PROFESSIONAL STAGE APPLICATION EXAMINATION TUESDAY 14 JUNE 2011 (2 hours)

AUDIT AND ASSURANCE

This paper consists of SIX short-form questions (20 marks) and THREE written test questions (80 marks). 1. 2. Ensure your candidate details are on the front of your answer booklet. Answer each question in black pen only.

Short-form Questions (1 6) 3. 4. Answer the short-form questions in note form only. Complete sentences are not required. Answers to each short-form question must begin on a new page and must be submitted in numerical order.

Written Test Questions (7 9) 5. 6. Answers to each written test question must begin on a new page and must be clearly numbered. Use both sides of the paper in your answer booklet. The examiner will take account of the way in which answers are presented.

IMPORTANT Question papers contain confidential information and must NOT be removed from the examination hall. Place your label here. If you do not have a label you MUST enter your candidate number in this box

DO NOT TURN OVER UNTIL YOU ARE INSTRUCTED TO BEGIN WORK

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1.

Erica Green is the engagement partner responsible for the external audit of Snipe plc (Snipe), a listed company. Erica is due to be rotated off the audit team as she has been in post for the last five years. Following recent substantial changes in the structure of the companys business, the audit committee of Snipe has requested that Erica continues to act as engagement partner for the next two years. State, with reasons, whether it is appropriate for Erica to comply with the audit committees request. (2 marks)

2.

The managing director of Birdie Ltd, an external audit client of your firm, has discovered that an employee has diverted 30,000 of company funds into his own bank account by creating and paying purchase invoices on fictitious supplier accounts over the last twelve months. The managing director has contacted your firm to express his concern that the audit team did not discover this fraud during the external audit and has requested a meeting with the engagement partner to discuss the issue. The financial statements for the current year show revenue of 25 million and profit before tax of 1.5 million. Explain why the managing directors expectation that the audit team should have discovered the fraud is unrealistic. (4 marks)

3.

Your firm has been engaged by the management of Divot plc (Divot) to undertake a review of and provide an assurance report on the interim financial information of Divot for the six months ended 31 May 2011. The terms of the engagement include applying analytical procedures to the interim financial information. Divot operates in the textile sector and has a comprehensive system for reporting financial results to the board of directors, including comparison against budget. Outline how you should use analytical procedures when reviewing the interim financial information and state the limitations of using analytical procedures as a source of evidence. (4 marks)

4.

Animal Welfare is a not-for-profit entity which derives some of its income from donations made by the public through collecting boxes in retail outlets and restaurants. Following a number of thefts of cash collected through collecting boxes and, in some cases, theft of the collecting boxes, the trustees of Animal Welfare have requested that your firm undertakes a comprehensive review of the internal controls exercised over the collection, custody and recording of cash donated through collecting boxes. Describe four internal control procedures that should be exercised over the system of cash donations received through collecting boxes. (4 marks)

5.

During the external audit of Albatross Ltd for the year ended 31 March 2011, it was discovered that a sales credit note, relating to a large pre-year-end delivery of inventory, was issued to a customer on 21 April 2011. Explain why the external audit team should investigate this matter. (2 marks)

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6.

During the external audit of Eagle Ltd (Eagle), the audit senior discovered that the company does not undertake periodic reconciliations of the plant and equipment register with the physical assets. Prepare notes, in readiness for drafting the audit firms report to the management of Eagle, which outline the possible consequences of this internal control deficiency and provide recommendations to remedy the deficiency. (4 marks)

QUESTION 6 COMPLETES THE SHORT-FORM QUESTIONS WRITTEN TEST QUESTIONS (7 9) FOLLOW

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7.

Your firm is the external auditor of Brandsco Retail Ltd (Brandsco) for the year ended 31 May 2011. The audit manager responsible for the external audit of Brandsco has been taken ill and you have been assigned to replace her. She has prepared the audit strategy but not the audit plan. The audit strategy identifies the following as key areas of audit risk: (1) (2) (3) (4) Revenue Purchases and trade payables Inventory E-commerce development costs

The strategy also includes the following extracts from the financial statements for the years ended 31 May: 2011 (draft) 000 Income statement Revenue Purchases Statement of financial position Non-current assets E-commerce development costs Current assets Inventory Current liabilities Trade payables 106,400 84,800 2010 (audited) 000 95,100 77,900

3,200 15,100 8,200

13,200 8,400

On reading the background information you ascertain the following: The principal activity of Brandsco is the retailing of discounted branded goods, including designer clothing, beauty products and household goods, at up to 60% off their recommended retail prices. The company purchases products which are end-of-line, close to end of shelf-life, slightly damaged and in the case of designer clothing, the previous years designs, from suppliers based throughout the world. The majority of overseas suppliers are paid in their local currency. Historically, goods were only sold through the companys 15 retail outlets in the UK. However, in March 2011, the company launched its new website with e-commerce features including online ordering and payment. The development of the website was undertaken by Desweb Ltd (Desweb), a company specialising in website design and e-commerce development, in conjunction with employees from Brandscos IT department. Desweb supplied the software and other support services. Additional hardware, necessary for the launch, was purchased from a variety of suppliers. Initially, the company suffered operational problems with its e-commerce sales due to a technical fault with the online ordering system resulting in duplication of orders and shipments. Additional costs were incurred to fix the fault and the directors are now confident that the technical problem has been resolved and all of the inventory relating to the duplication of orders has been recovered.

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Customers buying from the retail outlets pay by cash, credit or debit card. Customers buying over the internet pay by credit or debit card. Any customers who are not satisfied with a purchase are entitled to a full refund, if they return the product within 30 days of purchase. The company has standardised operating procedures, processes and structures in every retail outlet. All outlets have electronic point of sale systems which record the sale of an item and update the inventory records which are checked by periodic counting by store staff. Consequently, the company does not undertake an inventory count at the year end. Each week, the inventory system generates an inventory valuation listing and an aged inventory report. The inventory valuation listing includes the cost, current selling price and quantity on hand for each inventory item. The aged inventory report details the length of time each item has been in the retail outlet. All employees are entitled to a bonus based on the level of profit achieved by the company. At a meeting with Navan Patel, the finance director of Brandsco, he informed you of the following developments: (i) The board of directors of Brandsco (the board) has decided to introduce an internal audit function to evaluate and monitor the adequacy and effectiveness of the companys internal controls. The board intends to outsource the function for five years and would like your firm to tender for the contract. Navan is due to retire in September and the board would like your firm to assist with the recruitment of a suitable candidate to replace him and also advise on the remuneration package. The board has decided to introduce cafs into its retail outlets to widen its customer base. The finance director has prepared profit and cash flow forecasts which are to be submitted to the companys bank in support of an application for funding. The board would like your firm to examine and provide an assurance report on the forecasts.

(ii)

(iii)

Requirements (a) Justify why the items listed in (1) to (4) in the scenario have been identified as key areas of audit risk and, for each item, describe the procedures that should be included in the audit plan in order to address those risks. (24 marks) NOTE: (b) You should present your answer in a two-columnar format using the headings (i) Justification; and (ii) Procedures to address the risk.

Identify and explain the threats to objectivity and state how your firm should respond to those threats in respect of the boards requests for the provision of services regarding: (i) (ii) the internal audit function; and the recruitment and remuneration package of the finance director. (10 marks)

(c)

Describe the matters to be included in your firms engagement letter for the examination of the profit and cash flow forecasts in respect of: (i) (ii) the directors responsibilities; and the purpose and scope of your firms work. (6 marks) (40 marks)

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8.

Your firm, which has 15 offices throughout England and Wales, has been invited by Alison Stableford, the managing director and majority shareholder of Traveluxe Buses Ltd (Traveluxe), to accept appointment as external auditor of the company for the year ending 31 December 2011. Traveluxes current auditors have notified the company that they will not be seeking re-appointment at the companys forthcoming AGM. Traveluxe operates bus services in Wales and the south west of England. The provision of such services is highly regulated as operators must have a licence to operate and are required to comply with regulations relating to bus drivers working hours and the safe condition of the buses. Traveluxe has two main lines of business: contract hire and private hire. Contract hire includes the provision of scheduled bus services and school buses, all of which are commissioned by government bodies under renewable contracts. Private hire includes the provision of bus services to individuals and organisations. The accounting function is centralised at Traveluxes head office in Wales. However, the processing of payroll is outsourced to a service organisation, which is responsible for payroll preparation and the submission of returns to HMRC. Traveluxe has grown significantly over the last six months. In March 2011, Traveluxe acquired all of the share capital of Roaches Coaches, a company specialising in private hire, based in the Republic of Ireland. The purchase consideration was paid in euro, the currency of the Republic of Ireland. As a result of the acquisition, Traveluxe will have to prepare, for the first time, consolidated financial statements for the year ending 31 December 2011. The expansion was funded by a bank loan and cash introduced as an interest-free loan by Alison Stableford. The loan agreement with the bank specifies that audited financial statements must be delivered to the bank within three months of the year end. Requirements (a) Identify and explain the matters that should be considered by your firm in deciding whether to accept appointment as external auditor to Traveluxe. Your answer should include any preliminary audit risks identified from the information provided. (14 marks) State the responsibilities of the outgoing firm of external auditors relating to the change of appointment as set out in the ICAEW Code of Ethics. Give reasons for each of the responsibilities. Note: You are not required to refer to the Companies Act 2006 provisions in respect of a change of external auditor. (6 marks) (20 marks)

(b)

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9(a) Explain and distinguish between the following three types of modified audit opinions: (i) (ii) (iii) qualified opinion; adverse opinion; and disclaimer of opinion. (6 marks)

9(b) You are an audit manager. Described below are situations which have arisen at two unrelated external audit clients of your firm which have been brought to your attention by members of the audit teams. The year end in each case is 31 March 2011. Par Ltd (Par) Whilst inspecting customer correspondence, an audit junior discovered a letter from Tee plc (Tee), Pars largest customer. The letter, dated 20 April 2011, informed Par that following a strategic review of its supply base, Tee was not going to renew its contract with Par when the current contract expires in September 2011. Sales to Tee represent 60% of Pars revenue. Fairway Ltd (Fairway) Work in progress at 31 March 2011 includes a batch of partly-finished agricultural machines at a cost of 700,000. The machines were completed during the first week of April 2011 at a further cost of 300,000. The machines were rejected by the customer who had commissioned them, but were sold to another customer for 950,000 on 12 May 2011. The total assets of Fairway at 31 March 2011 are 19.8 million and the profit before tax for the year ended 31 March 2011 is 2.5 million. Requirement For each of the situations outlined above: (i) (ii) state, with reasons, the actions you would take; and discuss the implications for the audit reports on the financial statements of Par and Fairway and describe the effects, if any, on each audit report. (14 marks) (20 marks)

The Institute of Chartered Accountants in England and Wales 2011.

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