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BP2313 Audit With Answers)

BP2313 Audit With Answers)

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Materiality & Risk Question 1: M&B p.91 #3-32 Answer: 3-32 a. 1.

Audit risk is the risk that the auditor may unknowingly fail to appropriately modify the auditor's opinion on financial statements that are materially misstated. 2. Inherent risk is the susceptibility of an assertion to material misstatement, assuming no related internal controls. Control risk is the risk that material misstatements that could occur will not be prevented or detected by the internal controls. Detection risk the risk that the auditor will not detect a material misstatement that exists in the financial statements. 3. Inherent risk and control risk differ from detection risk in that they exist independently of the audit of financial statements, whereas detection risk relates to the auditor's procedures and can be changed at the auditor's discretion. Detection risk has an inverse relationship to inherent and control risk. b. 1. Materiality is the magnitude of an omission or misstatement of accounting information that, in the light of surrounding circumstances, makes it probable that the judgment of a reasonable person relying on the information would have been changed or influenced by the omission or misstatement. This concept recognizes that some matters, either individually or in the aggregate, are important for the fair presentation of financial statements in conformity with generally accepted accounting principles, while other matters are not. 2. Materiality is affected by the nature and amount of an item in relation to the nature and amount of items in the financial statements under examination, and the auditor's judgment as influenced by the auditor's perception of the needs of a reasonable person who will rely on the financial statements. 3. The auditor's judgment about materiality for planning purposes may be different from materiality for evaluation purposes because the auditor, when planning an audit, cannot anticipate all of the circumstances that may ultimately influence judgment about materiality in evaluating the audit findings at the completion of the audit. If significantly lower materiality levels become appropriate in evaluating the audit findings, the auditor should reevaluate the sufficiency of the audit procedures already performed.

Materiality & Risk Question 2 Your firm has recently been appointed as external auditor to EWheels. EWheels is a private .dot.com. company that operates an internet auction service for the sale of used motor vehicles. You are planning the audit of the financial statements. The company has been in existence for four years and has grown rapidly. It was founded by three individuals who are a former car auctioneer, an internet specialist with an interest in cars, and an accountant. The company now has three offices and some 100 employees. The on-line car auction market is very competitive. The company is the biggest provider of the service in the south of the country, but the directors have ambitious plans which include an aggressive marketing campaign, the take-over of a number of target competitors and additional office space and staff, all of which will require considerable additional finance. The company is financed partly by private capital brought in by the three founders, and partly by bank loans. The three founders were all directors, but the accountant resigned six months ago and has commenced a legal action against the company for a considerable amount of money, claiming that he has effectively been excluded from management by the other two directors. The company.s balance sheet shows net liabilities. The company has not yet made a profit although preliminary figures indicate that it has reached break-even point in the current year. Your firm has discovered that the previous auditors were not reappointed because they refused to issue an unmodified audit opinion on the previous year.s financial statements, and instead made reference to the going concern status of the company in their audit report. Your firm has made it clear to the directors that it may be necessary to make reference to the going concern status of the company again in the current year, but they have indicated that they would prefer an unmodified report if at all possible. You are also aware that loan facilities for this type of company are becoming more scarce, as there are too many companies seeking such finance. The director who resigned six months ago was responsible for the day to day accounting function and for the preparation of the financial and management accounts. The company has been unsuccessful in recruiting a permanent replacement and has used a number of temporary accountants. Your initial investigations have highlighted a number of weaknesses in the operation of the accounting and internal control systems. Required: (a) Explain your understanding of audit risk. (4 marks) (b) Describe the risks associated with the audit of EWheels. (7 marks) (c) List the enquiries you will make and the procedures you will perform in deciding whether to make reference to the going concern status of Ewheels in your audit report on the financial statements. (5 marks) (d) Describe the different ways in which your audit report might refer to the going concern status of the company. (4 marks) (20 marks)

Materiality & Risk Answer (a) Audit risk (i) audit risk is the product of inherent risk, control risk and detection risk. Audit risk is often .set. by the audit firm at a certain level (say 3% to 5%), and the nature and extent of testing in a particular audit are determined by an assessment of the other elements of risk. (ii) inherent risk is the risk that material errors will occur both at the entity level, and at the level of individual transactions and balances. Certain account balances and certain entities are more inherently risky than others. For example, inventory is more inherently risky than cash, volatile businesses are more inherently risky than stable businesses. (iii) control risk is the risk that internal controls will not prevent or detect material errors, both at the entity level, and at the level of individual transactions and balances. (iv) detection risk is the risk that auditors will fail to detect material errors (due to human error or sampling risk, for example). (b) Risks associated with the audit (i) in the case of EWheels, the level of inherent risk, control risk and detection risk all appear to be higher than normal. (ii) EWheels is in a volatile sector of the economy. It has grown rapidly and is planning further expansion which will require additional resources. There is a real risk of .overtrading., i.e. that the business will exhaust its cash resources too soon as a result of rapid growth. In such circumstances, there is a risk that creditors will go unpaid and that the business will be forced into liquidation. This is risky for both the directors and for the auditors. (iii) in a highly competitive sector, there is a possibility that the company itself will be vulnerable to take-over, particularly if it is in a weak financial position which it appears to be with net liabilities. The dispute between the ex-director and the current director means that the current directors do not have overall control of the company. It is particularly important in take-over situations for auditors to be cautious in the audit opinion they give. (iv) the overall control environment at EWheels is weak. There has been no proper control of the accounting function for six months and errors are appearing as a result. This may mean that the accounting records are unreliable and the financial statements may be materially misstated. (v) the attitude of the directors (which is relevant to the overall control environment) is suspect, they have indicated that they would prefer an unmodified opinion in circumstances which may warrant a modified opinion. They also appear to be overly ambitious in their expansion plans. (vi) EWheels is suffering from financial pressures; it wishes to expand but additional resources are needed and they are becoming scarcer, loan finance may become more expensive. The ex-director is claiming a substantial amount of money from the company. It may be preferable for the company to seek further equity finance or to delay the expansion plans. (vii) the audit is also risky for the firm because this is the first year of audit (and mistakes are therefore more likely to be made) and because there is pressure to issue an unmodified opinion. It will be important for the firm to ensure that adequate time and resources are allocated to what is likely to be a difficult audit. Any pressure by the directors to complete the audit quickly should be resisted. (c) Reference to going concern status (i) it will be necessary to review the overall financing position of the company in detail. This will involve examining budgets and cash flow forecasts, and performance against budgets and cash flow forecasts. If this information is not available for whatever reason, it will probably be necessary for the directors to produce it.

Materiality & Risk (ii) the relationship between the company and its bankers should be investigated thoroughly, because if the relationship is poor, additional finance is unlikely to be forthcoming. (iii) it is likely that financial information will sent to the bank on a regular basis and this should be inspected. It will be necessary to inspect correspondence with the bank and possibly for the auditors to make their own enquiries of the bank, although banks do not normally provide much information to auditors in this context. (iv) enquiries should be made of directors about that availability of additional equity and other finance which will be necessary for the planned expansion. All statements in this respect should be corroborated and supported by documentation. (v) enquiries should be made of the company.s lawyers as to the nature and likely outcome of the dispute with the exdirector. It will be necessary to make either a provision or disclosure in the financial statements unless it is very unlikely that any amount will be payable to him. (d) Audit reports (i) the audit report would probably be modified by means of the inclusion of an ‘emphasis of matter’ paragraph, highlighting the problem. This would only be possible however, if the matter were adequately disclosed in the financial statements. (ii) if the matter were not adequately disclosed in the financial statements, it might be necessary to issue an ‘except for’ opinion, disagreeing with the lack of disclosure in the financial statements. (iii) an ‘adverse’ opinion stating that the financial statements do not fairly present the position at all because of the lack of disclosure might be necessary if the auditors considered the matter to be fundamental to the view given by the financial statements as a whole. (iv) in extreme circumstances, where it was clear that the company was not a going concern, and the financial statements were still prepared on a going concern basis, it would probably be necessary to issue an ‘adverse’ opinion.

b. Observation is not as reliable because the individuals performing the functions may not act properly when no one is observing them. 3. High because it comes from an external party. E x t e r n a l 4. 2. The auditor's recalculation of depreciation is more reliable than the examination of the raw material requisitions because the auditor has direct personal knowledge of the outcome.127 #4-37 Answer: 4-37 a. High if internal control is excellent. d.127 #4-36 Answer: 4-36 a. Additionally. E x t e r n 4.Audit Evidence. Type 1. Reliability 1. the auditor may not be able to easily determine the quality or value of the computer components. Internal Internal b. The bank confirmation would be considered more reliable than the observation of segregation of duties because an independent external party provided the information. . High if internal control is excellent. moderate to low otherwise. Audit Procedures & Working Paper Documentation Question 1: M&B p. The physical examination of the common stock certificates would generally be considered more reliable than a physical examination of inventory components for a personal computer because the stock certificates are prepared by an entity external to the client. 2. moderate to low otherwise. 3. High to moderate because the document has been circulated to a party outside the entity. Question 2: M&B p. c. The bank statement would be considered more reliable than shipping documents because the bank statement was prepared by an entity that is external to the client.

moderate to low otherwise.Audit Evidence. High if internal control is excellent. Internal Internal Internal 6. Audit Procedures & Working Paper Documentation a l 5. High because it comes from an external party. moderate to low otherwise. High to moderate because the document has been circulated to a party outside the entity. 8. 9. 5. High if internal control is excellent. E x t e r n a l 6. 8. High because it comes from an external party. High if internal control is excellent. . E x t e r n a l 10. 7. 9. 7. E x t e r n a l 10. moderate to low otherwise.

159 #5-38 5-38 a. Analytical procedures are used for three broad purposes: • To assist the auditor in planning the nature. There is pressure from institutional investors for better returns in the form of dividends and the main institutional investors are considering selling a proportion of their shares in the company. and there is a good set of permanent inventory records. and extent of other auditing procedures. • As a substantive test to obtain evidential matter about particular assertions related to account balances or classes of transactions. and from rising raw material costs. • Information regarding the industry in which the client operates. c. . timing. No year-end inventory count is conducted.g. Nepco is listed on a stock exchange. Profits are coming under increasing pressure from manufacturers in the Far East and Asia with lower labour costs. Question 2 Nepco is a European company that manufactures high quality computer components and assembles computer parts. It has existed for some years and is part of a vertical supply chain for a well-known brand of computer hardware. Operational compliance issues are important to Nepco. b. The factors that influence an auditor's consideration of the reliability of data for purposes of achieving audit objectives are whether the • Independence of the source of the evidence. Nepco has good accounting and internal control systems. All staff and directors of Nepco are remunerated (at least in part) on a performance-related basis. Staff are generally highly qualified and wellpaid. • As an overall review of the financial information in the final review stage of the audit. forecasts. giving consideration to known changes. • Relationships among elements of financial information within the period. budgets. • Relationships of financial information to relevant nonfinancial information.. The directors of Nepco are considering whether to move into new market areas.Audit Planning Question 1: M&B p. An auditor's expectations (types of analytical procedures) are developed from the following sources of information: • Financial information for comparable prior periods. • The effectiveness of internal controls. • Anticipated results (e. Inventory is material to the accounts. and extrapolations). Many countries have inflexible quality standards and some projects are being held up because of difficulties in obtaining approval from regulators for new components. some with share options. • The auditor’s direct personal knowledge.

Audit Planning This is your first year as auditors. Required: (a) Describe the risks relating to Nepco under the headings of inherent risk. (8 marks) (20 marks) . control risk and detection risk. External audit costs are tightly controlled and your firm has agreed to a budget that will allow very little flexibility. (12 marks) (b) In the light of the risks identified in (a) above. Your firm has very little experience in this industry. list the matters to which you will pay particular attention during the audit of Nepco and explain the work you will perform in relation to them.

figures. (ii) Audit work will need to be directed towards inventory (despite the fact that it is well controlled) because it is material to the accounts.Accounting and Internal Control Systems. (b) Matters to which attention should be paid and work to be performed (i) The good accounting records and internal control combined with the need to keep audit costs down means that a compliance approach. (5) The possible sale of shares. and inventory is relatively easy to manipulate. including share options. the company must be adaptable. at least in a review capacity. (ii) Control risks: there are apparently very few except for the performance-related payment. and rising raw material prices. which may lead to inadequate audit evidence unless the audit is properly directed.s lack of experience in this area. . There is no year-end inventory count. It is likely that there will be a substantial amount of work-in-progress and its valuation will need to be reviewed carefully. This means that there is an ongoing risk to the business as a whole (a potential going concern risk) . (iii) Detection risk: this is the firm. (iv) Overall profits and any unadjusted errors should be examined carefully because of the inherent risks noted above and the performance-related pay.s going concern status should be reviewed by examining its financial status. states that audit risk is the product of inherent risk. (3) The risk that regulators may reject a product which has taken many months or years to develop. It is important that those with experience are employed on this audit. This means that there is pressure on profits and the ability to reward employees and pay dividends to institutional shareholders which increases the pressure to manipulate the financial statements to show good returns. (2) The potentially volatile market (computer components) in which new technology can render hardware obsolete in a very short time. (iii) The projects on which compliance problems have arisen should be examined carefully as the costs may be significant and there may be a temptation to understate them.acceptable. which increases the pressure to manipulate the financial statements. This is compounded by the firm. supervised and reviewed. (6) The inherent risks in diversification into unknown areas (the supply of other customers) . (v) The company. It may be possible to rely on any interim or cyclical inventory counting. (i) Inherent risks include: (1) The competition from Asian and Far Eastern companies. increasing the pressure for returns in order to get the best possible price. (4) The pressures for returns from institutional investors which means that there may be a temptation to manipulate the financial statements. control risk and detection risk. but these are not current risks.s first year as auditors and there are tight controls on audit costs. rather than a substantive approach will be necessary wherever possible. which provides an incentive to produce . financial support and likely future developments in high risk areas.Audit Planning Answer (a) Risks ISA 400 .

an entity's internal control system consists of the following components: • The control environment • Risk assessment • Control activities • Information and communication • Monitoring b. d. e. f. To support assessing control risk at less than the maximum level. or because evaluating their effectiveness would be inefficient. . If control risk is assessed at the maximum level. However. An auditor may assess control risk at the maximum level for some or all assertions because the auditor believes controls are unlikely to pertain to an assertion. For purposes of an audit of financial statements. the auditor should obtain an understanding of each of the components of internal control sufficient to plan the audit by performing procedures to understand the design of controls relevant to the preparation of financial statements and whether they have been placed in operation. the auditor should document the basis of the conclusion that the effectiveness of the design and operation of internal controls supports that assessed level. if the assessed level of control risk is below the maximum level. An auditor should document the understanding of the internal control components obtained to plan the audit. The auditor should also document the basis of the auditor's conclusion about the assessed level of control risk. In planning an audit. c. or are unlikely to be effective. an auditor must determine whether the controls are suitably designed to prevent or detect material misstatements in specific financial statement assertions and obtain evidence that the controls are operating effectively. When seeking a further reduction in the assessed level of control risk. the auditor should document that conclusion but is not required to document the basis of that conclusion.Internal controls Question: M&B p.198 #6-34 Answer: 6-34 a. an auditor should consider whether additional evidential matter sufficient to support a further reduction is likely to be available and whether it would be efficient to perform tests of controls to obtain that evidential matter.

credit notes or contras. (3 marks) (20 marks) Answer (a) Error. list and describe the types of error. credit notes. This means that auditors can never rely on the proper operation of the internal control systems alone. it will be easy to hide the misappropriation of cash that is received from customers. (ii) inherent weakness include human error. (iii) the effect of this will be that receivables may be under or over-stated in the records and that the company will not receive that money that is due to it. (4 marks) (b) Explain why even a good system of internal control will not necessarily prevent or detect errors. Even if their tests show that the system appears to be working perfectly. (9 marks) (d) Explain why external auditors seek to rely on the proper operation of internal controls wherever possible. the issue of invoices and credit notes to the wrong customers. cash and contras in the ledgers and daybooks. For example. omission and misappropriation (i) where internal controls are weak. If records are poor. (iii) other inherent weaknesses include the abuse of authority. or that goodwill with customers is damaged. (4 marks) (c) List the main internal controls that you would expect to be in operation in the receivables system at a small manufacturing company with a computerised accounting system.Internal controls Question 2: There are many reasons for maintaining internal control systems. omissions and misappropriation of assets are likely and external and internal auditors pay particular attention to both the design and operation of internal control systems. false invoices may be issued towards the yearend to improve the sales figure and false credit notes to . the errors that occur may include the issue of invoices and credit notes for the wrong amounts. In the absence of internal controls. (iv) the assets that may be misappropriated include cash and inventory. and explain why a good system of internal control is important to auditors. the incorrect recording of invoices. it will be necessary to perform some substantive testing. (ii) where internal controls are weak. (b) Inherent weaknesses (i) no internal control system is perfect and all internal control systems are subject to inherent weaknesses. omissions and the misappropriation of assets in a receivables system. invoices. These include the need to ensure that: (i) transactions are properly authorised (ii) transactions are promptly and accurately recorded (iii) access to assets and records is properly authorised (iv) recorded assets represent actual assets. Required: (a) In the context of receivables. credit notes cash and contras may simply go unrecorded. Receivables is an area in which most organisations expect internal controls to be operating effectively. errors. People operate the control systems and people make mistakes. omission and misappropriation of assets that can occur in practice where internal controls are weak or non-existent. and the incorrect setting of credit limits. It will also be possible for inventory to be misappropriated and hidden by the issue of false or incorrect invoices.

Internal controls cancel them out may be issued just after the year-end.. (d) Proper operation of internal controls (i) auditors seek to rely on the proper operation of internal controls wherever possible because where internal controls are operating properly. (v) arithmetical and accounting controls over the issue of invoices and credit notes. . those who authorise the issue of invoices and credit notes and those who issue the goods to customers. Those who have the right to authorise the issue of credit notes may authorise false credit notes for customers who are their friends. and make entries in the accounting records to hide the misappropriation. (c) Main internal controls (i) segregation of duties between those who control the accounting records. Those who have access to cash and the receivables records may collude to misappropriate cash. together with restricted access to those sections of the system that contain credit limits. (vi) the use of batch and hash totals. but given the volume of transactions (in all but the smallest of businesses) such an approach would be prohibitively expensive for the audited entity. (viii) the use of exception reporting to highlight overdue accounts and accounts where the credit limits have been exceeded. document counts and sequence checks in the input of transactions into the computer system to ensure completeness and accuracy. (iv) fraudulent collusion can happen both within the company and outside the company. (iii) it is always possible (in theory) to perform an audit on the basis of substantive testing alone. (iv) the issue of statements to customers at the end of each month (from the ledger) showing how much is owed by the customer. in order to ensure that they are calculated correctly in accordance with authorised prices. This is sometimes known as . This ledger should be reconciled at least monthly to the total figure in the nominal ledger. some of which may be computerised. (ii) two people should be involved wherever cash or inventories are being handled in order to prevent both the misappropriation of assets and to prevent false accusations of misappropriation. (ii) if the auditor. (iii) the maintenance of a separate receivables ledgers showing the individual balances owing from customers. those who receive the cash. (ix) the regular review by the financial controller of amounts receivable and the independent authorisation of the write-off of bad debts. the volume of substantive testing on transactions and balances can be reduced.window-dressing.teeming and lading.s tests show that internal controls are operating properly. (vii) the appointment of a credit controller who limits the credit available to customers.. This is sometimes known as . reliance on internal controls is the most efficient method of auditing. together with a system for investigating and dealing with such accounts.

• Select all debits posted to the sales account and all postings to the sales account from a source other than the sales journal. • Print a workpaper that lists each item selected. trends. Hastings should do the following: • Trace data from sales invoices to invoice copies. • Determine that all sales invoices and other related documents have been accounted for (e. Hastings may choose to use the computer to examine these records for quality.g. Based upon the information given. consistency. and so forth). lack of completeness. • Verify the mathematical accuracy of postings from the sales journal to appropriate ledger accounts. by accounting for the integrity of the numerical sequence). For example.The Effect of IT on the Audit Function Question 1: M&B p. 4 5 2 3 1 Question 2: M&B p. d. and so forth. the computer may be used to compare the client's records of quantities sold with the client's records of quantities shipped. • Compare dates of recorded sales transactions with dates on shipping records. c. .. a complete printout is needed to examine their quality. e. The quality of visible records is readily apparent to the auditor. and so on. the computer may be used by Hastings to do the following: • Test extensions and footings of computerized sales records that serve as a basis for the preparation of the invoices and sales journal. • Determine that all shipping documents have been accounted for (e. with relevant data inserted in applicable columns. • Select sales transactions for review (based upon predetermined criteria) through a review of the sales journal or the accounts receivable subsidiary ledger.g. are observed by the auditor in the normal course of the audit.232 #7-38 Answer: 7-38 a.231 #7-36 Answer: 7-36 a. on a periodic or annual basis). In addition to the procedures outlined above.. Sloppy record keeping. b. • Trace data from sales invoices to the sales journal. If machine-readable records are evaluated manually. gross margin. b. • Examine records for quality (completeness. by accounting for the integrity of the numerical sequence). • Analytically review recorded sales by use of predetermined criteria (percentage relationships. • Compare duplicate data maintained in separate files for correctness.

. shipment of goods. • Test pricing by comparing invoices to daily price list. • Verify the sales cutoff at the beginning and end of the period to determine whether the recorded sales represent revenues of the period. • Determine the extent and nature of business transacted with major customers (for indications of previously undisclosed relationships--related parties--and for determination of the applicability of disclosure requirements required by generally accepted accounting principles).The Effect of IT on the Audit Function • Examine documents for appropriate approval (e.. grant of credit.g. and determination of price and billing).

Since the sample deviation rate is less than the expected population deviation rate of 3 percent.0 percent (2 ÷ 50).267 #8-34 8-34 The computed upper deviation rate and the auditor's decision for each control procedure are: Control Procedure Results Number of deviations Sample size Sample deviation rate Computed upper deviation rate Auditor's decision 1 0 156 0.0 2. the control can be relied upon.5 percent (1 ÷ 40).7 Does not support 4 3 98 3. Since the sample deviation rate is less than the expected population deviation rate of 3 percent.3 8.Audit Sampling Question 1: M&B p.268 #8-38 8-38 Isaac’s conclusion on each item would be as follows: 1.3 Supports Question 2: M&B p. The sample deviation rate is 2. .0 percent (1 ÷ 20). the control cannot be relied upon.0 percent (1 ÷ 50). The sample deviation rate is 4. 2. 2. Since the sample deviation rate exceeds the expected population deviation rate of 4 percent.8 6. The sample deviation rate is 5.268 #8-37 8-37 Austen's conclusion on each item would be as follows: 1.1 7. the control cannot be relied upon. Question 3: M&B p. The sample deviation rate is 2. Since the sample deviation rate exceeds the expected population deviation rate of 3 percent. the control can be relied upon.9 Does not support 3 4 94 4.0 Support s 2 5 181 2.

Based on the following information. Jerry.00 * * 7.00 149 99 0.75 * 208 1.25 * * 1.50 * * 1.25 * * 2. Sampling tables: Estimate d populati 2 3 on exceptio n rate (%) 0.75 * * 2.00 * * 5. the senior in charge of the audit.000 Risk of incorrect acceptance = 5% (2 marks) 5% ARACR Tolerable exception rate (%) 4 5 6 7 8 9 10 15 20 74 59 49 117 93 78 117 93 78 117 93 78 156 93 78 156 124 78 192 124 103 227 153 103 * 181 127 * 208 127 * * 150 * * 173 * * 195 * * * * * * * * * * * * * * * * * * * * * be cost-effective 42 66 66 66 66 66 66 88 88 88 109 109 129 148 167 185 * * * * 36 58 58 58 58 58 58 77 77 77 77 95 95 112 112 129 146 * * * 32 51 51 51 51 51 51 51 68 68 68 68 84 84 84 100 100 158 * * 29 46 46 46 46 46 46 46 46 61 61 61 61 61 76 76 89 116 179 * 19 30 30 30 30 30 30 30 30 30 30 30 30 30 40 40 40 40 50 68 14 22 22 22 22 22 22 22 22 22 22 22 22 22 22 22 22 30 30 37 .00 * * 3. compute the required MUS sample size. plans to use monetary unit sampling (MUS) to audit ABC’s inventory account.00 * * * sample is too large to Required: a. based on the sampling tables given above: Tolerable misstatement = RM360.00 * * 1.25 * * 3.50 * 157 0.50 * * 2.25 236 157 0.00 * * 6.50 * * 3.00 * * 2.75 * * 4.Audit Sampling Question 4 Wong and Kasim were conducting the audit of Syarikat ABC Berhad for the year ended 31 December 2004.000.000 Expected misstatement = RM90. The balance at 31 December 2004 was RM9.75 * * 3.000.

The sampling interval is $57.Audit Sampling Risk of incorrect acceptance = 5%. since the book value exceeds the sampling interval .500 6.33 Not applicable.000 ÷ 156). What conclusion should Sheila make concerning the inventory? (12 marks) Overstatement Errors Error Numbe r 1 2 3 Book Value 10. tolerable misstatement = 4% ($360. used the sample items selected in part (a) and performed the audit procedures listed in the inventory audit programme.692 ($9. an audit assistant.000 Audit Value 7.20 6 4 800 640 Calculation of ULM Taintin g Factor Samplin g Interval Projecte d Misstat e-ment Increment al Change Projected Misstatement plus Allowance for .000 0 640 Using this information.000). and expected misstatement = 1% ($90.000 ÷ $9.000 9.000 0 Tainting Factor 4 .000.000 60. Sheila.000. sample size is equal to 156.500 6.000 800 Audit value RM 7.25 .000). She notes the following misstatements: Misstateme nt number 1 2 3 4 Book value RM 10.000 ÷ $9. calculate the upper limit on misstatement (ULM). 2 b.000 60.000.000 9.

46 33.595) is less than the tolerable misstatement 2 ($360.076 305.75 1. Adjustment for Understatement Errors Tainting Sampling Projected 2 . Sheila had identified the following two (2) understatements: Misstateme nt number 5 6 Book value RM 6.423 11. in addition to the four (4) misstatements identified in part (b).595 Since the ULM ($305.000 750 Audit Value 6. Assuming that.538 1.000).692 57.000 750 Audit value RM 6.500 800 (4 marks) Understatement Errors Error Number 5 6 Book Value 6.20 57.25 .000.067 2 Calculate the net upper limit on misstatement.317 22.Audit Sampling Sampling Risk .55 1. Van Pelt can accept the inventory account as being fairly stated since there is only a 5 percent risk that the account contains a misstatement greater than $360.356 16. c.692) ULM 19.846 72.500 800 Tainting Factor .038 14.519 60.083 .692 Total Known misstatement from error 2 Basic Precision (3.692 57.33 .000 173.0 x 57.

sampling 2 error is reduced if the rate of misstatements in the expanded sample.083 . the auditor will have to issue either a qualified or an adverse opinion. (7 marks) Take no action until tests of other audit areas are completed. If none of the prior 2 courses of action result in an acceptable population. their dollar amount. if the 2 client corrects the misstatements discovered by the auditor.692 57. 2 Refuse to give an unqualified opinion. the auditor may conclude that the population is acceptable. Request the client to correct the entire population. Perform expanded audit tests in specific areas.788 3.Audit Sampling Factor Interval Misstatemen t . (2 marks per point. the book value of the account may become acceptable. This may result in the population being acceptable. Adjust the account balance. In some circumstances.692 4.067 57. 2 If offsetting misstatements are found in other parts of the audit. As sample size increases.865 8. max 7 marks) . Discuss the possible courses of action the auditor can take when he or she has concluded that the population is misstated by more than a tolerable misstatement. and their direction are similar to those in the original sample.653 Adjustment to ULM d. 2 Increase the sample size.

no adjustment" and "Confirmation Requests" to the confirmation control schedule. • There is no indication of follow-up or cross-referencing of the account confirmed-related-party transaction. a complete printout is needed to examine their quality.344 #10-41 10-41The working paper contains the following deficiencies: • The working paper was not initialed and dated by the audit assistant.Revenue Cycle Question 1: M&B p.347 #10-46 10-46The computer can be used in the following way to aid the auditor in examining accounts receivable in a highly computerized system: • Testing extensions and footings: The computer can be used to perform simple summations and other computations to test the correctness of extensions and footings. • There is no explanation for proposed disposition of the ten differences aggregating $12. consistency." • The "Dollars-Percent" for "Confirmation Requests-Negatives" is incorrectly calculated at 10 percent. • Examining records for quality (completeness. The auditor may choose to perform tests on all records instead of just on samples. since the speed and low cost per computation of the computer enable this at only a small amount of extra time and expense. If the computer is to be used for the . • The dollar amount and percentage of the six accounts selected for confirmation that the client asked the auditor not to confirm is omitted from the "Dollars" columns for the "Total selected for testing. • There is no notation that a projection from the sample to the population was made. such as the eighteen "Differences reported and resolved. The program can be written to select the accounts according to any set of criteria desired and using any sample plan. valid conditions. • The overall conclusion reached is not appropriate." • The two positive confirmations that were sent but were unanswered are not accounted for.): If machine-readable records are evaluated manually. The auditor may choose to use the computer to examine these records for quality. etc. • The tick mark "‡" is used but is not explained in the tick mark legend.000. Question 2: M&B p. • There is no reference to second requests. • Selecting and printing confirmation requests: The computer can select and print out confirmation requests on the basis of quantifiable selection criteria. • Negative confirmations not returned cannot be considered to be accounts "confirmed without exception. possible scope limitation. or other working paper reference for the six accounts selected for confirmation that the client asked the auditor not to confirm. • Cross-referencing is incomplete. • There is no documentation of alternate procedures.

the computer can be used to test for consistency (e. reasonable amounts. such as the selection of a random sample of items under a certain dollar amount plus the selection of all items over a certain dollar amount. • The computer may be programmed to print a workpaper listing of each account selected. a program can be written to examine the records for completeness. and those for which credit limits exceed a stipulated amount. such as unusual transactions. dormant accounts. customer file records might be examined to determine those for which no credit limit is specified. • Comparing duplicate data (maintained in separate files) for correctness and consistency: Where there are two or more separate records having identical data fields. The computer may be programmed to compare the customer's account balance with the customer's history of purchases or to determine whether credit limits have been exceeded. • Selecting and printing audit samples: The computer can be programmed to select audit samples by use of random numbers or by systematic selection techniques.Revenue Cycle examination.g. . consistency among different items. • Summarizing data and performing analyses useful to the auditor : The auditor frequently needs to have the client's data analyzed and/or summarized. those for which account balances exceed the credit limit. valid conditions. with relevant data inserted in applicable columns. and so forth. • Comparing confirmation information with company records: For example. The sample selection procedure may be programmed to use multiple criteria. For instance.. Such procedures as aging accounts receivable or listing all credit balances in accounts receivable can be accomplished with a computer program. and so forth. Other considerations can be included. to compare catalogue prices with invoice prices). the computer can be used to compare payment dates indicated on customer confirmations with client cash receipts records.

it is approved by the cashier by reference to the approved credit list. The third copy of the sales invoice is retained by the sales clerks. The total is posted to the cash receipts book. the cashier summarizes the sales and cash receipts and forwards the cash (including cheques) and the top copy of the sales invoices to the accounts receivable clerk. and files the sales summaries by date. Define an internal control system. At the end of each day. The remittance advices are posted directly to the accounts receivable ledger cards. Cash received on account: Cash received on account is initially received by a mail clerk in the sales department. Required: i. After posting. The accounting department supervisor. The accounts receivable clerk balances the cash received with cash sales invoices and prepares a daily sales summary. the cashier validates the second copy of the invoice and gives it to the customer. the payment is also given to the cashier by the sales clerks. and then all invoices are forwarded to the inventory clerk for posting to the inventory control card. the accounts receivable clerk prepares the daily deposit slip in triplicate. who also functions as the credit manager reviews all cheques for payment of past due balances and then forwards all items to the accounts receivable clerk who arranges the remittance advices in alphabetical order. The cheques and remittance advices are forwarded to the sales department supervisor who reviews each cheque and then forwards all items to the accounting department supervisor. The cheques are stamped and totalled. the inventory clerk posts the daily sales summary to the cash receipts book and the sales journal. for daily deposit to the bank. Where the sale is for cash. The remittance advices are filed chronologically. After receiving the cash from the previous day’s cash sales. (3 marks) All the policies and procedures (internal controls) adopted by the management of an entity 1 . When the sale is for credit. The credit sales invoices are posted to the accounts receivable ledger. After receiving payments and approving the credit sales. The top two (2) copies of the sales invoice are given to the cashier. The cash from cash sales is combined with cash received on account (see below). Exceptions to the credit list are cleared by the cashier at his discretion. A remittance advice either accompanies each receipt or the mail clerk prepares one.Revenue Cycle Question 3 Syarikat Hanif Sdn Bhd processes its sales and cash receipts transactions in the manner described below: Sales: Customers purchase products directly from sales clerks who prepare a three-part sales invoice which are not pre-numbered. The third copy of the deposit slip is filed by date and the first and second copies accompany the bank deposit.

but still not satisfactory as far as details in accounts receivable ledger are concerned. Comment on the strengths and weaknesses of the existing internal control system over cash receipts and sales. but also handles all cash and prepares bank deposits. Since accounts receivable clerks posts all details and totals to the records. safeguarding of assets. there is no independent reconciliation function regarding sales. (7 marks) 3 (b) 3 3 3 .Revenue Cycle to assist in achieving management’s objectives of ensuring the efficient conduct of the business including adherence to management policies. (15 marks) (a) Cash receipts There is no proper segregation of duties. 3 Sales invoices are not pre-numbered. this segregation is mitigated by transferring all documents and cash and checks to the accounts receivable clerk. prevention and determination of fraud and error. iii. The situation is better for cash receipts. Although cash is received by mail clerk and cashier. Thus. 1 1 ii. cashier handles exceptions at his discretion. Missing invoices would have an effect on the accuracy of the value of sales. the clerk not only does all record keeping. Although preprinted sales invoices are used. without any compensating controls other than bank reconciliation. No segregation of duties. The sales clerk does not reconcile sales invoices to recorded sales. Sales There is no proper authorization. they are not pre-numbered thus making it difficult to determine whether there are missing sales invoices. List three (3) recommendations to management as to how you can improve the weaknesses of the two internal control systems in (ii) above. There is no reconciliation of sales invoices to recorded sales. Although control over sales to unauthorized customers is good as far as not allowing sales clerks to make the decision. accuracy and completeness of the accounting records and timely preparation of reliable financial information.

transmit 2. 5 .5 the accounts receivable supervisor. 6 . max 7 marks) Total: 25 marks . This greatly improves control over cash receipts. b.5 Whether this control is necessary will depend on the extent of expected errors. 2 . Require exceptions to the credit list to be approved by 2. Send monthly statements to all credit customers. 2. Have accounts receivable supervisor review 2. Postings of details of a separate copy and reconciliation of invoices by the accounts receivable clerk would provide additional control. and transmit receipts to cashier for preparation of bank deposit.Revenue Cycle 1 . Copy 2. Use pre-numbered sales invoices.would be routed directly to the accounts receivable clerk by sales clerk at end of day.5 would provide a basis for correcting posting errors for both sales and cash receipts. 7 . would provide control over total sales. 2.retained in sales clerk’s book 2. This step would provide good segregation of duties over recording sales in that the cashier would no longer handle all copies of the sales invoices. The totals on cash register tapes. 4 .5 prelisting and remittance advices to supervisor as now done. Consider having cashier audit sales invoices for accuracy.5 marks per point.5 Process the pre-numbered sales invoices as follows: a. Copy 1. A scan and initializing could also be implemented. (2.5 reconciliations of accounts receivable ledger to general ledger at month end. Copy 3. This 2.5 c. 3 . The validation would be done by the cashier.validated and returned to customer with goods by cashier. Have mail clerk stamp and prelist cash receipts. required by the validation procedure.

(5 marks) (b) Cosmo is a high-quality. delivery time and specification. Purchases and capital expenditure There are complex internal rules relating to what constitutes a purchase. Required: Set out.s department. This system has only been in operation for a few months. It has recently joined a consortium for the purchase of parts. through a reasonably well-controlled buying department. The remaining purchases are ordered directly from manufacturers. in a form suitable for inclusion in a report to management. (15 marks) (20 marks) . private motor manufacturing company.s computers and is suspected of causing problems in other systems. It is difficult to use and so far. and what constitutes capital expenditure and the budgets for both are tightly controlled. This system does not work well because the system uses outdated purchasing and production patterns and many manual adjustments are required. The system for authorising capital expenditure is not well controlled which results in some capital items being acquired without proper consideration. Cosmo’s purchases and capital expenditure systems are not integrated. only two of the production controller. as before. amongst other things. As a result. the parts ordered through the system are sometimes of the incorrect specification or are delivered late. Problems associated with the internal rules result in a significant number of manual adjustments to the management accounts which take up an excessive amount of management time.Purchase Cycle Question 1 (a) Internal control systems are designed.s junior managers are able to use it. at the monthly meetings of the capital expenditure committee. The system takes up a substantial amount of disk space on the company. Required: Describe the errors and misappropriations that may occur if purchases and capital expenditure are not properly controlled. The orders are reviewed by the production controller and her junior managers and changes are made informally by junior clerical staff in the production controller. potential consequences and your recommendations relating to the purchases and capital expenditure systems of Cosmo. the weaknesses. Purchase orders Purchase orders are generated automatically by the computerised inventory system when inventory levels fall below a given level in the context of scheduled production. Some of the purchases are input into the buying consortium system which shows the optimum supplier for any combination of cost. to prevent error and misappropriation.

. • Apply other appropriate audit procedures which may be deemed necessary in the circumstances. trends analysis. including analytical procedures. by performing a comparison of statistical data from sales departments with accounting records or relationships between changes in sales and changes in accounts receivable balances). forecasts. • Compare the financial information with similar information regarding the industry in which the entity operates (e. • Test the arithmetic accuracy of perpetual inventory records.g.g. long-term agreements. • Compare records of monthly physical counts with perpetual inventory records. cups and saucers etc. This system has proved successful in recent years but unfortunately. At the yearend inventory count. • Trace entries from perpetual inventory records to receiving reports and shipping reports. because it was not in the allocated area..) and it maintains an integrated computerised system that shows the inventory held at any given point in time. gross profit percentage. • Compare financial information with anticipated results based upon budgets. The company manufactures high quality tableware (plates.s warehouse. and so forth). • Compare unit costs on inventory listings with paid vouchers (purchase orders and vendor's invoices). trade association data). commitments. by relating insurance coverage to inventory amounts.g.. • Ascertain whether perpetual inventory records have been adjusted based upon physical counts.Inventory Cycle Question 1: M&B p. dollar and unit sales.. your notes show a number of weaknesses in the current year-end inventory count. and so forth.g. in government publications. • Reconcile beginning inventory quantities with ending inventory quantities. for later comparison with the computerised quantity. Many areas in which the count took place were untidy and inventory was sometimes difficult to find. inventory turnover. • Ascertain the consistency of the methods of determining cost and market value. The same categories of inventory were sometimes found in several different areas and some inventory . comparing inventory quantities with the capacity of storage facilities. • Study the relationships of elements of financial information that would be expected to conform to a predictable pattern based upon the entity's experience (e. and so forth). that Dunne should apply are as follows: • Trace entries to perpetual inventory records from receiving reports and shipping reports. the various categories of inventory (but not the quantities) are printed off the system and the quantities of inventory actually counted are inserted manually by the counters. • Compare financial information with information for comparable prior periods (e. Question 2 Your firm is the external auditor of Chingford Potteries.431 #13-32 13-32The audit tests. The count instructions were received by both you and the counters the day before the count was due to take place. • Study the relationships of the financial information to relevant nonfinancial information (e. and you recently attended the yearend inventory count at the company.

profits will be overstated and if inventory is undervalued. provided that the auditor has performed tests during the period that confirm that the inventory records are accurate. (iv) where inventory is well controlled. If inventory is overvalued. taking account of movements in inventory in the intervening period. (4 marks) (b) Draft for inclusion in a report to the management on Chingford Potteries: (i) the weaknesses you found (ii) the potential consequences (iii) your recommendations for remedying the weaknesses in the current year count. it may be possible to rely on the records. It was difficult to reconcile the inventory quantities recorded at the count to the computerised records and some significant differences remain outstanding. the count to arrive at the year-end figure.Inventory Cycle was incorrectly labelled. (6 marks) (c) describe the basis for valuing inventories as required by FRS 102 Inventories. Where this is the case it is important that the count is performed correctly at the year-end. (b) Report to management (i) Weakness The inventory count was poorly planned. it was difficult to find certain inventories as they were not in their proper places and certain inventories were incorrectly labelled. and your recommendations for future years. and list the types of inventories which may be worth less than cost at Chingford Potteries. The issue and receipt of inventory sheets (on which the quantities were recorded by counters) was not properly controlled. The manipulation of inventory valuation is a common method of manipulating profits. (iii) if it is not convenient to perform the inventory count at the year-end. The count was conducted in a hurry in order to close the warehouse before a public holiday and there were insufficient counters to conduct the count properly in the time available. Count instructions were received late. . (5 marks) (20 marks) Answer (a) Inventory valuation (i) inventory valuation is important to the audit of financial statements because inventory is often material to the financial statements. or . There was insufficient time to conduct the count properly. (ii) the year-end inventory count is often used as a basis for inventory valuation. particularly were there are few other controls over inventory. and records are kept such that they accurately represent the inventory figure at any given point in time. Potential consequence There is a possibility that certain inventories were not counted at all. the areas to be counted were untidy. and that the auditor attends the count. and that others may have been counted twice.roll-back. it may be possible to perform the count shortly before or after the year-end and to . profits will be understated.roll-forward. Required: (a) Explain why the inventory valuation and the year-end inventory count are important to the audit of financial statements and describe the alternatives to a year-end count as a basis for the year-end valuation. (5 marks) (d) Describe the work that you would perform to establish which inventories are worth less than cost at Chingford Potteries.

Recommendation The accuracy of the inventory quantities and valuation in the current year may be confirmed by means of analytical procedures which focus on unusual movements in inventory quantities. Analytical procedures should also be performed to confirm the accuracy of quantities. The company should also consider the possibility of recounting certain areas of inventory where significant errors or omissions are suspected. It will therefore be necessary to enquire of management as to how they account for and identify such inventories. as suggested above. (v) the types of inventory that may be worth less than cost include imperfectly manufactured pottery (. This may ultimately mean that inventory is materially misstated both in the financial statements.seconds. or in gross margins. (ii) Weakness The issue and receipt of inventory sheets was not properly controlled and there are significant differences outstanding between the computerised records and the quantities actually recorded. The cost of purchased goods includes import duties. for example. including direct labour costs and production overheads based on a normal level of activity. and performing a .Inventory Cycle There is also a possibility that certain inventories may be incorrectly classified. (ii) for work-in-progress and finished goods. . (d) Less than cost (i) it is the responsibility of management to identify and account for inventory that is worth less than cost. that inventories are properly labelled. (iii) net realisable value is the estimated selling price net of the costs necessary to make the sale. all costs of completing the inventory are also deducted from selling price. resulting in the under-valuation of inventories. condition and value of inventories. Trade discounts and rebates are deducted from cost. that they are in their proper places before the count starts and that there are sufficient resources in terms of both time and manpower to conduct the count properly. In future years. (c) FRS 102 (i) FRS 102 requires that inventories are valued at the lower of cost and net realisable value. it is possible that certain areas of inventory were not counted at all. Potential consequence If inventory sheets are missing. transport and handling costs and other directly attributable costs. If certain sheets have been duplicated or omitted. and are properly accounted for when they have been completed. and the amounts involved are potentially material. damaged pottery. to the year-end. for example). (iv) for work-in progress and raw materials. it is important to ensure that the count is better planned. it is essential that all inventory sheets are properly recorded before they are issued (by means of pre-numbering.). that instructions are received on time. In future years.roll-back. cost includes the direct cost of production. it will be necessary to re-perform a count in those areas. old and slow-moving pottery and pottery which is intended to be sold below cost. Recommendation The inventory sheets that were issued should be reconciled to a schedule of inventory sheets that should have been issued. The fact that there are significant differences outstanding reinforce this view. and in the internal inventory records. and what assumptions they make about the relationship between the age. as noted above.

(iv) what is old or slow-moving will be determined by the business. The records may also show seconds and damaged goods. or the information may be specifically extracted at the year-end. and to review the extent to which inventories which are worth less than cost have been reduced to net realisable value in prior years. Analytical procedures may be performed to evaluate the appropriateness of the write-down in the current year. (v) at the inventory count. a note should have been made of any items that appeared to be old. . The system may automatically produce such information for management purposes. Computer assisted audit techniques may be used for these purposes.Inventory Cycle (ii) it will be useful to inspect sales. marketing and other reports. (iii) an analysis of the computerised records should enable the identification of goods that are old or slow-moving. slow-moving or damaged and the count records should be inspected to see if they do show such goods. in this case it is high quality pottery and as such inventories may be held for a considerable period of time before they are considered to be slow-moving.

• Determine that the totals of accumulated depreciation recorded in the plant and equipment subsidiary records agree with the applicable general ledger control accounts. and accumulated provisions. • Inquire whether extra working shifts or other conditions of accelerated production are present which might warrant adjustment of normal depreciation rates. Question 2 . and ending balances. • Discuss with executives the possible need for recognition of extraordinary obsolescence resulting from inventions. • Determine the propriety of estimated salvage values for fixed assets. • Compare credits to accumulated depreciation accounts for the year's depreciation provisions with debit entries to unrelated depreciation expense accounts. and interplant transfers. • Obtain or prepare a summary analysis of depreciation allowances for the major property classifications as shown by the general ledger control accounts. • Review appropriateness of proposed disclosure of depreciation methods. design changes. analyzing retirements of assets during the year. interdivision. • Review company manuals or other management directives that set forth depreciation policies to determine whether the methods are carefully designed and intended to allocate costs of plant.Property. • Compare depreciation rates and methods used in the current year with those employed in prior years and investigate any variances. annual expense. • Review computations of depreciation provisions for a representative number of units and trace them to individual records in the property ledger. provisions for depreciation during the tear. Plant & Equipment Question 1: M&B page 450 #14-32 Answer 14-32A program for accumulated depreciation and depreciation expense accounts should include the following: • Review internal controls over the computation and determination of depreciation charges. • Compare beginning balances with the adjusted amounts in last year's working papers. or economic developments. • Verify deductions from accumulated depreciation for assets retired by tracing deductions to the working papers. • Summarize conclusions as to whether all material elements of accumulated depreciation and depreciation expense have met the financial statement objectives. • Consider the propriety of useful lives for the client's assets. and testing the accuracy of accumulated depreciation to the date of retirement • Examine intercompany. • Compare the percentage relationships between accumulated depreciation and related property accounts with those prevailing in prior years and discuss significant variations from the normal depreciation program with appropriate members of management. listing beginning balances. and equipment equitably over their useful lives. retirements.

(5 marks) (d) Describe the action you would take if you disagreed with any of the depreciation rates used and explain the potential effect of the disagreement on your audit report. (iv) as with all financial statement assertions. shrubs and trees.Property. (b) Ownership and cost (i) land and buildings . (9 marks) (c) List the procedures you would perform to check the appropriateness of the depreciation rates on each of the three categories of non-current asset. none of which are leased) (ii) computers (on which an integrated inventory control and sales system is operated) (iii) a number of large and small motor vehicles. (3 marks) (b) List the sources of evidence available to you in verifying the ownership and cost of: (i) the land and buildings (ii) the computers and motor vehicles. (iii) there is also a risk that non-current assets are overstated because of the inclusion of items (such as small tools) that should be expensed through the profit and loss account rather than capitalised in the balance sheet. . (ii) there is a risk that the non-current assets do not exist. The main categories of non-current assets are as follows: (i) land and buildings (all of which are owned outright by the company. (3 marks) (20 marks) Answer (a) Main risks (i) all assets in practice are liable to be overstated rather than understated. The company holds records of these assets on a computerised non-current asset register. Plant & Equipment Your firm is the auditor of Springfield Nurseries. Required: (a) Explain the main risks associated with financial statement assertions relating to noncurrent assets. a company operating three large garden centres which sell plants. or that they are overvalued either because they are impaired in some way or have been under-depreciated. where assets are overstated it is likely that profits are overstated. mostly used for the delivery of inventory to customers (iv) equipment for packaging and pricing products. the ownership of land will normally be shown in some sort of central land register maintained by a government or other department . there is a risk that the values are misstated because of errors in the accounting and internal control systems. The depreciation rates used are as follows: (i) buildings 5% each year on cost (ii) computers and motor vehicles 20% each year on the reducing balance basis (iii) equipment 15% each year on cost You are concerned that these depreciation rates may be inappropriate.documents of title. garden furniture and gardening equipment (such as lawnmowers and sprinklers) to the general public. ownership will be evidenced by purchase documents or other . You are involved in the audit of the company’s non-current assets.

the depreciation rates may be too low. (c) Depreciation rates (i) the depreciation rates on the buildings may be too high (buildings are commonly depreciated over 50 years). it will be necessary to issue an ‘except for’ modified opinion (explaining the disagreement). (iv) review the profit or loss on disposals of assets. motor vehicles (and land and buildings) also provide some evidence of ownership. and the reason for the choice of the straight line/reducing balance methods. (ii) computers and motor vehicles . . (iii) review the actual life of all of the assets by inspecting assets that are fully depreciated to see if they are still in use. and review the physical condition of the assets. the physical existence and use by company of the computers. the depreciation rate may be too high. but visible by using special lights. the knowledge of and a proper record of these codes provide some evidence of ownership . ownership may also be evidenced indirectly by the payment of insurance premiums and other costs associated with the ownership of land and buildings . payments should be traced through the cash records. Where assets that are not yet fully depreciated are no longer in use. the cost of land and buildings may be shown in the purchase documentation. bearing in mind the fact that there may be special considerations to be taken into account). any recent changes in rates. motor vehicles also normally have associated documentation that show the tax payable and the history of ownership . If management agrees. losses may indicate that rates are too low. The depreciation rates on the computers. if they are.Property. (v) inspect a sample of new assets. (ii) enquire of management as to the reasons for the depreciation rates (and why they are different to the rates suggested above. if it is not. although the error should be added to the summary of unadjusted differences (and if these are material. Modified audit opinions relating to disagreements over depreciation policies are relatively rare (often because the amounts involved are immaterial). it will be necessary to request management to make an adjustment to the financial statements. (d) Disagreement with rates (i) assess whether the total error in the depreciation is material to the financial statements. assets that have been depreciated to half their original value and assets that have been written off. adverse opinions are very rare. profits may indicate that depreciation rates are too high. and also in documentation relating to the taxes that are payable when land and buildings are transferred . it will have no direct effect on the audit report. motor vehicles and equipment might be too low (computer equipment is often over depreciated over three years and motor vehicles over four years. these codes may be invisible to the eye. it is common to mark both computers and vehicles with security codes designed to prevent and detect theft. it will be possible to issue an unmodified audit opinion. an adjustment to the financial statements may be necessary). or even an ‘adverse’ opinion (stating that the financial statements do not present fairly the position) if the amounts involved affect the view given by the financial statements as a whole. If management refuses. (ii) if the amounts involved are material to the financial statements. computers and motor vehicles may be held on leases. both ownership and cost of computers and motor vehicles will be shown in the purchase documentation and in the cash records . in which case the leasing documentation should be inspected . on a straight line basis). Plant & Equipment .

. it may be necessary to review other areas in which management estimates form the basis of the accounting treatment. Plant & Equipment (iii) if there is a serious disagreement.Property.

and evaluating the adequacy of disclosure and compliance with restrictions. by direct communication. • Reconcile the details of the individual certificates in the stock certificate book with the individual shareholders' accounts in the stockholders' ledger. if not otherwise apparent. • Confirm the loans. • Compare the financial statement presentation and disclosure with generally accepted accounting principles.Long-term liabilities. • Recompute (or verifying) interest expense and interest payable. • Foot the total shares outstanding in the stockholders' ledger and stock certificate book. • Amounts due the president and. including terms.. par value. • Obtain or prepare an analysis of changes in common-stock and treasury-stock accounts. • Obtain a management representation letter. • Determine authorization for common-stock issuances and treasury-stock transactions by inspecting the minutes of the board of directors' meetings. Broadwall's financial statements should disclose the following information concerning the loans from its president: • The nature of the related-party relationship. • Inspect all treasury-stock certificates owned by the client. Question 2: M&B page 467 #15-27 15-27The substantive audit procedures that Lee should apply in examining the common stock and treasury stock accounts of Wu. • Examine all certificates canceled during the year. • Review minutes of meetings of the board of directors for proper authorization. including footnotes and loan agreements. The procedures that Maslovskaya should employ in examining the loans are as follows: • Obtain an understanding of the business purpose of the loans made by the president. are as follows: • Review the corporate charter to verify details of the common stock such as authorized shares. • Verify capital-stock issuances by examining supporting documentation and tracing entries into the records. • Recompute the weighted average number of shares outstanding. the terms and manner of settlement. • Verify payments made during the year and transactions after year-end. • Consider any tax implications for the interest on the loan from the company’s president. • The dollar amounts of the loans. b. • Verify treasury-stock transactions by examining supporting documentation and tracing entries into the records. shareholders’ equity & Income Statement items Question 1: M&B page 467 #15-26 15-26a. Inc. • Recompute the long-term and short-term portions of the debt. • Compare opening balances with prior year's working papers. • Compare the totals in the stockholders' ledger and the stock certificate book to the balance sheet presentation. . • Read the financial statements. etc.

shareholders’ equity & Income Statement items • Determine the existence of and proper accounting for common-stock and treasury-stock transactions occurring since year-end. • Obtain written representations concerning common and treasury stock in the client representation letter .Long-term liabilities.

Check the balances on shareholders’ accounts in the register of members and the total lists with the amount of issued share capital in the nominal ledger. the memorandum and articles and the receipt of the proceeds. Obtain written representations concerning share capital in the client representation letter. Develop substantive audit procedures to audit the share capital account. Verify taxation on dividends. Check the register of director’ holding. issued new shares during the year under audit. For the issue during the year. another client company having only ordinary share capital.correspondence .cancelled share certificates .minutes of directors meetings. Verify transfers of shares by reference to: .Long-term liabilities. shareholders’ equity & Income Statement items Question 3 Moonlight Sdn Bhd. Interim and final dividends were also distributed during the year. Check dividend payments with documentary evidence for example copies of dividend warrant. Verify that the issued share capital as stated in the accounts agrees with the total in the share register.completed and stamped transfer forms . If shares have been issued at a premium verify that the premiums have it has been credited to share premium account. assuming that control risk is high. Verify authority for dividend payments in the minutes and check calculation with total share capital issued. Compare the financial statements presentation and disclosure with generally accepted accounting principles. 2 2 2 2 2 2 2 2 2 2 2 2 2 . Large transfers of shares also took place during the year. (11 marks) Verify that the authorized share capital agrees with statutory documentation (MOA). Reconcile movements on share capital and reserves to the supporting board resolutions. check the minutes. Any change must be made through authorized resolutions. File a copy of certificate from any central registry (where appropriate) on the permanent file.

You have worked on the audit for three (3) years and this year you are the leader of the audit team. Villawood Computers Bank Reconciliation as at 31 December 2004 RM Balance per bank statement as at 31 December 2004 Add: Deposits outstanding: 30 December 31 December Less: Outstanding cheques: 2696 2724 2725 2728 2729 2730 2731 2732 2733 Cheque returned ‘not sufficient funds’ 30 1. b. You also plan to perform the audit around the computer as the software is known to be reliable and details of all transactions and balances can be readily printed out. Because of the small size of the company there is limited opportunity for segregation of duties.Cash & Investments Question 1: M&B p. 1. a private company. 5 5. AAB is the external auditor of Villawood Computers. you obtain a copy of the year end bank reconciliation prepared by the bookkeeper and checked by the managing director. that the appropriate audit strategy is to obtain evidence through the performance of substantive procedures. e. 4. 10 9 Question 2 You work at an audit firm called AAB. 10 7. Accounting records are maintained on a computer using special software.990·80 16. On arriving at the company’s premises in February 2005 to perform the final audit on the 31 December 2004 financial statements. d. 9. 2.860·00 22. 3 9 7.973·00 RM 18.375·91 3.900·00 398·00 53·50 1.245·11 . 9. f. as in previous years. 8. You decide. Your assistant is a new accounting graduate with no practical experience. 8.492 #16-34 16-34 a.776·00 255·65 5. This is reproduced below. c.887·00 1.235·91 25·00 289·40 569·00 724·25 1.

discuss the reliability of bank statements as audit evidence. From the December bank statement trace deposits Purpose To agree the correctness of the amount. . Agree the balance per books with the trial balance and draft financial statements. c. Required: a. i. You decide the first task to set for your assistant is the verification of the bank reconciliation. 4. The procedures should be described in enough detail to be followed by an inexperienced staff member. 1 mark x 7=7 (total) 1 mark x 7=7 (total) ii.Cash & Investments December Bank charges December Balance per books as at 31 December 2004 348·00 90·00 16. (7 marks) b. These lists have been added and the totals agreed with ledger postings.683·11 You have already obtained the bank confirmation and lists of cash (and cheque) receipts and payments printed out from the computer. What steps can be taken to increase their reliability? (3 marks) i. Agree the balance per bank with the bank statement and with the bank confirmation. To agree the correctness of the amount recorded in the reconciliation. 2. 3. Add the bank reconciliation. distinguish between ‘auditing around the computer’ and ‘auditing through the computer’. (7 marks) explain the purpose of each procedure in terms of audit objectives. list the audit procedures to be followed by your assistant in verifying the bank reconciliation. ii. (4 marks) explain the circumstances when the auditor should not rely on auditing around the computer. (4 marks) Total: 25 marks Answer (a) (i) Audit procedures and (ii) their purpose Procedure 1. To agree the correctness of the amount arrived at.

agree the amount with the original entry recording the receipt. . b To verify the existence and correctness of the amount of the returned cheque. b. 5. For returned cheques recorded on the bank statement a. deposits on the December bank reconciliation. Obtain the January 2005 bank statement amounts listed as and: outstanding on the December bank a. examine reversing entry for correctness. trace outstanding deposits and cheques from reconciliation. To verify that all outstanding cheques are recorded at the correct amount. b. ensure that there are no other outstanding b. To verify that all cheques recorded as outstanding are in agreement with the books. list outstanding items appearing on the December bank reconciliation not traced to a subsequent bank statement for follow up before the end of the audit. To verify that the returned item has been correctly credited to cash and debited to debtors. To verify the existence and correctness as to amount of 6. ensure that there are no other outstanding b.Cash & Investments to the list of receipts in December or to the November bank reconciliation and: a. From the December bank statement trace cheques to the list of payments in December or to the November bank reconciliation and: a. b. 7. cheques or other payments on the December b. the 31 December bank reconciliation to the bank statement. To verify that all deposits recorded as outstanding are in agreement with the books. carry forward outstanding cheques on the November bank reconciliation and the December in the reconciliation and list of payments not appearing on the December bank statement to the December bank reconciliation. trace outstanding deposits on the November bank reconciliation (if any) and the December list of receipts not appearing on the December bank statement to the December bank reconciliation. To verify that all outstanding deposits are recorded and at the correct amount. b. bank reconciliation.

Bank statements are moderately reliable as they are provided by a third party from a source known to maintain reliable records. (c) (i) Auditing around and through the computer. (Or vouches transactions from the records to the output from the computer and picks them up at the point of entry to the computer back to the source documents. Auditing around the computer is inefficient. – Source documents are not available in hard copy form – It is not possible to follow the audit trail from input to output or vice versa because there is no hard copy of the output – the output summarises input data in such a way that reconciliation is impractical such as where sales and cash receipts data are input into the system but the output is in the form of unpaid invoices listed by customer. for partner’s attention. 10. such as credit approval of sales orders evidenced electronically by the credit manager’s password. There is a possibility of the bank statement being altered or that it could even be a forgery.) Any processing performed by the computer is verified by reference to input or output documents. Auditing through the computer is where the audit verifies the processing of the transaction by the computer using computer assisted audit techniques (CAATs). The auditor should be particularly suspicious if the entity provides a fax or photocopy for the auditor’s use and not the original. 8. Auditing around the computer is where the auditor traces transactions recorded on documents to the point of entry into the computer and picks up those transactions as part of the output and continues from that point to the entry in the ledger. – Control risk assessment is based on computerised application controls which cannot be verified by comparison of input with output. Auditing around the computer is impractical. 1 2 2 1 mark x 4=4 (total) . (ii) Inappropriateness of auditing around the computer Auditing around the computer is inappropriate where: 1. For all other items such as bank charges. 9. Enquire into other items appearing on the bank reconciliation as appropriate. (b) Reliability of bank statements as audit evidence. The limitation is that they are obtained from the entity being audited. Where necessary their reliability can be improved by asking the audit entity to request their bank to send a copy statement directly to the auditor or.Cash & Investments To ensure that cash at bank per the books is correctly adjusted by the amount of all such items. credit transfers and direct debits recorded on the bank statement trace to the entry in the company’s books. 2. List. 1 1 To ensure that there are no fictitious items that might be concealing an error or misstatement. better still. for the auditor to collect a copy directly from the bank. outstanding items (in 6b) not cleared through the bank by the completion of the audit.

Valuation: As the shares in Mega Bhd are actively traded on the Kuala Lumpur Stock Exchange its value on the balance sheet date can be determine by examining any investment journal or local newspaper. but the use of audit software enables us to program the computer to perform this test. Shares in Garuda Sdn Bhd and Daulat Sdn Bhd are free of any encumbrances. (8 marks) Answer Existence: Bank to confirm directly to the auditor that the bank is holding the shares as collateral against the bank loan. 2 2 2 Inspect shares on hand in the presence of the custodian. if any. Determine that gains and losses on dispositions have been properly computed. Shares in Mega Bhd are actively traded on the Bursa Malaysia Stock Exchange and are used as collateral for a bank loan. which can only be verified by the use of CAATs could reduce control risk and the level of substantive procedures significantly. Determine that sales and purchases were properly approved by the board of directors or its designee. Examine supporting evidence for transactions between balance sheet date and the inspection date. – Substantive procedures could be performed more efficiently through the use of CAATs. Trace payments for purchases to accounting records and supporting documents. and proceeds from sales to entries in the cash receipts journal and purchases if 2 2 2 2 2 2 . we can verify completeness by testing the numerical continuity of input documents. Ownership: Bank to confirm that the shares are registered under Jaya Bhd’s name. a listed company. Required: Explain how you would verify the ownership. (6 marks) Describe the audit procedures to be undertaken in auditing the investments in Garuda Sdn Bhd and Daulat Sdn Bhd.Cash & Investments – Substantive procedures around the computer are practicable but computerised application controls. For example. For example invoice pricing could be verified against the hard copy of the price list but it would be much easier to verify the reliability of pricing information held by the computer. Obtain confirmation from the issuers or trustees of investments in private entities. and two (2) private companies Garuda Sdn Bhd and Daulat Sdn Bhd. Question 3 The scrutiny of the Investment Accounts of a client company reveals that the company holds shares in Mega Bhd. existence and valuation of investments in Mega Bhd.

Impairment test of carrying value. 2 .Cash & Investments any made during the year.

• Obtain a management representation letter. • Inquire whether any contingent liabilities or commitments existed at the balance sheet date or the date of inquiry. preliminary. long-term debt. The two types of subsequent events that require Namiki’s consideration and evaluation are: • Events that provide additional evidence concerning conditions that existed at the balance sheet date and affect the estimates inherent in the process of preparing financial statements. Question 2 You are in charge of the audit of Growfast Computers Bhd. A review for subsequent events after the balance sheet date is necessary prior to completion of the audit and signing of the audit report. • Ascertain whether the interim statements were prepared on the same basis as the audited financial statements. (4 marks) Auditors’ responsibility/liability extends to the date on which they sign the audit report. a public-listed company. 2 Explain the importance of a review for subsequent events after the balance sheet . b. The auditing procedures Namiki should consider performing to gather evidence concerning subsequent events include the following: • Compare the latest available interim statements with the financial statements being audited. • Events that provide evidence concerning conditions that did not exist at the balance sheet date but arose subsequent to that date. This type of subsequent event requires that the financial statements be adjusted for any changes in estimates resulting from the use of such additional evidence. • Inquire about the current status of items in the audited financial statements that were accounted for on the basis of tentative. dated as of the date of Namiki's audit report.Completing The Audit Question 1: M&B p. • Inquire whether there was any significant change in the capital stock. Required: a.520 #17-29 17-29a. and assessments. date. Such events result in financial statement disclosure. • Make such additional inquiries or perform such additional procedures Namiki considers necessary and appropriate. • Inquire of the client's legal counsel concerning litigation. As this date falls after the year end. claims. for the financial year ending 31 December 2004. or inconclusive data. • Read or inquire about the minutes of meetings of stockholders or the board of directors. or working capital to the date of inquiry. as to whether any subsequent events would require adjustment or disclosure.

Inquiring. . the 2 board of directors and audit and executive committees held after period end and inquiring about matters discussed at the meetings for which minutes are not available. of the 2 entity’s lawyers concerning litigation and claims. Reading minutes of the meetings of the shareholders. as considered necessary and appropriate. adjusting and non adjusting events).Whether new capital commitments. the auditors must extend their audit work to cover the post balance sheet events. cash flow forecasts and other related management reports. or extending previous oral or written inquiries. (i. Reviewing the post balance sheet period enables the auditor to ascertain whether management has dealt correctly with any events.Completing The Audit it follows that in order to discharge their responsibilities and avoid any liability. b. budgets. Examples include. Inquiring of management as to whether any subsequent 2 events have occurred which might affect the financial statements. if those financial statements are to show true and fair view. both favorable and unfavorable. max 8 marks) . borrowings or guarantees have been entered into . which occurred after the year end and which need to be reflected in the financial statements. (2 marks per point. Reading the entity’s latest available interim financial 2 statements and. 2 Describe the audit procedures necessary to obtain evidence in regard to subsequent events. (8 marks) Review procedures management has established to ensure 2 that subsequent events are identified.e.Whether the issue of new shares or debentures or an agreement to merge or discontinue operations has been made or is planned.

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