GROUP AUDITS QUESTION AND ANSWERS

QUESTION 1

Your audit firm, Ricky Rose and Co., Certified Public Accountants have recently been appointed the auditors of Impact Group Ltd. which is a highly geared manufacturing concern: The holding company is based in Nairobi with several small manufacturing subsidiary companies located in other towns in East Africa. It also recently acquired a subsidiary company in Europe dealing in e-c ommerce. The outgoing auditors, Richard Mathews and Associates, Certified Public Accountants had issued an unqualified audit opinion on the group financial statements for the year ended 31 March 2014.

Required:

Summarize the special planning considerations to take into account with respect to the audit of Impact Group Ltd, for the year ended 31. March 2015.

The auditor should be aware that the audit report will cover both the individual parent company and the group financial statement in particular the auditor should consider the client procedures for preparing the group accounts and the auditor’s own timetable. The auditor should in particular consider;-

  • The client group accounting instructions.
  • The standard accounting forms – specifying the layout of the financial statements of each subsidiary to facilitate consolidation.
  • The ‘client’s timetable for production of financial statements of individual companies. Complexity of audit of company dealing in e-commerce hence reliance on the work of the auditors as well as experts.
  • Audit staff for the assignment.
  • Liaison with other auditors of subsidiaries and associates.
  • Liason with outgoing auditors given this is the first assignment.
  • Anticipating problem areas such as certain overseas subsidiaries and problem of obtaining information.
  • Other relevant planning consideration acceptable.

Explain the importance of comparatives to the conduct of the audit of the group.

The comparative figures include amount and disclosures derived from preceding financial statements included in the current year’s period. It is important for the auditor to note that an auditors report and opinion is on the current period Financial statements as a whole including the corresponding figures.

For initial engagements the auditor seeks to obtain sufficient appropriate evidence to confirm that;

  • Opening balances do not contain misstatements that materially affect the current period financial statements
  • Prior period closing balances have been properly brought forward as current periods opening balance,
  • Accounting policies have been consistently applied.

To obtain the necessary assurance on opening balances additional procedures could be performed such as:

  • Review of working papers and accounting records for the previous year end,
  • Audit work on current year’s transactions and balances can provide some evidence to support completeness, valuation, existence and rights of obligations of the opening balances.
  • It is important for the auditor to note that lack of audit evidence on the opening balances may result in qualified opinion.

Discuss the audit procedures you would undertake in relation to the consolidation of the group financial statements.

  • Agreeing the transposition of component information to the consolidation schedule including casing and cross-casting all the consolidation schedule.
  • Checking that consolidation adjustment and classification of items are appropriate and consistent among the group and previous year.
  • Verification test on fair value with reference to valuers report.
  • Calculation of goodwill on consolidation including impairment test should be carried out.
  • Agreeing sales proceeds and purchase consideration transactions to underlying documentation and records.
  • Reconciling inter-company sales, purchases, depreciation and adjustment and other receivables.
  • For acquisition and disposals determine the correct proportion of net assets have been correctly accounted for determining goodwill/profit on disposal reference to date of acquisition/disposal.
  • Reconciling intercompany balances and obtaining letters of confirmations.
  • Consider related parties within the group.
  • Consider whether group accounts show a true and fair view.
  • Consider the reports for experts in relation to audit of c-commerce and also reports of other auditors or the subsidiaries.

QUESTION 2

Rangi Products Ltd. manufactures paints for the defence industry in your country. The company had no subsidiaries but in January 2014, it acquired 60 per cent of the share capital of an American company Croscolin Ltd. for Sh.6 billion paid partly in cash and partly in shares in Rangi Products Ltd. The net assets of Croscolin Ltd., were Sh.4.8 billion at the time of the purchase. Since then, Croscolin Ltd. has made a loss of Sh.1.5 billion, but is expected to break even in the year 2015 and thereafter realise significant profits.

Your firm, TMR and Associates has been appointed as the auditors of Rangi Products Ltd.

In the context of International Standard on Auditing (ISA) 600: Special Considerations – Audit of Group Financial Statements (Including the work of Component Auditors), explain five indicators of risk of material misstatement of the Group financial statements of Rangi Products Ltd. for the year ending 31 December 2014.

  • A complex group structure, especially where there are frequent acquisitions. disposal or reorganizations.
  • Poor corporate governance structures, including decision-making processes that are not transparent.
  • Non-existent or ineffective group-wide controls, including inadequate group management information on monitoring of components’ operations and their results.
  • Components operating in foreign jurisdictions that might be exposed to factors such as unusual government intervention in areas such as trade and fiscal policy.
  • Business activities of components that involve high risk such as long-term contracts or trading in innovative or complex financial instruments.

Uncertainties regarding which components’ financial information require incorporation in group financial statements in accordance with applicable financial reporting framework. Unusual related party relationships and transactions.

  • Prior occurrences of inter-group account balances that did not balance or reconcile on consolidation.
  • Components application of accounting policies that differ from those applied to group financial statements.
  • Components with different financial-year end which might be utilised to manipulate the timing of transactions.

QUESTION 3

You are the audit senior in charge of the audit of AML Group Ltd. You have been assigned three members of staff to form the engagement team.

The team comprises an audit semi-senior and two relatively new audit assistants.

You are well aware of the fact that there are many related party transactions among the group. To help the members of the team understand AML Group Ltd.’s related party relationships and transactions, you call for a meeting.

Required:

Discuss four matters that might be addressed in the meeting with the engagement team.

  • The nature and extent of the entity’s relationships and transactions with related parties (using, for example, the auditor’s record of identified related parties updated after each audit).
  • An emphasis on the importance of maintaining an attitude of professional scepticism throughout the audit regarding potential for material misstatement associated with related party relationships and transactions.
  • The circumstances or conditions of the entity that may indicate the existence related party transactions that management has not identified or disclosed to the auditor.
  • The records or documents that may indicate existence of related party transactions. The importance that management and those charged with governance attach to the
  • identification, appropriate accounting or, and disclosure of related party relationships and transactions.
  • How transactions between the entity and a known business partner of a key member of management could be arranged to facilitate misappropriation of the entity’s assets.

QUESTION 4

According to ISA 600: Special Considerations-Audits of Group Financial Statements (including the work of Component Auditors). “The group engagement shall request the component auditor to communicate matters relevant to the group engagement team’s conclusion with regard to the group audit”.

Highlight the matters that. such communication should include.

The communication should include the following matters:

  • Whether the component auditor has complied with ethical requirements that are relevant to the group audit, including independence and professional competence.
  • Whether the component auditor has complied with the group engagement team’s requirement.
  • Identification of the financial information of the component on which the auditor is reporting.
  • Information on instances of non-compliance with laws or regulations that could give rise to a material misstatement of group financial statements.
  • Indicators of possible management bias.
  • Description of any identified significant deficiencies in internal control at component level.
  • The component auditors overall findings; conclusions or opinions.
  • A list of uncorrected misstatement of the financial information of the component.

 

QUESTION 5

International Standard on Auditing (ISA) 600: Special considerations: Audit of group financial statements, provides examples of conditions or events that may indicate risks of material misstatement of the group financial statements.

Summarize these conditions or events.

  1. Complex group structure especially where there is frequent acquisition disposal or reorganisation.
  2. Poor corporate governance structure including decision making process which is not transparent.
  3. Non-existence or ineffective group control including inadequate group management information system on monitoring the components operations and their results.
  4. Business activities of the components that involve high risk such as long-term contracts or trading in innovative or complex financial instruments.
  5. Contingencies existing at the year end.
  6. Post-balance sheet events existing.

QUESTION 6

The following are some of the internal controls instituted MKB Company Limited:

  1. A lock box for customer collections is used for most cash receipts.
  2. Sales invoices are pre-numbered.
  3. Customer order forms are completed and signed the customer.
  4. A credit limit checlois performed.
  5. Sales invoices are priced at the selling price in the master file unless a different selling price is input at the time the sales order is entered.
  6. Cash receipts per the account receivable subsidiary ledger are reconciled on a monthly basis.

Required:

QUESTION 6

The following are some of the internal controls instituted MKB Company Limited:

  1. A lock box for customer collections is used for most cash receipts.
  2. Sales invoices are pre-numbered.
  3. Customer order forms are completed and signed the customer.
  4. A credit limit checlois performed.
  5. Sales invoices are priced at the selling price in the master file unless a different selling price is input at the time the sales order is entered.
  6. Cash receipts per the account receivable subsidiary ledger are reconciled on a monthly basis.

Required:

Discuss the control objective and assertion relevant to each of tile internal controls in I to 6 above.

Control objectives and assertions relevant to each of the internal control i) A lock box for customers collection is used fbr most cash receipts Control objectives

  • To ensure the safety of cash receipts
  • To prevent misappropriation ()leash dishonest cashiers Assertion
  • Occurrence — cash receipts under lock and key confirms that the transaction really took place
  1. Sales invoices are pre–numbered Control objective
    • To determine for the accuracy of the sales invoices, this will be reflected in the sales ledger:
    • To detect any fictitious sales made. Assertions
    • Completeness —Ensure that transactions has been processed, completely using the accounting system.

 

  • Customer orders forms are completed and signed the customer Control objective
    • To provide evidence if there is any fictitious transactions Assertion
    • Occurrence — Confirm the occurrence of the transactions/sales iv) A credit limit is performed Control objective
    • To determine the integrity of the sales staff
    • To check the authority and approval of the credit sales

Assertion

  • Accuracy
  1. v) Sale invoices are priced at the selling price in the master file unless a different selling price is input at the time the sales are .made. Control objective
  • To ensure there is consistency in the recording of the sales – To determine the accuracy of the sales ledger. Assertion
  • Completeness —Check the logistic of processing the sales order and pricing of the commodity.
  1. vi) Cash receipts per the account receivables subsidiary ledger are reconciled on a monthly basis.

Control objectives

To check the accuracy of the account receivables control account.

  • To detect fictitious debtors and sales made from the sales ledger. – To prevent teeming and lading and carry over fraud. Assertion
  • Accuracy —Ensure that the debtors balances have been recorded accurately
  • Completeness — ensures that the balances have been disclosed in the books of accounts completely.

QUESTION 7

Zed Company Ltd. operates a chain of supermarkets. The internal audit department of Zed Company Ltd. is centralized at the head office. Whereas it undertakes the internal audit functions for the head office, it only performs regular inventory counts in the branches.

Required:

Describe the additional assignments that the internal audit department could undertake in the branches.

  1. Testing cash controls at the branches.

They can test the control over cash receipts and payments and undertake the cash counts. The branches might have a significant amount of cash at each branch and would need tight controls over the cash receipt process. These controls should be tested at each location as well as performance of a cash count toll-educe the level of fraud and error reported.

  1. Customer shopping review.

In order to improve the customers experience in the stores the internal audit department will undertake mastering shopping review where they can enter the branch stores as customers and purchase goods rating the overall shopping experience.

They will then give a feedback to each shop to improve the customer service and this can provide the basis for further training where necessary.

  1. The overall review of the financial or operational controls.

The department could undertake review of the controls at the head office as well as the individual .stores and make recommendation to the management over such areas as the purchasing processes and the sales cycle.

  1. Routine verification of assets e.g. mobile assets and stocks.
  2. Risk assessment.

The internal audit department will review the key risk areas that will affect the operations and develop mechanism or measures to mitigate them.

  1. Fraud investigations.

It is likely that the company having many branches will have problems with the theft of inventory, assets and cash. Internal audit could be asked to review the main areas of the fraud risk and develop the controls to mitigate the risk. If the fraud is suspected then internal audit could be asked to investigate these cases further.

  1. IT system review

The company is likely to have a computer system linking all the cash tills in the branches to the head office. The internal audit department could be asked to perform a review of the computer environment and control existing to assess their proper functioning.

  1. Value for money review.

The internal audit department could be asked to assess whether the company is obtaining value for money in areas such as Just In Time ordering system in order to ensure effectiveness, efficiency and economy in the operations..

  1. Regulatory compliance.

Internal audit department could ensure compliance with the laws and regulation that affect the company’s operations.

 

QUESTION 8

You are the audit manager in K & Associates, a lm of certified public accountants and you are reviewing the working papers completed on the final audit of Ban Limited and the Bane Group for the year ended 31 December 2011. Bane Group consists of four wholly owned subsidiaries and the holding company Bane Limited,

Required:

Describe the principal audit procedures to be performed on the consolidation schedule of the Bane Group.

  • Agree correct extraction individual company figures reference to individual company audited financial statements.
  • Cost and cross-cast all consolidation schedules.
  • Recalculate all consolidation adjustments, including goodwill, elimination of pre- acquisition reserves, cancellation of inter-company balances, fair value adjustments and accounting policy adjustments.
  • By reference to prior year audited consolidated accounts, agree accounting policies have been consistently applied.
  • Agree brought down figures to prior year audited consolidated accounts and audit working papers such as goodwill figures for the acquisitions and consolidated reserves.
  • Agree that any post-acquisition profits consolidated for any acquisition during the year arose since the date of acquisition reference to date of acquisition as per the purchase agreement.
  • Reconcile opening and closing group reserves and agree reconciling items to group financial statements.

QUESTION 9

Mulo Hotels Ltd. is a listed company which has a chain of 20 hotels in the East African region.

 

 

The company has established an internal audit department which is based at the head office and which makes regular visits to the hotels.

The hotels provide business and tourist class accommodation. They also provide restaurants, bars, conference and leisure facilities which are open to the general public. The company operates a computerised central booking and billing system and an inventory and asset control system, both of which can be accessed via terminals in the hotels.

Access to the system is restricted the use of passwords and all significant expenditure is authorised at the head office. The payroll is operated at the head office. Hotel and regional managers are actively involved in the setting of budgets and cash flow forecasting. On average, throughout the year, the hotel chain has a 60% occupancy rate.

Required:

  • Describe the areas in which the internal audit department of Mulo Hotels Ltd. could check detailed transactions and balances.
  • They can trace a representative sample of room bookings and the booking of conference facilities from source documentation through the system, to ensure -that the correct amounts are billed, that the facilities are paid for within the time limits agreed and that the correct amounts have been recorded in the correct accounting period
  • They can trace a representation sample of orders for food and other consumables through the system to ensure that authorised suppliers are used where necessary, that the correct prices have been billed supplier.
  • That payment has been made on the agreed terms and that the correct amounts have been recorded in the correct accounting period.
  • They can trace a representative sample of additions to and disposals of assets through the system from the physical-assets themselves, through the day books and ledgers to the original authorization for purchase, to ensure that all assets acquired are properly authorized
  • They can trace a representative sample of additions to and disposals of assets in the opposite direction that is from authorizations to assets to ensure they are in good conditions and still in the hotel’s record.

They can select representative samples of debtors and creditors for direct confirmation. They might check on the existence of certain employees and on the accuracy of the payroll calculations with reference to records of hours worked kept at the hotels.

  • Explain areas in which the internal audit department of Mulo Hotels Ltd. could perform reviews of system or operational performance.
  • They’ might review the documentation of the centralised booking system and evaluate it. They might then review the actual operation of the system in practice and make recommendations for improvement or change.
  • They might review the integrity of the systems use of computer assisted audit techniques and other techniques to ensure that access to the system_ is restricted to those who should have access and to ensure that the system has produced exceptions reports as it should. The use of dummy data and false passwords might be used in such an assessment.
  • Analytical procedures could be performed to evaluate the relative financial and operational. performance of individual hotels, hotels in certain regions and the performance of the various classes of business (tourist and business accommodation) conference and leisure facilities, restaurants and bars. Performance could also be evaluated against budgets on a reasonable basis comparisons with prior years and period.
  • Analytical procedures could be performed as relationships such as those between drinks and meals consumed_ and those between drinks rates and other facilities used.

 

QUESTION 10

You are the audit manager in charge of the audit of Subira Limited, a local distributor of fast moving consumer goods. You are also the auditors of Sifa Limited which imports goods from a neighbouring country and sells all the goods to Subira Limited. The two companies have common shareholders and directors including the managing director.

Subira Limited also buys from three other local suppliers.

Whereas all purchases Subira Limited from Sifa Limited are paid for promptly. Subira Limited extends sixty days credit to its customers.

The managing director expresses doubt on the reliability of the inventories control system.

Sifa Limited owns some trucks which it uses to ferry goods from the neighbouring country. The trucks have a computerized mechanism for monitoring fuel consumption which is the basis of determining their transport costs which includes drivers allowance for upkeep while ferrying the goods.

In addition, Sifa Limited hires trucks from third parties which it pays for at agreed rates. These costs are categorized as transport expenses in the income statements of Sifa Limited.

The managing director is apprehensive about the inventory management system especially with regard to damaged packages regular stock takes adequate documentation of stock movements and slow moving goods.

Required:

  1. a) Describe the audit procedures you would undertake to verify the occurrence, completeness and validity of:
  2. Sifa Limited’s sales
  • Review the sales and the supporting documentation to ensure they relate to Sifa.
  • Obtain a sample of all receipts for all sales that were made and confirm that they tally with all the supporting documentation, that is, orders, LP0s, quotations etc.
  • Review the sales receipt to ensure all the relevant lam-nation is present.

Check the sales journal and control account and ensure they reconcile and the necessary information is present, i.e. all the sales were recorded correctly in the relevant accounts.

  1. Subira Limited’s purchases
  • Since Sifa sells all its goods to Subira, then ensure that the figure for sales for Sifa coincides with the figure for purchases in Subiras cost of sales.
  • Obtain a sample of all purchases made and ensure they are supported the supporting doctunentation, 1.30s, GRNs, orders etc.
  • Ensure all the purchases made relate to Subira and that they were not done on behalf of its sister company

Ensure all the purchases have been recorded in the accounts and in the period in which they relate

Subira Limited’s receivables

  • Compare the credit sales and the accounts receivable to ensure they all have been recorded appropriately and relate to sale made Subira.
  • Obtain a sample of the receivables and circularize them to confirm that they actually owe Subira and that the sale was made in the year under consideration.
  • Obtain a listing of all credit sales that were made at year end and test whether the receivables have been recorded in the correct period.

 Subira Limited’s inventories

  • Ensure that the purchases are supported with actual inventory checking the (.3RNs that accompanied the goods and ensure that the inventory that was paid for was the actual inventory received.
  • Review previous years’ working papers for the closing balance to avoid double counting.
  • Compare the current years’ inventory records with the purchases done in the year and the sales done in the year.
  • Review the inventory records to ensure all the inventory that was brought in, sold or otherwise has been recorded appropriately in the books.

Sifa Limited’s transport costs

  • Obtain a sample of all the extracts from the computer system and review the computations that were done to obtain the total transport costs including the drivers’ allowance.
  • Obtain the receipts from Sifa on the payments that were made on hiring the other trucks and ensure that they relate to the Sifa and were used for the correct purpose.
  • Ensure all the costs have been recorded appropriately in the books and that they relate to the year under consideration.

 Summarise the challenges you might face as an auditor in carrying out the audit.

  • Limited resources: The auditor may be unable to carry out the work effectively due to limited resources and time to efficiently carry out the audit.
  • Overstretched: The auditor is bound to be overstretched in his work as he has to provide an opinion on the accounts of two companies at the same time.
  • The auditor’s will be faced with a conflict of interest since he owes a duty of care to each and in some instances may be forced to use the information obtained on one side for or against the other company which is against professional ethics.
  • The auditor may be unable to uphold confidentiality since he reports to one office despite the fact that he is auditing two firms.

 

QUESTION 11

The auditor needs to examine investments held the parent company to determine whether an investment constitutes an associate company or a subsidiary company. In most cases, the auditor will not have a problem in identifying subsidiary companies.

 

However, the process which the auditor obtains sufficient evidence to confirm the position taken a client company to determine whether or not the investment constitutes a subsidiary undertaking is of major concern to the auditor.

The precise shareholding can be ascertained from the register of members of the potential subsidiary undertaking. Examination is then required of the particular circumstances against the relevant definition.

Once the group members have been identified, the auditor will be particularly concerned with the accounting treatment and accounting policies of the group companies.

Required:

Discuss the matter an auditor would consider when auditing the financial statements of group companies with respect to the following:

Accounting policies

  • Where there are differences in accounting policies, the auditor should obtain reconciliations of the accounting policies from the different firms that make up the group.
  • The group should use similar accounting policies and standards for ease of consolidations.
  • The auditor should establish that the accounting. policies are applied consistently within the group and incase of changes, the same changes are effected throughout the group.
  • The auditor should ensure there is correct classification of investments throughout the group.
  • The auditors should ensure the accounting policies applied within the group are consistent with the IFRSs and ISAs and any other relevant financial reporting framework. (b) Consolidation adjustments
  • There should be a proper mechanism of identifying inter-company transactions and balances.
  • The auditor should ensure that the inter-company transactions and balances are eliminated from the financial statements.
  • The auditor should ensure the consolidation adjustments are done in accordance with the firm’s accounting policies.
  • The auditor should ensure that all items to be included upon consolidations are included and those that require elimination have been eliminated. (c) Reporting periods
  • The firms within the group should have a similar reporting period and that all items to be consolidated are within the same reporting period.
  • The auditor should also ensure that the year ends fall within 3 months of each, in case there are disparities.
  • Loss making subsidiaries
    • Confirm whether the loss making subsidiary is consolidated according to LAS 27 consolidated and separate financial statements.
    • The auditor should confirm whether the losses attributable to NCI are charged to them accordingly.
    • The auditor should confirm whether in cases where the losses attributable to NCI are in excess of the shareholders’ funds attributable to NCI, the losses are charged to the group unless the minority has a binding obligation to, and is able to make good the losses.
    • Where the losses have been taken up the group and the subsidiary reports profits, all such profits are attributable to the group until the NCI’s share of losses previously absorbed has been recovered (LAS 27,35)
  • Contingent liabilities and events after the reporting period
    • The auditor needs to review the events after the date when the component’s financials were signed and the date the group financials were signed to establish whether any adjustments are necessary.
    • The auditor needs to review if there are any events before the year end that require disclosure in terms of a contingent liability where the possibility of cash outflow is very minimal.

 

QUESTION 12

  • With reference to International Standard on Auditing 550 (Related Parties), discuss the responsibility of an auditor with regard to related party transactions.
  • You are a partner in ABC Associates, a firm of Certified Public Accountants (CPAs) specializing in the audit of group accounts. One of your clients, Excel Ltd., is the parent company of a number of subsidiary companies. Some of these subsidiary companies are audited other audit firms.

Your firm is in the process of determining the extent to which the work of these subsidiary company auditors can be relied upon in the audit of the accounts of the parent company.

Required:

Explain the factors you would consider in deciding on the extent to which you could rely on the work of the auditor of a subsidiary company. Your answer should include a consideration of the size of the subsidiary.

ISA 550 (Related parties) defines related party as follow;

Parties are related if one party has the ability to control the other party or exercise significant influence over the other party in making financial and operating decisions. Related party transactions are a transfer of resources between related parties regardless of whether a price is charged.

ISA 550 requires the auditor to perform audit procedures designed to obtain sufficient, appropriate audit evidence regarding the identification and disclosure management of related parties and the effect of related transactions that are material to the financial statements. The auditors knowledge of the client must be sufficient to identify related parties for the following reasons;

  • The financial reporting framework may require disclosure in the financial statements of certain related party relationships and transactions, such as required lAS 24.
  • The existence of related parties or related party transactions may affect the financial statements i.e. tax liability
  • The source of the audit evidence affects the auditors assessment of its reliability. A greater degree of reliance may be placed on audit evidence that is obtained from or created unrelated third parties.
  • A related party transaction may be motivated considerations other than ordering business considerations.

Analyse the matters you would consider in deciding whether you should qualify your audit report on the parent .company’s accounts given that the audit report on the accounts of a subsidiary company is qualified.

  • The materiality of the portion of the financial statements which the principal auditor audits
  • The principals auditor degree of knowledge regarding the business of the components
  • The risk of material misstatement in the financial statements of the components audited the other auditor
  • The performance of additional procedures resulting in the principal auditor having significant participation.
  • The principal auditor should consider the competence of the other auditor in the context of the assignment
  • Obtain sufficient appropriate evidence that the work of the other auditor is adequate for the principal auditor purpose

When the principal auditor concludes that the work of the other auditor cannot be used and the principal auditor has not been able to perform, sufficient audit procedures, regarding the financial information of the component audited the other auditor, the principal auditor should express a qualified opinion or disclaimer of opinion because there is a limitation in the scope of the audit.

If the other auditor issues or intend to issue, a modified auditors report, the principal auditor would consider whether the subject of modification is of such a nature and significance in relation to the financial statements of the entity on which the principal auditor is reporting, that a modification of the principal auditors report is required.

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