AUDITING AND ASSURANCE Dec 2011

 

QUESTION ONE

 

  • What is the purpose of a letter of representation?(4 marks)
  • State and briefly explain the action auditors should take if the management refuses

to provide a letter of representation.                                              (4 marks)

( State the specific representations you, as an auditor, would wish to obtains from the  management in respect of :

  • (4 marks)
  • (4 marks
  •      Identify any four contents of an audit engagement letter                 (4 marks)

(Total 20 marks)

DECEMBER 2011

 QUESTION ONE

You are required to discuss the purpose of a letter of representation

 

A letter of representations is a source of audit evidence normally sought from the directors at the concluding stages of an audit to confirm various matters stated in the accounts particularly those which concern questions of facts or judgment which are difficult for the auditor to prove objectively e.g. there is no need to obtain a letter of representation on the bank balance as this can be proved objectively but there is need to obtain a representation that all contingent liabilities have been properly stated because this is difficult to prove.

 

n

Auditors seek a letter of representation in order to obtain written audit evidence on

matters that are material to the financial statements when other  sufficient appropriate audit evidence cannot reasonably be expected to exist (ISA 580

‗Management Representations‘).

 

n

Representations may be the only evidence, which can reasonably be expected to be available, but they cannot be a substitute for other aud  it evidence that could reasonably be expected to be available.

 

n

The letter also ensures that directors acknowledge their collective responsibility for the presentation and approval of the financial statements. The letter is signed by   those with knowledge of the matters concerned, on behalf of management.

 

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The letter also seeks to confirm oral representations made by management during the   course of the audit and also provide corroborative audit evidence.

 

 

Auditors therefore obtain written representations from management on material matters where other sufficient appropriate audit evidence cannot reasonably be expected to exist.

 

 You are required to explain the action auditors should take if the management refuses to provide a letter of representation.

 

Management maybe unwilling to sign letters of representations. If management declines the auditor should inform management that he will himself prepare a statement in writing setting out his understanding of any representations that may have been made during the course of the audit and then sends this statement to management with a request for confirmation that the auditor‘s understanding of the representation is

correct.

If management disagrees with the auditor‘s statement of representation, discussions should be held to clarify the matters in doubt and if necessary a revised statement prepared and agreed. Should management fail to reply the auditor should follow the matter up to try to ensure that his understanding of the position as set out in his

statement is correct.

In rare circumstances the auditor may be completely unable to obtain written representations, which he requires. E.g. because of refusal by management to cooperate, or because management properly declines to give representations required on the grounds of its own uncertainty regarding that particular issue. In such circumstances the auditor may have to conclude that he has not received all the information and explanations required and consequently may need to consider qualifying his audit report on the grounds of limitation in the scope of the audit.

 

You are required to state the specific representations you, as an auditor, would wish to obtain from the management in respect of:

 

For assets the auditor would be interested in obtaining confirmations from management that the asset in question exists and belongs to the company. For example if it is goods in transit the auditor may wish management to confirm that such stock belongs to the company. In addition the auditor may also request management to confirm that the asset is properly valued and all the necessary information has been disclosed. For example in relation to debtors the auditor may require management to confirm that they have created an adequate provision for any doubtful accounts or in-case of stock that the an appropriate provision for damaged stock has been created.

 

However, it is important to note that the specific representations required will depend on the specific asset. The auditor will ordinarily seek to obtain confirmation from management on issues that require judgment and that are difficult to prove objectively. For example on issues touching on the levels of provisions created such as provisions for doubtful debts or the accounting treatment accorded to contingent liabilities where management will need to make assumptions in estimating the possible losses.

The main concern for liabilities is to obtain confirmation on completeness i.e. that all liabilities have been recorded and all the relevant information has been disclosed. This will mainly relate to liabilities that require the exercise of judgment such as contingencies. In case of contingencies such as litigations against the company, the auditor will require management to provide representations on the factors they have considered and assumptions they have made in deciding the accounting treatment adopted. The auditor will also require confirmation that management has disclosed all the contingent liabilities that existed as at the balance sheet date.

You are required to identify any four contents of an audit engagement letter.

 

The form and contents of an engagement letter may vary from client to client but would generally include:

 

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The objective of the audit of financial statements;

n Management‘s responsibility for the financial statements;

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The scope of the audit including reference to applicable legislation, regulations, or     pronouncements of professional bodies to which the auditor adheres;

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The form of any reports or other communication of the results of the engagement;

 

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The fact that because of the test nature and other inherent limitations of an audit, together with the inherent limitations of any accounting and internal control system, there is unavoidable risk that some material misstatements may   remain undiscovered;

 

n

That the auditor will have unrestricted access to whatever records, documentation and   other information requested in connection with the audit;

 

 

n

  • Details of other services to be provided such as taxation and management consultancy work;

n n

  • Fee – Basis on which it is computed, rendered and paid;

Expectation of receiving from management written confirmation concerning  

  • representations made in connection with the audit;

n

Request for the client to  confirm the terms of the engagement by acknowledging receipt of the engagement letter.

QUESTION TWO

 

(a)

 

Write brief explanation notes on each of the following terms:
(i) Audit risk.                                                                                 (2 marks)
(ii) Inherent risk                                                                              (2 marks)
(iii) Control risk                                                                               (2 marks)
(iv)

 

Detection risk                                                                            (2 marks)
(b)

 

Identify the circumstances when it is appropriate to use only a substantive approach in an audit and when a combination of compliance and substantive tests should be used. (4 marks)
 (c)

 

 

List four advantages and four disadvantages of using the risk-based audit approach when auditing the financial  statements of limited companies(8 marks)

(Total: 20 marks)

 QUESTION TWO

 You are required to write short notes on:

 

Audit risk

 

Audit risk means the risk that the auditor gives an inappropriate audit opinion. E.g. if the auditor reports that the financial statements show a true and fair view while in reality they are materially misstated. Audit risk has three components: inherent risk, control risk and detection risk.

 

Audit risk = Inherent risk * Control risk * Detection risk

 

Inherent risk

 

This is the susceptibility of an account balance or class of transactions to misstatement that could be material individually or when aggregated with misstatements in other balances or classes of transactions assuming there were no related internal controls. Inherent risk could increase as a result of:

  • An adverse attitude of managers to internal control matters;
  • The type of business carried out;
  • The environment within which the entity carries out its business;
  • Where there is a high degree of estimation or judgement associated with the transaction;
  • The entity is involved in very complex transactions;
  •             The assets involved are especially susceptible to loss or theft.

An assessment of inherent risk can be made by the auditor carrying out a review of these factors.

 

  • Control risk

 

Means that a material misstatement could occur in an account balance or class of transactions, which would not be prevented or detected in timely manner by the

entity‘s accounting and internal control systems.To assess control risk auditors should:

  • Investigate and document internal control systems;
  • Confirm their understanding of the systems by performing walk through tests.

These are performed to ensure that the auditor‘s understanding of the client‘s

  • accounting system is correct;
  • Make an initial assessment of control risk based upon their understanding;
  • Perform tests of controls to confirm their assessment;
  • Reassess the level of control risk if controls are found to be ineffective.

 

Detection risk

 

This is the risk that an auditor‘s substantive procedures will not detect a misstatement that exists in an account balance or class of transactions that could be material. This implies that detection risk is the only component of the audit risk model that is under the control of the auditor. The level of detection risk relatesdirectly to the auditor‘s substantive procedures. The auditor‘s control risk assessment, together with the inherent risk assessment, influences the nature, timing and extent of substantive procedures to be performed to reduce detection risk, and therefore audit risk to an acceptably low level.

 

 You are required to identify the circumstances when it is appropriate to use only a substantive approach in an audit and when a combination of compliance and substantive tests should be used.

 

Generally it is more appropriate to use a combination of compliance and substantive tests as it results in an overall saving in audit time. This occurs when the client has sufficient staff to allow an effective system of internal control to operate (usually with proper segregation of duties which will prevent or detect fraud and error) and there a large number of transactions. In such a situation using a substantive approach will not be effective since the auditor will require to test a large volume of transactions, whereas the auditor can rely on controls to reduce the level of substantive testing.

 

It is not appropriate to check internal controls when they are weak, as checking these will only confirm that control risk is high, so performing compliance tests will be a waste of time. Internal controls may be weak in small organizations where there are too few staff for a proper segregation of duties. Also in small organizations the owner will operate the system of internal check, but usually there is no control over his actions and this will create a weak system of control.

 

In very small organizations it is not appropriate to perform compliance tests, as it is quicker to check all, or a substantial proportion of the transactions during the year.

 

For large organizations with proper controls in place, auditors usually rely heavily on internal controls, which allows them to perform limited substantive tests. This reduces the audit time, compared with undertaking only substantive tests, and thus results in a cost effective audit.

 

 You are required to list four advantages and four disadvantages of using the risk-based audit approach when auditing the financial statements of limited companies.

 

Risk based audit approach is whereby the auditor identifies risks that could result in material misstatements in the financial statements of the client. It involves the analysis of overall audit risk into inherent risk, control risk and detection risk. The auditor formulates appropriate audit procedures that aim to address the identified risks. The auditor investigates the categories of audit risk so that more time is spent on risky areas and less on less risky areas.

 

Advantages of the approach

 

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  • It provides a framework for the conduct of the audit, it focuses auditor‘s attention on risk;

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The approach allows the development of effective and efficient audit programs and it develops an  

  • enquiring attitude of mind;

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The approach links into the concept of materiality, and the techniques of statistical sampling;

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The approach is helpful in identifying the areas where most work should be performed. It allows the auditor to spend more time in the areas of highest risk and less time in low   risk areas, thus reducing the overall time for the audit or reducing overall audit risk. It

 

avoids excessive time being spent on low risk areas. For instance, in many businesses petty cash expenditure is small. Although the risk of errors and fraud in petty cash is relatively high, it is most unlikely that they will be material so audit work in this areas

                   can be limited;

n

By examining each significant item in the profit and loss account and the balance sheet the auditor is able to evaluate the level of inherent and control risk and consequently the

amount of substantive testing required. This will ensurtesting will be carried out.   e that only the required level of

n  The audit is more effective because the auditor concentrates on key areas only;

n

The approach enables the auditor to provide management with valuable feed back on the overall effectiveness of the design and operation of controls in managing the risks   identified.

 

Disadvantages

 

n

One major limitation of this approach is that frequently it is impossible to estimate the values of inherent risk, and to a lesser extent, control risk with any degree of certainty. If these elements cannot be determined accurately, then one cannot accurately determine     the value of detection risk, which is required to achieve the overall level of audit risk;

n

A further problem is that the auditor may assume that his assessment of control risk may apply to the whole system e.g. a sales system. However, there may be little or no controls over some parts of accounting system, so the control risk for these aspects of the system could be as high as 100%. For example in the valuation of the year -end stock and determining the doubtful debt provision, which may be carried out by one person. If there is no internal check over such items, it will mean that the control risk is high and so the auditor should perform more checks to reduce the level of detection risk     and hence achieve the required level of audit risk;

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For the model to be useful the populations (i.e., numbers of items) involved need to be sufficiently large to allow for valid statistical conclusions to be drawn. This rules out the     use of the model in many smaller audits;

n

As is always the case with such models, there is a danger of adapting an overly mechanistic   approach and that the auditor will lose his ‗feel‘ for the assignment.

 

From the discussion above, it can be seen that the audit risk approach is helpful in achieving an efficient and low risk audit. However, it is difficult to quantify accurately each of the risk elements.

QUESTION THREE

 

The owner of a retail hardware shop has approached you for assistance in designing appropriate control procedures that would help in safe guarding the assets of the business against possible losses through theft and fraud. He is more particularly concerned about loss of cash and stocks. All sales are made across the counter and in cash only.

 

Required

 

For each of the following assets, suggest ten practical control procedures that the owner of the retail hardware shop should implement to minimise possible losses through theft and fraud:

 

  • Cash (10 marks)

Stocks   (10 marks)         (Total: 20 marks)

QUESTION THREE

 

You are required to suggest ten practical control procedures that the owner of the retail hardware shop should implement to minimize possible losses through theft or fraud:

 

  Cash

 

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The shop should ensure that the persons dealing with cash are trust worthy, competent  

  • and well trained in their duties;

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Only specific persons should have the responsibility of receiving cash from customer. There should be clear reporting lines of these cashiers within the

  • organization;

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  • shop such asAn appropriate method of recording the cash collected should be put in place in the retail

the use of cash registers to record the receipts or a computerized system that will     be able to record the cash collected and issue a receipt to the customer;

n

At the end of the day, cash count should be carried out by an independent person in the presence of the cashier. The physical cash should then be reconciled to the expected amount as per the cash register record. Any variances should be   investigated;

n

  • The cashiers should be supervised and surprise cash counts should be carried out by the  supervisor;
  • n The cash collections should be kept in a safe;
  • n Physical security measures such as employing guards should be put in place;
  • The recording of the cash receipts in the ledger should be done by an independent person;
    • .

Controls over stock

 

n

An appropriate inventory system should be put in place. This should be able to capture all stock purchases and up date the stock balances with every sale made.

  • All stock items should be appropriately coded;

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All stock purchases should be accompanied by a goods received note that is used by an  

  • independent person to update the stock records with the receipts;

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All issues of stock from the store to the shop should be authorised by a senior person and  

  • the stock movement up dated in the inventory system;

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There should be adequate documentation of all stocks returned back to the store or     warehouse. The stock records should be updated with such returns.

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On a monthly basis a stock count should be conducted. The physical stock counted   should be reconciled to the expected stock as per the inventory system;

  • n Closed circuit TV cameras should be installed to deter and detect shop lifting;     n Unauthorized persons should not be allowed into the shop premises;

n

Security measures should be put in place to ensure that employees  do not carry stolen items when leaving the premises; e.g. inspection locks etc.

n Stocks write offs should be authorised by a senior responsible official

QUESTION FOUR

Briefly explain the meaning of the term ―control procedures‖.(4 marks)

(What s the importance of segregation of duties as a control procedure?   (4 marks)

In carrying out an audit, the auditor appraises the tests and the system of internal control in order to ascertain that it is capable of processing transactions or determining the quantities and values completely and accurately. The auditor

Revision Questions and Answers

further carries out substantive tests in an attempt to ensure that the transactions, assets and liabilities recorded in the accounting records upon which the figures in the financial statements are based, are completely and accurately recorded.

 

Required

 

List and briefly explain the substantive tests the auditor would carry out to verify the values attributed to:

 

  • Trade and debtors in a company‘s financial statements. (6 marks)
  • Trade creditors in a company‘s financial statements. (6 marks)

(Total: 20 marks) 

QUESTION FOUR

 

  1. You are required to briefly explain the meaning of the term “control procedures”.

 

Control procedures are the detailed policies and procedures established by management within the control environment. Control procedures put together constitute an internal control system. For example the requirement that all purchase orders must be authorised by a senior responsible company official is an example of a control procedure. Control procedures are aimed at achieving a desired control objective. For example the above requirement that purchase orders should be authorised is an example of a preventive control aimed at ensuring that all purchase transactions have received the necessary approval which will assist in the prevention of errors and frauds.

 

You are required to discuss the importance of segregation of duties as a control

Segregation of duties refers to the separation of the various duties and responsibilities such that one person cannot process and record complete transactions from beginning to the end without being checked by another person. E.g. in the purchase of a company‘s fixed assets a single individual should not authorise the purchase, place the order, receive the asset and record the transaction in the accounting records, to minimise

the risk of error and/or intentional manipulation of information.Segregation of duties is important because:

 

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Helps detect errors in processing transactions. This is because the work of one   individual will be checked by another. Errors made will be detected;

 

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Helps in deterring fraud. Segregation of duties would help in deterring people from perpetrating frauds. This is because the work of every individual is counter checked   by another person.

 You are required to List and briefly explain the substantive tests the auditor would carry out to verify the values attributed to:

 

  Trade debtors in a company’s financial statements.

 

Substantive tests are the tests that the auditor carries out to obtain evidence as to the completeness and validity of the balances reported in the financial statements i.e. procedures carried out to test the management assertions.

 

In regard to debtors the following substantive procedures will be necessary:

 

n

To carry out a trend analysis on the level of debtors by comparing the current year debtors with the previous two years and obtaining explanations for the reported trend. The evidence obtained from this analysis will assist the auditor

  • balances;in identifying circumstances that could lead to the misstatement o f debtors n

Compute the debtors‘ days, debtors‘ turnover and the ratio of provisions for doubtful debts to trade debtors‘ balances. Compare the ratios with the previous year and obtain explanations for any significant variations. Such an analysis will assist the auditor in evaluating the recoverability of the debtors‘

  • balances and whether an adequate provision has been made;

n

  • Obtain a listing of balances as at the year end and agree the total to ledger balance;

n

  • confirming existence of the balances;Select a sample of debtors‘ balances and perform circularization. This will assist in

n

Obtain a sample of significant balances and verify if any payments have been received after the year-end. This will provide good evidence as to the

  • recoverability of debtors balances;

n

Discuss with management accounts that appear doubtful. This will include accounts above the authorised credit limits, accounts with disputed balances and balances that have been outstanding for a long period of time. Ensure

  • that an adequate provision has been made for these balances;

n

Test the operation of the cut-off procedures by obtaining details of the last dispatch note processed during the year and ensure that all transactions that     relate to the current financial period have been recorded. (ii) Trade creditors in a company’s financial statements.

 

  1. Compare the current years creditors balance with the previous year and obtain explanations for any significant movements. Such an analysis will give

indications for example on the completeness on creditors.

  1. Compute the creditors days and compare with the previous years and obtain explanations for any significant movements. Creditors days give an indication

of the number of days it takes on average to pay creditors.

  1. Obtain a creditors listing and verify that the total per the listing agrees with the total per the ledger.
  2. From the listing select a sample of creditors and carry out the following procedures:

 

Obtain or prepare a reconciliation of the creditors balance per the ledger to the   suppliers‘ statements;

 

Past Papers

Obtain explanations for all the reconciling items and where appropriate ensure that the reconciling items have been adjusted in the books of account. The reconciling items will mainly include suppliers invoices

  • not posted in the clients suppliers statements. ledger or payments not reflected in the e) Obtain a sample of payments made to suppliers after year- end and verify that

all the invoices that related to the period under review had been accrued for.

Obtain all the pending invoices that relate to the financial period under review and verify that these had been accrued for.

QUESTION FIVE

(Briefly explain how an audit firm may use third party confirmations to provide evidence in relation to six difference balance sheet items.    (12 marks)

List two advantages and two disadvantages of using standardised audit programmes

during audit assignments.                                                              (4 marks)

Identify four factors that should be taken into consideration by an audit firm when  allocating staff to audit assignments.         (4 marks)

(Total: 20 marks)

QUESTION FIVE

 

 You are required to explain how an audit firm may use third party confirmations to provide evidence in relation to six different balance sheet items.

 

One of the principal methods of obtaining corroborative evidence available to auditors is by inquiry. Inquiry involves seeking information from knowledgeable persons inside or outside the entity. Confirmation is the name given to a specific form of inquiry that is particularly widely used. It involves obtaining written confirmation from a third party, typically, although not exclusively, in relation to an account balance in which the third party has an interest. Confirmations can therefore be used for the following balances.

 

n

Bank balance- the auditor can request the client‘s bankers to confirm the balance they are holding on behalf of the client as at the end of the year. This

  • will confirm existence, completeness and accuracy;

n

Debtors- by carrying out debtors‘ circularization. The replies will provide corroborative  

  • evidence to confirm existence of the debtor;

n

Creditors- by carrying out creditors‘ circularization. The replies will provide  

  • corroborative evidence, completeness and accuracy of the creditor‘s balance;

n

Investments (such as government securities, shares)- requesting a confirmation from the issuer of the instrument will provide evidence to confirm existence and accuracy of the investment balances. E.g. requesting the Central bank to

  • confirm the amount of investments in government securities held by a client;

n

Loans – requesting the provider of the loan to confirm how much they have granted the  

  • company and the terms of such facilities;

n

Contingent liabilities – if the contingency relates to litigation against the company, the auditor could seek confirmation from the lawyers on the facts of the case and the likely outcome. This will assist in evaluating whether the   contingency has been properly treated in the financial statements.

 You are required to list two advantages and two disadvantages of using standardized audit programmes during audit assignments

 

Standardised audit programmes refers to where a firm has come up with standard audit programmes that provide the various audit procedures that are to be performed in the respective accounting areas. These are required to be applied when auditing the various clients.

 

        Advantages

n

Makes that audit efficient since there is no need to spend time in preparing new of audit  

    programmes;

n

Ensures that all issues are addressed in the respective accounting areas. The standardised   programmes provide the minimum tests that must be carried out in

 

 

 

Revision Questions and Answers

the respective accounting areas;

 

                     Disadvantages

n

May stifle the initiative of the audit staff. This is because the need to exercise judgment in     deciding the audit procedures to be carried out is eliminated;

n

Some audit issues may not be addressed. This is because in following the standard audit programme some audit procedures that might have been necessary might not   be carried out if they are not included in the standard audit programme.

 

 You are required to identify four factors that should betaken into consideration by an audit firm when allocating staff to audit assignments.

 

  • nThe level of experience and competence of the staff;
  • n Whether the staff is independent of the client;

n Whether the staff has appropriate training in the industry;  n The availability of the staff through out the duration of the audit.

QUESTION SIX

 

Auditors may be liable to shareholders and other parties who may have relied on the financial statements upon which the auditors have expressed an opinion. This is because the auditors are generally taken as owing a ―duty of care‖ those parties and they could be liable in the tort of negligence if they failed that duty.

 

Required

 

  • With reference to the external audit assignment, explain the meaning if the term ―duty of care‖      (4 marks)
  • Briefly explain the auditors‘ general responsibility. With regard to the prevention and

detection of fraud and errors.                                                            (6 marks)

  • State and briefly explain five possible measures that auditing firms should take in

order to avoid legal actions for negligence against  them.                      (10 marks)

(Total 20 marks)

QUESTION SIX

 

You are required to explain the meaning of the term “duty of care” in reference to the external audit assignment

 

What constitutes duty of care is not defined, however we can derive this from  decided cases.

According to case law a duty of care exists where there is a special relationship  between the parties. (Re: Hedley Byrne)

When carrying out his work the auditor must exercise care and skill. As stated in Re:London and General Bank (UK case). ― An auditor is not bound to do more thanexercise reasonable care and skill in making enquiries. He is not an insurer, he does not guarantee that the books do correctly show the true position of the company‘s affairs, he must be honest, he must not certify that he does not believe to be true, and he must take reasonable care and skill before he believes that what

he certifies is true‖

In the absence of suspicious circumstances, the auditor would not be liable for failing to uncover fraud and falsities which could not be discovered by exercise of

normal skill an care. This was stated in Re: City Equitable Fire Insurance (UK case).

From these decided cases the duty of care refers to the responsibility that the auditor assumes towards the client and other third parties whenever they undertake an assignment. The auditor should carry out his work to the best quality standards possible to protect the interest of the parties who have appointed him.

 

 You are required to explain the auditors’ general responsibility. With regard to the prevention and detection of fraud and errors.

 

The responsibility for the prevention and detection of fraud and errors rests with the management of the entity.

 

The auditor on his part seeks reasonable assurance that fraud or error, which may be material to the financial statements, has not occurred or if it has occurred, the effect is properly reflected in the financial statements. The auditor should plan his work so that he has reasonable expectation of detecting material misstatements in the financial information resulting from fraud and error.

 

The auditor is and cannot be held responsible for the prevention of fraud and error. However, if the auditor comes across any fraud or error regardless of the materiality he should:

 nInform management as soon as possible;

n

  • Carry out further procedures to confirm whether the fraud was an isolated case or indicative of others that had taken place;
  • n Evaluate whether the fraud could have an impact on his opinion.

n

If the error or fraud is material the auditor should consider whether management has adequately disclosed the effect in the financial statements. If there is adequate disclosure there will be no need to modify the opinion. However, if the effect has not been disclosed in the financial statements the auditor should express a qualified   opinion as appropriate.

 

 You are required to state and briefly explain five possible measures that auditing firms should take in order to avoid legal actions for negligence against them.

 

The auditor can undertake the following steps to reduce potential liabilities for negligence:

 

n

Undertaking measures to ensure that all assignments are performed to the highest quality standards. The auditor should ensure that the requirements of

  • the International Standards on Auditing are adhered to in all assignments;

n

Proper planning of the audit work to ensure that all potential risks that could affect the financial statements are identified and appropriate audit procedures

  • performed;

n

  • Putting in place appropriate quality control policies and procedures and monitoring  their effectiveness;

n Limit access to his work or reports, where possible;

  • n Include a  disclaimer  of  liability  clause  in  the  relevant  document  or

Example of such a clause would be ― while every care has been taken in the preparation of this document, it may contain errors for which we

  • cannot be held responsible‖

n

When submitting un-audited accounts or other un-audited financial statements (where the auditor prepares accounts on behalf of the client) the auditor should ensure that the purpose for which the statements or reports have been prepared     is properly explained on the face of the report.

n

Obtaining proper terms of engagement such that the auditor‘s roles and responsibilities are clearly laid out and the client understands his role in the   engagement.

QUESTION SEVEN

Explain the factors that external auditors should consider in determining whether the  financial statements of a limited company show a true and fair view.            (8 marks)

Identify six  basic elements of the auditor‘s report containing an unqualified opinion on       the financial statements.(6 marks)

Briefly explain the types of audit opinion that would normally arise from a limitation in

the scope of audit.                                                                                (6 marks)

(Total 20 marks)

QUESTION SEVEN

You are required to explain the factors that external auditors should consider in determining whether the financial statements of a limited company show a

            true and fair view.

The auditor will have to consider whether the financial statements have been prepared in accordance with the provisions of the companies Act, the International Financial Reporting framework and any other relevant legislation and are free from material misstatements. In particular the auditor‘s opinion will be influenced by:

 

n

Whether he has been able to obtain all the information and explanations that were necessary for the purposes of the audit. If the auditor has not been able to obtain to obtain information on issues that are considered material to the financial statements, this amounts to a limitation in the scope o f the work and the auditor should qualify his report or issue a disclaimer of opinion;

 

n

Whether the company has kept proper books of accounts. Management is required to maintain proper books of accounts, this include a ledger to record all the transactions, shareholders register and a record of minutes of the directors. If the company has not   maintained such books of accounts then this would be a ground to qualify the reports;

 

n

Whether the financial statements i.e. company‘s balance sheet and profit and loss   account are not in agreement with the books of accounts and returns;

 

n

Circumstances of disagreement for example where the auditor does not agree with the choice of accounting policy adopted by management or the mode of disclosure of facts   in the financial statements;

 

n

Whether there are unresolved inherent uncertainties such as conditions threatening the going   concern ability of the company;

 

n

Whether the financial statements have been prepared in accordance with the financial   reporting framework.

 You are required to identify six basic elements of the auditors’ report containing an unqualified opinion on the financial statements.

 

The elements of the auditors’ report include the following: (ISA 700)

 

n

Appropriate title-The auditor‘s report should have an appropriate title such as ‗theindependent auditors report‘ to distinguish the auditor‘s report from   any other reportsthat may be annexed to the annual report and financial statements.

 

n

Addressee-The Auditor‘s report should be appropriately addressed as required by the circumstances of the engagement and local regulations. Usually the auditors  report is addressed to the members on whose behalf the audit is carried out.

 

n

Introductory Paragraph-This identifies the Financial Statements audited including the date of and period covered by the financial statements. Under the Companies Act, financial statements or accounts consist primarily of the Balance Sheet, Profit and Loss account and notes to the account. International Accounting Standards on Cash Flow Statements requires auditors to recognize the Cash Flows as part of the Financial   Statements;

 

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Paragraph on the scope of the audit-The auditor‘s report should describe the scope of the audit by stating that the audit was conducted in accordance with the International Standards on Auditing (ISAs) or in accordance with relevant national standards or practices as appropriate. Scope refers to the auditor‘s ability to perform audit procedures deemed necessary in the circumstances. The report should include a statement that the audit was planned and performed to obtain reasonable assurance about whether the financial statements are free of material   misstatements. The auditor‘s report should describe the audit as including;

 

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Opinion Paragraph– The report should clearly state the auditor‘s opinion as to whether

the financial statements give a true and fair view in accordance with the relevant financial reporting framework and whether they comply with the companies Act requirements.

The terms used to express the auditor‘s opinion are ―give a true and fair view‖ or ―presents fairly, in all material respects‖ and are equivalent. Both terms indicate, amongstother things, that the auditor considers only those matters that   are material to the financial statements.

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Dating the audit report– the auditor should date the report as of completion date of the audit. This informs the reader that the auditor has considered the effect on the financial statements and on the report of events and transactions of which the auditor became   aware ad that occurred up to that date.

 

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Auditor‘s address-The report should name a specific location, which is ordinarily the city   where the auditor maintains the office that is responsible for the audit.

 

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Auditor‘s signature-The report should be signed in the name of the audit firm, the personal name   of the auditor or both, as appropriate.

Briefly explain the types of audit opinion that would normally arise from a limitation in the scope of an audit.

 

If for any reason the auditor is unable to receive all the information and explanation he deems necessary for the purposes of his audit then there has been a limitation in the scope of his work. It means that the auditor is unable to conclude objectively because he is unable to obtain sufficient appropriate audit evidence.

 

Effect of a limitation in scope on the auditor‘s opinion

 

If the possible effect of a limitation on scope of an audit is material but not fundamental              to the financial statements the auditor issues a qualified opinion (except for opinion)

If the possible effect of a limitation on scope of an audit is of fundamental importance that the auditor is unable to express an opinion on the financial statements, the auditor issues a disclaimer of opinion as mentioned above.

 

When there is a limitation on the scope of the auditor‘s work that requires the expression of a qualified opinion or disclaimer of opinion, the auditor should describe the nature of the limitation in his report and indicate the possible adjustments to the financial statements that might have been determined to be necessary, had the limitation not existed.

 QUESTION EIGHT

  • Identify five sections in which information technology can be used  to enhance the administration procedures and controls over an audit(5 marks)

 

  • Identify five audit benefits that could be derived from using Computer Assisted Audit Techniques (CAATs) when carrying out testing of computer records (5 marks)

                   

 

  • Briefly explain, giving an example in each case, five functions of an audit software interrogation programme (10 marks) (Total: 20 marks)
    1.  You are required to identify five ways in which information technology can be used to enhance the administration procedures and controls over an audit.

     

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    Cost budgeting -The firm‘s staffing requirements and planning can be performed using spreadsheets and individual audits can be costed and budgeted using integrated

    • software;

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    Word processing can be used for the routine production of reports, faxes, letters, memos, emails and other communications. It reduces the need for support staff and

    • friendly and can be used by professishortens the time in which documents can be produced, as the packages are useronal staff. –

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    It can also improve client and staff relations, particularly where email can be used to eliminate the physical movement of large documents that need to be reviewed or

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    Use of word processing to produce audit programs, audit planning documentation, ordinary working papers, lead schedules, and almost all other current file documentation. Providing there is adequate backup and proper contingency planning, it may be possible to reduce the number of paper based files kept, with a   consequent reduction in storage costs;

     

    using Computer Assisted Audit Techniques (CAATs) when carrying out testing of computer records.

     

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    CAATs are likely to be the only effective way of testing programmed controls. Computer programs often perform functions without leaving visible evidence and the controls inbuilt in such systems cannot be tested manually. E.g. it is not possible   to test the effective operation of passwords manually;

     

    n CAATs are quicker and more efficient enabling the auditor to test a large volume of   transactions quickly and accurately;

     

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    Once acquired the use of CAATs is cost effective provided that they can be used in a   large clients base;

     

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    Use of CAATs and especially audit software enable the auditor to test the accounting system directly rather than relying on printouts which   could be manipulated by the client;

     

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    CAATs provide the auditor with additional options, there are certain audit procedures   that can only be carried out through the use of CAATs.

     

    • Briefly explain, giving an example in each case, five functions of an audit software interrogation programme.

     

    • nFile reorganization – enables indexing, sorting, merging and linking with other files;
      • Data selection – enables data filtration
    • n File access- enables the reading of different record formats and file structures;
    • n Arithmetic functions – enables the performance of arithmetic functions;
      • Selecting samples or items for testing e.g. selecting debtors accounts that have been  outstanding for more than the credit period;
    • n Printing reports or letters in a format specified by the auditor.
    • n Detection of violation of systems limits e.g. a sales ledger can be checked to ensure no customer has a balance above the authorized credit limit;

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    Testing reasonableness checks e.g. ensuring the value of purchases is not greater than   the value of stocks received.

     You are required to identify five audit benefits that could be derived from

 

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