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Mock One

Advanced Audit and


Assurance
(International)
P7AAA-MK1-Z16-Q

Time allowed:

3 hours 15 minutes

This paper is divided into two sections


Section A BOTH questions are compulsory and MUST be attempted
Section B TWO questions ONLY to be attempted
Do NOT open this paper until instructed by the supervisor.

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Section A BOTH questions are compulsory and MUST be attempted


1

You are the manager responsible for the audit of Pavia Co. The companys core business is
the manufacture of eight models of sports cars. The company is organised on a divisional
basis with factories selling parts to assembly plants.
You have just received the following e-mail from Albret Plage, the lead partner of the audit:
To: You, Audit Manager
From: Albret Plage
Re: Pavia Co planning
Hi,
During your holiday I had a couple of meetings with Paris Mercedes, the finance director of
Pavia Co, and attach to this e-mail a summary of the information I obtained from her.
In respect of the financial statement audit of Pavia Co for the year ending 30 September 2016,
please complete the following before our meeting next week:
(a)

Prepare briefing notes that identify and explain the financial statement risks on the
basis of the draft financial statements for us to discuss as part of our planning
meeting.
(12 marks)

(b)

Suggest how we might be able use analytical procedures to provide audit evidence
and reduce the level of detailed substantive procedures.
(7 marks)

(c)

Recommend the principal audit work to be performed in respect of the carrying


amount of the following items in the statement of financial position:
(i)
(ii)
(ii)

development expenditure on the Fox model;


consignment inventory; and
the warranty provision.

(4 marks)
(4 marks)
(4 marks)

Many thanks.
PAVIA Co: Notes of meetings with Paris Mercedes for the year ending 30 September
2016
Statement of profit or loss for the year to 30 September
2016
Draft
$m
Note
645.5
Revenue
(1)
Other income
15.6
(2)
Changes in inventories
3.8
Cost of materials
(334.1)
Employee benefits expense
(91.0)
(3)
Depreciation and amortisation
(29.8)
Other expenses
(116.3)
(4)
Interest income, net
12.3
(5)

106.0
Profit before tax
Income tax expense
(44.4)

61.6
Profit for the period

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2015
Actual
$m
606.5
14.4
(16.4)
(286.8)
(83.9)
(23.6)
(100.6)
20.9

130.5
(47.7)

82.8

Statement of financial position at 30 September


ASSETS
Non-current assets
Intangible assets
Property, plant and equipment
Current assets
Inventories
Trade receivables
Cash and cash equivalents

(6)
(7)
(8)

Total assets
EQUITY AND LIABILITIES
Equity
Share capital
Share premium
Retained earnings
Non-current liabilities
Provisions

(9)

Current liabilities
Trade payables
Tax
Other liabilities
Total equity and liabilities

2016
Draft
$m
47.8
124.5

2015
Actual
$m
40.5
102.5

30.3
73.1
111.4

387.1

27.9
50.3
86.0

307.2

5.8
15.3
112.1

133.2

5.8
15.3
80.1

101.2

160.1

121.4

33.5
50.4
9.9

387.1

31.8
44.3
8.5

307.2

Notes:
(1)

Revenue from business activities:


2016
Draft
$m
588.0
39.6
17.9

645.5

Vehicles
Parts and accessories
Other

2015
Actual
$m
526.0
36.8
43.7

606.5

(2)

Other income includes gains on the disposals of tangible assets and income from the
reversal of provisions.

(3)

Average number of employees:


2016
Draft
484
483
36

1,003

Wage earners
Salaried employees
Apprentices and trainees

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2015
Actual
499
477
37

1,013

(4)

Other expenses include costs for warranties, administration and distribution,


maintenance and insurance.

(5)

Interest income, net:


2016
Draft
$m
16.8
(4.5)

12.3

Interest and similar income


Interest and similar expenses

2015
Actual
$m
25.1
(4.2)

20.9

(6)

Intangible assets include development costs, also franchises and industrial rights
and licences. During the year $12.7 million (prior year $6.3 million) was spent on
developing a new sports model, the Fox.

(7)

Property, plant and equipment:

Cost
1 October 2015
Additions
Disposals
Reclassification

Land and
buildings
$m
61.8
5.0
3.0

69.8

30 September 2016
Depreciation
Current year
Accumulated
Carrying amount
30 September 2016
30 September 2015
(8)

(11.9)

16.5

Total
$m
292.9
43.3
(4.5)
0.0

331.7

1.9

28.7

18.4

178.5

20.3

207.2

41.1

34.9

66.9

48.6

16.5

19.0

124.5

102.5

Inventories comprise:

Raw materials, consumables and supplies


Work-in process
Finished goods

(9)

Equipment
$m
212.1
28.9
(4.5)
8.9

245.4

Assets under
construction
$m
19.0
9.4

2016
Draft
$m
8.3
6.8
15.2

30.3

2015
Actual
$m
7.3
4.8
15.8

27.9

Provisions cover mainly manufacturing warranty, product liability and litigation


risks. Also, provisions have been established for deferred maintenance and IT
reorganisation.

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The following additional information is available:


(i)

Pavia Co has achieved record sales in 2016 with the delivery of 10,153 vehicles
(prior year 7,642 vehicles).

(ii)

Although some sales are direct to individual customers the majority are ordered
through dealers who take new vehicles on consignment.

(iii)

Since 1 October 2015 (i.e. from the beginning of the current financial year) Pavia Co
has offered 0% finance for three years on new vehicle sales in its most competitive
markets.

(iv)

The launch of the Fox range was expected to be made before the end of the current
financial year (September 2016) but has been postponed by six months as internal
trials have revealed that the doors are not sufficiently secure at high speeds.

(v)

A car part required for the Cipeta model is bought-in exclusively from an overseas
manufacturer. Deliveries of supplies have been unpredictable since last year
causing disruption to the Cipeta model assembly schedules.

Required:
Respond to Albret Plages e-mail.

(31 marks)

Note: The mark allocation is shown against each of the three requirements in the e-mail.
Professional marks will be awarded for the presentation, structure, logical flow and
clarity of your answer.
(4 marks)
(35 marks)

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(a)

You have just attended a meeting with the senior audit partner (SAP) in which you
were informed that your firm, York & Co, has been invited to tender for the
provision of internal audit services to the Retail and Business Group (RBG) for the
next three years. If successful, this will be the first time York & Co have acted as
internal auditors. He has asked you to prepare preparatory notes in relation to the
tender that:
(i)

Briefly describes the potential advantages and disadvantages to RBG of


outsourcing its internal audit services.
(6 marks)

(ii)

Describes the principal matters that should be included in the submission


to provide internal audit services to RBG.
(9 marks)

(iii)

Considers the potential impact of York & Co acting as the internal auditor
on the external audit performed by Grey & Co (RBGs auditors). (3 marks)

You made the following notes during your meeting with SAP together with extracts
from RBGs tender document:
NOTES OF MEETING WITH SAP ON THE RETAIL & BUSINESS GROUP
(RBG)
The invitation to tender indicates that written submissions will be used as a means
of shortlisting candidates to make a detailed presentation to the Groups Audit and
Risk Management Committee.
The activities of RBG comprise retailing of general merchandise and luxury goods.
They have developed an internal audit function over many years but recently
employee turnover in the internal audit department has risen, with high performing
employees moving to other departments and less successful ones moving out. This
has acted as a spur for them to consider outsourcing their internal audit function.
The CEO of RBG is adamant that to enhance the independence of their external
auditors (currently Grey & Co) the internal audit function should be outsourced to a
different professional firm
The appointment will include an evaluation of organisational risk, financial
compliance, information technology control and systems audits, and fraud
investigation.
EXTRACTS FROM RBGS TENDER DOCUMENT
The Audit and Risk Management Committee receives annual reports from the head
of internal audit on the controls over operational, financial and compliance risks
RBG has a comprehensive system of budgetary control including monthly
performance reviews of both financial and non-financial indicators
Financial extracts ($m):
Six months to
30 June 2016
Actual
387
46

Revenue
Profit before tax

Year to
31 Dec 2016
Draft
751
83

A substantial proportion of RBGs revenue is generated through retail outlets in


department stores and shopping centres. Many of the rents payable for these
premises are contingent on revenues earned.

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Required:
Prepare the briefing notes as requested by the senior audit partner. (18 marks)
Note: You should assume that York & Co has the necessary expertise and available
staff to carry out the engagement, if they are successful in the tender.
Note: The mark allocation is shown against each of the three requirements detailed
above.
(b)

One particular criticism of the audit profession is that auditors reduce their fees for
the external audit (lowballing) when tendering in order to obtain the appointment.
They then hope that more lucrative work (e.g. consultancy) will be awarded to them
by the audit client.
Required:
Explain the practice of lowballing and the associated ethical risks and
discuss whether current ethical guidance concerning lowballing is sufficient.
(7 marks)
(25 marks)

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Section B TWO questions ONLY to be attempted


3

You are the manager of the audit of Tyrex Co, a large private company which operates as a
retailer and fitter of electronic security equipment from fifteen locations throughout the
country. Each location is treated as a cost centre for management accounting purposes.
The chief accountant, Nick Jones, who was appointed in April 2016, qualified two years ago.
He is responsible for the central accounts department of eight staff and reports to the
managing director.
The managing director, Graham Philips, is not an accountant. He has just telephoned the
senior partner to complain about the conduct of the audit for the year ended 30 June 2016
which is nearing completion. Specifically:
(1)

The audit senior-in-charge, Stephen, has had no previous involvement with Tyrex
Co and Graham has had to spend valuable time recounting matters which he had
previously explained to last years senior.

(2)

Stephen was seen to spend time explaining to two of the audit assistants the reasons
for performing specific audit tests and ways to improve the presentation of the
working papers. Graham has expressed concern that such inexperienced trainees
are part of the audit team.

(3)

The final audit work commenced before the chief accountant had adjusted the
management accounts for a number of substantial trade payables arising from late
invoices received from suppliers. The audit team took a long time to verify the
subsequent amendments to the first draft management accounts.

(4)

Extensive substantive procedures carried out to verify the inventory allowances and
write-downs were clearly unwarranted as they did not disclose any problems of
consequence. Graham is annoyed that his offer, to provide a suitable management
representation instead, was declined by Stephen.

(5)

Finally, Graham is disputing the proposed increase in the current year audit fee as
he believes it is due to the audit having been badly controlled and conducted.
Graham had been hoping for a significant reduction in fees.

Required:
(a)

Define quality controls and list the elements of a firms system of quality
control.
(4 marks)

(b)

Draft, for inclusion in a formal letter to Mr Philips:


(i)

suitable responses to the issues he has raised; and

(12 marks)

(ii)

suggestions for steps which may be taken to resolve these issues in


future years.
(4 marks)
(20 marks)

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You are the senior in charge of the audit of the Rhondo Group. Its principal activities are the
manufacture and supply of laboratory scientific equipment which is marketed throughout the
world. There are five wholly-owned overseas subsidiaries.
You have just received an email from the auditors of the African subsidiary in respect of the
year ended 30 June 2016. Details are as follows:
(a)

A valuable consignment of equipment was detained by customs officials five


months ago. The equipment has now been paid for and is included at cost in the
financial statements, disclosed as goods-in-transit. It has not been possible to
physically verify, or obtain confirmation of, the equipment.
(7 marks)

(b)

To reduce the rate of devaluation of the local currency the government has imposed
temporary exchange control restrictions, effective 16 July 2016. Since then, the
company has only been able to settle half of its liabilities for purchases (i.e. bills of
exchange) as they fall due. Bills which cannot be settled are being extended,
resulting in additional interest costs and greater exposure to exchange rate
fluctuations.
(7 marks)

(c)

The auditors report has been modified regarding the inventory and the companys
ability to continue in operational existence for the foreseeable future.
(6 marks)

Required:
For each of the three matters, describe the additional information required from the
African auditors, the possible consequences for the group financial statements and for
your auditors report thereon.
(20 marks)
Note: The mark allocation is shown against each of the three issues.

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(a)

Explain the auditors responsibilities in respect of subsequent events. (6 marks)

(b)

You are the audit manager of Jinack Co. You are currently reviewing two matters
that have been left for your attention on the audit working paper file for the year
ended 30 June 2016:
(i)

Jinack holds an extensive range of inventory and keeps perpetual


inventory records. There was no full physical inventory count at 30
September 2016 as a system of continuous stock checking is operated by
warehouse personnel under the supervision of an internal audit
department.
A major systems failure in July 2016 caused the perpetual inventory
records to be corrupted before the year-end inventory position was
determined. As data recovery procedures were found to be inadequate,
Jinack is reconstructing the year-end quantities through a physical count
and rollback. The reconstruction exercise is expected to be completed
after the financial statements will have been issued to members. (8 marks)

(ii)

Audit work on after-date bank transactions identified a transfer of cash


from Batik Co. The audit senior has documented that the finance director
explained that Batik commenced trading on 7 July 2016, after being set up
as a wholly-owned foreign subsidiary of Jinack. No other evidence has
been obtained.
(6 marks)

Required:
Identify and comment on the implications of the above matters for the auditors report
on the financial statements of Jinack Co for the year ended 30 June 2016 and, where
appropriate, the year ending 30 June 2017.
(14 marks)
Note: The mark allocation is shown against each of the matters.
(20 marks)

End of Question Paper

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