AUDIT AND ASSURANCE (AA) REVISION KIT SECTION 2

Section 2

 

PRACTICE QUESTIONS

 

PLANNING AND RISK ASSESSMENT

 

 

151     PRANCER CONSTRUCTION                 Walk in the footsteps of a top tutor

 

You are an audit supervisor of Cupid & Co, planning the final audit of a new client, Prancer Construction Co, for the year ending 30 September 20X7. The company specialises in property construction and providing ongoing annual maintenance services for properties previously constructed. Forecast profit before tax is $13·8m and total assets are expected to be $22·3m, both of which are higher than for the year ended 30 September 20X6.

 

You are required to produce the audit strategy document. The audit manager has met with Prancer Construction Co’s finance director and has provided you with the following notes, a copy of the August management accounts and the prior year financial statements.

 

Meeting notes

 

The prior year financial statements recognise work in progress of $1·8m, which comprised property construction in progress as well as ongoing maintenance services for finished properties. The August 20X7 management accounts recognise $2·1m inventory of completed properties compared to a balance of $1·4m in September 20X6. A full year-end inventory count will be undertaken on 30 September at all of the 11 building sites where construction is in progress. There is not sufficient audit team resource to attend all inventory counts.

 

In line with industry practice, Prancer Construction Co offers its customers a five-year building warranty, which covers any construction defects. Customers are not required to pay any additional fees to obtain the warranty. The finance director anticipates this provision will be lower than last year as the company has improved its building practices and therefore the quality of the finished properties.

 

Customers who wish to purchase a property are required to place an order and pay a 5% non-refundable deposit prior to the completion of the building. When the building is complete, customers pay a further 92·5%, with the final 2·5% due to be paid six months later. The finance director has informed you that although an allowance for receivables has historically been maintained, it is anticipated that this can be significantly reduced.

 

Information from management accounts

 

Prancer Construction Co’s prior year financial statements and August 20X7 management accounts contain a material overdraft balance. The finance director has confirmed that there are minimum profit and net assets covenants attached to the overdraft.

 

A review of the management accounts shows the payables period was 56 days for August 20X7, compared to 87 days for September 20X6. The finance director anticipates that the September 20X7 payables days will be even lower than those in August 20X7.

 

Required:

 

  • Describe the process Cupid & Co should have undertaken to assess whether the PRECONDITIONS for an audit were present when accepting the audit of Prancer

 

Construction Co.                                                                                                              (3 marks)

 

  • Identify THREE main areas, other than audit risks, which should be included within the audit strategy document for Prancer Construction Co, and for each area provide

an example relevant to the audit.                                                                              (3 marks)

 

  • Using all the information provided describe SEVEN audit risks, and explain the auditor’s response to each risk, in planning the audit of Prancer Construction Co.

 

Note: Prepare your answer using two columns headed Audit risk and Auditor’s response

 

respectively.                                                                                                                                (14 marks)

 

(20 marks)

 

 

152     HURLING                 Walk in the footsteps of a top tutor

 

(a)      Define audit risk and the components of audit risk.                                             (4 marks)

 

You are an audit supervisor of Caving & Co and you are planning the audit of Hurling Co, a listed company, for the year ending 31 March 20X7. The company manufactures computer components and forecast profit before tax is $33·6 million and total assets are $79·3 million.

 

Hurling Co distributes its products through wholesalers as well as via its own website. The website was upgraded during the year at a cost of $1·1 million. Additionally, the company entered into a transaction in February to purchase a new warehouse which will cost $3·2 million. Hurling Co’s legal advisers are working to ensure that the legal process will be completed by the year end. The company issued $5 million of irredeemable preference shares to finance the warehouse purchase.

 

During the year the finance director has increased the useful economic lives of fixtures and fittings from three to four years as he felt this was a more appropriate period. The finance director has informed the engagement partner that a revised credit period has been agreed with one of its wholesale customers, as they have been experiencing difficulties with repaying the balance of $1·2 million owing to Hurling Co. In January 20X7, Hurling Co introduced a new bonus based on sales targets for its sales staff. This has resulted in a significant number of new wholesale customer accounts being opened by sales staff. The new customers have been given favourable credit terms as an introductory offer, provided goods are purchased within a two-month period. As a result, revenue has increased by 5% on the prior year.

A review of the management accounts shows the payables period was 56 days for August 20X7, compared to 87 days for September 20X6. The finance director anticipates that the September 20X7 payables days will be even lower than those in August 20X7.

 

Required:

 

  • Describe the process Cupid & Co should have undertaken to assess whether the PRECONDITIONS for an audit were present when accepting the audit of Prancer

 

Construction Co.                                                                                                              (3 marks)

 

  • Identify THREE main areas, other than audit risks, which should be included within the audit strategy document for Prancer Construction Co, and for each area provide

an example relevant to the audit.                                                                              (3 marks)

 

  • Using all the information provided describe SEVEN audit risks, and explain the auditor’s response to each risk, in planning the audit of Prancer Construction Co.

 

Note: Prepare your answer using two columns headed Audit risk and Auditor’s response

 

respectively.                                                                                                                                (14 marks)

 

(20 marks)

 

 

152     HURLING                 Walk in the footsteps of a top tutor

 

(a)      Define audit risk and the components of audit risk.                                             (4 marks)

 

You are an audit supervisor of Caving & Co and you are planning the audit of Hurling Co, a listed company, for the year ending 31 March 20X7. The company manufactures computer components and forecast profit before tax is $33·6 million and total assets are $79·3 million.

 

Hurling Co distributes its products through wholesalers as well as via its own website. The website was upgraded during the year at a cost of $1·1 million. Additionally, the company entered into a transaction in February to purchase a new warehouse which will cost $3·2 million. Hurling Co’s legal advisers are working to ensure that the legal process will be completed by the year end. The company issued $5 million of irredeemable preference shares to finance the warehouse purchase.

 

During the year the finance director has increased the useful economic lives of fixtures and fittings from three to four years as he felt this was a more appropriate period. The finance director has informed the engagement partner that a revised credit period has been agreed with one of its wholesale customers, as they have been experiencing difficulties with repaying the balance of $1·2 million owing to Hurling Co. In January 20X7, Hurling Co introduced a new bonus based on sales targets for its sales staff. This has resulted in a significant number of new wholesale customer accounts being opened by sales staff. The new customers have been given favourable credit terms as an introductory offer, provided goods are purchased within a two-month period. As a result, revenue has increased by 5% on the prior year.

 

The company has launched several new products this year and all but one of these new launches have been successful. Feedback on product Luge, launched four months ago, has been mixed, and the company has just received notice from one of their customers, Petanque Co, of intended legal action. They are alleging the product sold to them was faulty, resulting in a significant loss of information and an ongoing detrimental impact on profits. As a precaution, sales of the Luge product have been halted and a product recall has been initiated for any Luge products sold in the last four months.

 

The finance director is keen to announce the company’s financial results to the stock market earlier than last year and in order to facilitate this, he has asked if the audit could be completed in a shorter timescale. In addition, the company is intending to propose a final dividend once the financial statements are finalised.

 

Hurling Co’s finance director has informed the audit engagement partner that one of the company’s non-executive directors (NEDs) has just resigned, and he has enquired if the partners at Caving & Co can help Hurling Co in recruiting a new NED. Specifically he has requested the engagement quality control reviewer, who was until last year the audit engagement partner on Hurling Co, assist the company in this recruitment. Caving & Co also provides taxation services for Hurling Co in the form of tax return preparation along with some tax planning advice. The finance director has recommended to the audit committee of Hurling Co that this year’s audit fee should be based on the company’s profit before tax. At today’s date, 20% of last year’s audit fee is still outstanding and was due to be paid three months ago.

 

Required:

 

  • Describe EIGHT audit risks, and explain the auditor’s response to each risk, in

 

planning the audit of Hurling Co.                                                                                                                                          (16 marks)

 

Note: Prepare your answer using two columns headed Audit risk and Auditor’s response respectively.

 

  • (i)Identify and explain FIVE ethical threats which may affect the independence of Caving & Co’s audit of Hurling Co, and

 

  • For each threat, suggest a safeguard to reduce the risk to an acceptable level.

 

Note: The total marks will be split equally between each part. Prepare your answer using two columns headed Ethical threat and Possible Safeguard respectively.

 

(10 marks)

 

(30 marks)

 

 

153     CENTIPEDE                 Walk in the footsteps of a top tutor

 

You are an audit supervisor of Ant & Co and are planning the final audit of Centipede Co, which is a listed company, for the year ended 31 December 20X6. The company purchases consumer packaged goods and sells these through its website and to wholesalers. This is a new client for your firm and your audit manager has already had a planning meeting with the finance director and has provided you with the following notes along with financial statement extracts.

 

Client background and notes from planning meeting

 

Rather than undertaking a full year-end inventory count, the company undertakes monthly perpetual inventory counts, covering one-twelfth of all lines monthly. As part of the interim audit which was completed earlier in the year, an audit assistant attended a perpetual inventory count in September and noted that there were a large number of exceptions where the inventory records were consistently higher than the physical inventory in the warehouse. When discussing these exceptions with the finance director, the assistant was informed that this had been a recurring issue all year. In addition, the audit assistant noted that there were some lines of inventory which, according to the records, were at least 90 days old.

 

Centipede Co has a head office where the audit team will be based to conduct the final audit fieldwork. However, there are four additional sites where some accounting records are maintained and these sites were not visited during the interim audit. The records for these sites are incorporated monthly through an interface to the general ledger. A fifth site was closed down in 20X5, however, the building was only sold in 20X6 at a loss of $825,000.

 

One of Centipede Co’s wholesale customers is alleging that the company has consistently failed to deliver goods in a saleable condition and on time, hence it has commenced legal action against Centipede Co for a loss of profits claim.

 

The directors have disclosed their remuneration details in the financial statements in line with International Financial Reporting Standards, which does not require a separate list of directors’ names and payments. However, in the country in which Centipede Co is based, local legislation requires disclosure of the names of the directors and the amount of remuneration payable to each director.

 

Financial statement extracts for the year ended 31 December:

 

Draft Final
20X6 20X5
$000 $000
Revenue 25,230 21,180
Cost of sales (15,840) (14,015)
––––––– –––––––
Gross profit 9,390 7,165
Operating expenses (4,903) (3,245)
––––––– –––––––
Operating profit 4,487 3,920
––––––– –––––––
Inventory 2,360 1,800
Trade receivables 1,590 1,250
Cash 480
Trade payables 3,500 2,800
Overdraft 580

 

Required:

 

  • Describe the matters which Ant & Co should have considered prior to accepting the

 

audit of Centipede Co.                                                                                                   (5 marks)

 

  • Calculate SIX ratios, for BOTH years, which would assist you in planning the audit of

 

Centipede Co.                                                                                                                  (6 marks)

 

  • From a review of the above information and the ratios calculated, describe SEVEN audit risks and explain the auditor’s response to each risk in planning the audit of Centipede Co.

 

Note: Prepare your answer using two columns headed Audit risk and Auditor’s

 

response respectively.                                                                                                                                          (14 marks)

 

The finance director of Centipede Co informed Ant & Co that one of the reasons they were appointed as auditors was because of their knowledge of the industry. Ant & Co audits a number of other consumer packaged goods companies, including Centipede Co’s main rival. The finance director has enquired how Ant & Co will keep information obtained during the audit confidential.

 

Required:

 

  • Explain the safeguards which Ant & Co should implement to ensure that this

 

conflict of interest is properly managed.                                                                                                                                            (5 marks)

 

(Total: 30 marks)

 

 

154     SITIA SPARKLE                 Walk in the footsteps of a top tutor

 

(a)       Explain the benefits of audit planning.            (4 marks)

 

You are an audit supervisor of Chania & Co and are planning the audit of your client, Sitia Sparkle Co which manufactures cleaning products. Its year-end was 31 July 20X6 and the draft profit before tax is $33.6 million. You are supervising a large audit team for the first time and will have specific responsibility for supervising and reviewing the work of the audit assistants in your team.

 

Sitia Sparkle Co purchases most of its raw materials from suppliers in Africa and these goods are shipped directly to the company’s warehouse and the goods are usually in transit for up to three weeks. The company has incurred $1.3 million of expenditure on developing a new range of cleaning products which are due to be launched into the market place in November 20X6. In September 20X5, Sitia Sparkle Co also invested $0.9 million in a complex piece of plant and machinery as part of the development process. The full amount has been capitalised and this cost includes the purchase price, installation costs and training costs.

 

This year, the bonus scheme for senior management and directors has been changed so that rather than focusing on profits, it is instead based on the value of year-end total assets. In previous years an allowance for receivables, made up of specific balances, which equalled almost 1% of trade receivables was maintained. However, the finance director feels that this is excessive and unnecessary and has therefore not included it for 20X6 and has credited the opening balance to the profit or loss account.

 

A new general ledger system was introduced in May 20X6; the finance director has stated that the data was transferred and the old and new systems were run in parallel until the end of August 20X6. As a result of the additional workload on the finance team, a number of control account reconciliations were not completed as at 31 July 20X6, including the bank reconciliation. The finance director is comfortable with this as these reconciliations were completed successfully for both June and August 20X6. In addition, the year-end close down of the purchase ledger was undertaken on 8 August 20X6.

 

Required:

 

  • Describe SIX audit risks, and explain the auditor’s response to each risk, in planning the audit of Sitia Sparkle Co.

 

Note: Prepare your answer using two columns headed Audit risk and Auditor’s

 

response respectively.                                                                                                  (12 marks)

 

  • In line with ISA 220 Quality Control for an Audit of Financial Statements, describe the audit supervisor’s responsibilities in relation to supervising and reviewing the

audit assistants’ work during the audit of Sitia Sparkle Co.                               (4 marks)

 

(Total: 20 marks)

 

 

155   AQUAMARINE                 Walk in the footsteps of a top tutor

 

 

(a)      Define audit risk and the components of audit risk.                                             (5 marks)

 

You are an audit supervisor of Amethyst & Co and are currently planning the audit of your client, Aquamarine Co (Aquamarine) which manufactures elevators. Its year-end is 31 July 20X6 and the forecast profit before tax is $15.2 million.

 

The company undertakes continuous production in its factory, therefore at the year-end it is anticipated that work in progress will be approximately $950,000. In order to improve the manufacturing process, Aquamarine placed an order in April for $720,000 of new plant and machinery; one third of this order was received in May with the remainder expected to be delivered by the supplier in late July or early August.

 

At the beginning of the year, Aquamarine purchased a patent for $1.3 million which gives them the exclusive right to manufacture specialised elevator equipment for five years. In order to finance this purchase, Aquamarine borrowed $1.2 million from the bank which is repayable over five years.

 

In January 20X6 Aquamarine outsourced its payroll processing to an external service organisation, Coral Payrolls Co (Coral). Coral handles all elements of the payroll cycle and sends monthly reports to Aquamarine detailing the payroll costs. Aquamarine ran its own payroll until 31 December 20X5, at which point the records were transferred over to Coral.

 

The company has a policy of revaluing land and buildings and the finance director has announced that all land and buildings will be revalued at the year-end. During a review of the management accounts for the month of May 20X6, you have noticed that receivables have increased significantly on the previous year-end and against May 20X5.

 

The finance director has informed you that the company is planning to make approximately 65 employees redundant after the year-end. No decision has been made as to when this will be announced, but it is likely to be prior to the year-end.

 

Required:

 

  • Describe SIX audit risks, and explain the auditor’s response to each risk, in planning

 

the audit of Aquamarine Co.                                                                                                                                          (12 marks)

 

Note: Prepare your answer using two columns headed Audit risk and Auditor’s response respectively.

 

  • Explain the additional factors Amethyst & Co should consider during the audit in

 

relation to Aquamarine Co’s use of the payroll service organisation.                                                                                                                                            (3 marks)

 

(Total: 20 marks)

 

 

156   VENUS                 Walk in the footsteps of a top tutor

 

ISA 210 Agreeing the Terms of Audit Engagements requires auditors to agree the terms of an engagement with those charged with governance and formalise these in an engagement letter.

 

Required:

 

  • Identify and explain TWO factors which would indicate that an engagement letter

 

for an existing audit client should be revised.                                                                                                                                            (2 marks)

 

  • List SIX matters which should be included within an audit engagement letter.

 

(3 marks)

 

You have been asked by the audit engagement partner to gain an understanding about the new client as part of the planning process.

 

Required:

 

  • Identify FIVE sources of information relevant to gaining an understanding and

 

describe how this information will be used by the auditor.                                                                                                                                            (5 marks)

 

You are an audit supervisor of Pluto & Co and are currently planning the audit of your client, Venus Magnets Co (Venus) which manufactures decorative magnets. Its year-end is 31 December 20X5 and the forecast profit before tax is $9.6 million.

 

During the year, the directors reviewed the useful lives and depreciation rates of all classes of plant and machinery. This resulted in an overall increase in the asset lives and a reduction in the depreciation charge for the year.

 

Inventory is held in five warehouses and on 28 and 29 December a full inventory count will be held with adjustments for movements to the year-end. This is due to a lack of available staff on 31 December. In October, there was a fire in one of the warehouses; inventory of $0.9 million was damaged and this has been written down to its scrap value of $0.2 million. An insurance claim has been submitted for the difference of $0.7 million. Venus is still waiting to hear from the insurance company with regards to this claim, but has included the insurance proceeds within the statement of profit or loss and the statement of financial position.

 

The finance director has informed the audit manager that the October and November bank reconciliations each contained unreconciled differences; however, he considers the overall differences involved to be immaterial.

 

A directors’ bonus scheme was introduced during the year which is based on achieving a target profit before tax. In order to finalise the bonus figures, the finance director of Venus would like the audit to commence earlier so that the final results are available earlier this year.

 

Required:

 

  • Describe FIVE audit risks, and explain the auditor’s response to each risk, in

 

planning the audit of Venus Magnets Co.                                                             (10 marks)

 

Note: Prepare your answer using two columns headed Audit risk and Auditor’s response respectively.

 

(Total: 20 marks)

 

 

157   SYCAMORE                 Walk in the footsteps of a top tutor

 

 

 

Question debrief

 

You are the audit supervisor of Maple & Co and are currently planning the audit of an existing client, Sycamore Science Co (Sycamore), whose year-end was 30 April 20X5. Sycamore is a pharmaceutical company, which manufactures and supplies a wide range of medical supplies. The draft financial statements show revenue of $35.6 million and profit before tax of $5.9 million.

 

Sycamore’s previous finance director left the company in December 20X4 after it was discovered that he had been claiming fraudulent expenses from the company for a significant period of time. A new finance director was appointed in January 20X5 who was previously a financial controller of a bank, and she has expressed surprise that Maple & Co had not uncovered the fraud during last year’s audit.

 

During the year Sycamore has spent $1.8 million on developing several new products. These projects are at different stages of development and the draft financial statements show the full amount of $1.8 million within intangible assets. In order to fund this development, $2.0 million was borrowed from the bank and is due for repayment over a ten-year period. The bank has attached minimum profit targets as part of the loan covenants.

 

The new finance director has informed the audit partner that since the year-end there has been an increased number of sales returns and that in the month of May over $0.5 million of goods sold in April were returned.

 

Maple & Co attended the year-end inventory count at Sycamore’s warehouse. The auditor present raised concerns that during the count there were movements of goods in and out the warehouse and this process did not seem well controlled.

 

During the year, a review of plant and equipment in the factory was undertaken and surplus plant was sold, resulting in a profit on disposal of $210,000.

 

Required:

 

  • State Maples & Co’s responsibilities in relation to the prevention and detection of

 

fraud and error.                                                                                                                                            (5 marks)

 

  • Describe EIGHT audit risks, and explain the auditor’s response to each risk, in

 

planning the audit of Sycamore Science Co.                                                                                                                                          (16 marks)

 

Note: Prepare your answer using two columns headed Audit risk and Auditor’s response respectively.

 

  • Explain the quality control procedures that Maple & Co should have in place during

 

the engagement performance.                                                                                                                                            (5 marks)

 

  • Sycamore’s new finance director has read about review engagements and is interested in the possibility of Maple & Co undertaking these in the future. However, she is unsure how these engagements differ from an external audit and how much assurance would be gained from this type of engagement.

 

Required:

 

  • Explain the purpose of review engagements and how these differ from

 

external audits; and                                                                                                                                 (2 marks)

 

  • Describe the level of assurance provided by external audits and review

 

engagements.                                                                                                                                 (2 marks)

 

(Total: 30 marks)

 

 

Calculate your allowed time, allocate the time to the separate parts……………

 

 

 

158   RECORDER COMMUNICATIONS                Walk in the footsteps of a top tutor

 

  • ISA 300 Planning an Audit of Financial Statements provides guidance to auditors. Planning an audit involves establishing the overall audit strategy for the engagement and developing an audit plan. Adequate planning benefits the audit of financial statements in several ways.

 

Required:

 

Explain the importance of audit planning.                                                                                                                                            (5 marks)

 

Recorder Communications Co (Recorder) is a large mobile phone company which operates a network of stores in countries across Europe. The company’s year-end is 30 June. You are the audit senior of Piano & Co. Recorder is a new client and you are currently planning the audit with the audit manager. You have been provided with the following planning notes from the audit partner following his meeting with the finance director.

 

Recorder purchases goods from a supplier in South Asia and these goods are shipped to the company’s central warehouse. The goods are usually in transit for two weeks and the company correctly records the goods when received. Recorder does not undertake a year-end inventory count, but carries out monthly continuous (perpetual) inventory counts and any errors identified are adjusted in the inventory system for that month. Manufacturers regularly bring out new models of mobile

 

phones. When this happens, the old models have to be sold at a significant discount as customers usually want the latest model. Recorder has a number of older models in inventory.

 

During the year the company introduced a bonus based on sales for its sales persons. The bonus target was based on increasing the number of customers signing up for 24-month phone line contracts. This has been successful and revenue has increased by 15%, especially in the last few months of the year. The level of receivables is considerably higher than last year and there are concerns about the creditworthiness of some customers.

 

Recorder has a policy of revaluing its land and buildings and this year has updated the valuations of all land and buildings.

 

During the year the directors have each been paid a significant bonus, and they have included this within wages and salaries. Separate disclosure of the bonus is required by local legislation.

 

Required:

 

  • Describe SEVEN audit risks, and explain the auditor’s response to each risk, in

 

planning the audit of Recorder Communications Co.                                        (14 marks)

 

Note: Prepare your answer using two columns headed Audit risk and Auditor’s response respectively.

 

  • Explain the audit procedures you should perform in order to place reliance on the

 

continuous (perpetual) counts for year-end inventory.                                       (3 marks)

 

  • Describe substantive procedures you should perform to confirm the directors’

 

bonus payments included in the financial statements.                                       (4 marks)

 

The audit of Recorder is nearly complete and the auditor’s report is due to be signed next week. The directors are refusing to adjust the valuation of inventory to the lower of cost and net realisable value. The difference is considered to have a material effect on the financial statements.

 

  • Describe the impact on the auditor’s report if the issue remains unresolved.

 

(4 marks)

 

(Total: 30 marks)

 

 

159   KANGAROO CONSTRUCTION                 Walk in the footsteps of a top tutor

 

  • Explain the concepts of materiality and performance materiality in accordance with

 

ISA 320 Materiality in Planning and Performing an Audit.                                 (5 marks)

 

  • You are the audit senior of Rhino & Co and you are planning the audit of Kangaroo Construction Co (Kangaroo) for the year ended 31 March 20X3. Kangaroo specialises in building houses and provides a five-year building warranty to its customers. Your audit manager has held a planning meeting with the finance director. He has provided you with the following notes of his meeting and financial statement extracts:

 

Kangaroo has had a difficult year; house prices have fallen and, as a result, revenue has dropped. In order to address this, management has offered significantly extended credit terms to their customers. However, demand has fallen such that there are still some completed houses in inventory where the selling price may be below cost. Cash flow issues have been alleviated partly due to the requirement for customers to pay a deposit of $5,000 to secure the house they wish to buy. The deposit is refundable until the house is 75% complete. At this stage the house is deemed to be built to the customer’s specification and the deposit becomes non-refundable.

 

During the year, whilst calculating depreciation, the directors extended the useful lives of plant and machinery from three years to five years. This reduced the annual depreciation charge.

 

The directors need to meet a target profit before interest and taxation of $0.5 million in order to be paid their annual bonus. In addition, to try and improve profits, Kangaroo changed their main material supplier to a cheaper alternative. This has resulted in some customers claiming on their building warranties for extensive repairs. To help with operating cash flow, the directors borrowed $1 million from the bank during the year. This is due for repayment at the end of 20X3.

 

Financial statement extracts for year ended 31 March

 

DRAFT ACTUAL
20X3 20X2
$m $m
Revenue 12.5 15.0
Cost of sales (7.0) (8.0)
––––– –––––
Gross profit 5.5 7.0
Operating expenses (5.0) (5.1)
––––– –––––
Profit before interest and taxation 0.5 1.9
––––– –––––
Inventory 1.9 1.4
Receivables 3.1 2.0
Cash 0.8 1.9
Trade payables 1.6 1.2
Loan 1.0

 

Required:

 

Using the information above:

 

  • Calculate SIX ratios, for BOTH years, which would assist the audit senior in

 

planning the audit; and                                                                                                                                 (6 marks)

 

  • Using the information provided and the ratios calculated, identify and describe SEVEN audit risks and explain the auditor’s response to each risk in

planning the audit of Kangaroo Construction Co.                                                                                                                               (14 marks)

 

Note: Prepare your answer using two columns headed Audit risk and Auditor’s response respectively.

 

The audit of Kangaroo Construction is nearly complete and the auditor’s report is due to be signed next week. Your audit work discovered that the warranty provision of $0.6m should be increased to $0.9m as a result of the increase in claims. The directors are refusing to make this adjustment.

 

Required

 

  • Discuss the issue and describe the impact on the auditor’s report if the issue

 

remains unresolved.                                                                                                      (5 marks)

 

(Total: 30 marks)

 

 

160   SUNFLOWER STORES                 Walk in the footsteps of a top tutor

 

Sunflower Stores Co (Sunflower) operates 25 food supermarkets. The company’s year-end is 31 December 20X2. The audit manager and partner recently attended a planning meeting with the finance director and have provided you with the planning notes below.

 

You are the audit senior, and this is your first year on this audit. In order to familiarise yourself with Sunflower, the audit manager has asked you to undertake some research in order to gain an understanding of Sunflower, so that you are able to assist in the planning process. He has then asked that you identify relevant audit risks from the notes below and also consider how the team should respond to these risks.

 

Sunflower has spent $1.6 million in refurbishing all of its supermarkets; as part of this refurbishment programme their central warehouse has been extended and a smaller warehouse, which was only occasionally used, has been disposed of at a profit. In order to finance this refurbishment, a sum of $1.5 million was borrowed from the bank. This is due to be repaid over five years.

 

The company will be performing a year-end inventory count at the central warehouse as well as at all 25 supermarkets on 31 December. Inventory is valued at selling price less an average profit margin as the finance director believes that this is a close approximation to cost.

 

Prior to 20X2, each of the supermarkets maintained their own financial records and submitted returns monthly to head office. During 20X2 all accounting records have been centralised within head office. Therefore at the beginning of the year, each supermarket’s opening balances were transferred into head office’s accounting records. The increased workload at head office has led to some changes in the finance department and in November 20X2 the financial controller left. His replacement will start in late December.

 

Required:

 

  • List FIVE sources of information that would be of use in gaining an understanding of

 

Sunflower Stores Co, and for each source describe what you would expect to

obtain.                                                                                                                               (5 marks)

 

  • Using the information provided, describe FIVE audit risks and explain the auditor’s

 

response to each risk in planning the audit of Sunflower Stores Co.            (10 marks)

 

Note: Prepare your answer using two columns headed Audit risk and Auditor’s response respectively.

 

  • The finance director of Sunflower Stores Co is considering establishing an internal audit department.

 

Required:

 

Describe the factors the finance director should consider before establishing an

 

internal audit department.                                                                                                                                            (5 marks)

 

(Total: 20 marks)

 

161   ABRAHAMS                 Walk in the footsteps of a top tutor

 

  • Explain the components of audit risk and, for each component, state an example of

 

a factor which can result in increased audit risk.                                                                                                                                            (6 marks)

 

Abrahams Co develops, manufactures and sells a range of pharmaceuticals and has a wide customer base across Europe and Asia. You are the audit manager of Nate & Co and you are planning the audit of Abrahams Co whose financial year-end is 31 January. You attended a planning meeting with the finance director and engagement partner and are now reviewing the meeting notes in order to produce the audit strategy and plan. Revenue for the year is forecast at $25 million.

 

During the year the company has spent $2.2 million on developing several new products. Some of these are in the early stages of development whilst others are nearing completion. The finance director has confirmed that all projects are likely to be successful and so he is intending to capitalise the full $2.2 million.

 

Once products have completed the development stage, Abrahams begins manufacturing them. At the year-end it is anticipated that there will be significant levels of work in progress. In addition the company uses a standard costing method to value inventory; the standard costs are set when a product is first manufactured and are not usually updated. In order to fulfil customer orders promptly, Abrahams Co has warehouses for finished goods located across Europe and Asia; approximately one third of these are third party warehouses where Abrahams just rents space.

 

In September a new accounting package was introduced. This is a bespoke system developed by the information technology (IT) manager. The old and new packages were not run in parallel as it was felt that this would be too onerous for the accounting team. Two months after the system changeover the IT manager left the company; a new manager has been recruited but is not due to start work until January.

 

In order to fund the development of new products, Abrahams has restructured its finance and raised $1 million through issuing shares at a premium and $2.5 million through a long-term loan. There are bank covenants attached to the loan, the main one relating to a minimum level of total assets. If these covenants are breached then the loan becomes immediately repayable. The company has a policy of revaluing land and buildings, and the finance director has announced that all land and buildings will be revalued as at the year-end.

 

The reporting timetable for audit completion of Abrahams Co is quite short, and the finance director would like to report results even earlier this year.

 

Required:

 

  • Using the information provided, identify and describe FIVE audit risks and explain the auditor’s response to each risk in planning the audit of Abrahams Co.

(10 marks)

 

Note: Prepare your answer using two columns headed Audit risk and Auditor’s response respectively.

 

  • Describe substantive procedures you should perform to obtain sufficient appropriate evidence in relation to:

 

  • Inventory held at the third party warehouses; and

 

(ii)      Use of standard costs for inventory valuation.                                           (4 marks)

 

(Total: 20 marks)

 

 

162   REDSMITH                 Walk in the footsteps of a top tutor

 

  • In agreeing the terms of an audit engagement, the auditor is required to agree the basis on which the audit is to be carried out. This involves establishing whether the preconditions for an audit are present and confirming that there is a common understanding between the auditor and management of the terms of the engagement.

 

Required:

 

Describe  the  process  the  auditor  should  undertake  to  assess  whether  the

 

PRECONDITIONS for an audit are present.                                                              (3 marks)

 

  • List FOUR examples of matters the auditor may consider when obtaining an

 

understanding of the entity.                                                                                        (2 marks)

 

  • You are the audit senior of White & Co and are planning the audit of Redsmith Co for the year ended 30 September 20X5. The company produces printers and has been a client of your firm for two years. Your audit manager has already had a planning meeting with the finance director. He has provided you with the following notes of his meeting and financial statement extracts.

 

Redsmith’s management were disappointed with the 20X4 results and so in 20X5 undertook a number of strategies to improve the trading results. This included the introduction of a generous sales-related bonus scheme for their salesmen and a high profile advertising campaign. In addition, as market conditions are difficult for their customers, they have extended the credit period given to them.

 

The finance director of Redsmith has reviewed the inventory valuation policy and has included additional overheads incurred this year as he considers them to be production related. He is happy with the 20X5 results and feels that they are a good reflection of the improved trading levels.

 

Financial statement extracts for year ended 30 September
DRAFT ACTUAL
20X5 20X4
$m $m
Revenue 23.0 18.0
Cost of Sales (11.0) (10.0)
––––– –––––
Gross profit 12.0 8.0
Operating expenses (7.5) (4.0)
––––– –––––
Profit before interest and taxation 4.5 4.0
––––– –––––
Inventory 2.1 1.6
Receivables 4.5 3.0
Cash 2.3
Trade payables 1.6 1.2
Overdraft 0.9

 

Required:

 

Using the information above:

 

  • Calculate FIVE ratios, for BOTH years, which would assist the audit senior in

 

planning the audit, and                                                                                                                                 (5 marks)

 

  • From a review of the above information and the ratios calculated, explain

 

FIVE audit risks and explain the auditor’s response to each risk.                                                                                                                               (10 marks)

 

Note: Prepare your answer using two columns headed Audit risk and Auditor’s

 

response respectively.                                                                                      (Total: 20 marks)

 

 

163   SPECS4YOU                 Walk in the footsteps of a top tutor

 

ISA 230 Audit Documentation establishes standards and provides guidance regarding documentation in the context of the audit of financial statements.

 

Required:

 

(a)       List the purposes of audit working papers.            (3 marks)

 

  • You have recently been promoted to audit manager in the audit firm of Trums & Co. As part of your new responsibilities, you have been placed in charge of the audit of Specs4You Co, a long established audit client of Trums & Co. Specs4You Co sells spectacles; the company owns 42 stores where customers can have their eyes tested and choose from a range of frames.

 

Required:

 

List the documentation that should be of assistance to you in familiarising yourself with Specs4You Co. Describe the information you should expect to obtain from

 

each document.                                                                                                                                            (8 marks)

 

  • The time is now towards the end of the audit, and you are reviewing working papers produced by the audit team. An example of a working paper you have just reviewed is shown below.

 

Client Name Specs4You Co Year end 30 April Page xxxxxxx
Working paper Payables transaction testing Prepared by Date
Reviewed by CW Date 12 June 20X7

 

Audit assertion: To make sure that the purchases day book is correct.

 

Method: Select a sample of 15 purchase orders recorded in the purchase order system. Trace details to the goods received note (GRN), purchase invoice (PI) and the purchase day book (PDB) ensuring that the quantities and prices recorded on the purchase order match those on the GRN, PI and PDB.

 

Test details: In accordance with audit risk, a sample of purchase orders were selected from a numerically sequenced purchase order system and details traced as stated in the method. Details of items tested can be found on another working paper.

 

Results: Details of purchase orders were normally correctly recorded through the system. Five purchase orders did not have any associated GRN, PI and were not recorded in the PDB. Further investigation showed that these orders had been cancelled due to a change in spectacle specification. However, this does not appear to be a system deficiency as the internal controls do not allow for changes in specification.

 

Conclusion: Purchase orders are completely recorded in the purchase day book.

 

Required:

 

Explain why the working paper shown above does not meet the standards normally expected of a working paper. Note: You are not required to reproduce the working

paper.                                                                                                                                 (9 marks)

 

(Total: 20 marks)

 

INTERNAL CONTROLS AND AUDIT EVIDENCE

 

 

164     COMET PUBLISHING                 Walk in the footsteps of a top tutor

 

You are an audit supervisor of Halley & Co and you are reviewing the documentation describing Comet Publishing Co’s purchases and payables system in preparation for the interim and final audit for the year ending 30 September 20X7. The company is a retailer of books and has ten stores and a central warehouse, which holds the majority of the company’s inventory.

 

Your firm has audited Comet Publishing Co for a number of years and as such, audit documentation is available from the previous year’s file, including internal control flowcharts and detailed purchases and payables system notes. As far as you are aware, Comet Publishing Co’s system of internal control has not changed in the last year. The audit manager is keen for the team to utilise existing systems documentation in order to ensure audit efficiency. An extract from the existing systems notes is provided below.

 

Extract of purchases and payables system

 

Store managers are responsible for ordering books for their shop. It is not currently possible for store managers to request books from any of the other nine stores. Customers who wish to order books, which are not in stock at the branch visited, are told to contact the other stores directly or visit the company website. As the inventory levels fall in a store, the store manager raises a purchase requisition form, which is sent to the central warehouse. If there is insufficient inventory held, a supplier requisition form is completed and sent to the purchase order clerk, Oliver Dancer, for processing. He sends any orders above $1,000 for authorisation from the purchasing director.

 

Receipts of goods from suppliers are processed by the warehouse team, who agree the delivery to the purchase order, checking quantity and quality of goods and complete a sequentially numbered goods received note (GRN). The GRNs are sent to the accounts department every two weeks for processing.

 

On receipt of the purchase invoice from the supplier, an accounts clerk matches it to the GRN. The invoice is then sent to the purchase ordering clerk, Oliver, who processes it for payment. The finance director is given the total amount of the payments list, which she authorises and then processes the bank payments. Due to staff shortages in the accounts department, supplier statement reconciliations are no longer performed.

 

Other information – conflict of interest

 

Halley & Co has recently accepted the audit engagement of a new client, Edmond Co, who is the main competitor of Comet Publishing Co. The finance director of Comet Publishing Co has enquired how Halley & Co will keep information obtained during the audit confidential.

 

Required:

 

  • Explain the safeguards which Halley & Co should implement to ensure that the

 

identified conflict of interest is properly managed.                                                                                                                                            (5 marks)

 

  • Explain the steps the auditor should take to confirm the accuracy of the purchases

 

and payables flowcharts and systems notes currently held on file.                                                                                                                                            (5 marks)

 

  • In respect of the purchases and payables system for Comet Publishing Co:

 

  • Identify and explain FIVE deficiencies

 

  • Recommend a control to address each of these deficiencies, and

 

  • Describe a TEST OF CONTROL the auditor should perform to assess if each of these controls, if implemented, is operating effectively to reduce the identified deficiency.

 

Note: Prepare your answer using three columns headed Control deficiency, Control recommendation, and Test of control respectively. The total marks will be split

equally between each part.                                                                                                                                          (15 marks)

 

  • Describe substantive procedures the auditor should perform to obtain sufficient and appropriate evidence in relation to Comet Publishing Co’s purchases and other

 

expenses.                                                                                                                                            (5 marks)

 

(30 marks)

 

165     EQUESTRIAN                 Walk in the footsteps of a top tutor

 

  • ISA 315 Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and Its Environment requires auditors to obtain an understanding of control activities relevant to the audit.

 

Control activities are the policies and procedures which help ensure that management directives are carried out.

 

Required:

 

Describe FOUR different types of control activities and, for each type, provide an example

 

control a company may implement.                                                                                      (4 marks)

 

Equestrian Co manufactures smartphones and tablets. Its main customers are retailers who then sell to the general public. The company’s manufacturing is spread across five sites and goods are stored in its nine warehouses located across the country. You are an audit supervisor of Baseball & Co and in preparation for the forthcoming audit for the year ending 30 June 20X7, you are reviewing the following notes your audit manager has provided you with in relation to the company’s internal controls.

 

Equestrian Co has a small internal audit (IA) department. During the year, IA started a programme of physically verifying the company’s assets and comparing the results to the non-current assets register, as this type of reconciliation had not occurred for some time. To date only 15% of assets have had their existence confirmed as IA has experienced significant staff shortages and several members of the current IA team are new to Equestrian Co.

 

During the year, Equestrian Co conducted an extensive reorganisation of its manufacturing process to improve efficiency. Due to the significant number of employee changes required, the human resources department (HR) has been very busy and to ease their workload during this period, the payroll department has assisted by setting up any new employees who have joined the company. In January 20X7, the wage rate paid to employees was increased by the HR director and he notified payroll by emailing the payroll supervisor.

 

A new sales ledger system was introduced in May 20X6 and will continue to be run in parallel with the old system until IA has completed its checks between the two systems. New customers obtained by the sales team are required to undergo a full credit check. On the basis of this, a credit limit is proposed by sales staff and approved by the sales director and these credit limits remain static in the sales system.

 

Monthly perpetual inventory counts are undertaken at each of the nine warehouses, as a full year-end inventory count is too disruptive for the company. High value items are stored in a secure area in each warehouse. Access is via a four digit code, which for convenience is the same across all sites. Due to the company’s reorganisation programme, some of the monthly inventory counts were not performed.

 

Bank reconciliations are undertaken monthly by an accounts clerk and details of all reconciling items are included. Where the sum of the reconciling items is significant, the reconciliation is sent to the financial controller for review. In order to maximise cash balances, the finance director approves all purchase invoices for payment 75 days after receipt of the invoice.

 

Required:

 

  • Identify and explain EIGHT deficiencies in Equestrian Co’s internal controls and

 

provide a recommendation to address each of these deficiencies.                                                                                                                                          (16 marks)

 

Note: Prepare your answer using two columns headed Control deficiency and Control recommendation respectively.

 

(20 marks)

 

 

166     CATERPILLAR                 Walk in the footsteps of a top tutor

 

Caterpillar Co is a clothing retailer which operates 45 stores throughout the country. The company’s year end is 31 March 20X7. Caterpillar Co has an internal audit department which has undertaken a number of internal control reviews specifically focusing on cash controls at stores during the year. The reviews have taken place in the largest 20 stores as this is where most issues arise. You are an audit supervisor of Woodlouse & Co and are reviewing the internal controls documentation in relation to the cash receipts system in preparation for the interim audit which will involve visiting a number of stores and the head office.

 

Each of Caterpillar Co’s stores has on average three or four cash tills to take customer payments. All employees based at the store are able to use each till and individuals do not have their own log on codes, although employees tend to use the same till each day. Customers can pay using either cash or a credit card and for any transaction either the credit card payment slips or cash are placed in the till by the cashier. Where employees’ friends or family members purchase clothes in store, the employee is able to serve them at the till point.

 

At the end of each day, the tills are closed down with daily readings of sales taken from each till. These are reconciled to the total of the cash in the tills and the credit card payment slips and any discrepancies are noted. To save time, this reconciliation is done by the store’s assistant manager in aggregate for all of the store tills together. Once this reconciliation has taken place, the cash is stored in the shop’s small safe overnight and in the morning it is transferred to the bank via collection by a security company. If the store is low on change for cash payments, a junior sales clerk is sent by a till operator to the bank with money from the till and asked to change it into smaller denominations.

 

The daily sales readings from the tills along with the cash data and credit card payment data are transferred daily to head office through an interface with the sales and cash receipts records. A clerk oversees that this transfer has occurred for all stores. On a daily basis, he also agrees the cash transferred by the security company has been banked in full by agreeing the cash deposit slips to the bank statements, and that the credit card receipts have been received from the credit card company. On a monthly basis, the same clerk reconciles the bank statements to the cash book. The reconciliations are reviewed by the financial controller if there are any unreconciled amounts.

 

Required:

 

(a)      State TWO control objectives of Caterpillar Co’s cash receipts system.          (2 marks)

 

  • Identify and explain THREE KEY CONTROLS in Caterpillar Co’s cash receipts system which the auditor may seek to place reliance on and describe a TEST OF CONTROL the auditor should perform to assess if each of these controls is operating effectively.

 

Note: Prepare your answer using two columns headed Control strength and Test of

 

control respectively.                                                                                                       (6 marks)

 

  • Identify and explain SIX DEFICIENCIES in Caterpillar Co’s cash receipts system and provide a recommendation to address each of these deficiencies.

 

Note: Prepare your answer using two columns headed Control deficiency and Control

 

recommendation respectively.                                                                                  (12 marks)

 

(Total: 20 marks)

 

 

167     HERAKLION                 Walk in the footsteps of a top tutor

 

 

 

Question debrief

 

Heraklion Co is a manufacturer of footballs and is a new audit client for your firm. You are an audit supervisor of Spinalonga & Co and are currently preparing for the forthcoming interim and final audit for the year ending 31 October 20X6. You are required to document and assess the sales system, recommend control improvements to deal with a specific fraud issue as well as undertake substantive testing of revenue.

 

Sales ordering, goods despatched and invoicing

 

Heraklion Co sells footballs to a range of large and small sports equipment retailers in several countries. Sales are made through a network of sales staff employed by Heraklion Co, but new customer leads are generated through a third party company. Sales staff are responsible for assessing new customers’ creditworthiness and proposing a credit limit which is then authorised by the sales director. The sales staff have monthly sales targets and are able to use their discretion in granting sales discounts up to a maximum of 10%. They then record any discount granted in the customer master data file.

 

The sales staff visit customer sites personally and orders are completed using a two-part pre-printed order form. One copy is left with the customer and the other copy is retained by the sales person. The sales order number is based on the sales person’s own identification (ID) number.

 

The company markets itself on being able to despatch all orders within three working days. Once the order is taken, the sales person emails the finance department and warehouse despatch team with the customer ID and the sales order details and from this a pick list is generated. Sequentially numbered goods despatched notes are completed and filed in the warehouse.

 

Sequentially numbered invoices are generated using the pick lists for quantities and the customer master data file for prices. Standard credit terms for customers are 30 days and on a monthly basis sales invoices which are over 90 days outstanding are notified to the relevant sales person to chase payment directly with the customer.

 

Payroll fraud

 

The finance director, Montse Mirabelle, has informed you that a significant fraud took place during the year in the payroll department. A number of fictitious employees were set up on the payroll and wages were paid into one bank account. This bank account belonged to two supervisors, who were married, and were employed by Heraklion Co. One had sole responsibility for setting up new joiners in the payroll system and the other processed and authorised bank transfer requests for wages and supplier payments. These employees no longer work for the company and Montse has asked the audit firm for recommendations on how to improve controls in this area to prevent this type of fraud occurring again. Heraklion Co operates a Human Resources department.

 

Required:

 

  • Describe TWO methods for documenting the sales system, and for each explain

 

ONE advantage and ONE disadvantage of using this method.                                                                                                                                            (6 marks)

 

  • Identify and explain SEVEN deficiencies in the sales system of Heraklion Co and provide a recommendation to address each of these deficiencies.

 

Note: Prepare your answer using two columns headed Control deficiency and Control

 

recommendation respectively.                                                                                                                                          (14 marks)

 

  • In relation to the payroll fraud, identify and explain THREE controls Heraklion Co

 

should implement to reduce the risk of this type of fraud occurring again and, for

each control, describe how it would mitigate the risk.                                                                                                                                            (6 marks)

 

  • Describe substantive procedures the auditor should perform to obtain sufficient

 

and appropriate audit evidence in relation to Heraklion Co’s revenue.                                                                                                                                            (4 marks)

 

(Total: 30 marks)

 

 

Calculate your allowed time, allocate the time to the separate parts……………

 

 

168   LEMON QUARTZ                 Walk in the footsteps of a top tutor

 

You are an audit senior of Hessonite & Co and are in the process of reviewing the inventory system documentation for your audit client, Lemon Quartz Co (Quartz) which manufactures computer equipment. The company’s factory and warehouse are based on one large site, and their year-end is 30 June 20X6. Quartz is planning to undertake a full inventory count at the year-end of its raw materials, work in progress and finished goods and you will be attending this count. In preparation you have been reviewing the inventory count instructions for finished goods provided by Quartz.

 

The count will be undertaken by 15 teams of two counters from the warehouse department with Quartz’s financial controller providing overall supervision. Each team of two is allocated a number of bays within the warehouse to count and they are provided with sequentially numbered inventory sheets which contain product codes and quantities extracted from the inventory records. The counters move through each allocated bay counting the inventory and confirming that it agrees with the inventory sheets. Where a discrepancy is found, they note this on the sheet.

 

The warehouse is large and approximately 10% of the bays have been rented out to third parties with similar operations; these are scattered throughout the warehouse. For completeness, the counters have been asked to count the inventory for all bays noting the third party inventories on separate blank inventory sheets, and the finance department will make any necessary adjustments.

 

Some of Quartz’s finished goods are high in value and are stored in a locked area of the warehouse and all the counting teams will be given the code to access this area. There will be no despatches of inventory during the count and it is not anticipated that there will be any deliveries from suppliers.

 

Each area is counted once by the allocated team; the sheets are completed in ink, signed by the team and returned after each bay is counted. As no two teams are allocated the same bays, there will be no need to flag that an area has been counted. On completion of the count, the financial controller will confirm with each team that they have returned their inventory sheets.

 

Required:

 

  • In respect of the inventory count procedures for Lemon Quartz Co:

 

  • Identify and explain FIVE deficiencies

 

  • Recommend a control to address each of these deficiencies, and

 

  • Describe a TEST OF CONTROL the external auditors would perform to assess if each of these controls, if implemented, is operating effectively.

 

Note: The total marks will be split equally between each part.                        (15 marks)

 

Note: Prepare your answer using three columns headed Control deficiency, Control recommendation and Test of control respectively.

 

  • Quartz’s finance director has asked your firm to undertake a non-audit assurance engagement later in the year. The audit junior has not been involved in such an assignment before and has asked you to explain what an assurance engagement involves.

 

Required:

 

Explain the five elements of an assurance engagement.                                     (5 marks)

 

(Total: 20 marks)

 

 

169   BRONZE                 Walk in the footsteps of a top tutor

 

You are an audit senior of Scarlet & Co and are in the process of reviewing the systems testing completed on the payroll cycle of Bronze Industries Co (Bronze), as well as preparing the audit programmes for the final audit.

 

Bronze operate several chemical processing factories across the country, it manufactures 24 hours a day, seven days a week and employees work a standard shift of eight hours and are paid for hours worked at an hourly rate. Factory employees are paid weekly, with approximately 80% being paid by bank transfer and 20% in cash; the different payment methods are due to employee preferences and Bronze has no plans to change these methods. The administration and sales teams are paid monthly by bank transfer.

 

Factory staff are each issued a sequentially numbered clock card which details their employee number and name. Employees swipe their cards at the beginning and end of the eight-hour shift and this process is not supervised. During the shift employees are entitled to a 30-minute paid break and employees do not need to clock out to access the dining area. Clock card data links into the payroll system, which automatically calculates gross and net pay along with any statutory deductions. The payroll supervisor for each payment run checks on a sample basis some of these calculations to ensure the system is operating effectively.

 

Bronze has a human resources department which is responsible for setting up new permanent employees and leavers. Appointments of temporary staff are made by factory production supervisors. Occasionally overtime is required of factory staff, usually to fill gaps caused by staff holidays. Overtime reports which detail the amount of overtime worked are sent out quarterly by the payroll department to production supervisors for their review.

 

To encourage staff to attend work on time for all shifts Bronze pays a discretionary bonus every six months to factory staff; the production supervisors determine the amounts to be paid. This is communicated in writing by the production supervisors to the payroll department and the bonus is input by a clerk into the system.

 

For employees paid by bank transfer, the payroll manager reviews the list of the payments and agrees to the payroll records prior to authorising the bank payment. If any changes are required, the payroll manager amends the records. For employees paid in cash, the pay packets are prepared in the payroll department and a clerk distributes them to employees; as she knows most of these individuals she does not require proof of identity.

 

Required:

 

  • Identify and explain FIVE key controls in Bronze Industries Co’s payroll system

 

which the auditor may seek to place reliance on.                                                                                                                                            (5 marks)

 

  • In respect of the payroll system:

 

  • Identify and explain SIX internal control deficiencies

 

  • Recommend a control to address each of these deficiencies, and

 

  • Describe a test of control Scarlet & Co should perform to assess if each of these controls is operating effectively.

 

Note: The total marks will be split equally between each part.                                                                                                                                          (18 marks)

 

Note: Prepare your answer using three columns headed Control deficiency, Control recommendation and Test of control respectively.

 

  • Describe substantive ANALYTICAL PROCEDURES you should perform to confirm

 

Bronze Industries Co’s payroll expense.                                                                                                                                            (3 marks)

 

  • Explain the factors to be considered in determining the suitability of using

 

analytical procedures as a substantive procedure.                                                                                                                                            (4 marks)

 

(Total: 30 marks)

 

170   TROMBONE                 Walk in the footsteps of a top tutor

 

  • ISA 315 Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and Its Environment describes the five components of an entity’s internal control.

 

Required:

 

Identify and briefly explain the FIVE components of an entity’s internal control.

 

(5 marks)

 

Trombone Co (Trombone) operates a chain of hotels across the country. Trombone employs in excess of 250 permanent employees and its year-end is 31 August. You are the audit supervisor of Viola & Co and are currently reviewing the documentation of Trombone’s payroll system, detailed below, in preparation for the interim audit.

 

Trombone’s payroll system

 

Permanent employees work a standard number of hours per week as specified in their employment contract. However, when the hotels are busy, staff can be requested by management to work additional shifts as overtime. This can either be paid on a monthly basis or taken as days off.

 

Employees record any overtime worked and days taken off on weekly overtime sheets which are sent to the payroll department. The standard hours per employee are automatically set up in the system and the overtime sheets are entered by clerks into the payroll package, which automatically calculates the gross and net pay along with relevant deductions. These calculations are not checked at all. Wages are increased by the rate of inflation each year and the clerks are responsible for updating the standing data in the payroll system.

 

Employees are paid on a monthly basis by bank transfer for their contracted weekly hours and for any overtime worked in the previous month. If employees choose to be paid for overtime, authorisation is required by department heads of any overtime in excess of 30% of standard hours. If employees choose instead to take days off, the payroll clerks should check back to the ‘overtime worked’ report; however, this report is not always checked.

 

The ‘overtime worked’ report, which details any overtime recorded by employees, is run by the payroll department weekly and emailed to department heads for authorisation. The payroll department asks department heads to only report if there are any errors recorded. Department heads are required to arrange for overtime sheets to be authorised by an alternative responsible official if they are away on annual leave; however, there are instances where this arrangement has not occurred.

 

The payroll package produces a list of payments per employee; this links into the bank system to produce a list of automatic payments. The finance director reviews the total list of bank transfers and compares this to the total amount to be paid per the payroll records; if any issues arise then the automatic bank transfer can be manually changed by the finance director.

 

Required:

 

  • In respect of the payroll system of Trombone Co:

 

  • Identify and explain FIVE deficiencies

 

  • Recommend a control to address each of these deficiencies, and

 

  • Describe a test of control Viola & Co should perform to assess if each of these controls is operating effectively.

 

Note: The total marks will be split equally between each part.                                                                                                                                          (15 marks)

 

Note: Prepare your answer using three columns headed Control deficiency, Control recommendation and Test of control respectively.

 

  • Describe substantive procedures you should perform at the final audit to confirm

 

the completeness and accuracy of Trombone Co’s payroll expense.                                                                                                                                            (6 marks)

 

Trombone deducts employment taxes from its employees’ wages on a monthly basis and pays these to the local taxation authorities in the following month. At the year-end the financial statements will contain an accrual for income tax payable on employment income. You will be in charge of auditing this accrual.

 

Required:

 

  • Describe the audit procedures required in respect of the year-end accrual for tax

 

payable on employment income.                                                                                                                                            (4 marks)

 

(Total: 30 marks)

 

 

171   OREGANO                 Walk in the footsteps of a top tutor

 

You are a member of the recently formed internal audit department of Oregano Co (Oregano). The company manufactures tinned fruit and vegetables which are supplied to large and small food retailers. Management and those charged with governance of Oregano have concerns about the effectiveness of their sales and despatch system and have asked internal audit to document and review the system.

 

Sales and despatch system

 

Sales orders are mainly placed through Oregano’s website but some are made via telephone. Online orders are automatically checked against inventory records for availability; telephone orders, however, are checked manually by order clerks after the call. A follow-up call is usually made to customers if there is insufficient inventory. When taking telephone orders, clerks note down the details on plain paper and afterwards they complete a three part pre-printed order form. These order forms are not sequentially numbered and are sent manually to both despatch and the accounts department.

 

As the company is expanding, customers are able to place online orders which will exceed their agreed credit limit by 10%. Online orders are automatically forwarded to the despatch and accounts department.

 

A daily pick list is printed by the despatch department and this is used by the warehouse team to despatch goods. The goods are accompanied by a despatch note and all customers are required to sign a copy of this. On return, the signed despatch notes are given to the warehouse team to file.

 

The sales quantities are entered from the despatch notes and the authorised sales prices are generated by the invoicing system. If a discount has been given, this has to be manually entered by the sales clerk onto the invoice. Due to the expansion of the company, and as there is a large number of sale invoices, extra accounts staff have been asked to help out temporarily with producing the sales invoices. Normally it is only two sales clerks who produce the sales invoices.

 

Required:

 

  • Describe TWO methods for documenting the sales and despatch system; and for

 

each explain an advantage and a disadvantage of using this method.           (6 marks)

 

  • List TWO control objectives of Oregano Co’s sales and despatch system. (2 marks)

 

  • Identify and explain SIX deficiencies in Oregano Co’s sales and despatch system and

 

provide a recommendation to address each of these deficiencies.               (12 marks)

 

Note: Prepare your answer using two columns headed Control deficiency and Control recommendation respectively.

 

(Total: 20 marks)

 

 

172   FOX INDUSTRIES                 Walk in the footsteps of a top tutor

 

Fox Industries Co (Fox) manufactures engineering parts. It has one operating site and a customer base spread across Europe. The company’s year-end was 30 April 20X3. Below is a description of the purchasing and payments system.

 

Purchasing system

 

Whenever production materials are required, the relevant department sends a requisition form to the ordering department. An order clerk raises a purchase order and contacts a number of suppliers to see which can despatch the goods first. This supplier is then chosen. The order clerk sends out the purchase order. This is not sequentially numbered and only orders above $5,000 require authorisation.

 

Purchase invoices are input daily by the purchase ledger clerk, who has been in the role for many years and, as an experienced team member, he does not apply any application controls over the input process. Every week the purchase day book automatically updates the purchase ledger, the purchase ledger is then posted manually to the general ledger by the purchase ledger clerk.

 

Payments system

 

Fox maintains a current account and a number of saving (deposit) accounts. The current account is reconciled weekly but the saving (deposit) accounts are only reconciled every two months.

 

In order to maximise their cash and bank balance, Fox has a policy of delaying payments to all suppliers for as long as possible. Suppliers are paid by a bank transfer. The finance director is given the total amount of the payments list, which he authorises and then processes the bank payments.

 

Required:

 

  • As the external auditors of Fox Industries Co, write a report to management in respect of the purchasing and payments system described above which:

 

  • Identifies and explains FIVE deficiencies in the system, and

 

  • Provides a recommendation to address each deficiency.

 

A covering letter IS required.

 

Note: Up to two marks will be awarded within this requirement for presentation and

 

the remaining marks will be split equally between each part.                                                                                                                                          (12 marks)

 

  • Identify and explain THREE application controls that should be adopted by Fox Industries Co to ensure the completeness and accuracy of the input of purchase

 

invoices.                                                                                                                                            (3 marks)

 

  • Describe substantive procedures the auditor should perform to confirm the bank

 

and cash balance of Fox Industries Co at the year-end.                                                                                                                                            (5 marks)

 

(Total: 20 marks)

 

 

173   LILY WINDOW GLASS                 Walk in the footsteps of a top tutor

 

Lily Window Glass Co (Lily) is a glass manufacturer, which operates from a large production facility, where it undertakes continuous production 24 hours a day, seven days a week. Also on this site are two warehouses, where the company’s raw materials and finished goods are stored. Lily’s year-end is 31 December.

 

Lily is finalising the arrangements for the year-end inventory count, which is to be undertaken on 31 December 20X2. The finished windows are stored within 20 aisles of the first warehouse. The second warehouse is for large piles of raw materials, such as sand, used in the manufacture of glass. The following arrangements have been made for the inventory count:

 

The warehouse manager will supervise the count as he is most familiar with the inventory. There will be ten teams of counters and each team will contain two members of staff, one from the finance and one from the manufacturing department. None of the warehouse staff, other than the manager, will be involved in the count.

 

Each team will count an aisle of finished goods by counting up and then down each aisle. As this process is systematic, it is not felt that the team will need to flag areas once counted. Once the team has finished counting an aisle, they will hand in their sheets and be given a set for another aisle of the warehouse. In addition to the above, to assist with the inventory counting, there will be two teams of counters from the internal audit department and they will perform inventory counts.

 

The count sheets are sequentially numbered, and the product codes and descriptions are printed on them but no quantities. If the counters identify any inventory which is not on their sheets, then they are to enter the item on a separate sheet, which is not numbered. Once all counting is complete, the sequence of the sheets is checked and any additional sheets are also handed in at this stage. All sheets are completed in ink.

 

Any damaged goods identified by the counters will be too heavy to move to a central location, hence they are to be left where they are but the counter is to make a note on the inventory sheets detailing the level of damage.

 

As Lily undertakes continuous production, there will continue to be movements of raw materials and finished goods in and out of the warehouse during the count. These will be kept to a minimum where possible.

 

The level of work-in-progress in the manufacturing plant is to be assessed by the warehouse manager. It is likely that this will be an immaterial balance. In addition, the raw materials quantities are to be approximated by measuring the height and width of the raw material piles. In the past this task has been undertaken by a specialist; however, the warehouse manager feels confident that he can perform this task.

 

Required:

 

  • For the inventory count arrangements of Lily Window Glass Co:

 

  • Identify and explain SIX deficiencies; and

 

  • Provide a recommendation to address each deficiency.

 

Note: Prepare your answer using two columns headed Deficiency and Recommendation

 

respectively.                                                                                                                                (12 marks)

 

You are the audit senior of Daffodil & Co and are responsible for the audit of inventory for Lily. You will be attending the year-end inventory count on 31 December 20X2.

 

In addition, your manager wishes to utilise computer-assisted audit techniques for the first time for controls and substantive testing in auditing Lily Window Glass Co’s inventory.

 

Required:

 

  • Describe the procedures to be undertaken by the auditor DURING the inventory count of Lily Window Glass Co in order to gain sufficient appropriate audit

 

evidence.                                                                                                                           (6 marks)

 

  • For the audit of the inventory cycle and year-end inventory balance of Lily Window Glass Co:

 

  • Describe FOUR audit procedures that could be carried out using computer-assisted audit techniques (CAATS)

 

  • Explain the potential advantages of using CAAT,; and

 

  • Explain the potential disadvantages of using CAATs.

 

The total marks will be split equally between each part                                     (12 marks)

 

(Total: 30 marks)

 

 

174   PEAR INTERNATIONAL                 Walk in the footsteps of a top tutor

 

  • Auditors are required to document their understanding of the client’s internal controls. There are various options available for recording the internal control system. Two of these options are narrative notes and internal control questionnaires.

 

Required:

 

Describe the advantages and disadvantages to the auditor of narrative notes and internal control questionnaires as methods for documenting a system. (5 marks)

 

Pear International Co (Pear) is a manufacturer of electrical equipment. It has factories across the country and its customer base includes retailers as well as individuals, to whom direct sales are made through their website. The company’s year-end is 30 September 20X2. You are an audit supervisor of Apple & Co and are currently reviewing documentation of Pear’s internal control in preparation for the interim audit.

 

Pear’s website allows individuals to order goods directly, and full payment is taken in advance. Currently the website is not integrated into the inventory system and inventory levels are not checked at the time when orders are placed.

 

Goods are despatched via local couriers; however, they do not always record customer signatures as proof that the customer has received the goods. Over the past 12 months there have been customer complaints about the delay between sales orders and receipt of goods. Pear has investigated these and found that, in each case, the sales order had been entered into the sales system correctly but was not forwarded to the despatch department for fulfilling.

 

Pear’s retail customers undergo credit checks prior to being accepted and credit limits are set accordingly by sales ledger clerks. These customers place their orders through one of the sales team, who decides on sales discount levels.

 

Raw materials used in the manufacturing process are purchased from a wide range of suppliers. As a result of staff changes in the purchase ledger department, supplier statement reconciliations are no longer performed. Additionally, changes to supplier details in the purchase ledger master file can be undertaken by purchase ledger clerks as well as supervisors.

 

In the past six months Pear has changed part of its manufacturing process and as a result some new equipment has been purchased, however, there are considerable levels of plant and equipment which are now surplus to requirement. Purchase requisitions for all new equipment have been authorised by production supervisors and little has been done to reduce the surplus of old equipment.

 

Required:

 

  • In respect of the internal control of Pear International Co:

 

  • Identify and explain FIVE deficiencies

 

  • Recommend a control to address each of these deficiencies, and

 

  • Describe a test of control Apple & Co would perform to assess if each of

 

these controls is operating effectively.                                                                                                                               (15 marks)

 

Note: Prepare your answer using three columns headed Control deficiency, Control recommendation and Test of control respectively.

 

  • Describe substantive procedures you should perform at the year-end to confirm each of the following for plant and equipment:

 

  • Additions; and

 

(ii)      Disposals.           (6 marks)

 

Pear’s directors are considering establishing an internal audit department next year, and the finance director has asked what impact, if any, establishing an internal audit department would have on future external audits performed by Apple & Co.

 

Required:

 

  • Explain the potential impact on the work performed by Apple & Co during the interim and final audits, if Pear International Co was to establish an internal audit

 

department.                                                                                                                     (4 marks)

 

(Total: 30 marks)

GREYSTONE                            Walk in the footsteps of a top tutor

 

  • Auditors have a responsibility under ISA 265 Communicating Deficiencies in Internal Control to those Charged with Governance and Management, to communicate deficiencies in internal controls. In particular SIGNIFICANT deficiencies in internal controls must be communicated in writing to those charged with governance.

 

Required:

 

Explain examples of matters the auditor should consider in determining whether a

 

deficiency in internal controls is significant.                                                           (3 marks)

 

Greystone Co is a retailer of ladies clothing and accessories. It operates in many countries around the world and has expanded steadily from its base in Europe. Its main market is aimed at 15 to 35 year olds and its prices are mid to low range. The company’s year-end was 30 September 20X0.

 

In the past the company has bulk ordered its clothing and accessories twice a year. However, if their goods failed to meet the key fashion trends then this resulted in significant inventory write downs. As a result of this the company has recently introduced a just in time ordering system. The fashion buyers make an assessment nine months in advance as to what the key trends are likely to be, these goods are sourced from their suppliers but only limited numbers are initially ordered.

 

Ordering process

 

Each country has a purchasing manager who decides on the initial inventory levels for each store, this is not done in conjunction with store or sales managers. These quantities are communicated to the central buying department at the head office in Europe. An ordering clerk amalgamates all country orders by specified regions of countries, such as Central Europe and North America, and passes them to the purchasing director to review and authorise.

 

As the goods are sold, it is the store manager’s responsibility to re-order the goods through the purchasing manager; they are prompted weekly to review inventory levels as although the goods are just in time, it can still take up to four weeks for goods to be received in store.

 

It is not possible to order goods from other branches of stores as all ordering must be undertaken through the purchasing manager. If a customer requests an item of clothing, which is unavailable in a particular store, then the customer is provided with other branch telephone numbers or recommended to try the company website.

 

Goods received and invoicing

 

To speed up the ordering to receipt of goods cycle, the goods are delivered directly from the suppliers to the individual stores. On receipt of goods the quantities received are checked by a sales assistant against the supplier’s delivery note, and then the assistant produces a goods received note (GRN). This is done at quiet times of the day so as to maximise sales. The checked GRNs are sent to head office for matching with purchase invoices.

 

As purchase invoices are received they are manually matched to GRNs from the stores, this can be a very time consuming process as some suppliers may have delivered to over 500 stores. Once the invoice has been agreed then it is sent to the purchasing director for authorisation. It is at this stage that the invoice is entered onto the purchase ledger.

 

Required:

 

(b)      List THREE control objectives of Greystone’s purchasing system.            (3 marks)

 

  • In respect of the purchasing system above:

 

  • Identify and explain SIX deficiencies in that system

 

  • Provide a recommendation to address each deficiency

 

  • Describe a test of control the auditor would perform to assess if each of

 

these controls is operating effectively.                                                                                                                               (18 marks)

 

Note: Prepare your answer using three columns headed Control deficiency, Control recommendation and Test of control respectively.

 

  • Describe substantive procedures the auditor should perform on the year-end trade

 

payables of Greystone Co.                                                                                                                                            (6 marks)

 

(Total: 30 marks)

 

 

176   SHINY HAPPY WINDOWS                 Walk in the footsteps of a top tutor

 

  • Explain the terms ‘control objectives’ and ‘control procedures’ and explain the

 

relationship between them.                                                                                                                                            (3 marks)

 

  • Shiny Happy Windows Co (SHW) is a window cleaning company. Customers’ windows are cleaned monthly, the window cleaner then posts a stamped addressed envelope for payment through the customer’s front door.

 

SHW has a large number of receivable balances and these customers pay by cheque or cash, which is received in the stamped addressed envelopes in the post. The following procedures are applied to the cash received cycle:

 

  • A junior clerk from the accounts department opens the post and if any cheques or cash have been sent, she records the receipts in the cash received log and then places all the monies into the locked small cash box.

 

  • The contents of the cash box are counted each day and every few days these sums are banked by which ever member of the finance team is available.

 

  • The cashier records the details of the cash received log into the cash receipts day book and also updates the sales ledger.

 

  • Usually on a monthly basis the cashier performs a bank reconciliation, which he then files, if he misses a month then he catches this up in the following month’s reconciliation.

 

Required:

 

For the cash cycle of SHW:

 

  • Identify and explain FOUR deficiencies in the system

 

  • Suggest controls to address each of these deficiencies

 

  • List tests of controls the auditor of SHW would perform to assess if the

 

controls are operating effectively.                                                               (12 marks)

 

Note: Prepare your answer using three columns headed Control deficiency, Control recommendation and Test of control respectively.

 

  • Describe substantive  procedures  an  auditor  would  perform  in  verifying  a

 

company’s bank balance.                                                                                             (5 marks)

 

(Total: 20 marks)

 

 

177   DASHING                 Walk in the footsteps of a top tutor

 

Dashing Co manufactures women’s clothing and its year end was 31 July 20X7. You are an audit supervisor of Jaunty & Co and the year-end audit for Dashing Co is due to commence shortly.

 

The draft financial statements recognise profit before tax of $2·6m and total assets of $18m. You have been given responsibility for auditing receivables, which is a material balance, and as part of the audit approach, a positive receivables circularisation is to be undertaken.

 

At the planning meeting, the finance director of Dashing Co informed the audit engagement partner that the company was closing one of its smaller production sites and as a result, a number of employees would be made redundant. A redundancy provision of $110,000 is included in the draft financial statements.

 

Required:

 

  • Describe the steps the auditor should perform in undertaking a positive receivables

 

circularisation for Dashing Co.                                                                                    (4 marks)

 

  • Describe substantive procedures, other than a receivables circularisation, the auditor should perform to verify EACH of the following assertions in relation to Dashing Co’s receivables:

 

  • Accuracy, valuation and allocation

 

  • Completeness, and

 

  • Rights and obligations.

 

Note: The total marks will be split equally between each part.                          (6 marks)

 

  • Describe substantive  procedures  the  auditor  should  perform  to  confirm  the

 

redundancy provision at the year end.                                                                     (5 marks)

 

  • A few months have now passed and the audit team is performing the audit fieldwork including the audit procedures which you recommended over the redundancy provision. The team has calculated that the necessary provision should amount to $305,000. The finance director is not willing to adjust the draft financial statements.

 

Required:

 

Discuss the issue and describe the impact on the auditor’s report, if any, should this

 

issue remain unresolved.                                                                                                                                            (5 marks)

 

(20 marks)

 

 

178   AIRSOFT                 Walk in the footsteps of a top tutor

 

 

 

Question debrief

 

Airsoft Co is a listed company which manufactures stationery products. The company’s profit before tax for the year ended 31 December 20X6 is $16·3 million and total assets as at that date are $66·8 million. You are an audit supervisor of Biathlon & Co and you are currently finalising the audit programmes for the year-end audit of your existing client Airsoft Co. You attended a meeting with your audit manager where the following matters were discussed:

 

Trade payables and accruals

 

Airsoft Co purchases its raw materials from a large number of suppliers. The company’s policy is to close the purchase ledger just after the year end and the financial controller is responsible for identifying goods which were received pre year-end but for which no invoice has yet been received. An accrual is calculated for goods received but not yet invoiced (GRNI) and is included within trade payables and accruals.

 

The audit strategy has identified a risk over the completeness of trade payables and accruals. The audit team will utilise computer assisted audit techniques (CAATs), in the form of audit software while auditing trade payables and accruals.

 

Bank overdraft and savings accounts

 

Airsoft Co’s draft financial statements include a bank overdraft of $2·6 million, which relates to the company’s main current account. In addition Airsoft Co maintains a number of savings accounts. The savings account balances are classified as cash and cash equivalents and are included in current assets. All accounts have been reconciled at the year end.

 

Directors’ remuneration

 

Airsoft Co’s board comprises eight directors. Their overall remuneration consists of two elements: an annual salary, paid monthly and a significant annual discretionary bonus, which is paid in a separate payment run on 20 December. All remuneration paid to directors is included within wages and salaries. Local legislation requires disclosure of the overall total of directors’ remuneration broken down by element and by director.

 

Required:

 

  • Describe substantive procedures the auditor should perform to obtain sufficient

 

and appropriate audit evidence in relation to the COMPLETENESS of Airsoft Co’s

trade payables and accruals.                                                                                       (4 marks)

 

Excluding procedures included in part (a):

 

  • Describe audit software procedures which could be carried out during the audit of

 

Airsoft Co’s trade payables and accruals.                                                                 (3 marks)

 

  • Describe substantive procedures the auditor should perform to obtain sufficient and appropriate audit evidence in relation to Airsoft Co’s year-end bank balances.

(5 marks)

 

  • Describe substantive procedures the auditor should perform to confirm the directors’ remuneration included in the financial statements at the year end.

(3 marks)

 

A member of your audit team has asked for information on ISA 701 Communicating Key Audit Matters in the Independent Auditor’s Report as she has heard this standard is applicable to listed clients such as Airsoft Co.

 

Required:

 

  • Identify what a key audit matter (KAM) is and explain how the auditor determines

 

and communicates KAM.                                                                                             (5 marks)

 

(20 marks)

 

 

Calculate your allowed time, allocate the time to the separate parts……………

 

 

179     INSECTS4U                 Walk in the footsteps of a top tutor

 

You are an audit manager of Snail & Co and you are in charge of two audits which are due to commence shortly. Insects4U Co is a registered charity which promotes insect conservation and has been an audit client for several years. Spider Spirals Co, also an existing audit client, manufactures stationery products and its draft total liabilities are $8.1 million. Both clients’ financial year ended on 31 October 20X6. The following matters have been brought to your attention for each company.

 

Insects4U Co

 

  • Completeness of income

 

Insects4U Co is a not-for-profit organisation which generates income in a number of ways. It receives monthly donations from its many subscribers and these are paid by bank transfer to the charity. In addition, a large number of donations are sent through the post to the charity. Insects4U Co also sells tickets for their three charity events held annually. During the audit planning, completeness of income was flagged as a key risk.

 

Note: Assume that the charity adopts International Financial Reporting Standards.

 

(4 marks)

 

 

Spider Spirals Co

 

  • Trade payables

 

The finance director of Spider Spirals Co has informed you that at the year end the

 

purchase ledger was kept open for one week longer than normal as a large bank transfer and cheque payment run was made on 3 November 20X6. Some purchase invoices were received in this week and were recorded in the 20X6 purchase ledger

 

as well as the payment run made on 3 November.                                                                                                                                            (6 marks)

 

  • Trade receivables

 

Spider Spirals Co has a large number of small customers; the normal credit terms offered to them is 30 days. However, the finance director has informed you that the average trade receivables days have increased quite significantly this year from 34 days to 55 days. This is partly due to difficult trading conditions and also because for six months of the year the role of credit controller was vacant. The company has

 

historically maintained on average an allowance for trade receivables of 1.5% of

gross trade receivables.                                                                                                                                            (5 marks)

 

Required:

 

  • Describe substantive procedures the auditor should perform to obtain sufficient, and appropriate audit evidence in relation to the above three matters.

 

Note: The mark allocation is shown against each of the three matters above.

 

  • The finance director of Spider Spirals Co has informed you that he is not proposing to make an adjustment for the trade payables payment run made on 3 November, as the total payment of $490,000 would only require a change to trade payables and the bank overdraft, both of which are current liabilities.

 

Required:

 

Discuss the issue and describe the impact on the auditor’s report, if any, should this

 

issue remain unresolved.                                                                                                                                            (5 marks)

 

(Total: 20 marks)

 

 

180     ELOUNDA                 Walk in the footsteps of a top tutor

 

Elounda Co manufactures chemical compounds using a continuous production process. Its year-end was 31 July 20X6 and the draft profit before tax is $13.6 million. You are the audit supervisor and the year-end audit is due to commence shortly. The following matters have been brought to your attention.

 

  • Revaluation of property, plant and equipment (PPE)

 

At the beginning of the year, management undertook an extensive review of Elounda Co’s non-current asset valuations and as a result decided to update the carrying value of all PPE. The finance director, Peter Dullman, contacted his brother, Martin, who is

 

a valuer and requested that Martin’s firm undertake the valuation, which took place

in August 20X5.                                                                                                                                            (5 marks)

 

  • Inventory valuation

 

Your firm attended the year-end inventory count for Elounda Co and ascertained that the process for recording work in progress (WIP) and finished goods was acceptable.

 

Both WIP and finished goods are material to the financial statements and the quantity and stage of completion of all ongoing production was recorded accurately during the count.

 

During the inventory count, the count supervisor noted that a consignment of finished goods, compound E243, with a value of $720,000, was defective in that the chemical mix was incorrect. The finance director believes that compound E243 can

 

still be sold at a discounted sum of $400,000.                                                         (6 marks)

 

  • Bank loan

 

Elounda Co secured a bank loan of $2.6 million on 1 October 20X4. Repayments of $200,000 are due quarterly, with a lump sum of $800,000 due for repayment in January 20X7. The company met all loan payments in 20X5 on time, but was late in

 

paying the April and July 20X6 repayments.                                                             (4 marks)

 

Required:

 

  • Describe substantive procedures you should perform to obtain sufficient, appropriate audit evidence in relation to the above three matters.

 

Note: The mark allocation is shown against each of the three matters above.

 

  • Describe the procedures which the auditor of Elounda Co should perform in

 

assessing whether or not the company is a going concern.                                (5 marks)

 

(Total: 20 marks)

 

 

181   ANDROMEDA                 Walk in the footsteps of a top tutor

 

(a)      Explain FOUR factors which influence the reliability of audit evidence.         (4 marks)

 

Andromeda Industries Co (Andromeda) develops and manufactures a wide range of fast moving consumer goods. The company’s year-end is 31 December 20X5 and the forecast profit before tax is $8.3 million. You are the audit manager of Neptune & Co and the year-end audit is due to commence in January. The following information has been gathered during the planning process:

 

Inventory count

 

Andromeda’s raw materials and finished goods inventory are stored in 12 warehouses across the country. Each of these warehouses is expected to contain material levels of inventory at the year-end. It is expected that there will be no significant work in progress held at any of the sites. Each count will be supervised by a member of Andromeda’s internal audit department and the counts will all take place on 31 December, when all movements of goods in and out of the warehouses will cease.

 

Research and development

 

Andromeda spends over $2 million annually on developing new product lines. This year it incurred expenditure on five projects, all of which are at different stages of development. Once they meet the recognition criteria under IAS® 38 Intangible Assets for development expenditure, Andromeda includes the costs incurred within intangible assets. Once production commences, the intangible assets are amortised on a straight line basis over five years.

 

Required:

 

  • Describe audit procedures you would perform during the audit of Andromeda Industries Co:

 

(i)        BEFORE and DURING the inventory counts, and            (8 marks)

 

(ii)      In relation to research and development expenditure.           (4 marks)

 

  • During the audit, the team discovers that one of the five development projects, valued at $980,000 and included within intangible assets, does not meet the criteria for capitalisation. The finance director does not intend to change the accounting treatment adopted as she considers this an immaterial amount.

 

 

Required:

 

Discuss the issue and describe the impact on the auditor’s report, if any, if

 

the issue remains unresolved.                                                                                                                                 (4 marks)

 

(Total: 20 marks)

 

 

182   HAWTHORN                 Walk in the footsteps of a top tutor

 

 

 

Question debrief

 

  • (i)Identify and explain FOUR financial statement assertions relevant to classes of transactions and events for the year under audit; and

 

  • For each identified assertion, describe a substantive procedure relevant to

 

the audit of REVENUE.                                                                                                                                 (8 marks)

 

  • Hawthorn Enterprises Co (Hawthorn) manufactures and distributes fashion clothing to retail stores. Its year-end was 31 March 20X5. You are the audit manager and the year-end audit is due to commence shortly. The following three matters have been brought to your attention.

 

  • Supplier statement reconciliations

 

Hawthorn receives monthly statements from its main suppliers and although these have been retained, none have been reconciled to the payables ledger as at 31 March 20X5. The engagement partner has asked the audit senior to recommend the procedures to be performed on supplier statements. (3 marks)

 

  • Bank reconciliation

 

During last year’s audit of Hawthorn’s bank and cash, significant cut off errors were discovered with a number of post year-end cheques being processed prior to the year-end to reduce payables. The finance director has assured the audit engagement partner that this error has not occurred again this year and that the bank reconciliation has been carefully prepared. The audit

 

engagement partner has asked that the bank reconciliation is comprehensively

audited.                                                                                                                                 (4 marks)

 

  • Receivables

 

Hawthorn’s receivables ledger has increased considerably during the year, and

 

the year-end balance is $2.3 million compared to $1.4 million last year. The finance director of Hawthorn has requested that a receivables circularisation is not carried out as a number of their customers complained last year about the inconvenience involved in responding. The engagement partner has agreed to this request, and tasked you with identifying alternative procedures to confirm

 

the existence and valuation of receivables.                                                  (5 marks)

 

Required:

 

Describe substantive procedures you would perform to obtain sufficient and appropriate audit evidence in relation to the above three matters.

 

Note: The mark allocation is shown against each of the three matters above.

 

(Total: 20 marks)

 

 

Calculate your allowed time, allocate the time to the separate parts……………

 

 

 

183   ROSE LEISURE CLUB                 Walk in the footsteps of a top tutor

 

  • Identify and explain each of the FIVE fundamental principles contained within

 

ACCA’s Code of Ethics and Conduct.                                                                          (5 marks)

 

  • Rose Leisure Club Co (Rose) operates a chain of health and fitness clubs. Its year-end was 31 October 20X2. You are the audit manager and the year-end audit is due to commence shortly. The following three matters have been brought to your attention.

 

  • Trade payables and accruals

 

Rose’s finance director has notified you that an error occurred in the closing of the purchase ledger at the year-end. Rather than it closing on 1 November, it accidentally closed one week earlier on 25 October. All purchase invoices received between 25 October and the year-end have been posted to the 20X3

 

year-end purchase ledger.                                                                                 (6 marks)

 

  • Receivables

 

Rose’s trade receivables have historically been low as most members pay monthly in advance. However, during the year a number of companies have taken up group memberships at Rose and hence the receivables balance is

 

now material. The audit senior has undertaken a receivables circularisation for the balances at the year-end; however, there are a number who have not

 

responded and a number of responses with differences.                         (5 marks)

 

  • Reorganisation

 

The company recently announced its plans to reorganise its health and fitness clubs. This will involve closing some clubs for refurbishment, retraining some

existing staff and disposing of some surplus assets. These plans were agreed at a board meeting in October and announced to their shareholders on 29 October. Rose is proposing to make a reorganisation provision in the

 

financial statements.                                                                                           (4 marks)

 

Required:

 

Describe substantive procedures you would perform to obtain sufficient and appropriate audit evidence in relation to the above three matters.

 

Note: The mark allocation is shown against each of the three matters above.

 

(Total: 20 marks)

 

184   PINEAPPLE BEACH HOTEL                 Walk in the footsteps of a top tutor

 

  • (i)Identify and explain FOUR financial statement assertions relevant to account balances at the year-end; and

 

  • For each identified assertion, describe a substantive procedure relevant to

 

the audit of year-end inventory.                                                                                                                                 (8 marks)

 

  • Pineapple Beach Hotel Co (Pineapple) operates a hotel providing accommodation, leisure facilities and restaurants. Its year-end was 30 April 20X2. You are the audit senior of Berry & Co and are currently preparing the audit programmes for the year-end audit of Pineapple. You are reviewing the notes of last week’s meeting between the audit manager and finance director where two material issues were discussed.

 

Depreciation

 

Pineapple incurred significant capital expenditure during the year on updating the leisure facilities for the hotel. The finance director has proposed that the new leisure equipment should be depreciated over 10 years using the straight-line method.

 

Food poisoning

 

Pineapple’s directors received correspondence in March from a group of customers who attended a wedding at the hotel. They have alleged that they suffered severe food poisoning from food eaten at the hotel and are claiming substantial damages. Pineapple’s lawyers have received the claim and believe that the lawsuit against the company is unlikely to be successful.

 

Required:

 

Describe substantive procedures to obtain sufficient and appropriate audit evidence in relation to the above two issues.

 

Note: The total marks will be split equally between each issue.

 

(8 marks)

 

  • List and explain the purpose of FOUR items that should be included on every

 

working paper prepared by the audit team.                                                                                                                                            (4 marks)

 

(Total: 20 marks)

 

THE FOLLOWING QUESTIONS ARE EXAM STANDARD BUT DO NOT REFLECT THE CURRENT EXAM FORMAT. THESE QUESTIONS PROVIDE VALUABLE PRACTICE FOR STUDENTS NEVERTHELESS.

 

 

AUDIT FRAMEWORK

 

 

185   CINNAMON                 Walk in the footsteps of a top tutor

 

Salt & Pepper, a firm of Chartered Certified Accountants, has recently been approached by a prospective new audit client, Cinnamon Brothers Co (Cinnamon), whose year-end is 31 December. Cinnamon requires their audit to be completed by the end of February; however, this is a very busy time for Salt & Pepper and so it is intended to use more junior staff as they are available. Additionally, in order to save time and cost, Salt & Pepper have not contacted Cinnamon’s previous auditors.

 

The firm is seeking to reduce audit costs and has therefore decided not to update the engagement letters of existing clients, on the basis that these letters do not tend to change much on a yearly basis. One of Salt & Pepper’s existing clients has proposed that this year’s audit fee should be based on a percentage of their final pre-tax profit. The partners are excited about this option as they believe it will increase the overall audit fee.

 

Required:

 

  • Describe the steps that Salt & Pepper should take in relation to Cinnamon:

 

(i)       Prior to accepting the audit; and                                                                    (5 marks)

 

(ii)      To confirm whether the preconditions for the audit are in place.        (3 marks)

 

  • State FOUR matters that should be included within an audit engagement letter.

 

(2 marks)

 

  • Explain the quality control procedures Salt & Pepper should implement to ensure the audit is performed efficiently and effectively given the time pressure for

 

completion and the use of junior staff.                                                                    (4 marks)

 

  • (i)Identify and explain THREE ethical risks which arise from the above actions of Salt & Pepper & Co; and

 

  • For each ethical risk explain the steps which Salt & Pepper & Co should adopt to reduce the risks arising.

 

Note: The total marks will be split equally between each part. Prepare your answer using

 

two columns headed Ethical threat and Possible Safeguard respectively.                    (6 marks)

 

(Total: 20 marks)

 

186   ORANGE FINANCIALS                 Walk in the footsteps of a top tutor

 

 

 

Question debrief

 

  • Explain the external auditors’ responsibilities in relation to the prevention and

 

detection of fraud and error.                                                                                                                                            (4 marks)

 

You are the audit manager of Currant & Co and you are planning the audit of Orange Financials Co (Orange), who specialise in the provision of loans and financial advice to individuals and companies. Currant & Co has audited Orange for many years.

 

The directors are planning to list Orange on a stock exchange within the next few months and have asked if the engagement partner can attend the meetings with potential investors. In addition, as the finance director of Orange is likely to be quite busy with the listing, he has asked if Currant & Co can produce the financial statements for the current year.

 

During the year, the assistant finance director of Orange left and joined Currant & Co as a partner. It has been suggested that due to his familiarity with Orange, he should be appointed to provide an independent partner review for the audit.

 

Once Orange obtains its stock exchange listing it will require several assignments to be undertaken, for example, obtaining advice about corporate governance best practice. Currant & Co is very keen to be appointed to these engagements, however, Orange has implied that in order to gain this work Currant & Co needs to complete the external audit quickly and with minimal questions/issues.

 

The finance director has informed you that once the stock exchange listing has been completed, he would like the engagement team to attend a weekend away at a luxury hotel with his team, as a thank you for all their hard work. In addition, he has offered a senior member of the engagement team a short-term loan at a significantly reduced interest rate.

 

Required:

 

  • (i)Explain SIX ethical threats which may affect the independence of Currant & Co’s audit of Orange Financials Co; and

 

  • For each threat explain how it might be reduced to an acceptable level.

 

(12 marks)

 

Note: The total marks will be split equally between each part. Prepare your answer using two columns headed Ethical threat and Possible Safeguard respectively.

 

  • Orange is aware that subsequent to the stock exchange listing it will need to establish an audit committee and has asked for some advice in relation to this.

 

Required:

 

Explain the benefits to Orange of establishing an audit committee.         (4 marks)

 

(Total: 20 marks)

 

 

Calculate your allowed time, allocate the time to the separate parts……………

 

187   LV FONES                 Walk in the footsteps of a top tutor

 

  • State the FIVE threats contained within ACCA’s Code of Ethics and Conduct and for each threat list ONE example of a circumstance that may create the threat.

 

(5 marks)

 

You are the audit manager of Jones & Co and you are planning the audit of LV Fones Co, which has been an audit client for four years and specialises in manufacturing luxury mobile phones.

 

During the planning stage of the audit you have obtained the following information. The employees of LV Fones Co are entitled to purchase mobile phones at a discount of 10%. The audit team has in previous years been offered the same level of staff discount.

 

During the year the financial controller of LV Fones was ill and hence unable to work. The company had no spare staff able to fulfil the role and hence a qualified audit senior of Jones

 

  • Co was seconded to the client for three months. The audit partner has recommended that the audit senior work on the audit as he has good knowledge of the client. The fee income derived from LV Fones was boosted by this engagement and along with the audit and tax fee, now accounts for 16% of the firm’s total fees.

 

From a review of the correspondence files 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.

 

Required:

 

  • (i)Explain the ethical threats which may affect the independence of Jones & Co’s audit of LV Fones Co.

 

(ii)      For each threat explain how it might be avoided.                                   (10 marks)

 

Note: The total marks will be split equally between each part. Prepare your answer using two columns headed Ethical threat and Possible Safeguard respectively.

 

 

  • Describe the steps an engagement.

 

 

audit firm should perform prior to accepting a new audit (5 marks)

 

(Total: 20 marks)

 

 

188   SAXOPHONE ENTERPRISES                 Walk in the footsteps of a top tutor

 

Saxophone Enterprises Co (Saxophone) has been trading for 15 years selling insurance and has recently become a listed company. In accordance with corporate governance principles Saxophone maintains a small internal audit department. The directors feel that the team needs to increase in size and specialist skills are required, but they are unsure whether to recruit more internal auditors, or to outsource the whole function to their external auditors, Cello & Co.

 

Saxophone is required to comply with corporate governance principles in order to maintain its listed status; hence the finance director has undertaken a review of whether or not the company complies.

 

Bill Bassoon is the chairman of Saxophone, until last year he was the chief executive. Bill is unsure if Saxophone needs more non-executive directors as there are currently three non-executive directors out of the eight board members. He is considering appointing one of his close friends, who is a retired chief executive of a manufacturing company, as a non-executive director.

 

The finance director, Jessie Oboe, decides on the amount of remuneration each director is paid. Currently all remuneration is in the form of an annual bonus based on profits. Jessie is considering setting up an audit committee, but has not undertaken this task yet as she is very busy. A new sales director was appointed nine months ago. He has yet to undertake his board training as this is normally provided by the chief executive and this role is currently vacant.

 

There are a large number of shareholders and therefore the directors believe that it is impractical and too costly to hold an annual general meeting of shareholders. Instead, the board has suggested sending out the financial statements and any voting resolutions by email; shareholders can then vote on the resolutions via email.

 

Required:

 

  • Explain the advantages and disadvantages for each of Saxophone Enterprises Co AND Cello & Co of outsourcing the internal audit department.

 

Note: The total marks will be split as follows:
Saxophone Enterprises Co (8 marks)
Cello & Co (2 marks)
(Total: 10 marks)

 

  • In respect of the corporate governance of Saxophone Enterprises Co:

 

  • Identify and explain FIVE corporate governance weaknesses, and

 

  • Provide a recommendation to address each weakness.

 

Note: The total marks will be split equally between each part. Prepare your answer using two columns headed Corporate governance weakness and Recommendation respectively.

 

(10 marks)

 

(Total: 20 marks)

 

 

189   GOOFY                 Walk in the footsteps of a top tutor

 

You are an audit manager in NAB & Co, a large audit firm which specialises in the audit of retailers. The firm currently audits Goofy Co, a food retailer, but Goofy Co’s main competitor, Mickey Co, has approached the audit firm to act as auditors. Both companies are highly competitive and Goofy Co is concerned that if NAB & Co audits both companies then confidential information could pass across to Mickey Co.

 

Required:

 

  • Explain the safeguards that your firm should implement to ensure that this conflict

 

of interest is properly managed.                                                                                (4 marks)

 

Goofy Co’s year-end is 31 December, which is traditionally a busy time for NAB & Co. Goofy Co currently has an internal audit department of five employees but they have struggled to undertake the variety and extent of work required by the company, hence Goofy Co is considering whether to recruit to expand the department or to outsource the internal audit department. If outsourced, Goofy Co would require a team to undertake monthly visits to test controls at the various shops across the country, and to perform ad hoc operational reviews at shops and head office.

 

Goofy Co is considering using NAB & Co to provide the internal audit services as well as remain as external auditors.

 

Required:

 

  • Discuss the advantages and disadvantages to both Goofy Co and NAB & Co of

 

outsourcing their internal audit department.                                                      (10 marks)

 

  • The audit engagement partner for Goofy Co has been in place for approximately six years and her son has just accepted a job offer from Goofy Co as a sales manager; this role would entitle him to shares in Goofy Co as part of his remuneration package. If NAB & Co is appointed as internal as well as external auditors, then Goofy Co has 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 NAB & Co and Goofy Co.

 

Required:

 

Explain THREE ethical threats which may affect the independence of NAB & Co in

 

respect of the audit of Goofy Co, and for each threat explain how it may be

reduced.                                                                                                                            (6 marks)

 

Note: The total marks will be split equally between each part. Prepare your answer using two columns headed Ethical threat and Possible Safeguard respectively.

 

(Total: 20 marks)

 

 

190   MONTEHODGE                Walk in the footsteps of a top tutor

 

  • Discuss the  advantages  and  disadvantages  of  outsourcing  an  internal  audit

 

department.                                                                                                                     (8 marks)

 

  • MonteHodge Co has a sales income of $253 million and employs 1,200 people in 15 different locations. MonteHodge Co provides various financial services from pension and investment advice to individuals, to maintaining cash books and cash forecasting in small to medium-sized companies. The company is owned by six shareholders, who belong to the same family; it is not listed on any stock-exchange and the shareholders have no intention of applying for a listing. However, an annual audit is required by statute and additional regulation of the financial services sector is expected in the near future.

 

Most employees are provided with on-line, real-time computer systems, which present financial and stock market information to enable the employees to provide up-to-date advice to their clients. Accounting systems record income, which is based on fees generated from investment advice. Expenditure is mainly fixed, being salaries, office rent, lighting and heating, etc. Internal control systems are limited; the directors tending to trust staff and being more concerned with making profits than implementing detailed controls.

 

Four of the shareholders are board members, with one member being the chairman and chief executive officer. The financial accountant is not qualified, although has many years experience in preparing financial statements.

 

Required:

 

Discuss the reasons for and against having an internal audit department in

 

MonteHodge Co.                                                                                                                                          (12 marks)

 

(Total: 20 marks)

 

 

REVIEW AND REPORTING

Walk in the footsteps of a top tutor

 

  • ISA 700 Forming an Opinion and Reporting on Financial Statements requires auditors to produce an auditor’s report. This report should contain a number of consistent elements so that users are able to understand what the auditor’s report means.

 

Required:

 

Describe FIVE elements of an unmodified auditor’s report and for each explain why

 

they are included.                                                                                                                                            (5 marks)

 

You are the audit manager of Chestnut & Co and are reviewing the key issues identified in the files of three audit clients.

 

Palm Industries Co (Palm)

 

Palm’s year-end was 31 March 20X5 and the draft financial statements show revenue of $28.2 million, receivables of $5.6 million and profit before tax of $4.8 million. The fieldwork stage for this audit has been completed.

 

A customer of Palm owed an amount of $350,000 at the year-end. Testing of receivables in April highlighted that no amounts had been paid to Palm from this customer as they were disputing the quality of certain goods received from Palm. The finance director is confident the issue will be resolved and no allowance for receivables was made with regards to this balance.

 

Ash Trading Co (Ash)

 

Ash is a new client of Chestnut & Co, its year-end was 31 January 20X5 and the firm was only appointed auditors in February 20X5, as the previous auditors were suddenly unable to undertake the audit. The fieldwork stage for this audit is currently ongoing.

 

The inventory count at Ash’s warehouse was undertaken on 31 January 20X5 and was overseen by the company’s internal audit department. Neither Chestnut & Co nor the previous auditors attended the count. Detailed inventory records were maintained but it was not possible to undertake another full inventory count subsequent to the year-end.

 

The draft financial statements show a profit before tax of $2.4 million, revenue of $10.1 million and inventory of $510,000.

 

Bullfinch.com (Bullfinch)

 

Bullfinch.com is a website design company whose year-end was 31 October 20X5. The audit is almost complete and the financial statements are due to be signed shortly. Revenue for the year is $11.2 million and profit before tax is $3.8 million. A key customer, with a receivables balance at the year-end of $283,000, has just notified Bullfinch.com that they are experiencing cash flow difficulties and so are unable to make any payments for the foreseeable future. The finance director has notified the auditor that he will write this balance off as an irrecoverable debt in the 20X6 financial statements.

 

Required:

 

  • For each of the issues:

 

  • Discuss the issue, including an assessment of whether it is material;

 

  • Recommend ONE procedure the audit team should undertake to try to resolve the issue; and

 

  • Describe the  impact  on  the  auditor’s  report  if  the  issue  remains

 

UNRESOLVED.

 

Notes:

 

1         Marks will be split equally between each issue.

 

2         Report extracts are NOT required.                                                                             (15 marks)

 

(Total: 20 marks)

CLARINET                 Walk in the footsteps of a top tutor

Question debrief

 

Clarinet Co (Clarinet) is a computer hardware specialist and has been trading for over five years. The company is funded partly through overdrafts and loans and also by several large shareholders; the year-end is 30 April 20X4.

 

Clarinet has experienced significant growth in previous years; however, in the current year a new competitor, Drums Design Co (Drums), has entered the market and through competitive pricing has gained considerable market share from Clarinet. One of Clarinet’s larger customers has stopped trading with them and has moved its business to Drums. In addition, a number of Clarinet’s specialist developers have left the company and joined Drums. Clarinet has found it difficult to replace these employees due to the level of their skills and knowledge. Clarinet has just received notification that its main supplier who provides the company with specialist electrical equipment has ceased to trade.

 

Clarinet is looking to develop new products to differentiate itself from the rest of its competitors. It has approached its shareholders to finance this development; however, they declined to invest further in Clarinet. Clarinet’s loan is long term and it has met all repayments on time. The overdraft has increased significantly over the year and the directors have informed you that the overdraft facility is due for renewal next month, and they are confident it will be renewed.

 

The directors have produced a cash flow forecast which shows a significantly worsening position over the coming 12 months. They are confident with the new products being developed, and in light of their trading history of significant growth, believe it is unnecessary to make any disclosures in the financial statements regarding going concern.

 

At the year-end, Clarinet received notification from one of its customers that the hardware installed by Clarinet for the customers’ online ordering system has not been operating correctly. As a result, the customer has lost significant revenue and has informed Clarinet that they intend to take legal action against them for loss of earnings. Clarinet has investigated the problem post year-end and discovered that other work-in-progress is similarly affected and inventory should be written down. The finance director believes that as this misstatement was identified after the year-end, it can be amended in the 20X5 financial statements.

 

Required:

 

  • Describe the procedures the auditors of Clarinet Co should undertake in relation to

 

the uncorrected inventory misstatement identified above.                                                                                                                                            (4 marks)

 

(b)      Explain SIX potential indicators that Clarinet Co is not a going concern.            (6 marks)

 

  • Describe the audit procedures which you should perform in assessing whether or

 

not Clarinet Co is a going concern.                                                                                                                                            (6 marks)

 

  • The auditors have been informed that Clarinet’s bankers will not make a decision on the overdraft facility until after the auditor’s report is completed. The directors have now agreed to include some going concern disclosures.

 

Required:

 

Describe the impact on the auditor’s report of Clarinet Co if the auditor believes the company is a going concern but that this is subject to a material uncertainty.

(4 marks)

 

(Total: 20 marks)

 

 

Calculate your allowed time, allocate the time to the separate parts……………

 

193   PAPRIKA                 Walk in the footsteps of a top tutor

 

Question debrief

 

  • (i)Explain the  meaning  of  the  term  ‘pervasive’  in  the  context  of  the

 

independent auditor’s report.                                                                         (2 marks)

 

  • Explain the two types of modified opinions when there is an issue which is

 

considered material and pervasive.                                                               (2 marks)

 

You are an audit manager in Brown & Co and you are nearing completion of the audit of Paprika & Co (Paprika). The audit senior has produced extracts below from the draft auditor’s report for Paprika.

 

  • Our responsibility is to express an opinion on all pages of the financial statements based on our audit.

 

  • We conducted our audit in accordance with most of the International Standards on Auditing.

 

  • Those standards require that we comply with ethical requirements and plan and perform the audit to obtain maximum assurance as to whether the financial statements are free from all misstatements whether caused by fraud or error.

 

  • We have a responsibility to prevent and detect fraud and error and to prepare the financial statements in accordance with International Financial Reporting Standards.

 

  • An audit involves performing procedures to obtain evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the availability and experience of audit team members.

 

  • We considered internal controls relevant to the entity; and express an opinion on the effectiveness of these internal controls.

 

  • We did not evaluate the overall presentation of the financial statements, as this is management’s responsibility.

 

  • We considered the reasonableness of any new accounting estimates made by management. We did not review the appropriateness of accounting policies as these are the same as last year.

 

  • In order to confirm raw material inventory quantities, we relied on the work undertaken by an independent expert.

 

Required:

 

  • Describe the factors to consider and steps Brown & Co should take, prior to placing

 

reliance on the work of the independent expert, in order to confirm raw material

quantities.                                                                                                                         (4 marks)

 

  • For the above report extracts, identify and explain SIX elements of this report which require amendment.

 

Note: Redrafted report extracts are not required.                                                                                                                                                      (12 marks)

 

(Total: 20 marks)

 

 

Calculate your allowed time, allocate the time to the separate parts……………

194   PANDA                 Walk in the footsteps of a top tutor

 

(a)       Explain the five elements of an assurance engagement.            (5 marks)

 

  • Panda Co manufactures chemicals and has a factory and four offsite storage locations for finished goods. Panda Co’s year-end was 30 April 20X3. The final audit is almost complete and the financial statements and auditor’s report are due to be signed next week. Revenue for the year is $55 million and profit before taxation is $5.6 million.

 

The following two events have occurred subsequent to the year-end. No amendments or disclosures have been made in the financial statements.

 

Event 1 – Defective chemicals

 

Panda Co undertakes extensive quality control checks prior to despatch of any chemicals. Testing on 3 May 20X3 found that a batch of chemicals produced in April was defective. The cost of this batch was $0.85 million. In its current condition it can be sold at a scrap value of $0.1 million. The costs of correcting the defect are too significant for Panda Co’s management to consider this an alternative option.

 

Event 2 – Explosion

 

An explosion occurred at the smallest of the four offsite storage locations on 20 May 20X3. This resulted in some damage to inventory and property, plant and equipment. Panda Co’s management have investigated the cause of the explosion and believe that they are unlikely to be able to claim on their insurance. Management of Panda Co has estimated that the value of damaged inventory and property, plant and equipment was $0.9 million and it now has no scrap value.

 

Required:

 

For each of the two events above:

 

  • Explain whether the financial statements require amendment; and

 

  • Describe audit procedures that should be performed in order to form a conclusion on any required amendment.

 

Note: The total marks will be split equally between each event.                                                                                                                                          (12 marks)

 

  • The directors do not wish to make any amendments or disclosures to the financial statements for the explosion (event 2).

 

Required:

 

Explain the impact on the auditor’s report should this issue remain unresolved.

 

(3 marks)

 

(Total: 20 marks)

 

 

195   VIOLET & CO                 Walk in the footsteps of a top tutor

 

  • Explain the purpose of, and procedures for, obtaining written representations.

 

(5 marks)

 

  • The directors of a company have provided the external audit firm with an oral representation confirming that the bank overdraft balances included within current liabilities are complete.

 

Required:

 

Describe the relevance and reliability of this oral representation as a source of evidence to confirm the completeness of the bank overdraft balances. (3 marks)

 

  • You are the audit manager of Violet & Co and you are currently reviewing the audit files for several of your clients for which the audit fieldwork is complete. The audit seniors have raised the following issues:

 

Daisy Designs Co (Daisy)

 

Daisy’s year-end is 30 September, however, subsequent to the year-end the company’s sales ledger has been corrupted by a computer virus. Daisy’s finance director was able to produce the financial statements prior to this occurring; however, the audit team has been unable to access the sales ledger to undertake detailed testing of revenue or year-end receivables. All other accounting records are unaffected and there are no backups available for the sales ledger. Daisy’s revenue is $15.6m, its receivables are $3.4m and profit before tax is $2m.

 

Fuchsia Enterprises Co (Fuchsia)

 

Fuchsia has experienced difficult trading conditions and as a result it has lost significant market share. The cash flow forecast has been reviewed during the audit fieldwork and it shows a significant net cash outflow. Management are confident that further funding can be obtained and so have prepared the financial statements on a going concern basis with no additional disclosures; the audit senior is highly sceptical about this.

 

The prior year financial statements showed a profit before tax of $1.2m; however, the current year loss before tax is $4.4m and the forecast net cash outflow for the next 12 months is $3.2m.

 

Required:

 

For each of the two issues:

 

  • Discuss the issue, including an assessment of whether it is material;

 

  • Recommend procedures the audit team should undertake at the completion stage to try to resolve the issue; and

 

  • Describe the impact on the auditor’s report if the issue remains unresolved.

 

Notes: 1 The total marks will be split equally between each issue.
2 Report extracts are NOT required. (12 marks)
(Total: 20 marks)

 

 

196   MINNIE                 Walk in the footsteps of a top tutor

 

You are the audit manager of Daffy & Co and you are briefing your team on the approach to adopt in undertaking the review and finalisation stage of the audit. In particular, your audit senior is unsure about the steps to take in relation to uncorrected misstatements.

 

During the audit of Minnie Co the following uncorrected misstatement has been noted.

 

The property balance was revalued during the year by an independent expert valuer and an error was made in relation to the assumptions provided to the valuer.

 

Required:

 

  • Explain the term ‘misstatement’ and describe the auditor’s responsibility in relation

 

to misstatements.                                                                                                                                            (4 marks)

 

  • Describe the factors Daffy & Co should consider when placing reliance on the work

 

of the independent valuer.                                                                                                                                            (4 marks)

 

  • The following additional issues have arisen during the course of the audit of Minnie Co. Profit before tax is $10m.

 

  • Depreciation has been calculated on the total of land and buildings. In previous years it has only been charged on buildings. Total depreciation is $2.5m and

 

the element charged to land only is $0.7m.                                                                                                                                 (4 marks)

 

  • Minnie Co’s computerised wages program is backed up daily, however for a

 

period of two months the wages records and the back-ups have been corrupted, and therefore cannot be accessed. Wages and salaries for these

 

two months are $1.1m.                                                                                                                                 (4 marks)

 

  • Minnie Co’s main competitor has filed a lawsuit for $5m against them alleging a breach of copyright; this case is ongoing and will not be resolved prior to the

 

auditor’s report being signed. The matter is correctly disclosed as a contingent

liability.                                                                                                                                 (4 marks)

 

Required:

 

Discuss each of these issues and describe the impact on the auditor’s report if the

 

above issues remain unresolved.                                                                 (Total: 20 marks)

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