Audit Practice & Assurance Services Professional 2 Examination Pilot Paper

Notes:
SECTION A Answer Question 1, and SECTION B Answer any 2 from Questions 2, 3 and 4.

Time Allowed 3.5 hours plus 10 minutes to read the paper Examination Format This is an open book examination. Hard copy material may be consulted during this examination subject to the limitations advised on the Institutes website. Reading Time During the reading time you may write notes on the examination paper but you may not commence writing in your answer booklet. Marks Marks for each question are shown. A mark of 50 or more is required to achieve a pass in this paper. Answers Start your answer to each question on a new page. You are reminded that candidates are expected to pay particular attention to their communication skills. Care must be taken regarding the format and literacy of the solutions. The marking system will take into account the content of the candidates answers and the extent to which the answers are supported with relevant legislation, case law or examples where appropriate. Answer Booklets List on the cover of each answer booklet, in the space provided the number of each question attempted. Additional instructions are shown on the front cover of each answer booklet.

The Institute of Certified Public Accountants in Ireland

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PROFESSIONAL 2 EXAMINATION - PILOT PAPER

Audit Practice & Assurance Services

PROFESSIONAL 2 EXAMINATION - PILOT PAPER TIME ALLOWED: 3.5 Hours and 10 minutes to read the paper. SECTION A - Answer Question 1, and SECTION B - Answer any 2 from Questions 2, 3 and 4. Case Study. In 2001, Roisin Everett founded Everett Stone and Quarry Ltd (ESQL). Within its first year of existence, the company completed initial development of the extraction pit area and constructed an aggregate processing plant, which is equipped to crush, screen, and wash aggregate products. By 2003 the sand and gravel operation was profitable and growing market conditions justified modifications and expansion. Currently, in early 2009, ESQL produces a wide range of sand and stone products from its pit near Cong, Co. Mayo. The materials it develops range from various sand and stone materials for residential and commercial construction and highway projects. ESQL sells to a wide variety of residential, commercial and state sector customers, with no one customer accounting for more than 5% of its total sales. ESQL has worked closely with stucco manufacturers and plastering contractors in the Irish plastering industry to produce a plaster sand (Plasand) that exceeds normal specifications and produces a superior ingredient which improves stucco and plastering finished products. Plasand has been increasingly widely accepted as superior to products offered by competitors, and now accounts for approximately 10% of the companys sales, and 12% of its profits. ESQL is currently working closely with sport complexes and golf course architects in conjunction with test laboratories to develop a sand of higher quality for use in the construction and top dressing of golf courses and sport complex playing fields. The companys level of profitability in 2008 was similar to that of 2007 - but this is well below the profitability of the preceding several years. Roisin suggested to you that, surprisingly, intense price competition from several smaller competitors in the Irish market together with the slowdown in the building industry, caused the somewhat low level of profitability. But, she added, she didnt expect the problem to last for long because she doubted that those companies could continue to operate selling at these lower prices. Roisin had hoped for a more profitable year in 2008 as a significant amount of the companys long-term debt is payable in 2009. ESQL is currently involved in discussions with the bank on refinancing. ESQL added significant additional crushing and washing plants and equipment during 2008 to increase production in the future by more than 100% while expanding capabilities to produce custom specification materials.

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In late 2008 a significant robbery took place at the companys quarrying facilities in Co. Mayo. About 20,000 of sand and aggregate was stolen during the night of December 8th when several trucks apparently drove up to the facility; loaded up and drove away. Security was lax because it was always believed that there was only a low risk of these products being stolen given their nature as high-volume low-value material. The loss is not currently shown separately in the draft financial statements but is, in effect, reflected in a lower closing inventory than would otherwise have been the case. The companys insurers have been informed and are considering the matter. They are likely, inter alia, to demand tighter security arrangements in future. However, no further details are yet available in this regard. Until 2007 and 2008, most of earnings were distributed through dividends to ESQLs five shareholders - CEO and Chair of the Board of Directors Roisin Everett, her husband Desmond Everett, CFO John Walsh and two college friends of Roisins who invested in the company, Liam Timmons and Brenda Fussmore. These five individuals make up the companys Board of Directors. This year, in reaction to pressure from a bank that provides a significant portion of the financing, ESQL established an audit committee composed of John, Liam, and Brenda. You are planning your firms fifth audit of ESQL. The previous audits have all resulted in standard unmodified audit reports with the exception of last years report which was qualified except for our inability to confirm the closing inventory valuation due to the disorganised nature of the inventory lay out and counting process. Reports from the December 2008 counts detail no such issues. The industry consists of preparation for the mining and extraction of sand and rock products. These include the activities of cleaning, separating and sorting of quarried sand and the crushing of rocks. The products are in the form of sand used in making concrete; sand used in laying bricks (contains little soil); sand used for fill (contains lots of soil, and quartz sand); and excluding the products of gravel quarrying (sandstone, gravel stone, and iron sand). While sales within the industry are relatively unaffected by changes in technology, or obsolescence, sales rely upon both the residential and commercial construction markets as well as government spending. During the past five years construction has performed well and, until the recent sharp downturn, that trend was expected to continue at least for the coming several years. The sand and gravel market in Ireland had been particularly healthy due in large part to the growth in the construction sector. The most significant question facing the industry is the length and severity of the current downturn. During the past two years the Irish economy has been in an uncertain period, and unemployment is creeping up. Thus, the questions remain concerning the continuing construction demand.

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Everitt Stone and Quarry BALANCE SHEET 31 December 2008 and 2007 (Draft) 2008 Assets Property, Plant & Equipment, net Current assets Inventory Trade receivables Other current assets Cash and cash equivalents Total current assets Current liabilities Accounts payable Current maturities of long-term loans Accrued expenses Other current liabilities Total current liabilities Net Current Assets Total assets less current liabilities 397,749 1,713,118 3,369,971 17,140 5,055 5,105,284 340,995 1,262,379 187,190 158,603 1,949,167 3,156,117 3,553,866

(Audited) 2007 74,769 1,810,361 2,383,055 10,200 3,822 4,207,438 316,164 416,607 208,460 199,629 1,140,860 3,066,578 3,141,347

Long-Term Liabilities and shareholders equity Long-term debt, less current maturity 3,249,934 Shareholders equity Ordinary Share Capital 57,333 Retained earnings 246,599 Total shareholders equity 303,932 Total Capital Employed 3,553,866

2,959,200 57,333 124,814 182,147 3,141,347

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Everitt Stone and Quarry INCOME STATEMENT Two Years Ended December 31, 2008 and 2007 2008 Sales Cost of goods sold Gross profit on sales Operating expenses Repairs and maintenance Depreciation Interest expense Total expenses Net profit before Tax Corporation Tax Net Profit after Tax 21,312,665 18,029,838 3,282,827 2,707,606 104,168 31,673 265,398 3,108,845 173,982 52,197 121,785 2007 17,261,974 14,397,853 2,864,121 2,185,542 132,083 30,098 314,419 2662,142 201,979 80,792 121,187

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Section A: Answer Question 1 Question 1 Required You are the audit manager for the year ended 31 December 2008 and you are asked to draw up extracts from the audit planning memorandum which, after consultation with the engagement partner, will be used as the basis for the initial audit team planning meeting due at the end of next week. The following issues should be covered in your extracts: a) Make a preliminary assessment of the materiality level for use on this client (4 marks) b) Identify and briefly explain how each of the components of audit risk will be affected by the information you have so far gathered about the client. (6 marks) c) Outline the main business risks faced by the client classified in the most appropriate way. Detail also factors which mitigate these risks. (12 marks) d) Identify and show the appropriate treatment of any four Key Audit Planning Issue (KAPIs) and discuss their implications in terms of the organisation of the audit. (12 marks) e) Identify and discuss the most critical financial statements assertions for the client. (8 marks) f) In relation to each of the following, list very briefly six specific audit procedures to be executed (or courses of action to be followed) i) As a result of the robbery and ii) In auditing the current maturities of long-term loans (8 marks) Your answer should demonstrate your exercise of professional judgment and understanding of an audit risk based approach as well as taking into account the information provided. (Total: 50 Marks)

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Section B: Answer any 2 out of 3 questions in this section Question 2.

An ISA (UK and Ireland) has been issued on Subsequent Events (ISA 560).

You are carrying out the audit of Richmond Engineering Limited for the year-ended 31 March 2009, and you have been asked by the partner in charge of the audit to consider the work you would perform on post balance sheet events during the audit. You expect the detailed audit work to be completed by 20 June 2009 but the directors have informed you that they will not approve the financial statements until their board meeting on 25 July 2009 - your partner will sign the audit report on the same day. In your audit of trade receivables you found that one customer, Nasser Manufacturing Limited, had a receiver appointed on 25 May 2009. The following amounts, relating to that customer, have been included in the balance sheet at the year-end: (a) A balance on the sales ledger amounting to 300,000; (b) Goods included in inventory, valued at cost, amounting to 400,000. These goods had been ordered by Nasser Manufacturing plc and were held in inventory by Richmond Engineering Ltd. at 31st March 2009. However, due to the appointment of the receiver, they were not shipped as planned on 31st May 2009. It appears as if these goods will now have to be sold at a material discount in order to recover some value. No provision has been made in the accounts (for the year-ended 31 March 2009) for these items - an appropriate note has been included in the notes to the accounts. In answering the question you should assume: (a) The potential bad debt relating to Nasser Manufacturing is material in the accounts of Richmond Engineering; (b) Richmond Engineering continues to be a going concern. Required: (a) Describe the audit work you would perform to decide whether the transactions relating to Nasser Manufacturing have been correctly treated in the financial statements, and in particular whether: (i) The item has been correctly treated as a non-adjusting post balance sheet event; (ii) The provision for the bad debt is correctly stated; (iii) Disclosure of the loss in the value of the inventory is correctly stated. (12 marks) (b) List and briefly describe seven general audit procedures relevant to this client which you would carry out during the main part of the audit (i.e. to 20 June 2009) which involve consideration of post balance sheet events. (7 marks) (c) List and briefly describe four audit procedures you would carry out immediately before the partner signs the audit report on 25 July 2009, which will cover the period (6 marks) from 20 June 2009 to 25 July 2009. (Total: 25 marks)

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Question 3. You are an audit manager currently finalising your 31 December 2008 audits. The following independent and material matters have come to your attention: 1. The audit of the statutory records of Whale Ltd, a reporting entity, revealed the following problems: Failure to update the members register for changes in shareholders; Failure to obtain written consent from directors to act; Directors minutes not prepared in respect of the current year; Failure to hold the AGM in respect of the previous financial year. The company made no comment in respect of either the failure to keep properly updated statutory registers or the holding of the AGM. 2. Shark Ltd, a reporting entity, uses the last-in first-out basis in respect of valuation of closing inventory, which is one of the most significant balance sheet accounts. The difference between first-in first-out and last-in-first-out has a material effect on the closing inventory balance. 3. ABC Ltd (ABC) is a holding company with a number of wholly owned subsidiaries. One of these, FX Ltd (FX), is a self-sustaining foreign subsidiary with manufacturing and distribution facilities throughout South-East Asia. The group accounts of ABC and its subsidiaries consist of the consolidated accounts of ABC and its subsidiaries and exclude the accounts of FX, which are attached separately. The consolidated accounts include a note stating that the directors believe that it is misleading to consolidate FX as its operations are very different from those of the rest of the group and carried out under substantially different conditions. The note includes details of inter-company balances and transactions. Required Discuss in relation to each of the above circumstances the audit issues to be considered and their likely impact on the audit opinion to be issued. Justify your answer with references to ISAs (UK and Ireland) and the Companies Acts (19632006), as appropriate. (25 marks)

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Question 4 Discuss the following issues in the context of the audit of a company such as ESQL described in the Case Study in Question 1. (a) The merits or otherwise of subjecting such a company to an obligation to have a statutory audit. (8 marks) (b) The functions that could be most usefully carried out by an internal audit function in such an organisation. (9 marks) (c) The potential impact on such a company of an obligation to have an environmental audit carried out. (8 marks) (25 Marks)

END OF EXAMINATION PAPER

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THE INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS IN IRELAND AUDIT PRACTICE AND ASURANCE SERVICES

PROFESSIONAL 2 EXAMINATION PILOT PAPER

SUGGESTED SOLUTIONS

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SOLUTION 1 Audit Planning Memorandum Client: Everitt Stone & Quarry Ltd. (ESQL) Year ended: 31 December 2008 Date: March 2009 Prepared by: A. Manager Reviewed by: a) Preliminary assessment of materiality Based on turnover ( to 1%) Based on net assets (1 to 2%) Based on PBT (5 to 10%) 107,000 to 213,000 35,000 to 71,000 8,700 to 17,400

PBT is very low compared to turnover. There is no common ground between different criteria. Suggest initial preliminary materiality 100,000. b) The components of audit risk are connected as follows: AR = IR * CR * DR AR is set by the auditor. I would suggest 3-5% (or minimum) in this case. IR would appear to be moderate to high a more detailed discussion follows but there are problems with the industry in which client operates, corporate governance, security, the general economy etc. CR would also appear to be moderate to high since the IC system would not seem to be working to its optimum. However, in previous years with one exception we have been able to give a clean audit report DR therefore needs to be low; we will need considerable evidence from substantive testing. c) There are many ways of classifying business risk. One way is to look at operational risk, financial risk and compliance risk. In this case Operational Risk Investment in development of sand and stone materials will not yield results. Mitigated by companys track record which is good, and its collaboration with customers etc. Downturn in building sector will adversely affect results. Mitigated to some degree by having a wide range of customers. Physical and security risks from nature of business and product Financial risk Decreasing profitability although for the moment company has avoided losses. Potential difficulty re-financing the companies long-term debt in 2009. Page 11 of 24

Compliance risk

Weak corporate governance structures. E.g. No outsiders on the board or audit committee. Mitigated to some extent by the entirely private nature of the company and consequently little public interest in their results.

d) KAPI Development of Plasand how is development expenditure accounted for. Going concern and refinancing

Appropriate Treatment Must follow IAS 38 if appropriate currently no such asset in BS Need to be aware of companys plans for refinancing in 2009 & to include a going concern section in our audit file. Need to ensure that this is correctly reflected and classified in the financial statements e.g. possibly as an exceptional item. Need to allow extra time on the audit of this section. Consider if there is any evidence of impairment (IAS 36) given the downturn in building insustry. Need to advise company of best practices in corporate governance matters. Need to examine the legality of any proposed dividends

Robbery and details thereof

Considerable additions to property, plant, and equipment

Corporate Governance Structures and dividend policy

e) The most critical financial statement assertions are Property, Plant & Equipment Existence & Valuation (especially new additions and possible impairments). Inventory Existence & Valuation (opening & closing), and cut-off Trade Receiveables Valuation Accounts Payable Completeness Current maturities of long-term loans Accuracy and completeness Sales Occurrence & cut-off Cost of goods sold Classification (e.g. cost of robbery) Operating expenses Classification

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f) i)_Robbery at Mayo facility: - We should follow the procedures listed below in this regard. Enquire of the company personnel of their knowledge of the matter. Review reports made to the police, insurance company etc. Enquire if any suspicions have fallen on employees or others connected to the company. We may need to report to police under money laundering legislation we will file report to practice MLRO. Consider need for separate disclosure as exceptional item. Consider effect on margins when carrying out analytical review. Review entitys calculation of amount of loss. Possible contingent asset re insurance claim. Examine the ability to make required security improvements or implications of not being able to do so. ii) Current maturities of long-term loans are critical to this companys financial statements because the going concern of the company could rest on the ability to refinance these loans. We must therefore perform the following audit tasks: Obtain a schedule of all loans and read the terms of issue Enquire/search for evidence of any breaches in covenants which could render loans repayable earlier. Ensure all interest/capital repayments are being made on time. Obtain and recheck the entitys calculation of the current portion of the loans. Circularise the financial institutions concerned for details. The standard bank letter should give sufficient details in most cases. Read details of correspondence with financial institutions. Check all direct debits to financial institutions to ensure that no unrecorded financial obligations (e.g. HP agreements) exist. Consider including in Letter of Representation.

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Marking Scheme for Solution 1 (a) Calculation based on Turnover, net assets & PBT Conclusion (b) Comments on each of AR, IR, CR, and DR Maximum of 1.5 marks each (c ) Identifying a suitable classification of risk e.g. operational, compliance and financial or internal and external For individual points maximum 1 marks for any 6 to a maximum of 6 For mitigating circumstances maximum 2 marks for any 4 up to a maximum of 6 Overall maximum for this part (d) Any 4 KAPIs 1.5 marks each Appropriate treatment of any 4 KAPIs 1.5 marks each Overall maximum for this part (e) 1 mark for each appropriate assertion identified (f) (i) 0.5 mark for any 8 appropriate points (f) (ii) 0.5 mark for any 8 appropriate points Total available marks

3 1 6 3 6 6 12 6 6 12 8 4 4 50

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SOLUTION 2 (a) It is apparent from the question that the company is treating the potential bad debt relating to Nasser Manufacturing Limited as a non-adjusting event (according to FRS 21/IAS 10). However, to decide whether it is a non-adjusting event, I would have to find out whether the appointment of a receiver to Nasser Manufacturing Limited could have been foreseen at the year-end - if the appointment of a receiver could have been foreseen at the year-end, the item should be treated as an adjusting event. To decide whether the appointment of a receiver could have been foreseen at the year-end I would: (i) Check the age of the debt at the year-end and payments by Nasser Manufacturing before the year-end - if the debt is getting progressively older, then this is an indication that it may be doubtful at the year-end. Inspect correspondence with Nasser Manufacturing - was Richmond Engineering concerned about the debt before the year-end? Was Nasser Manufacturing giving reasons for delays in repaying the debt? Ask the company's staff - the sales staff, credit controller and directors - if they were concerned about the debt before the year-end. Inspect board minutes, management reports and the credit controller's report (or 'stop list') to see if there was concern about the debt before the year-end.

(ii)

(iii) (iv)

Based on this work I would decide whether the bad debt could have been foreseen at the year-end - if it could have been foreseen at the year-end, then the item should be included as an adjusting post balance sheet event (otherwise the company's method of treating it as a non-adjusting event would be acceptable). In practice, it may be difficult to determine whether the bad debt could have been foreseen at the year-end, in which case the company's treatment would be acceptable. However, it should be noted that FRS 21/IAS 10 (Accounting for Post Balance Sheet Events) states in the appendix that this item would normally be treated as an adjusting event. The next matter to consider is how much of the year-end debt is likely to prove bad. To estimate this provision I would: (i) Check if there has been any cash received between the year-end and the date of the audit - this would reduce any provision required against the year-end debt. In practice it is unlikely that any cash will have been received since the year-end. Ask the company's staff if they have received any notification from the receiver about the likely dividend to unsecured creditors. Contact the receiver and ask him if he can give an estimate of the dividend to unsecured creditors. Ask if there is a statement of affairs prepared by the receiver, which may give an indication of the dividend to unsecured creditors. Page 15 of 24

(ii)

(ii)

(iii)

(iv)

Ask the company if they have supplied any of the goods subject to reservation of title-if they say this is the case, I would obtain legal advice on whether the retention of title clause is likely to be effective. If the goods are validly sold subject to reservation of title, they may be either repossessed or the money obtained for the debt, in which case a smaller bad debt provision may be required.

Based on this work I would decide whether the provision included in the notes to the accounts is correctly stated. I would then have to consider the position of the goods held in inventory at the yearend: (i) If some of these goods were sold to Nasser Manufacturing between the year-end and the date the receiver was appointed, a provision should be made on this inventory, which would be the same percentage as that taken for the bad debt. It is probable that this item will be disclosed as a non-adjusting event, as the sale took place after the year-end. For the remaining inventory I would have to consider what its net realisable value is likely to be - if net realisable value is less than cost, the loss to be included in the accounts should be the difference between the cost of the inventory and its net realisable value. I would ask the company's staff if the inventory could be sold to another customer - if this is the case, then it is probable that net realisable value will be more than cost.

(ii)

However, if the inventory is of a specialised nature I will have to consider: Whether Nasser Manufacturing will continue in business, and produce items that will require this inventory - Nasser Manufacturing's business may be sold to another company and its trade continued. If this is likely, then the inventory may be worth more than cost - I will ask Nasser Manufacturing's receiver if he is likely to sell Nasser's business; If Nasser Manufacturing is unlikely to stay in business, then the value of the inventory is likely to be scrap value.

Based on this work I would consider whether the company's disclosure of the likely loss on the inventory is correctly stated in the notes to the accounts - it is probably acceptable to treat this loss as a non-adjusting post balance sheet event. (b) Many audit procedures include consideration of post balance sheet events. These include: a. Inventories and work in progress - looking at the selling price of inventory and the level of sales of inventory after the yearend to determine whether any year-end inventory should be valued at net realisable value. Page 16 of 24

b. Trade receivables -look at cash received after the year-end, which clears year-end debts, to see where bad and doubtful debt provisions are required. c. Prepayments and sundry receivables - check the 'cash book to see if any cash is received after the year-end relating to these items - this may also highlight any items which have not been included in the accounts. d. Cash at bank or bank overdraft - in the bank reconciliation, checking that the bank credits un-credited lodgments at the year-end promptly after the year-end -late crediting of these items may indicate a teeming and lading fraud. Checking that un-presented cheques in the bank reconciliation are debited by the bank promptly after the year-end if there is a significant delay in a batch of cheques being paid by the bank, then this may be an indication that the cheques (included in the cash book before the year-end) were sent to customers after the yearend, in which case an appropriate adjustment should be made to the year-end bank overdraft and creditors. e. For trade creditors and accruals, a payment after the year-end may be a good indication of the amount owing at the year-end payments in the cash book after the year-end should be scrutinised to check that all creditors at the year-end have been included. Purchase invoices received after the year-end may help in estimating accruals at the year-end (e.g. electricity and telephone invoices). f. Board minutes and management reports should be inspected to see if there are any post balance sheet events relevant to the accounts. I would also look at any monthly accounts issued after the year-end. g. Any disposals of fixed assets after the year-end would be checked to see if there are any significant profits or losses on their disposal - if there is a loss on disposal, and the disposal could have been foreseen at the year-end, an appropriate provision should be made against the item in the year's accounts. Checking post balance sheet events is also helpful in determining whether the disclosure of capital commitments is correct (e.g. checking fixed assets ordered or purchased immediately after the year-end).

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h. The company secretary and the directors would be asked if there are any material post balance sheet events not included in the accounts (e.g. legal claims against the company) - a note that there are no undisclosed material post balance sheet events could be included in the letter of representation. i. Any post balance sheet information relating to other items in the accounts (e.g. agreement of taxation liabilities) would also be considered. (c) The checks I would perform for the period between 20 June 2009 and 25 July 2009 are likely to be similar to those described in (b) above, but normally in less detail. I would: a. Check any board minutes and management reports issued during this period. b. Check if there is any further information about items which were uncertain at the end of the main audit - these could include: The outcome of the bad debt with Nasser Manufacturing Limited, and any other doubtful debts; Whether any slow moving inventory has subsequently been sold - if it was sold, it would help to determine its value in the accounts; The outcome of any legal claims against the company. c. The company secretary and the directors would be asked if there have been any material post balance sheet events in the period that may affect the accounts. d. Check transactions in the cash book to the date the accounts are approved by the directors - this could highlight any unusual items. I would also look at the level of bank overdraft to check that the bank overdraft limit is not being exceeded. Marking Scheme for Question 2 (a)(i) (ii) (iii) 1 mark for any points as per solution or other relevant points max 1 mark for any points as per solution or other relevant points max 2 marks for each of the 2 main points in solution or 2 marks for discussion of the position if inventories are specialised maximum Overall maximum for this part 1 mark for any of the 9 procedures mentioned in the solution or other relevant procedures to a maximum 1.5 mark for any of the 4 procedures mentioned in the solution or other relevant procedures to a maximum Total available marks 5 5

6 12 7 6 25

(b) (c )

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SOLUTION 3 1. In this case there are a number of breaches of the Companies Acts (1963-2006) by Whale Ltd. When the audit is conducted in accordance with the Companies Act, the auditor has a duty to report on compliance with the requirements of that Act. A qualified opinion is expressed when there is non-compliance with relevant statutory or other requirements. The opinion may be separate from the opinion on truth and fairness. The auditor also has responsibilities to report certain breaches of the Companies Acts (1963-2006). The 1990 Act requires the auditor to report if: Proper accounting records and returns from branches adequate for the audit have not been kept; The financial statements are not in agreement with the accounting records; The auditor has not received information and explanations necessary for the purpose of the audit. Furthermore, if the financial statements do not meet requirements as to the disclosure of directors' remuneration, the auditor must provide the required information in the report. In the case of Whale Ltd there are breaches of the Companies Acts (1963-2006) which may require to be reported to the Office of the Director of Corporate Enforcement (ODCE) under S74 of the Company Law Enforcement Act, 2001. The auditor may also take the view that the failure to keep minutes of directors meetings constitutes a failure to keep proper books of account this would also both require to be reported to the ODCE and would required a qualified audit report. It could also mean the auditor is unable to obtain all the information and explanations he requires. This could be another point of qualification on the audit report because it would amount to a limitation of scope. 2. LIFO is not a permitted method to account for stock under IAS 2 or SSAP 9, Accounting for Stock and Long-term-contracts. The difference between Shark Ltd using LIFO and FIFO has a material effect on the closing inventory account balance and on the income and expenditure statement. You would request Sharks management to change its stock valuation method to FIFO (or another acceptable method according to IAS2/SSAP 9). If management disagree with you over this matter you would probably issue an except for audit opinion. This audit opinion is issued when the auditor in his or her report can readily explain the nature of the disagreement and its impact on the financial statements. 3. The argument put forward by ABC Ltd not consolidate would appear not be acceptable in that the Accounting Standards state that exclusion on the grounds of different activities does not apply merely because some of the undertakings are industrial and some commercial or because their activities involve different products or services. The audit report on the financial statements of ABC Ltd therefore needs to be qualified on the grounds that certain subsidiaries have been excluded from consolidation. It would be up to the auditor to decide if this matter was material and thus merited an except for disagreement qualification, or if it was a fundamental matter that warranted an adverse opinion. In the unlikely that the auditor agrees that Page 19 of 24

exclusion from consolidation is acceptable; even then it would appear that the accounting treatment is inadequate. The financial statements of the excluded subsidiary should be included with the group financial statements and the excluded subsidiary accounted for, within the consolidated financial statements by the equity method. Marking scheme for Solution 3 1 General comment on position Need to keep proper books of account Need for information & explanations Mention of need to report to ODEC under CLEA 2001 Potential failure to keep proper books of account need to report to ODEC and qualify audit report Possible limitation of scope Other relevant points up to Overall maximum for this part LIFO not allowed by IAS 2, or Companies Acts Impact is material Qualified AR - disagreement Overall maximum for this part Consolidated accounts required by Company Law & IFRSs Dissimilar activities no reason for exclusion Attaching separately considered inadequate Qualified AR needed Material or fundamental and consequences If auditor agrees with non-consolidation use equity method Other relevant points Overall maximum for this part Total available marks 2 1 1 2 2 1 3 10 2 1 2 5 2 2 1 1 2 2 2 10 25

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SOLUTION 4 (a) ESQL could reasonably be described as a large private company. It has a turnover well in excess of the current threshold in Ireland above which a company is required by stature to have an audit i.e. 7.3M. In general the merits or otherwise of subjecting companies such as ESQL to audit are as follows. Subject to mandatory audit The audit, via reports to management, provide useful commercial advice i.e. improvement to control/efficiency. An example of this in the case of ESQL Ltd could be the provision of advice on an appropriate corporate governance structure for the company. For most small/medium firms the auditor will also act as accountant/tax advisor and the relative costs of removing audit work will be low. If companies such as ESQL wish to save the audit fee they can reform as partnerships/sole traders, although in the case of ESQL legal factors may mean that this is not really an option. The regulatory regime of the Recognised Supervisory Bodies provides quality control safeguards, which will be lost as accountants need not be Registered Auditors. Abolish mandatory audit It is an unfair burden on companies and proportionally more unfair on relatively smaller companies because there are certain fixed costs associated with having an audit. If 'other users' wish to rely on the financial statements they can require an audit to be conducted (and hence greater opportunity for 'auditor' to be liable). In any case for a company such as ESQL there are a limited number of other users who may all have access to the additional information they need. Other users do not rely on auditor's report (hence credit rating agencies, employee tax and sales tax (VAT) inspections). If companies such as ESQL wanted an auditor's report included with their financial statements, they could still have one.

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(b)

Some potential internal audit assignment in ESQL would be as follows: Operational reviews Systems reviews Value for money reviews Financial reviews Carrying out risk assessments

An operational review is a review of the operational processes of the organisation. They are also known as management or efficiency audits. Their prime objective is the monitoring of managements performance, ensuring company policy is adhered to. An operational review involves two areas: Evaluating whether the policies are adequate Evaluating whether the policies work effectively.

The former is achieved by obtaining, reading and discussing the policies with members of the department concerned. The latter is achieved by observing the policies and testing them. approach is very similar to tests of controls for external audit work. The testing

A good example of an area requiring an operational review in ESQL would be security. Systems reviews can involve: Reviewing company procedures and processes Reviewing computer systems operation, adequacy and effectiveness (IT reviews).

Value for money (VFM) reviews are concerned with evaluating the three Es: Economy Obtaining the resources needed at the cheapest cost

Efficiency

Using the resources purchased as wisely as possible Doing the right things and meeting the organisations objectives

Effectiveness

Reviews concerned with solely the Economy objective are often termed Best Value reviews. Financial reviews are undertaken Either for performance evaluation purposes Or as a control performed by internal or external audit. A financial review of ESQL may be needed in the light of the impending need to repay borrowings in 2009.

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Internal Audit would also be likely to carry out risk assessments in certain areas such as, for example assessments of physical risk in the quarrying activities or assessment of financial risk arising from the levels of gearing. (c) Over the last 10 years environmental issues have become increasingly important as public awareness has grown. As a result: (a) (b) There are numerous environmental laws which must be complied with (e.g. clean air requirements, green belt protection). Companies are required or being encouraged to provide extra disclosures.

However, at the moment there is no specific requirement for companies to produce an environmental report. A template for best practice in the area is the Global Reporting Initiative. However, adherence to this tends to be confined to the large multinationals and smaller companies such as ESQL do not normally produce such reports. Environmental compliance is, however, relevant to both big and small companies. Implications for businesses Even now companies must comply with environmental laws or risk a fine. There are, no doubt, many environmental regulations relevant to ESQL. These may include: Direct regulation (e.g. in relation to the operation of quarries) Specific market issues (e.g. use of certain substances may be prohibited) In the future they might include requirements for environmental reporting, The exact consequences for ESQL would depend on what type of requirement was brought into being. Even now, auditors have a duty to assess the material impact of noncompliance with laws and regulations under ISA 250 as part of their risk assessment. Auditors must therefore collect information on laws and regulations that the entity must comply with by, for example: Discussion with management Discussion with compliance departments Correspondence with regulatory authorities Industry experts within the firm

Where non-compliance is detected, the effect on the financial statements and the auditors report needs to be considered. Examples of effects on financial statements: Accruals for fines Asset impairments as a result of contamination Provisions for legal/constructive obligations for environmental clean-up Going concern issues where environmental licences are withdrawn. All of these issues could be expected to increase in importance in the future. Companies such as ESQL will therefore face higher audit fees and greater regulatory burdens. However, they may benefit from good publicity from being seen as green and less scepticism on such matters from the general public. Page 23 of 24

Marking Scheme for Question 4 Note: Question 4 is more discursive than the other question so the marking scheme reflects this. (a) Advantages of an audit 3 Disadvantages of an audit 3 Application of the solution to ESQL or similar company 3 Overall maximum for this part 8 (b) Functions that can be carried out Systems review 2 Operational review 2 VFM review 2 Financial review 2 Other type of review 2 Overall maximum for this part 9 (c) Environmental reporting - explanation 2 Current impact 2 Effect of non-compliance 1 More expensive & burdensome 1 Depends on specific requirements 1 Possible positive consequences 1 Other relevant points 2 Overall maximum for this part 8 Total available marks 25

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