of the financial statements.
• There are no circumstances requiring the addition of an explanatory paragraph or
modification of the wording of the report.
C3 (3 points with explanation X 2 marks each = 6 marks)

6
 AUD589 – DEC 2018

B. Type of audit report that auditor would issue and the reason of the issuance of such
report:

Type of audit report Justification

i. Modified opinion The financial statements are materially misstated
(qualified/except since the management disagrees with the auditor
for opinion) regarding the application of an appropriate accounting
standard. The effect is material but not pervasive. The
auditor’s opinion should cite the accounting standard
and quantify the financial effects of the disagreement.
ii. Modified opinion The auditor was not able to obtain sufficient
(disclaimer appropriate audit evidence on which to base the
opinion) opinion. The year end balances cannot be verified, so
it is reasonable to assume that the possible effects of
the adjustments are pervasive. Therefore, the
financial report as a whole is meaningless.
iii. Modified opinion Financial statements are materially misstated. The
(qualified/except disagreement of the directors to provide allowance for
for opinion) doubtful debts in order to reflect the fair value of the
accounts receivable had misstated the validity of the
assertion on the valuation and the impact is material.
iv. Unmodified There is appropriate disclosure in the financial
opinion with statement regarding the losses suffered by the
emphasis of company. Hence, financial statements are presumed
matter not materially misstated. Nevertheless, an emphasis
paragraph of matter paragraph mentioning the going concern
situation facing the company should be mentioned in
the audit report, to draw the attention of financial
statements’ users to the fact that could be
fundamental to the users’ understanding of the overall
financial statements.

C4 (1 mark for type of audit opinion + 1 mark for justification X 4 situations = 8 marks)

7
 AUD589 – DEC 2018

C. Errors or omissions that have been made by the audit junior in drafting the audit report:

• The title of the report should include the addressee. The title should be
“Independent Auditor’s Report to the Members of Sorry Mart Sdn. Bhd.”
• The report should consist of 4 paragraphs:
o Introductory paragraph.
o Directors’ responsibility for the financial statements.
o Auditor’s responsibility.
o Auditor’s opinion.
• The financial statements were mentioned as balance sheet, income statement
and statement of cash flow. The financial statements should be written as
statement of financial position, statement of comprehensive income, statement of
changes in equity and statement of cash flows.
• The auditors do not “certify” the financial statements. Auditors are required to
give an “opinion” on the financial statements.
• The auditors do not give opinion that the financial statements give a “true and
correct view”. The auditors should provide opinion as to whether the financial
statements give a “true and fair view”.
• The report should be signed both in the name of the audit firm and personal
name of the auditor.
• The report should be dated and also include the auditor’s address (i.e. the city).
C6 (3 errors/omissions X 2 marks each = 6 marks)
(Total: 20 marks)

END OF SOLUTION