AUDITING AND ASSURANCE REVISION KIT (QUESTION AND ANSWER)

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TOPIC 1

 

NATURE AND PURPOSE OF AN AUDIT

 QUESTION 1

April 2024 Question One A

Private companies are not required by law to have their financial statements examined by an auditor. However, all public entities are required by law to have their financial statements audited.

Required:

Explain SIX reasons why an audit is considered necessary for limited liability companies and other public entities.  (6 marks)

ANSWER

Reasons for Audits in Limited Liability Companies and Public Entities:

• Compliance with Legal Requirements: For public entities, audits are mandatory as per the securities laws and regulations. The capital markets Act requires all publicly traded companies to have their financial statements audited by an independent accounting firm. This requirement is essential to protect investors from potential fraudulent activities and to maintain confidence in the capital markets.
• Enhancing Credibility: An audit provides an independent assessment of an organization’s financial statements, which can significantly enhance their credibility among stakeholders such as investors, creditors, customers, employees, and regulatory bodies. A clean audit report signifies that the financial statements have been prepared in accordance with generally accepted accounting principles (GAAP) and provide a true and fair view of the organization’s financial position.
• Identifying Errors or Fraud: During an audit, the auditor examines the organization’s financial transactions, internal controls, and accounting practices to identify any errors or discrepancies that may exist. These findings can help management address any issues promptly and prevent potential future problems. Moreover, audits can also help detect fraudulent activities that might go unnoticed otherwise.
• Assessing Risk Management: Audits enable assessing an organization’s risk management processes by evaluating its internal controls system’s effectiveness in managing risks related to financial reporting. This assessment can provide valuable insights for management to improve their risk management strategies and mitigate potential threats to their business operations.
• Maintaining Regulatory Compliance: In certain industries or sectors where regulatory compliance is mandatory, audits play a significant role in demonstrating adherence to specific regulations or standards set by regulatory bodies.
• Enhanced Public Confidence: Audits can help to enhance public confidence in the financial reporting process. This is important for maintaining a healthy capital market.

 

QUESTION 2

April 2023 Question One A

Highlight THREE benefits that may be derived from independently audited financial statements.          (3 marks)

ANSWER

1. Enhanced Credibility and Reliability: Independent audits enhance the credibility and reliability of financial information presented in the statements. External auditors provide assurance that the financial statements are free from material misstatements and are prepared in accordance with relevant accounting standards.
2. Increased Transparency: Audited financial statements increase transparency by providing an unbiased assessment of an organization’s financial position and performance. This transparency helps stakeholders make informed decisions based on reliable information.
3. Improved Access to Capital: Companies with independently audited financial statements often find it easier to access capital from investors and lenders. The audit report serves as a signal of financial health and integrity, which can attract potential investors and creditors.
4. Compliance with Regulations: Audited financial statements help organizations comply with regulatory requirements. Many regulatory bodies mandate the audit of financial statements for publicly traded companies or entities receiving public funding.
5. Detection of Errors and Fraud: Independent audits can help detect errors, irregularities, or fraudulent activities within an organization. Auditors perform detailed testing procedures to identify any discrepancies or inconsistencies in the financial records.
6. Risk Mitigation: Audited financial statements assist in identifying risks and weaknesses in internal controls. By highlighting areas of concern, audits enable management to take corrective actions to mitigate risks and improve operational efficiency.
7. Stakeholder Confidence: The independent verification provided by audits instills confidence in stakeholders, including shareholders, customers, suppliers, and employees. Stakeholders are more likely to trust organizations that undergo regular audits by reputable auditing firms.
8. Benchmarking and Performance Evaluation: Audited financial statements serve as a benchmark for evaluating an organization’s performance over time or against industry peers. Comparing audited financial data can help identify trends, strengths, weaknesses, and areas for improvement.
9. Facilitation of Due Diligence: In mergers, acquisitions, or partnerships, audited financial statements play a crucial role in due diligence processes. Potential buyers or partners rely on audited information to assess the value and risks associated with a target company.
10. Legal Protection: Audited financial statements provide legal protection to stakeholders by reducing the risk of litigation related to inaccurate financial reporting. In case of disputes or investigations, auditors’ opinions can support the organization’s position.

QUESTION 3

August 2022 Question Two C

Your firm has been appointed as incoming auditors of Taratibu Motors Ltd. Part of  the agreement is a proposal of undertaking of continuous audits on the company’s financial statements.

 Required:

Explain four disadvantages of conducting the proposed continuous audits.          (4 marks)

ANSWER

1. Change in Figures: In Continuous Audit some part of the accounting work is completed earlier, and therefore, there is a fear that the account books which have been audited may be tampered later on by the employees. If this happens then the Final Accounts shall not be able to show the true picture of the commercial organisation.
2. Hinderance in the Work of Business:
3. In Continuous Audit, presence of the auditor and his staff creates hinderance in the regular work of the commercial organisation. Attention of the employees is drawn by them and some of the employees are asked to attend them only. This creates obstacles in the smooth working of the business-houses. Sometimes, even the management feels inconvenience due to the frequent appearance of the auditor.
4. Expensive: Continuous Audit is expensive than Balance Sheet Audit. Since the auditor and his staff visits the commercial organisation to frequently, the management has to spend more on them, both time-wise and money-wise. Further auditor charges more audit fees for Continuous Audit.
5. Break of Work Chain: In this system the audit work is done in piece Every time the auditor has to prepare his audit programme before starting his work. This requires more time and energy on his part.
6. Secret Pact with Employees: The staff of the auditor comes in close contact with the employees of the organisation. It develops intimacy with them and there is every possibility of concealment of important facts with their connivance.
7. Mechanical Work of Auditing: The audit work becomes mechanical since the work continues throughout the year and the interest of the staff or auditor is reduced. This has an adverse impact on audit work.
8. Luxury for Small Business: Continuous Audit is more expensive, and therefore, small-scale commercial organisations are not able to adopt it. If they go for it, it proves to be a waste and luxury for them.
9. Decrease in Moral Duty of Employees: The auditor visits the commercial house too frequently. This adversely affects the moral of the employees of the organisation as they do not pay attention to the audit work and the auditor. The staff of the employer may become friendly with the closeness/nearness the auditor and his staff. This may give an opportunity to misuse this relationship.

 

QUESTION 4

April 2022 Question One A

Your firm has been engaged in auditing small entities for the last five years. In a recent development, your firm has been appointed to conduct an audit on a large entity; which is the first assignment of such magnitude. You are required to undertake an interim audit and a final audit of the large entity.

 Required:

(i) Explain the objective of an external audit.     (2 marks)

(ii)  Highlight five audit procedures you could undertake during the interim audit of the large entity.     (5 marks)

(iii) Describe five audit procedures you would undertake during the final audit of the large entity.         (5 marks)

(iv) Present two drawbacks of conducting an interim audit.                                                                  (2 marks)

 

ANSWER

i) Objective of an external audit

1. It enhances the credibility of the financial statements prepared by the management
2. It protects the interests of the third parties who are involved the management of the business.

• It acts as a preventive and detective measure against frauds and errors. The audited accounts can be used by the company for negotiating for loans from banking institutions

 

ii) Audit procedures you could undertake during the interim audit of a large entity.

1. Ascertaining and evaluating the accounting and internal control systems
2. Recording and evaluating the systems.
3. Limited analytical review procedures
4. Limited substantive testing
5. Notifying the weakness in the systems and providing recommendations for improvement.
6. Planning the substantive procedures for the final audit

 

iii) Audit procedures you would undertake during the final audit of a large entity.

1. Updating auditor’s knowledge on the client business and systems
2. Determining whether the internal control systems have changed during the interim up to the year end
3. Carrying out compliance testing
4. Final analytical review procedures
5. Final substantive testing
6. Vouching transactions
7. Assessing the appropriateness of accounting policies
8. Assessing the reasonableness of accounting estimates

 

iv) Drawbacks of conducting interim audit

1. It may be expensive for an average business
2. it may be disruptive
3. Figures already audited may be altered by the client staff
4. Client staff may depend on the auditor to solve their accounting problems.

 

QUESTION 5

December 2021 Question Three C

You are the auditor of Sharoh Ltd. which was incorporated in December 2018. The company’s main business is in real estate. Over the last two years, the company has recorded increased profits as a result of the Property Market-boom in the country. Due to the increased number of transactions, you as the auditor feel that it is prudent to have an interim audit. The management are however hesitant about your proposal.

Required:

Explain three reasons to the management of Sharoh Ltd. why an interim audit is necessary and how it could be of benefit to the client.             (6 marks)

 

ANSWER

Reasons to the management of Sharoh Ltd why an interim audit is necessary and how it could be of benefit to the client.

Interim audit is necessary since it helps in increasing the efficiency and effectiveness of the management functioning concerning the accounting and the financial part of the business.

It involves preliminary audit work that facilitates faster completion of the final audit.

 

Benefits to the Client

1. It facilitates declaration of interim dividends
2. It is less expensive as compared to the other audits that are required to be conducted
3. Errors and frauds are detected at an early stage.
4. It is less disruptive than continuous audit
5. Act as a preventive and detective measure against fraud and errors.

 

QUESTION 6

December 2021 Question Four C

Examine six factors that would lead to change in the inherent risk of Relax lintels and Cottages Ltd.   (6 marks)

 

ANSWER

Factors that lead to change in the inherent risk of relax hotels and cottages ltd.

1. Management integrity
2. Management knowledge, competence and experience
3. Any recent changes in management especially in the finance and accounting function.
4. Unusual pressure on the management and staff
5. Nature of the clients business for example some business models are complex
6. Factors affecting the industry such as the regulatory framework.
7. Significant related party transactions and balances.

 

QUESTION 7

December 2021 Pilot Paper Question One A and B

(a) Explain the meaning of the term “inherent risk”.       (2 marks)

(b) State with reasons five factors that would affect the initial assessment of inherent risk at the financial statement level.             (10 marks)

ANSWER

a)Inherence risk – This is the susceptibility or likely hood of account balances either individually or where aggregated with other 40 material misstatement assuming that there are no related controls.

 b) Factors that would affect the initial assessment of inherent risk at the financial statement level

1. Management integrity – How the management are honest and straightforward in providing information
2. Management knowledge, competence and experience – the level of knowledge and skills posed by the management
3. Any recent change in management especially in the finance and accounting function.
4. Nature of the client business for example some business models are very complex.
5. Significant related party transactions and balances – those transactions that have being done by directors or related parties generally.

 

QUESTION 8

September 2021 Question One C

Highlight two features of a non-statutory audit.  (2 marks)

 ANSWER

Features of non statutory audit

• Nature and scope of audit is determined by the client
• Audit is conducted within the limits determined by the client
• Conducted any time.