Emali Co. Ltd. has undergone a period of substantial growth following its establishment five years ago. At the last annual general meeting Smith & Co. Associates, a tow-partner firm ofCertified Public Accountants were re-appointed as auditors. However, Smith & Co. Associates have decided that they do not have the necessary resources to audit the enlarge company.



  • Briefly, explain how Smith & Co. Associates may resign from its appointment before the

next annual general meting. (4 marks)

  • How any a casual vacancy arising from the resignation of present auditors be filled and what procedures are necessary before the company‘s next annual general meeting at which the appointment will be presented for ratification? (7 marks) c) Outline the

steps the prospective auditor must take before deciding whether or not to

accept the nomination as an auditor.                                                           (9 marks)

(Total: 20 marks)



  • If Smith & Co. wish to resign from its appointment before the next AGM, they must carry out the following procedures:


  • Smith & Co. must deposit written notice of their resignation at the registered office of Emali Co. The resignation is effective on the day it is received unless the auditors have specified some later date


  • Smith & Co. must accompany such notice with a statement that either: –


  • There were no circumstances connected with this resignation which they consider

should be brought to the notice of the members or creditors of the company or

  • A statement detailing any such surrounding circumstances which in the case of Smith & Co. for example in this case Smith & Co could state that their resignation was as a result of the fact that they believe that their firm does not have the capacity to serve the company as a result of its rapid growth.


Additional considerations (do not form part of the answer)


Resignation under different circumstances


Where the auditors are resigning due to a disagreement with management in addition to depositing the explanatory Statement at the company‘s registered office, the auditors may attach a signed requisition for the directors to convene an extra ordinary General Meeting in order for circumstances surrounding his resignation can be brought to the attention of shareholders. A 28 days notice for the meeting is required.


Before the meeting is convened, the auditors may request the coy to circulate to its members a written statement of circumstances. If for any reason this fails to happen, the statement can be read out at the meeting.


  • Section 159 (6) Casual vacancies


The companies Act provides that the directors may fill any casual vacancy in the office of the auditor, but while any such vacancy continues the surviving or continuining auditor or auditors, if any, may act. A casual vacancy could arise as a result of:

  • death
  • incapacitation or
  • resignation


Basing on this provision the directors can fill the vacancy created by the resignation of Smith & Co. however; the shareholders of the company still have a right to remove the auditor so appointed during the AGM.


                     Before accepting nomination as the company‟s auditor the

following stepsand factors should be considered Statutory matters


Ensure that your firm is professionally, legally and ethically qualified to act as an auditor. The auditor must ensure that he has not contravened any provisions of the companies Act in regard to independence. He must ensure that he is not a servant or in partnership with a servant of the company. In case Relief Supplies has a holding company or subsidiaries it is also important to ensure that your firm has not





previously been disqualified from being eligible for appointment as auditors of such subsidiaries or the holding company.


Ethical matters



Your firm must also ensure that it has fulfilled all the professional ethical requirements in regard to independence. I.e. the firm must not have any personal, family or business   relationships with the prospective client among other provisions;



Your firm should establish it has the technical proficiency to undertake the audit. This will include determining whether the firm posses the necessary technical skills to carry   out the assignment;



Establish whether the firm‘s resources are adequate to service the needs of the new client i.e.   staff time with the necessary technical competence and experience;



Your firm should seek references about the status of the company and its management. Such references will assist the auditor in assessing the potential risk in associating with this new client. Information sought would include the reputation of the company and its directors. It is a professional requirement that very firm must evaluate all prospective clients before accepting appointment. Seeking references abou  t the client provides useful information in carrying out this evaluation;



I would try to determine the reason for the change in auditor. The question says that the directors believe they do not receive a cost effective service from the existing auditor. However, there may be problems with the level of audit fee or the existing   auditor may want to qualify his report which the directors are trying to prevent;



I would obtain a copy of the previous years audited accounts. If the audit report is qualified, it indicates that the audit has a higher than normal risk. From these accounts I would assess whether the company is having going concern problems by calculating appropriate ratios such as the gearing ratio and if there could be weaknesses in the   system of internal control;



I would check that no conflict of interest arises through my acceptance of appointment as   auditor of the company;



I would consider the level of fee I would charge. It should be sufficient to provide an acceptable return, as an inadequate fee could result in insufficient audit work being   carried out and thus increase the audit risk;



Communicate to the outgoing auditor-Your firm should request Relief Supplies permission to communicate with the existing/outgoing auditor. If such permission is denied your firm should decline the appointment. If your firm receives permission from the client, you should write to the existing auditor requesting all the information which ought to be made available to you to enable you decide whether or not you are prepared to accept appointment. Communication with the existing auditor is not just a matter of professional courtesy. Its main purpose is to enable the prospective auditor ensure that there are no reasons which preclude him from accepting the appointment. It would be important at this stage to confirm with the outgoing auditor whether the true reason for being requested to resign is because their firm is perceived by management as not providing a value for money audit or could there be other reasons   behind this.






Before replying to the prospective auditor the outgoing auditor should obtain the client‘s permission to discuss his affairs fully with the prospective auditor. If the outgoing auditor is duly authorized by the client to discuss the client‘s affairs with the prospective auditor, then he may communicate any relevant information he believes to be true, including the reasons for the proposed change and any other matter he considers that the prospective auditor should be made aware.


The prospective auditor must treat any information given by the outgoing auditor in the strictest confidence and should weigh this carefully in reaching a decision whether or not to accept the appointment.


If the client refuses the existing auditor authority to discuss his affairs with the prospective auditor, the outgoing auditor should inform the prospective auditor who should then decline the appointment.


If the outgoing auditor considers that there are professional reasons to prevent the prospective auditor accepting nomination he must disclose these to the prospective auditor. The prospective auditor should endeavor to ascertain the reasons for the change in auditors. If after doing this, he is of the opinion that the existing auditor is

being treated unfairly, he may decline the appointment.              Therefore communicating with the outgoing auditor is important: n

  • To get necessary information that could guide him on  whether to accept or reject nomination;
  • n To enquire on the reasons for the change in auditors;
    • Professional courtesy.


Having considered these factors your firm should then make a decision on whether to accept the appointment.


After your firm accepts nomination it should carry out the following procedures



Ensure that the removal or resignation of existing auditor is properly carried out in accordance with the Companies Act Chapter 486. I.e. a simple resolution was     passed at the AGM removing the current auditors.


That your appointment is valid and obtain a copy of new resolution passed in AGM to   appoint you as the new auditor.

  • Set up a letter of engagement to the directors of company.




Restmount Kenya Ltd. was formed on 1 October 1997 in order to export tea and coffee to European markets. The Directors are unsure as to their responsibilities and the nature of their relationship with the external auditors. The audit partner has asked you to visit the client and explain to the directors, the fundamental aspects of the accountability of the directors and their relationship with the auditor.



Explain to the directors of Restmount Kenya Ltd: –

  • The need for an audit. (6 marks)
  • Procedures for the appointment of an auditor of a public company under the

Companies Act.                                                                                      (5 marks)

  • Directors‘ responsibilities in relation to the accounting function of the Company.

(4 marks)

  • Auditors‘ statutory responsibilities in relation to the audit of the company‘s financial

statements.        (5 marks)           (Total: 20 marks)


  •  Need for an audit


Today most businesses are operated by limited companies, which are owned by the shareholders and managed by directors appointed by such shareholders. The appointed management is faced with a conflict of interest i.e. whether to act in the best interest of

the company and by extension the shareholders‘ interest or to act in their best interest.This is what is referred to as the agency problem.


The separation that exists between the owners and management forces the absentee owners to institute control measures to ensure honesty of their company‘s stewards (i.e. management). The companies Act attempts to remedy this problem by requiring the management to maintain proper accounting records of all the transactions of the company and to prepare financial statements that show a true and fair view to be presented to the shareholders at the annual general meeting.


However, even with this requirement there still exists the risk that the accounting

records maintained and the financial statements prepared by management might not be




accurate, free from bias and reflect the true financial position and performance of the company. The companies Act therefore goes further to require that management must have the financial statements subjected to an independent examination and a report issued to the shareholders as to whether the financial statements show a true and fair view. This therefore creates the need for an audit. The auditor carries out this independent examination. To ensure independence of the auditor the companies Act gives the power of appointment and removal of the auditor from office to the shareholders.


The primary objective of an audit of financial statements is to enable the auditor to express an opinion whether the financial statements are prepared, in all material respects, in accordance with an identified financial reporting framework and show a true and fair view. (Financial reporting framework refers to the international accounting standards, provisions of the companies Act and other relevant statutes and legislation). The auditor expresses an opinion as to whether the financial statements give a true and fair view of the financial position and performance of the company.


Note that: an auditor does not certify the financial statements as true and fair but onlyreports his opinion basing on the evidence obtained.


 Procedures for appointment of auditor


The appointment of a statutory auditor is governed by the Company‘s Act Cap 486.


S.259 (2) provides that ―every company shall at each annual general meeting appointan auditor or auditors to hold office from the conclusion of that, until the conclusion of the next, annual general meeting.‖


The auditor‘s appointment thus runs for approximately a year from the moment the meeting ends. This section makes it clear that it is the company (i.e. the members/shareholders) which appoints the auditor(s) and not the directors.


However, in practice it is important to note that there will be occasions where the company is wholly, or mainly made up of director shareholders. Also in most cases the directors; acting as agents of the company will choose or recommend to the shareholders which auditing firm to appoint.




S.259 (2)‖ a retiring auditor shall be deemed to be re-appointed without any  resolutionbeing passed unless: –

  1. He is not qualified for appointment; or
  2. A resolution has been passed at that meeting (i.e. annual general meeting) appointing somebody instead of him or providing expressly that he shall not be

re-appointed; or

  1. He has given the company notice in writing of his unwillingness to be reappointed.


According to this provision of the company‘s Act an appointed auditor is deemed to be automatically re-appointed come the next annual general meeting for another term in office unless any of the three mentioned situations exist.











S.259 (3) ―Where at an annual general meeting no auditors are appointed or deemed to be appointed, the registrar may appoint a person to fill the vacancy‖


The directors have the duty of informing the registrar of the failure by the company to appoint an auditor within seven (7) days.




  • 259 (5)-the first auditors of a company may be appointed by the directors at any time before the annual general meeting, and the auditors so appointed shall hold office until the conclusion of that meeting.


In default of appointment, the first auditors by the directors the company may do so. Where the directors have appointed the first auditors, the company may at a general meeting remove such auditors and appoint in their place any other persons who have been nominated for appointment by any member of the company. Notice of nomination to be given to the members at least 24 days before the date of the meeting.


Casual vacancies


  • 159 (6) ―The directors may fill any casual vacancy in the office of the auditor, but while any such vacancy continues the surviving or continuing auditor(s), if any may act.‖


A casual vacancy may arise out of any of the following reasons; a) Death of the auditor

  • Incapacitation
  • Resignation


i.e. a casual vacancy arises when any of the above circumstances arise leaving the office of the auditor vacant before the expiry of the term in office under the contract.


The directors of the company may fill a casual vacancy in the office of the auditor.


  • The responsibilities of the directors in relation to the accounting function of the company are as follows:-


  • To safeguard the company‘s assets and to prevent fraud and errors in the
  • To ensure that the company keeps proper accounting records.
  • To prepare annual financial statements to show the results of the company for the year and the state of affairs of the company at the balance sheet date.

(Must show a true and fair view).

  • To deliver to the registrar of companies a copy of the company‘s audited financial statements within seven months of the end of the accounting year.
  • To set up an ICS in the company to ensure that all the above are carried out.


  • Duties/responsibilities of the auditor



To report to the shareholders on whether the financial statements of the company (or group of companies) show a true ad fair view or present fairly and have been properly prepared in accordance with the requirements of the companies Act i.e.   the profit and loss account and the balance sheet show a true and fair view.






  • To consider whether the information on the directors report is consistent with the financial  statements and if not, to state the fact in his report.
  • n To report whether proper accounting records have been kept by the company


To report whether proper returns adequate for their audit have been received by branches  

  • not visited by them


To report whether the company‘s balance sheet and its profit and loss account are in  

  • agreement with the acting records


To report whether he has received such information and explanations s he thinks necessary   for the performance of his duties.




  • What is meant by the term ‗fraud‘? Give four examples of fraudulent activities.

(6 marks)

  • What do you consider to be the auditor‘s responsibilities in the course of  the normal annual audit in relation to the detection of fraud?       (6 marks)
  • Explain the way in which the auditor should approach and perform his

work in order to meet these responsibilities.                                       (8 marks)

(Total: 20 marks)



  •  Fraud refers to the intentional misrepresentation of financial information by one or more individuals amongst management, employees and third parties.


Fraud involves: –


  • Manipulation, falsification or alteration of records or documents. For example where an employee alters the amount payable to a supplier as per the invoice with the

objective of obtaining a financial gain.

  • Misappropriation of assets. For example where cash collections are misappropriated and the amount is not recorded.
  • Suppression/omission of the effects of transactions from records/documents. For example failure to recognise liabilities in the accounting records.
  • Recording and transactions without substance.
  • Misappropriation of acting policies.
  • Reporting to management where any frauds have been detected or suspected.
  • Providing recommendations through the management letter on ways of strengthening the system to minimise the potential frauds.


  •  The primary responsibility for the prevention and detection of frauds and errors rests on management of the company.


Auditors should assess the risk that fraud/error may cause the financial status to contain material misstatements and should enquire of management as to any fraud or error that has been discovered based on that risk assessment, which will involve consideration of the integrity of the client, unusual pressures on the entity, unusual transactions and problems in obtaining sufficient appropriate evidence, the auditor should design appropriate tests.


Auditors accept representations and documents as genuine unless evidence to the contrary, appears but conduct their work with an attitude of professional scepticism.


An auditor should design audit procedures to obtain reasonable assurance that those frauds and errors, which are material, have not occurred or if they have occurred they have either been corrected or properly disclosed in the financial statements.


Due to the inherent limitations of an auditor, there is an unavoidable risk that some material misstatements will not be detected even though the audit is properly planned and performed. This is because fraudulent conduct is often deliberately concealed and all internal controls and audit procedures are subject to inherent limitations. Any accounting and internal control system has inherent limitations which means that it may be ineffective against frauds such as collusion between employees and management override of controls.





Comprehensive Mock Examinations

If the auditor detects any fraud regardless of the materiality he has a duty to report this to management.


  •  The auditor should plan his work with a reasonable expectation of detecting any material frauds or errors. He should approach his work with an attitude of professional scepticism. He should be on the look out for any factors that increase the risk of fraud or error. Where fraud is suspected the auditor should carry out additional audit procedures as appropriate to dispel his suspicion.


Procedures where fraud or error is suspected: –


  • Consideration of potential effects: – If the auditor believes that the indicated fraud or error could have a material effect on the financial status, he should perform modified or additional procedures.
  • Modified or additional procedures: – This will depend on the nature of the fraud indicated the likelihood of its occurrence and the likely effect on the financial status where such audit procedures do not dispel the suspicion of fraud or error. The auditor should discuss the matter with management and consider if it has been properly reflected in the financial status. 3. Approaching his work with seasonal scepticism.


Implications for the audit


Where fraud is discovered the auditor should report this to management and also consider the implications on other evidence obtained from management. Where the fraud discovered is material the auditor should ensure that the effects are properly reflected in the financial statements. Auditors should consider the effect of the fraud or error on their preliminary risk assessment and on the reliability of management responsibility especially where senior management is involved.




During the final stage of the first audit of Nairobi National Bank Ltd. You request theclient to provide you with a letter of representation. The Client reads representations you are requesting and refuses to furnish the letter. The client states its position to be as follows:-


―You are asking us to tell you all manner of things which we appointed you to find out. You are requesting us to say such things as ‗all the transactions undertaken by the bank have been


properly reflected in the accounting records‘ and yet we pay you to carry out the audit. You should know whether these statements are true or not‖.



  • Explain to the client the purpose of the letter of representation. (6 marks)
  • Describe the nature of the content of a letter of representation. Your answer should be illustrated with specific examples of items which may appear in a letter of

representation.                                                                                    (6 marks)

  •  Explain the reliability of a letter of representation as audit evidence and the extent to  which the auditors could rely on this evidence.      (5 marks)
  •  Explain the consequences of your client‘s refusal to furnish a letter of representation.

(3 marks)

(Total: 20 marks)



  • A letter of representation is written by the directors of a company to the auditors of that company normally towards the end of an audit before the auditor signs his audit report. The letter confirms verbal representations made by the directors during the audit as well as providing audit evidence on areas where other audit evidence is not available e.g. where a company settles a legal claim out of court, the directors would then provide representations to the auditor that they know of no other claims on the company in this area.


In addition the letter of representation will serve the following functions:-



It reminds the directors of their duties concerning the financial statements. In the letter the directors acknowledge their responsibility for their preparation of the     financial statements event though the auditor may have assisted in this area.


It provides the auditor with a further source of audit evidence to corroborate other   information obtained.


  1. Example of a letter of representation


Set out below is an example of a letter of representation, which relates to matters, which are material to financial statements and to circumstances where the auditor cannot obtain independent corroborative evidence and could not reasonably expect it to be available. It is not intended to be a standard letter because representations by management can be expected to vary not only from one enterprise to another but also from one year to another in the case of the same client.











Dear Sirs,



We confirm to the best of our knowledge and belief and having made appropriate enquiries of other directors and officials of the company, the following representations given to you in connection with your audit of the company‟s financial statements for the year ended 31 December. …


(b)    We acknowledge as directors our responsibility for the financial statements which you have prepared for the company. All the accounting records have been made available to you for the purpose of your audit and all the transactions undertaken by the company have been properly reflected and recorded in the accounting records. All

other records and related information including minutes of all management and shareholders‟ meetings have been made available to you..


(c)     The legal claim by Mr. G.H. …… has been settled out of court by the company paying him

Sh. 638,000. No further amounts are expected to be paid, and no similar claims by employees or former employees have been received or are expected to be received.



(c)     In connection with deferred tax not provided, the following assumptions reflect the intentions and expectations of the company/


i)            Capital investment of Sh.260,000 is planned over the next three years.

ii)           There are no plans to sell revalued properties

iii) We are not aware of any indications that the situation is likely to change so as to necessitate the inclusion of a provision for tax payable in the financial statements.



(d)    The company has had at no time during the year any arrangement, transaction or agreement to provide credit facilities (including loans, quasi-loans or credit transactions) for directors nor to guarantee or provide security for such matters


  1. The letter of representation is considered reliable audit evidence because:-


It provides written confirmation of managements representation. It therefore has more credibility than oral evidence especially in instances where the management representations in the letter appear reasonable and consistent with other sources of audit evidence.


The reliability if the evidence will also depend on whether the individuals making the representations can be expected to be informed on the matter.


If the letter of representation is contradicted by other evidence, the auditor should

investigate the circumstances and where necessary, reconsider the reliability of other  representations made by management.

The Company‘s Act make it an offence to give the auditor false information thus the management is bound to provide the auditor with information that is true.


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 auditing the financial statements of Newbridge Trading plc, for the year-ended 31 October 1997.


The senior partner of your audit firm has asked you to consider the auditor‘s responsibilities for identifying subsequent events. Also, he has asked you to describe the audit procedures, which examine subsequent events. He has suggested that an example of one point in answer to part (b) below would be:


‗Checking sales ledger cash received after the year-end to determine the realisability ofdebtors at the year-end and highlight doubtful debts.‘


The detailed audit work was completed on Friday 5 December 1997.  It is proposed that:


  • The audit report will be signed on Friday 19 December;
  • The financial statements will be sent to shareholders on Monday 5 January 1998; and
  • The company‘s annual general meeting will be held on Wednesday 28 January 1998.



  • Consider the auditor‘s responsibilities for detecting material subsequent events in the periods:


  • 31 October to 5 December 1997
  • 5 December to 19 December 1997 iii) 19 December 1997 to 5 January 1998
  • 5 January 1998 to 28 January 1998
  • After 28 January 1998 (7 marks)
  • List and briefly explain audit procedures, which involve examination of subsequent

events.                                                                                               (10 marks)

  • Describe the audit work you will carry out in period (a) (ii) above. (3 marks) (Total: 20 marks) 


Note: An alternative term for „subsequent events‟ is „post balance sheet events.‟ 



Tutor‟s hint: What your answer should demonstrate is that the date the detailed audit workis finished is irrelevant from the viewpoint of the auditor‘s responsibilities. What matters is the date the audit report is signed. The position after the audit report is signed may appear to be complicated, but you do need to be aware of the various possibilities and what the auditor should do in each set of circumstances. In (c) your answer should list various ways in which auditors can actively obtain evidence; they should not just rely on the representations of the directors.


Examiners comment: Candidates lost marks through discussing accounting forsubsequent events rather than audit. Few candidates understood that auditors only have responsibilities after the audit report is signed if they become aware of any further subsequent events. Answers to (c) were poor.



  • Between the year-end and the end of the performance of detailed audit work, auditors should identify and detect all material subsequent events which take place in that period. Such events which are non-adjusting should be disclosed in the notes to the accounts of the company, whereas all adjusting events should be incorporated in the accounts.


  • As the auditors‘ responsibility extends to the date on which they sign their report

(which should be the same day as the directors signed the accounts), it follows that they must obtain reasonable assurance up to than date in respect of all significant events. Auditors should ensure that any such significant events are appropriately accounted for or disclosed in the financial statements. If not, a qualification of their report may be necessary. In other words, the auditors‘ responsibility is the same as it was during the detailed audit work.


  • Auditors‘ responsibilities after the date of the audit report are not as clear cut as they are in the period prior to the date of the audit report. After the date of the audit report auditors do not have a duty to search for evidence of subsequent events. However, auditors should ask the directors to let them know if any

material post balance sheet events occur during this period. If, before the AGM




they become aware of information which might have made them give a different audit opinion had they known of it at the time, they should act as follows:


  • They should discuss the matter with the directors, carry out further procedures to obtain sufficient audit evidence and then consider whether the financial statements should be amended by the directors.


  • If the directors are unwilling to take action which the auditors consider necessary to inform the members of the changed situation, auditors should consider exercising their statutory rights to make a statement at the general meeting. They should also consider taking legal advice on their position.


  • If the directors wish to amend after the auditors have signed their report, the auditors will need to consider whether the proposed amendments affect their report. The audit report should not be dated before the date on which the amended financial statements are approved by the directors. Auditors should follow the procedures for auditing events after the balance sheet date before making their report on the amended financial statements.


  • If auditors become aware of subsequent events during this period that may affect the accounts, they should consider whether to withdraw their audit report. Legal advice may be required. As in (iii) the auditors should consider making a statement at the annual general meeting.


If the directors do decide to change the accounts, further post balance sheet work will be necessary to cover events up to the revised date of the audit report. In the later audit report, the auditors should refer to their original audit report, and to the note in the accounts which should give details of the changes.


  • Auditors have no responsibility for identifying subsequent events during this period. If however the directors find material errors in the accounts and inform the auditors, similar procedures to those used in (iv) will be needed.


(b) The audit work for subsequent events will normally be concerned with balance sheet values at and after the year-end. The following procedures will be carried out.


  • Fixed Assets


  • Check for any sales or proposed sales after the year-end which may mean a write down to net realizable value at the year-end.


  • Consider obsolescence of fixed assets, for example plant used to make a discontinued line, which might only become apparent after the year-end.


  • Stock


  • Check post year-end selling price of major items of stock and compare to value in year-end accounts. Consider write-downs to net realizable value.


  • Consider the possible existence of obsolete, damaged or slow moving stock and the consequent value of any write down.


  • Perform a (limited) stock-take after the year-end if the existence of all stock is not known for certain.



  • Debtors


  • Check sales ledger cash received after the year-end to determine realisability of debtors and highlight doubtful debts.


  • Take doubtful debts out of the provision and consider writing parts of the provision off for which no money has been received.


  • Review trade press and correspondence and consult the sales manager about any major customers who have become insolvent recently.
  • Check the issue of credit notes and return of goods after the year-end to determine the provision for credit notes required in the accounts.


  • Cash at bank


  • Check that outstanding items on the bank reconciliation have cleared promptly after the year-end (to spot teeming and lading and late payment to creditors).


  • Write back any stale cheques not cleared (over 6 months old).


  • Check all material payments and receipts around the year-end to check the completeness of both accruals and prepayments (including NI and PAYE sundry creditors).


  • Trade Creditors


  • Check reconciling items on suppliers‘ statements have cleared promptly after the year-end.


  • If a creditors‘ circularisation has been carried out then verify balances by examining post year-end payments, in cases where there was no supplier‘s statement and no reply.


  • Going concern problems and other matters


  • Check profit and cash flow forecasts for evidence of future liquidity.


  • Review management accounts and reports after the year-end.


  • Review board minutes after the year-end.


  • Request any information on subsequent events and going concern matters from the directors and check their information.


  • The directors should also state they have given all such information in the letter of representation.







  • Non-adjusting events


Look in board minutes and cash book for any matters which are non-adjusting but which should be disclosed in the accounts, for example, major sales of fixed assets, accidental losses and issues of shares and debentures.


I will check whether there have been any material subsequent events in this period, particularly if there is a significant delay between completing the detailed audit work and signing the report. I will not undertake such detailed enquiries as in (b) above, but I will perform the following procedures:


sk the management or directors if any further material events have occurred which might affect my opinion on the accounts.

Review the latest board minutes, reports and managements accounts issued since the end of the audit.


  • Any matters which were uncertain at the end of the audit should be reviewed again to establish an outcome and any effect on the accounts. Examples would include doubtful debts, contingencies and stock obsolescence (perhaps due to new developments).


Consider any matters which have arisen in the industry or the economy which might affect the company.





  •  Define tests of controls, substantive procedures and walk-through tests.  (6 marks)
  • Explain how assessment of systems and controls impacts upon the main stages of the audit process     (9 marks)
  •  Explain the role that internal control questionnaires and internal control evaluation  questionnaires play in determining the effectiveness of the systems of internal control.

(5 marks)



  • Tests of control are tests to obtain audit evidence about the effective operation of the accounting and internal control systems, that is, that properly designed controls identified in the preliminary assessment of control risk exist in fact and have operated effectively throughout the relevant period.


Substantive procedures are tests to obtain audit evidence to detect material misstatements in the financial statements. They are generally of two types:


  • analytical procedures
  • other substantive procedures, such as tests of details of transactions and balances, review of minutes of directors meetings and enquiry.


Walk through tests involve tracing one or more transactions through the accounting system and observing the application of relevant aspects of the internal control system.


  •  The first stage in any audit should be to determine its scope and the auditors general approach and preferably to draw an audit programme.


  • The objective of the next stage of an audit is to determine the flow of documents and the extent of controls in existence within the clients systems.


Determining the mechanics of a system is frequently achieved by performing walk through tests.


  • The next stage is to prepare a comprehensive record (using ICQs and flow charts) of the clients systems to facilitate the evaluation of those systems.


  • Having confirmed the clients systems auditors should then evaluate the systems after which they will be able to recommend improvements to the systems as required.


  • If the controls are assessed as being effective, it will be necessary to select and perform tests designed to establish compliance with the systems. It is necessary for the auditors to check that the controls are as effective in practice as they are on paper by carrying out tests of controls. The conclusion drawn from the results of a test of control may be either:-


  • That the controls are effective in which case the auditors will only need to carry out restricted substantive procedures.
  • That the controls are ineffective in practice, although they had appeared strong in theory, in which case the auditors will need to carry out more extensive substantive tests.
  • If the controls are assessed as being ineffective, the auditors should move straight to a programme of full substantive procedures. This tests are designed for two purposes:


  • To support the figures in the financial statement
  • Where errors exist, to assess their effect in monetary terms


The major question which internal control questionnaires are designed to answer is

‗How good is the system of controls?‘ Its primary purpose being to evaluate the system. One of the most effective ways of designing an internal control questionnaire is to phrase the question so that all the answers can be given as YES or NO, when a NO, will indicate a weakness in the system.


Whereas internal control questionnaires tend to ask separate questions in relation to each individual aspect of internal control, internal control evaluation questionnaires tend to concentrate on key questions.


Internal control questionnaires and internal control evaluation questionnaires both have an important role to play in the evaluation of systems. ICQs have the added advantage that they can infact help to document the system as well, whereas internal control evaluation questionnaires are perhaps more useful in focusing attention on the more important aspects of control systems.




In auditing the financial statements of companies which use computerized accounting systems, the auditors may find that this traditional (audit) trail is often obscured. Various techniques can be used in order to give the auditors greater assurance when the audit trail is lost.



  • Explain why there is a possible loss of audit trail when companies utilize computerized accounting systems and why auditing through the computer assists

the auditors in overcoming this loss of audit trail.                           (6 marks)

  • Explain how the auditors can use analytical procedures in order to give them greater

assurance when there is a loss of audit trail.                                    (4 marks)

  • Outline how audit software can be used by the auditors in order to assist them in

carrying out their analytical procedures.                                         (6 marks)

  • Explain the possible reasons and implications (audit) of significant changes in the following ratios when compared to the prior years ratios:
  •          The debtors turnover ratio has decreased over the year.      (2 marks) ii.             The stock turnover ratio has decreased from the previous year‘s rate.

(2 marks)

(Total: 20 marks) 



The original concept of an audit trail was to print out data at all stages of processing. Computer auditing methods have now cut out much of this (a bonus, time consuming,) working and make use of:


a more limited audit trail

efficient control total

            use of enquiry facilities            

   audit packages

file dumps


This can however mean that auditors have difficulty tracing individual transactions within the system.


Auditing through the computer


This involves an examination of the detailed processing routines of the computer to determine whether the controls in the system are adequate to ensure complete and correct processing of all data.




Audit test data consists of data submitted by the auditors for processing by the enterprises computer based accounting system either during a normal production run or during a special run at a point in time outside the normal cycle.


Audit software comprises computer programs used by the auditors to examine an enterprise computer files. Types of audit software include:


  • Package programs consist of prepared generalized programs for which the auditors will specify their detailed requirements by means of parameter or supplementary program code.


  • Purpose written programs involve the auditors satisfying their detailed requirements by means of program code specifically written for the purpose.


  • Utility programs consist of programs available for performing simple functions, such as sorting and printing data files.


  • Analytical procedures are substantive process which can be useful at most stages of the audit. As well as confirming figures directly (such as the PAYE due on salaries for a period) they may also be used to give additional comfort where other audit tests and other figures are also available.


The analytical procedures will not guarantee that certain transactions have been processed, but they will give some assurance that the records are accurate and complete.


Analytical procedures compare figures, trends and ratios to one another, to prior periods and to budgeted or forecast figures where variations occur from what is expected then investigations can be made to establish the reasons.


  • The auditors can use audit software for analytical procedures in the following ways:-


  • It can read computer files and extract data, such account balances, agreeing analysis for stock and debtors etc.


  • If the relevant information is on the computer, the audit software can compare current results to prior year or to budget.


  • Other computational aspects would be the calculation of days sales in debtors or days purchases in stock and creditors.


  • The audit software can calculate any amount of variance, trends and ratios. The auditor must still analyse what the software produces which will involve them using professional judgment in analyzing the figures.


  • (i) Debtors turnover ratio = Sales



A decrease in debtors turnover means that debtors have risen faster than sales. This could be due to:          –

n  Changes in sales mix

n  Changes in credit terms

n Worsening economy or industrial conditions


  • nChanges in credit control department staffing
  • n Changes in customers
  • n Teeming and lading frauds taking place   n Cut-off errors

n Sales may have declined suddenly



Audit Implications


  • Recoverability of debtors becomes more doubtful as age of debtors increases. This could raise the need to increase the provisions for doubtful debts.


  • Questions as to the completeness of sales ideally a growth in debtors should be a reflection of a growth in sales.


  •  Stock turnover ratio = Cost of sales



Possible reasons for the decrease:


A new method of valuing stock may have been adopted

n Sales may have declined suddenly

n  Cut-off errors

n  Increase in stock quantities perhaps due to bulk buying to obtain discounts

n  Stock values and amounts incorrectly calculated  n Changes in types of stock held due to change in sales mix


Audit Implication


  •  Dead/ slow moving stock. There is need to review stock and possibly create a provision.





Your firm is the auditor of Trent Textiles Ltd, and you are planning your audit work on the stock-take, which will be carried out at the firm‘s year-end of 31 May 19X3.


Trent Textiles manufactures knitted garments, including pullovers. The production process comprises:

Knitting the individual components (e.g body and arms);

Sewing the components together to form the finished garment;

Cleaning, finishing, pressing and folding the garments;

Packing the garments, ready for dispatch to the customer.


Trent Textiles does not have a perpetual inventory system, so the value of the stock in the accounts is found from the stock-take at the year-end. For management purposes, Trent Textiles carries out a full stock-take every three months.


Your permanent file of the company confirms that it has a single factory and no internal audit department.


You have been asked by the manager in charge of the audit to suggest the work you will perform at the stages listed below.



  • State the work you will carry out prior to the commencement of the stock-take.

(5 marks)

  • State the procedures you will check during the stock-take to ensure the company‘s

staff have accurately recorded the stock.                                          (8 marks)

  • State the work you will carry out and the matters you will record at the stock-take.

(7 marks)

(Total: 20 marks) 



Tutor‟s hint: The audit of stock is an important subject in this paper. Remember that thestock-take attendance gives the auditor assurance of existence of stock, not ownership or value. In (a) think of the information the auditor needs, and then ask how it will be obtained. Key elements in (b) are supervision, who caries out the count, how the count is to be carried out and recorded, and special arrangements for certain stock.


  • The work I will carry out prior to the commencement of the stock-take will be as follows:



  • Review previous year‘s audit working papers and discuss any developments in the year with management. ii) Obtain and review a copy of the company‘s stock taking instructions.
  • Arrange attendance at stock count planning meetings, with the consent of
  • Gain an understanding of the nature of the stock and of any special stock taking

problems this is likely to present, for example scrap in piles.

  • Consider whether specialist involvement is likely to be required as a result of any

circumstances noted in (iv) above.

  • Using the results of the above steps, plan for audit attendance by appropriately experienced audit staff.
  • Consider the impact of internal controls upon the nature and timing of the stock taking attendance.





  • Discuss with the management the extent to which each garment is considered complete at each stage of the manufacturing process.


  • The first step in checking that the company‘s staff have accurately recorded the stock will be to examine the stock taking instructions issued to stock taking staff. This will involve checking that the following procedures are in place:


  1. Supervision of the planning and execution of the stock-take by sufficient senior and qualified personnel drawn from various departments: at least some of the

officials should not normally be involved with the custody of stocks. ii) Tidying and marking stock to facilitate counting of items of stock. The whole of

the stock taking area should be divided into sections for control purposes.

  • The serial numbering and control of the issue and return of all the rough count

records, and their retention.

  1. Systematic carrying out of counts to ensure coverage of the whole stock.
  2. Arrangements for the count to be conducted by at least two people, with one counting and the other primarily to check the count, or alternatively for tow independent counts to be carried out; and for any differences arising to be

investigated and resolved.

  1. Stock sheets being complete in ink and being signed by those who carried out and          checked the count.
  • Information to be recorded on the count records. (normally this will include the location and identity of the stock items, the unit of count, the quantity counted,

the condition of the items and the stage reached in the production process).

  • Restriction and control of the production process and stock movements during the count.
  1. Identification and segregation of damaged, obsolete, slow moving, third parties‘ stocks and returnable stocks, so that these can be properly accounted for and
  2. Recording the quantity, condition and stage of production of all the work in

progress for subsequent checking with the costing and stock records.

  1. Co-ordination of the count with cut off procedures so that documentation concerned with the flow of goods can be reconciled with the financial records.

For this purpose, last numbers of goods inwards and outward records and of  internal transfer records should be noted.

  • Reconciliation with the stock records, if any and identification and correction of differences.


  • The following work should be carried out at the stock-take:


  1. Carry out a series of test counts between the stock and the count records and vice versa. Attention should be given to high value stocks.
  2. Obtain information about the stock‘s condition, age, usage and, in the case of work in progress, its stage of completion.
  • In order to ensure that cut-off stock is correct, the following procedures should be carried out:
    1. Make a record during the stock taking attendance of all movement notes relating to the period, including:
      • All inter-departmental requisition numbers;
      • The last goods received note and dispatch note prior to the count;
      • The first goods received note and dispatch note after the count.


  • Observe whether correct cut-off procedures are being followed in the dispatch and receiving areas. Discuss procedures with company staff performing the

count to ensure they are understood.

  • Ensure that no goods finished on the day of the count are transferred to the warehouse.


Finally the auditors should:


  • Conclude whether the stock taking has been properly carried out and is sufficiently reliable as a basis for determining the existence of stock;
  • Consider where any amendment is necessary to their subsequent audit procedures;


  • Try to gain from their observations an overall impression of the levels and values of stocks held so that they may, in due course, judge whether the figure for stocks appearing in the financial statements is reasonable.



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