OBJECTIVE TEST CASE QUESTIONS
The following scenario relates to questions 1 – 5
The board of directors of Sistar Co are concerned that they are not currently applying best practice in terms of corporate governance and are seeking to make improvements.
The company currently has three non-executive directors (NEDs) on the board, who are paid a fee which changes annually depending on company performance. The NEDs all sit on the audit, nomination and remuneration committees. There are currently no formal documents setting out the responsibilities of these committees.
At present, Sistar Co does not have an internal audit function but the directors are establishing a team which will be responsible for a range of internal audit assignments.
The following is the current proposed structure for the internal audit (IA) department
The only role still to be filled is the Head of internal audit. There are two potential candidates: Paul Belling a consultant who helped design and implement the company’s current control system, and Maria Marquez who is currently an audit manager at Rossi & Bell, an audit firm which has never been used by Sistar Co.
Out of the other three members of the proposed IA department, two of them have moved from other departments in Sistar Co and one of the audit assistants has audit experience.
- Select whether the following should be included in a formal document regarding the responsibilities of the audit committee.
Include in formal document
To monitor and review the effectiveness of the newly established internal audit function
To evaluate the balance of skills, experience and independence of board members
To take responsibility for the appointment and removal of the external auditors
To monitor and review the effectiveness of internal financial controls established by the company
- Which of the following options correctly describes the deficiency relating to NEDs’ remuneration and makes a valid recommendation for improvement?
|A||Compromises NED independence||NEDs should be remunerated on the same|
|basis as the executive team|
|B||Compromises the motivation of NEDs||NEDs’ remuneration should be tied to profit|
|C||Compromises NED independence||NEDs’ remuneration should be a set amount|
|based on time committed|
|D||Compromises the motivation of NEDs||NEDs’ remuneration should be linked to|
|individual performance||(2 marks)|
- The board is in the final stages of establishing the IA department.
Select one option from each column which provides appropriate recommendations to improve the effectiveness and independence of the IA department.
- The board has started to compile a list of tasks for the IA department to carry out once it is up and running. It has been agreed that the first assignment to be completed will be for IA to review Sistar Co’s processes over capital expenditure to verify if the right items are purchased at an appropriate time and competitive price.
What type of internal audit assignment does this represent?
- A value for money audit
- A management audit
- A financial audit
D An IT audit (2 marks)
- When deciding on the role of the IA department in undertaking operational audits, which TWO of the following should the team NOT be involved in?
AObserving procedures carried out by Sistar Co’s staff
BReperforming procedures documented in procedures manuals
CDesigning and implementing internal control procedures to address deficiencies
DReporting findings directly to the board of directors
E Authorising transactions and performing reconciliations (2 marks)
The following scenario relates to questions 6 – 10
You are an audit senior of Bark & Co and have been allocated to the audit of Foliage Co, a listed company which has been an audit client for eight years and specialises in manufacturing musical instruments. Jane Leaf was the audit engagement partner for Foliage Co and as she had completed seven years as the audit engagement partner, she has recently been rotated off the audit engagement. The current audit partner has suggested that in order to maintain a close relationship with Foliage Co, Jane Leaf should undertake the role of Engagement Quality Control Reviewer this year. The total fees received by Bark & Co for last year amounted to 16% of the firm’s total fee income. The current year’s total fee income for audit, non-audit and tax services is expected to be greater than last year. The audit manager for Foliage Co has just announced that he is leaving Bark & Co to join Foliage Co as the financial controller.
- What is the most appropriate response to the suggestion that Jane Leaf takes on the role of Engagement Quality Control Reviewer?
AJane Leaf could take the review role immediately
BJane Leaf could take the review role immediately but additional safeguards will be required
- Jane Leaf should not serve as the Engagement Quality Control Reviewer for a period of at least two years
D Bark & Co will need to consider resigning as auditors of Foliage Co (2 marks)
- Which is the LEAST appropriate response in relation to fee income received by Bark & Co from Foliage Co?
ABark & Co should assess whether audit and non-audit fees would represent more than 15% of gross practice income for two consecutive years
BIf the recurring fees are likely to exceed 15% of annual practice income this year Bark will need to resign as auditors of Foliage Co
CIf the recurring fees are likely to exceed 15% of annual practice income this year, additional consideration should be given as to whether the taxation and non-audit assignments should be undertaken by the firm
D If the fees do exceed 15% this should be disclosed to those charged with governance
at Foliage Co (2 marks)
- Which ethical threat will be created when the audit manager commences employment with the client and what action should be taken to manage the threat?
The manager should not be allowed to take the role of financial controller
The composition of the audit team must be reviewed and changed as appropriate
The manager should not be allowed to take the role of financial controller
The composition of the audit team must be reviewed and changed as appropriate
- Select whether the following statements describe a rulebook approach or a conceptual framework approach to ethics.
Clearly defined laws for the auditor to follow
Useful in a dynamic profession
A set of guidelines with which the auditor uses judgment to apply to specific circumstances
Easy to know what is allowed and not allowed
OBJECTIVE TEST CASE QUESTIONS : SECTION 1
- Which TWO of the following are fundamental principles as stated in the ACCA’s Code of Ethics and Conduct?
- Professional scepticism
- Professional judgment
E Confidentiality (2 marks)
The following scenario relates to questions 11 – 15
You are the audit manager of Miranda & Co and you are planning the audit of Milberry Co, which has been an audit client for four years and specialises in manufacturing luxury handbags. The audit senior has recently resigned and is now employed as financial controller of Milberry Co. During the planning stage of the audit you have obtained the following information. The employees of Milberry Co are entitled to purchase handbags at a discount of 40%. The audit team has been offered the same level of staff discount.
From a review of the correspondence file you note that the partner and the finance director have known each other socially for many years and in fact went on holiday together last summer with their families. As a result of this friendship the partner has not yet spoken to the client about the fee for last year’s audit, 20% of which is still outstanding.
- Which of the following statements in respect of the relationship between the new financial controller and the audit firm are true?
AThe audit approach should be revised to ensure procedures and items to be tested are not predictable
BThe audit team should comprise people who know the audit senior as this will make the audit run more smoothly and increase efficiency
CThe firm must resign as auditor as the threat to objectivity is too significant to safeguard
D The audit senior should not be allowed to be the financial controller and should
resign (2 marks)
- Which of the following threats to objectivity does the offer to purchase handbags at a discount of 40% create?
D Intimidation (2 marks)
- Which is the MOST appropriate response with respect to the discount offered by Milberry Co to the audit team?
AThe discount may be accepted as it is the same as that offered to the client’s employees
BThe discount should be rejected as it is unlikely to be a trivial monetary amount
- The discount should be rejected as gifts or hospitality are not acceptable per the ACCA Code of Ethics
D Audit manager approval must be obtained before the discount is accepted (2 marks)
- Select which threat to objectivity is created by the information obtained from the review of the correspondence file.
Advocacy Familiarity Self-interest
The partner and the finance director have
known each other socially for many years
20% of the fee for last year’s audit is still
- Which is the most appropriate response to the outstanding fees from Milberry Co?
AThe auditor should resign from the client
BThe auditor should report the client to the ACCA
CThe auditor can continue working for the client but should ensure that the audit firm’s credit control department are informed of the outstanding fees
D No work should be performed until either payment is made or a repayment plan
agreed (2 marks)
The following scenario relates to questions 16 – 20
You are an audit manager in Tigger & Co, a large audit firm which specialises in the audit of car manufacturers. The firm currently audits Winnie Co. Winnie Co’s main competitor, Piglet Co, has approached Tigger & Co to act as auditor. The audit engagement partner for Winnie Co has been in place for approximately six years. Winnie Co has approached Tigger & Co to provide internal audit services as well as the external audit. They have suggested that the external audit fee should be renegotiated with at least 20% of the fee being based on the profit after tax of the company as they feel that this will align the interests of Tigger & Co and Winnie Co.
- Which of the following statements is FALSE in respect of the audits of Winnie Co and Piglet Co?
ATigger & Co will have a good understanding of the car manufacturing industry making them a good choice of firm for both companies
BWinnie Co and Piglet Co may be concerned that commercially sensitive information may be disclosed by Tigger & Co to their competitor
CTigger & Co must ask permission of ACCA before accepting the audit of Piglet Co
D Tigger & Co must obtain consent of both clients before continuing with the
engagements (2 marks)
- Which of the following is NOT an action that your firm should take to manage the conflict of interest between Winnie Co and Piglet Co?
ARegular monitoring of safeguards by an engagement quality control reviewer
- Require every employee of Tigger & Co to sign a confidentiality agreement
- Use separate engagement teams with different engagement partners
D Operate secure data filing of all audit information (2 marks)
- Select whether the following statements are true or false in respect of the audit of Winnie Co.
The audit partner must be rotated
The proposal of 20% of the audit fee being based on profit is acceptable if appropriate safeguards are implemented
Being appointed as internal auditor as well as
external auditor for Winnie Co will create a
- In relation to the proposal that 20% of the audit fee is based on the profit after tax of the company, which of the following statements is TRUE?
AThis will lead to fee-dependency which is a self-interest threat. The proposal should be rejected.
BThis is a contingent fee arrangement which creates an advocacy threat. The proposal should only be accepted if no more than 15% of the audit fee is based on profit before tax
CThis is a contingent fee arrangement which creates a self-interest threat. The proposal should be rejected.
- This will lead to fee-dependency which is a self-interest threat. The proposal should only be accepted if no more than 15% of the audit fee is based on profit before tax
. (2 marks)
- For which TWO of the following situations should an auditor make VOLUNTARY disclosure of confidential information?
- If an auditor knows or suspects his client is engaged in money laundering
- Where disclosure is made to non-governmental bodies
- When the client has given permission
D If an auditor suspects his client has committed terrorist offences (2 marks)
The following scenario relates to questions 21 – 25
Cameron Co has recently become a listed company. Cameron Co is required to comply with corporate governance principles in order to maintain its listed status; hence the finance director has undertaken a review of compliance with corporate governance regulations.
Mr Osbourne is the chairman of Cameron Co and is also the chief executive. Cameron Co’s board of directors comprises six members, two of which are independent non-executive directors. Mr Osbourne is considering appointing one of his close friends as a non-executive director.
Executive directors are paid a fixed salary which increases annually in line with inflation. There is no performance related pay or bonus as the company does not want to provide incentive for financial results to be manipulated.
The company does not have an audit committee or an internal audit department.
- Which of the following is NOT a benefit to Cameron Co of forming an audit committee?
AThe audit committee will provide the shareholders with a channel to communicate with the company on a monthly basis to increase shareholder satisfaction
BThe quality of financial reporting may be improved
C Liaison with the external audit firm will improve its independence
D Internal control awareness will be enhanced within Cameron Co (2 marks)
- Select whether the following matters represent a corporate governance strength or deficiency.
Mr Osbourne is the chairman and chief executive of Cameron Co
All of the current NEDs are independent
Once established, the finance director will head the audit committee
For each of the following issues match to the appropriate response.
- The board is not balanced
- Mr Osbourne is considering appointing his friend as a non-executive director
- An audit committee should be set up immediately
- Remuneration of executive directors should be performance related
- Appointment of non-executives should be based on experience
- Appoint two more independent non-executive directors
- Reduce the number of executive directors on the board
- Select whether the following statements in relation to directors’ remuneration are true or false.
The Chairman of the company, Mr Osbourne, should be responsible for setting the remuneration of each director
The remuneration of executive directors should be sufficient to attract, retain and motivate
An element of the executive directors remuneration should be performance related
- Which of the following is NOT a principle of the UK Corporate Governance Code?
AThere should be a rigorous and transparent procedure for the appointment of new directors to the board
BThe board should use the AGM to communicate with shareholders
CA risk committee must be established to ensure effective risk management systems are established
D All directors should receive induction training on joining the board and regular
training to ensure they maintain their skills and knowledge (2 marks)
The following scenario relates to questions 26 – 30
Sycamore & Co is the auditor of Fir Co, a listed company operating in the computer software industry. The audit team comprises an engagement partner, a recently appointed audit manager, an audit senior and a number of audit assistants. The audit engagement partner has only been appointed this year due to the rotation of the previous partner who had been involved in the audit for seven years. Only the audit senior has experience of auditing a company in this specialised industry. The previous audit manager left the firm before the completion of the prior year audit and is now the finance director of Fir Co. The finance director and new audit manager are good friends.
The board of Fir Co has asked if Sycamore & Co can take on some additional work and have asked if the following additional non-audit services can be provided:
- Routine maintenance of payroll records
- Assistance with the selection of a new non-executive director
- Tax services whereby Sycamore & Co would liaise with the tax authority on Fir Co’s behalf.
Sycamore & Co has identified that the current year fees to be received from Fir Co for audit and other services will represent 16% of the firm’s total fee income and totalled 15.5% in the prior year. The audit engagement partner has asked you to consider what can be done in relation to this self-interest threat.
- In relation to the composition of the current audit team, select which of the fundamental principles is at risk and select an appropriate safeguard.
- Professional competence and due care
- Reinstate previous partner
- Resign from the engagement
- Assign a completely new audit team
- Provide industry training for team members
- Select the type of threat which could arise as a result of the finance director’s relationship with the audit manager.
Type of threat
- The finance director must not have contact with the audit manager whilst the audit is ongoing
- The firm should resign from the engagement
- A different audit manager should be appointed
- Which of the following audit procedures should be performed to form a conclusion as to whether the financial statements require amendment in relation to the unfair dismissal claim?
1Inspect relevant correspondence with Sampson Co’s lawyers
2Write to the finance director to confirm the claim and level of damages
3Review the post year-end cash book and bank statements for evidence the claim has been settled
4Request management confirms their views in a written representation letter
- 1, 2 and 3
- 1, 2 and 4
- 1, 3 and 4
D 2, 3 and 4 (2 marks)
- Select the type of opinion that is appropriate and the nature of any additional communications necessary if the unfair dismissal case is NOT adjusted for or disclosed within the financial statements.
|Unmodified||No additional communication|
|Qualified||Emphasis of Matter paragraph|
|Adverse||Material Uncertainty Related to Going|
|Disclaimer||Other matter paragraph|
- You are drafting the auditor’s report for Sampson Co and the audit engagement partner has reminded you that as Sampson Co is a listed company, the report will need to reflect the requirements of ISA 701 Communicating Key Audit Matters in the Independent Auditor’s Report.
According to ISA 701, which TWO of the following should be included in the Key Audit Matters section of the auditor’s report?
AMatters which required significant auditor attention
BMatters which result in a modification to the audit opinion
CAll matters which were communicated to those charged with governance
DAll matters which were material to the financial statements
EAdditional information on significant matters to assist users’ understanding
- One month after the financial statements were issued the legal claim was finalised with the court awarding compensation of $500,000 to the ex-finance director. The directors of Sampson Co have contacted Blenkin & Co to inform them of the outcome.
Which TWO of the following are appropriate actions for Blenkin & Co to take?
ADiscuss the matter with management and, where appropriate, those charged with governance
BObtain a written representation from management
CConsider whether the firm should resign from the engagement
D Enquire how management intends to address the matter in the financial statements
where appropriate (2 marks)
The following scenario relates to questions 121 – 125
You are the manager responsible for the audit of Mississippi Co and you are completing the audit of the financial statements. The draft financial statements report revenue of $18 million (prior year – $17 million). The draft annual report of Mississippi Co contains a Chairman’s statement in which the chairman has commented that he is pleased to report an increase in revenue of 20% this year. The report also includes an operating review, corporate social responsibility report, financial statements and notes to the financial statements.
The directors of Mississippi Co have indicated that they intend to distribute the annual report to prospective investors in order to obtain additional finance. The engagement partner has informed the directors that the auditor’s report is only intended for reliance by the existing shareholders and that no liability will be assumed to any other party. The engagement partner has asked you to draft the auditor’s report for Mississippi Co and requested that this restriction is included.
- Which of the following statements best describes the auditor’s responsibilities in respect of other information?
AThe auditor provides limited assurance over the completeness and accuracy of the other information
BThe auditor must read the other information to ensure it is consistent with the financial statements and their knowledge of the entity obtained during the audit
CThe auditor must audit the other information and obtain sufficient appropriate evidence that the other information is true and fair
D Other information only needs to be considered if it is made available at the start of
the audit with the draft financial statements (2 marks)
- Which of the following sections of Mississippi Co’s annual report would NOT be considered ‘Other information’?
C Corporate social responsibility report
D Notes to the financial statements (2 marks)
- How should the inconsistency between the Chairman’s statement and financial statements be referred to in the auditor’s report of Mississippi Co?
AWithin the Other Information section
- Within an Emphasis of Matter paragraph
- Within an Other Matter paragraph
D Within the audit opinion section (2 marks)
- Select whether the following statements are true or false in relation to referring to the Chairman’s statement in the auditor’s report of Mississippi Co.
|Users may be misled if the other information|
|contains incorrect information or information which|
|contradicts the financial statements such as that in|
|the Chairman’s statement|
|Users may believe the auditor has not audited the|
|financial statements properly if the inconsistency is|
|The inconsistency may undermine the credibility of|
|your auditor’s report if not highlighted|
- In respect of the partner’s request for restricting liability, how should this be addressed in the auditor’s report?
- Within the Auditor’s Responsibility section
- By including an Emphasis of Matter paragraph
- By including an Other Matter paragraph
D Within the Basis for Opinion section (2 marks)
The following scenario relates to questions 126 – 130
You are completing the audit of Pacific Co and the auditor’s report is due to be signed shortly. Revenue for the year is $2.6 million, profit before tax is $1.4 million and total assets are $7.5 million. A key customer, with a receivables balance at the year-end of $85,000, has just notified Pacific that they are unlikely to be able to pay the balance due to cash flow problems and have asked for an extension of credit for a further three months. You believe that an allowance should be made. The finance director has notified the auditor that he will make adjustment for this balance in the following year’s financial statements if the debt is not paid in three months.
- Which of the following statements is correct regarding the materiality of the irrecoverable debt?
AThe matter is material by nature
BThe matter is not material as the debt is less than 5% of revenue
CThe matter is not material as the debt is less than 10% of profit
D The matter is likely to be material as it is over 1% of assets (2 marks)
- Which THREE of the following procedures would allow the auditor to form a conclusion as to the level of adjustment required to the receivables balance?
AReview correspondence with the customer indicating when payment will be made
BDiscuss with management why they feel an adjustment is not required in the current year
CPerform a direct confirmation of the balance outstanding at the year-end
- Review post year-end bank statements to identify if any payment has been received from the customer
E Inspect the sales invoice and GDN relating to the receivable balance (2 marks)
- Assuming the matter is considered material and Pacific’s directors have refused to adjust the financial statements, what is the appropriate opinion to be issued?
D Disclaimer (2 marks)
- Select whether the following elements should be included in the auditor’s report of Pacific Co.
Other Matter paragraph
Emphasis of Matter paragraph
- Which TWO of the following are reasons why the auditor would need to modify the auditor’s opinion?
AThey conclude that there is a material inconsistency between the audited financial statements and the other information contained in the annual report
BThey wish to draw attention to a matter that is fundamental to the users’ understanding of the financial statements
CThey conclude that the financial statements as a whole are not free from material misstatement
DThey have been unable to obtain sufficient appropriate evidence to conclude that the financial statements as a whole are free from material misstatement
EThey wish to restrict reliance on the auditor’s report by third parties
The following scenario relates to questions 131 – 135
Magical Mystery Tour (MMT) is a travel agency which has been trading for over five years. The company arranges holidays and hotel bookings to individual customers and corporate clients. The company is financed partly through overdrafts and loans and also by several large shareholders. The year-end is 30 April. In the current year a new competitor, Pure Shores Co has entered the market and through competitive pricing has gained considerable market share from MMT. One of MMT’s larger corporate clients has moved its business to Pure Shores. In addition, a number of MMT’s agents have left the company and joined Pure Shores. MMT has found it difficult to replace these employees due to the level of skills and knowledge of remote overseas locations required. The directors have produced a cash flow forecast which shows a significantly worsening position over the coming 12 months. The auditors have been informed that MMT’s bankers will not make a decision on the renewal of the overdraft facility until after the auditor’s report is issued. The directors have agreed to include some going concern disclosures.
131 Which THREE of the following statements correctly describes the respective responsibilities of directors and auditors in relation to going concern?
- The directors must assess whether the company can continue to trade for the foreseeable future.
- The auditors and the directors must make disclosure of going concern uncertainties in the financial statements
- The auditor will evaluate management’s assessment of going concern
- The directors will usually prepare a cash flow forecast to assess whether the company is likely to be able to trade for the foreseeable future
- The directors must assess a period of at least twelve months from the date the
financial statements are issued (2 marks)
- Which THREE of the following procedures should be performed to assess the uncertainty arising in relation to the overdraft renewal?
ACalculate key ratios to identify possible financial problems
BInspect correspondence with the bank to identify any disputes which may indicate the overdraft facility will not be renewed
CReview the level of profit made in previous periods to assess whether the company is likely to continue to trade
DEnquire with management whether any alternative sources of finance have been considered if the bank does not renew the overdraft facility
E Inspect board minutes for discussions of management as to how they plan to
improve the financial position of MMT (2 marks)
133 What will be the impact on the auditor’s report of MMT in the following circumstances?
|opinion with||opinion||opinion with||opinion with|
|no additional||Going Concern||Emphasis of|
|disclosure of going|
|disclosure of going|
- Under which circumstance should a company NOT prepare financial statements using the break up basis?
AThe company has ceased to trade
- A decision has been made to close the company
- There are material uncertainties relating to going concern
D The company has run out of cash and is unable to pay its debts (2 marks)
- What will be the impact on the auditor’s report of MMT if the auditor believes the basis of preparation of the financial statements is incorrect?
- Unmodified opinion with no additional communication
- Unmodified opinion with an Emphasis of Matter paragraph
- Qualified opinion with Basis for Qualified Opinion
D Adverse opinion with Basis for Adverse Opinion (2 marks)
The following scenario relates to questions 136 – 140
You are an audit manager in Bond & Co and the audit of Paddington Co is nearing completion. You are now resolving the last few issues before deciding on the appropriate audit opinion. Paddington Co’s profit before tax is $29 million. During the audit the following issues have been identified:
- Paddington Co’s main competitor filed a lawsuit for $3 million alleging a breach of copyright. This case is ongoing and will not be resolved prior to the auditor’s report being signed. Paddington Co’s lawyers believe the claim is only possible to succeed. Paddington Co has sufficient cash to make the settlement if they lose the case. The lawsuit has not been mentioned in the financial statements or related disclosures.
- A warranty provision of $25 million has not been recognised.
- Depreciation of $1 million has not been recorded in the financial statements.
- Intangible assets have been overstated in the financial statements by $12 million.
- Which of the issues identified during the audit is likely to lead to an adverse opinion on Paddington Co’s financial statements?
- Warranty provision
D Intangible assets (2 marks)
- Which of the following statements is true in respect of the lawsuit and its impact on the financial statements and auditor’s report thereon?
AA provision should be recognised in the financial statements of $3 million
BA contingent liability should be disclosed in the notes to the financial statements
CThe matter is not material as it represents 10.3 % of profit before tax.
D The lawsuit does not need to be referred to in the financial statements as the case is
not settled at the year-end date (2 marks)
- The audit is now complete and the auditor’s report is due to be issued next week. All adjustments requested have been corrected by management.
Which of the following correctly identifies the opinion that should be issued and the appropriate report modification, if any, that should be included in the report of Paddington Co?
AUnmodified opinion with no additional communication
BUnmodified opinion with an Emphasis of Matter paragraph
CQualified opinion with Basis for Qualified Opinion
DDisclaimer of opinion with Basis for Disclaimer of Opinion
- Match the following auditor’s report sections to the appropriate explanation of its purpose.
- Basis for opinion
- Key audit matters
- Name of engagement partner
- Provides a description of the professional standards applied during the audit to provide confidence to users that the report can be relied upon
- Identifies the intended user of the report
- Identifies the person responsible for the audit opinion in case of any queries
- Clearly identifies the report as an Independent Auditor’s Report
- Draws attention to any other significant matters of which the users should be aware which have been discussed with those charged with governance
- Which of the following correctly matches the opinion type with the wording for that opinion?
|B||Disclaimer||Do not express an opinion|
|C||Adverse||True and fair view|
|D||Qualified||Do not give a true and fair view||(2 marks)|
The following scenario relates to questions 141 – 145
Humphries Co operates a chain of food wholesalers across the country and its year-end was 30 September 20X1. The final audit is nearly complete and it is proposed that the financial statements and auditor’s report will be signed on 13 December. Revenue for the year is $78 million and profit before taxation is $7.5 million. The following events have occurred subsequent to the year-end.
Humphries Co has just become aware that one of its customers is experiencing significant going concern difficulties. There is a receivables balance in respect of this customer at the year-end of $0.3 million. Humphries Co believe that as the company has been trading for many years, they will receive some, if not full, payment from the customer therefore no adjustment has been made for the balance in the financial statements.
A key supplier of Humphries Co is suing them for breach of contract. The lawsuit was filed prior to the year-end, and the sum claimed by them is $1 million. This has been disclosed as a contingent liability in the notes to the financial statements. Recent correspondence from the supplier indicates that they are willing to settle the case for $0.6 million. It is likely that Humphries Co will agree to this.
Following significant rain on 20 November, one of Humphries Co’s three warehouses was flooded. All of the inventory stored there was damaged and has been disposed of. The insurance company has already been contacted but no response has been received as of yet. No amendments or disclosures have been made in the financial statements.
- Calculate the materiality level of the receivable and settlement figure for the lawsuit by reference to profit before tax and state whether they are material. Answers to calculations should be rounded to the nearest whole number with no decimal places.
- In respect of the receivable and lawsuit, select the type of event and the appropriate accounting treatment.
|Type of event||Accounting treatment|
- State whether each of the following procedures is appropriate or not appropriate in order to reach a conclusion on the issue concerning receivables.
Contact the customer directly and enquire when they are likely to pay the outstanding balance
Review correspondence between the customer and Humphries Co to assess whether there is any likelihood of payment
Review the post year-end period to see if any payments have been received from the customer
Inspect the original invoice and goods despatch note to confirm the customer received the goods and therefore owes the money
- Assuming that the receivable and warehouse issued are resolved but the lawsuit issue remains unresolved, which FOUR of the following section titles must be included in the auditor’s report?
|Section Titles||Include in auditor’s report|
Auditor Responsibilities for the Audit of the Financial Statements
Basis for Opinion
Basis for Qualified Opinion
Key Audit Matters
Responsibilities of Management and Those Charged With
- Which of the following statements is TRUE in respect of the warehouse?
AThe value of the assets damaged during the flood should be written down to their realisable values
BIf the impact of the flood is material, the directors should include a disclosure note detailing the impact to the company
CThe insurance claim should be recognised as a contingent asset
DAs the flood occurred after the year end it will have no impact on the auditor’s report
The following scenario relates to questions 146 – 150
Greenfields Co specialises in manufacturing equipment which can help to reduce toxic emissions in the production of chemicals. The company has grown rapidly over the past eight years and this is due partly to the warranties that the company gives to its customers. It guarantees its products for five years and if problems arise in this period it undertakes to fix them, or provide a replacement product. You are the manager responsible for the audit of Greenfields Co and you are performing the final review stage of the audit and have come across the following two issues.
Receivable balance owing from Yellowmix Co
Greenfields Co has a material receivable balance owing from its customer, Yellowmix Co. During the year-end audit, your team reviewed the ageing of this balance and found that no payments had been received from Yellowmix Co for over six months, and Greenfields Co would not allow this balance to be circularised. Instead management has assured your team that they will provide a written representation confirming that the balance is recoverable.
The warranty provision included within the statement of financial position is material. The audit team has performed testing over the calculations and assumptions which are consistent with prior years. The team has requested a written representation from management confirming the basis and amount of the provision are reasonable. Management has yet to provide this representation.
- Select the appropriate words/phrases from the options to complete the sentences below. Options may be selected more than once.
A written representation ______________in respect of the receivable balance.
This is because ___________________.
A written representation ______________in respect of the warranty provision.
This is because___________________.
- Is appropriate
- Is not appropriate
- The matter is not material
- The matter involves management judgment
- Other procedures can be performed which provide more reliable evidence
- An ISA specifically requires a written representation to be obtained for the item
- Assuming that the directors of Greenfields Co refuse to provide a written representation to the auditor, which of the following statements is correct?
AThe refusal to provide a written representation will only be a matter of concern if it relates to a material area of the financial statements
BThe refusal to provide a written representation may cast doubt over management integrity and as such the reliability of other evidence provided by the client may be called into question
- The refusal to provide a written representation will result in the need for the auditor to report the directors to the industry regulator
D The auditor will need to notify the shareholders of the issue in person (2 marks)
- Which TWO of the following audit reporting implications could result if Greenfields Co refuse to provide a written representation letter?
AUnmodified opinion and report
BUnmodified opinion with Emphasis of Matter paragraph
CQualified opinion due to material misstatement
DQualified opinion due to an inability to obtain sufficient appropriate evidence
EAdverse opinion as the financial statements do not show a true and fair view
F Disclaimer of opinion as the auditor does not have sufficient appropriate evidence to
be able to express an audit opinion (2 marks)
- Written representations are required by international auditing standards in respect of particular areas of the audit. Which of the following areas of the audit require written representation to be obtained?
Required by an ISA
Area of the audit
Fraud and error
Laws and regulations
- Which THREE of the following MUST be included in every written representation according to ISA 580 Written Representations?
Required by ISA 580
Plans or intentions of management that affect carrying values of assets
Confirmation from management that they have provided the auditor with all information and access to records during the audit
Confirmation from management that the financial statements are accurate/free from error
Confirmation from management that all transactions have been reflected in the financial statements
Confirmation from management that they have prepared the financial statements in accordance with the applicable financial reporting framework