MOCK MID-SEMESTER EXAMINATION

-Solutions
AUTUMN SESSION 2011
SCHOOL OF ACCOUNTING
Student Family Name:
Student Given Names:
Student Number:
Tutor’s name

Unit Name (In Full): Auditing and Assurance Services

Unit Number: 200535
Time Allowed: 90 minutes (inclusive of reading time).
Number of Questions: Five (5) questions
Total Number of Pages: 15 (including the cover sheet)
Unit Co-ordinator’s Name: Dr Kym Butcher
Assessor Associate Professor Philip Ross

INSTRUCTIONS
PLEASE READ CAREFULLY BEFORE PROCEEDING

1. Ensure your name and student number is written on the top of this examination paper.
2. This is a CLOSED BOOK examination. The Auditing and Assurance Standards Handbook 2011 is
not permitted to be used in this examination.
3. The value of each question is indicated at the start of each question.
4. Calculators are not permitted.
5. Attempt all questions.
6. Answer Questions 1 through 5 inclusive in the spaces provided within this examination paper.
Answers outside the spaces will not be marked.
7. This assessment is worth 30% of the overall assessment mark.
Question Marks available Student’s Mark /100

1 20
2 22
3 20
4 6
5 32
TOTAL 100
DO NOT TAKE ANY PART OF THIS PAPER FROM THE EXAMINATION ROOM

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Question 1: Multiple Choice Questions [20 marks]

1. An example of an unmodified audit opinion is:

a. qualified audit opinion
b. adverse audit opinion
*c. unqualified audit opinion with an emphasis of matter.
d. none of the above.

2. Which of the following statements regarding statistical sampling is correct?

a. it is easier to use than non-statistical sampling

b. it involves haphazard selection
c. it is generally used for low risk accounts
*d. it involves random selection

3. Which of the following is an example of a misappropriation of assets fraud?

*a. Unauthorised discounts or refunds to customers

b. Inappropriate application of accounting principles
c. Unrecorded liabilities
d. Improper asset valuations

4. In addition to the preparation of financial statements, it is also the

responsibility of those charged with governance to:
a. identify the financial reporting framework to be used in the preparation and
presentation of their financial report.
b. establish and maintain internal controls that are effective in preventing and
detecting material misstatements
c. selecting and applying appropriate accounting policies and making
reasonable accounting estimates
*d. all of the above.

5. Preliminary risk identification can be affected by:

a. fraud risk
b. corporate governance
*c. Both a and b
d. None of the above

6. The objective of the Financial Reporting Council does not include:

a. to oversee the process used for setting accounting and auditing standards
b. to monitor and report regularly on matters concerning auditor independence
*c. to be involved in the technical issues around the standard-setting process.
d. all of the above are included in the objectives of the Financial Reporting Council

7. An example of a safeguard to independence created by accounting firms is:

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 a. the establishment of a code of ethics
b. legislation that requires that an auditor be independent
*c. the existence of client acceptance and continuation procedures
d. the establishment of an audit committee

8. When testing controls, a decrease in the sample size will occur when there is:

*a. an increase in the tolerable rate of deviation

b. a decrease in the tolerable rate of deviation
c. an increase in the extent to which the auditor's risk assessment takes into
account relevant controls
d. an increase in the number of sampling units in the population

9. In a review engagement, which of the following is least likely to occur during

the engagement?
a. analytical procedures
b. enquiries with management and other personnel
*c. substantive audit procedures
d. review of the internal controls of the entity.

8. Which of the following is an example of information used by auditors in

gaining an understanding of a client at the entity level?

a. The level of competition in the client's industry

*b. Whether the client is an importer or exporter of goods
c. The client's ability to withstand currency fluctuations
d. The level of government support in the client's industry

11. The following can be said about an emphasis of matter:

a. it is included when the auditors opinion has changed and the auditor wants
to bring the users’ attention to a particular matter.
b. it is only used in unqualified audit opinions.
*c. it is included when the auditor’s opinion has not changed and the auditor
wants to bring the users’ attention to a particular matter.
d. it can not be used when expressing audit opinion that has pervasive
misstatements.

12. Which of the following is not an example of a mitigating factor that reduces the
risk that the going concern assumption may be in doubt?

a. The ability to raise additional funds via borrowings

b. A letter of guarantee from a parent company
c. The ability to sell an unprofitable segment of the business
*d. Significant rapid increase in competition

13. Which of the following statements is correct about audit risk?

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 a. It is impossible to completely eliminate audit risk
b. Audit risk is the risk that an auditor expresses an inappropriate opinion when
a financial report is materially stated
c. Audit risk can be reduced at the planning stage of an audit by identifying the
key risks faced by the client
*d. All of the above

14. The audit strategy for a client with high inherent risk and high control risk will
include:

*a. no or very limited tests of controls

b. decreased reliance on substantive tests
c. increased testing of controls
d. increased reliance on controls

15. Analytical procedures are conducted at the planning stage of the audit to:

a. aid in the identification of risk

b. identify where fraud has occurred
c. enhance the understanding of a client
*d. both a and c

16. Which of the following statements regarding using the work of another auditor
is correct?

*a. The group engagement partner will spend more time reviewing the
component auditor's work when the component is at risk of material
misstatement
b. The group engagement partner will spend more time reviewing the
component auditor's work if the component auditor has a good reputation
c. The group engagement partner will spend less time reviewing the
component auditor's work when the component is at risk of material
misstatement
d. The component auditor sets out the work to be conducted by the group
engagement partner

17. An auditor verifies amounts recorded in their client's records using:

a. electronic evidence
b. verbal evidence
c. confirmations
*d. all of the above

18. Why do auditors inspect records and documents?

a. To check the dates of transactions

b. For evidence that management have authorised significant purchases
c. To check that a transaction occurred
*d. All of the above

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19. Sampling is not required when:

a. it is the first year that the auditor has done the audit for a client
b. the auditor is conducting tests of controls
*c. an audit procedure is conducted on an entire group of transactions
d. the client requests the auditor not to collect samples of certain transactions

20. Professional scepticism does not involve:

*a. the professional requirement that all management representations be
substantiated with supporting documentation.
b. seeking independent evidence to corroborate information provided by their
client
c. being suspicious when evidence contradicts documents held by their client
or enquiries made of client personnel
d. none of the above.

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Question 2 [22 marks]

(a) Explain the cause of the expectation gap providing an example. Identify two
ways the expectation gap can be reduced. (6 marks)

Cause (2 marks for reasonable explanation of unrealistic expectations)

The expectation gap is caused by unrealistic user expectations about what the auditors have
actually done, i.e. the gap is the difference between the expectations of assurance providers
and financial report users about the work actually performed by auditors (2 marks)

Example (2 marks for any example of an unrealistic expectation and the reality)

e.g., Unrealistic expectations by users include:

-an unqualified (clean) opinion is an indicator of complete accuracy
-unqualified (clean) opinion is a guarantee that the client with continue as a going concern
indefinitely
-auditors will detect all fraud
-auditors check every transactions

Reality of auditor performance is that:

-an audit provides reasonable not absolute assurance
-an audit does not guarantee the future viability of the entity (only reasonable assurance
about the next 12 months)
-auditors will assess the risk of fraud and try to detect fraud, but there is no guarantee
(Auditors responsibility with regard to fraud is to plan and conduct the audit so as to have
the best chance of uncovering. Fraud by it’s nature is designed to conceal, hence a
guarantee of detection is impossible)

Reducing the expectation gap: (1 mark each, to max of 2 marks for a good explanation of
any of the following)

The expectation gap can be reduced by: (i) auditors performing their duties properly, i.e.,
complying with auditing standards and meeting minimum performance levels
(ii) enhanced reporting to explain what processes have been followed in arriving at an audit
(reasonable assurance ) or a review (limited assurance opinion (e.g. audit on a test basis of
samples identified by risk, more extensive audit procedures for an audit engagement)
(iii) assurance providers reporting accurately the level of assurance being provided (i.e.,
limited, reasonable or none)
(iv) peer review of audits to ensure compliance with auditing standards
(iv) education of the public

(b) What is an audit assertion? How are audit assertions used in the audit
process? (4 marks)

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What is an audit assertion? (2 marks)
-Audit assertions are management representations about account balances, classes of
transactions and disclosures. Each line item disclosure in the financial report consists of a
number of assertions.

How are audit assertions used in the audit process -The risk of material misstatement is
identified at the assertion level. (1 mark)
-Audit tests/procedures are designed to gather evidence that the assertions at risk of
material misstatement are fairly stated. (1 mark)

(c) Differentiate between tests of control and substantive tests. In your answer
indicate which component of audit risk the audit test is aimed at supporting. (8
marks)

Difference between tests of control and substantive tests

-Tests of control are aimed at the design and (consistent) effectiveness of controls at
detecting and preventing material misstatements (2 marks)
-Substantive tests are aimed at detecting material monetary misstatements that exist in the
accounts (i.e, the dollar/monetary misstatement) (2 marks)

Component of audit risk the audit test is aimed at supporting

-tests of control – aimed at supporting (providing evidence for) an assessed level of control
risk of low or medium (2 marks)
-substantive tests-aimed at reducing detection risk. Low detection risk requires extensive
substantive tests (more tests of detail and less analytical procedures) while high detection
risk requires less substantive testing (more analytical procedures and less tests of detail) (2
marks)

(d) What is non-sampling risk? Identify and explain two causes of non-
sampling risk. (4 marks)

What is non-sampling risk?

Non-sampling risk is the risk that the auditor reaches an inappropriate conclusion for
any reason not related to sampling risk. That is, even when examining every item in a
population, an auditor still faces non-sampling risk. (2 marks)

Identify and explain two causes of non-sampling risk.

Non-sampling risk is determined by the auditor’s expertise, experience and understanding
of the client and is caused by: (1 mark to max of 2 for any of)

-incorrect interpretation of results; e.g., the auditor could misinterpret the

evidence or draw the wrong conclusion from the results because they didn’t
understand them (1 mark)

-use of the wrong audit procedure; e.g., the auditor could have chosen the wrong
type of test, or applied the test to transactions from the wrong period

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-over-reliance on non-persuasive on incorrect evidence, e.g., the auditor could
have been given incorrect information by management to conceal a fraud, which
they didn’t detect using other techniques

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Question 3 [20 marks]

You are the audit partner in charge of 30 June 2011 audit of BurgersRUS Ltd, a
multinational burger company. You have reviewed the work performed by audit team
audit assistant and have noted the following independent matters.

Required:
For each of the four independent scenarios presented below, explain, with reference to audit
assertions, whether sufficient appropriate audit evidence has been obtained.

Scenario Has sufficient appropriate Give reasons as to why

audit evidence been sufficient appropriate audit
obtained? evidence has or has not been
(Yes or No) obtained in terms of audit
assertions
[1 mark each]
[4 marks each]

Note, your reason must be

consistent with your view as
to whether sufficient
appropriate audit evidence
has or has not been obtained.
(a) The audit assistant No Completeness is the greatest
performed testing on accounts risk for accounts payable and
payable. A random sample of no testing has been performed
creditors was selected from the on completeness.
accounts payable ledger and agreed [The auditor has obtained
to statements, invoices and evidence on existence
reconciliations (where appropriate). (vouching) and valuation and
The balance per the accounts payable allocation (agreeing balances)]
ledger was agreed to the general
ledger and trial balance. No
discrepancies were noted.
(b) The audit assistant No Theft of inventory means
performed testing on inventory. that existence of inventory is
During the year six managers had at risk of material
been dismissed for theft. A random misstatement. The audit
sample was selected from the assistant has not tested for
inventory listing. The audit assistant this.
attended the stock take and traced
test counts to the inventory listing, [Does have evidence on
confirmed all consignment stock and completeness (tracing),
checked sale prices with costs for rights and obligations
inventory items sold. He concluded (consignment stock) and
that the inventory balance was fairly valuation and allocation (net
stated. realisable value).

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 Scenario Has sufficient appropriate Give reasons as to why
audit evidence been sufficient appropriate audit
obtained? evidence has or has not been
(Yes or No) obtained in terms of audit
assertions
[1 mark each]
[4 marks each]

Note, your reason must be

consistent with your view as
to whether sufficient
appropriate audit evidence
has or has not been obtained.
(c) A positive debtors confirmation No The overstatement was
was carried out on the 30 June material by nature. It appears
balances. Elephant Water Ltd’s that the entire debtor is
outstanding balance per the fictitious, i.e., does not exist.
confirmation letter was $20,000.
There are likely to be more
However in their written reply they
noted that they did not owe anything
fictitious customers. Further
and had never had an account with work needs to be performed
this company. The materiality on the existence assertion.
threshold for debtors was
$1,000,000. The audit assistant
noted that Elephant Water’s account
appeared to be overstated, but as the
difference is immaterial, no further
work was performed.
(d)The audit assistant obtained the No The main risk for provisions
client’s annual leave provision is understatement and the
calculations. The balance per the auditor has not tested for
listing was agreed to the trial this.
balance, and a sample of employees
selected for detailed testing. The Has tested for valuation and
audit assistant recalculated the allocation (recalculation) and
provision balance, and agreed the occurrence (vouching)
employees’s start date and pay rate to
supporting documentation. The
assistant concluded that “all
calculations proved 100% accurate.
Hence no further testing is
considered necessary for the
provision of the annual leave
balance”.

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Question 4: [ 6 marks]

TedsAndfriends auditors, an international audit firm, has audited a major mining company, Major
Mines Ltd for the past four years and has been assigned the task of auditing the financial report for
the year ended 30 June 2011.
After experiencing declining profits over the past two years, Major Ltd suffered a net loss of $2,
455, 600 for the year ended 30 June 2011. As of that date current liabilities exceeded current assets
by $3, 525, 600 and total liabilities exceeded total assets by $750,000.
Major’s mining leases are due for renewal on 31 December. It is expected that an extra sum of $2
million will need to be spent in order to preserve these leases. Failure to make such payments may
result in the relinquishment of mining leases.
The financial statements, prepared on a going concern basis, do not include any adjustments
relating to the recoverability and classification of recorded asset amounts or to the amounts and
classification of liabilities that might be necessary should the company be unable to continue as a
going concern.

Required:
Identify and explain the going concern risk factors for Major Mines Ltd.

Financial statements of Major are prepared on a going concern basis but there is significant
uncertainty about the going concern principle's appropriateness.

Going concern risk factors include: (2 marks each to max of 6 for any of the following)

-Major has been experiencing declining profits for the last two years and has suffered a net
loss of $2,455,600 for the year ended 30 June 2010.

- Major does not appear to be capable of meeting its liabilities as and when they fall due as is
evident from excess of current (and total) liabilities over current (and total) assets.

- In addition, Major may be unable to continue its mining operation if it is unable to renew its
mining leases which can only be preserved with an extra expenditure of $2m by 31
December.

-Major has prepared its financial statements on a going concern basis without any disclosure about
the significant uncertainty and its effect on the assets and liabilities of the company. ASA/ISA
570.20 states that if adequate disclosure regarding material uncertainty is not made in the financial
report, the auditor shall express a qualified or adverse opinion, as appropriate.

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QUESTION 5 (32 marks)

Mick The-Monkey is an audit senior of TedsAndfriends Auditors, a large international audit firm. He has been asked by the audit
partner, Green Turtle to evaluate the following audit risks of a major international client.
Required:
For each of the four (4) independent audit risks described to Mick The-Monkey, and outlined below, complete the following:
(i) Identify the impact (i.e., increase or decrease) on the component (s)of audit risk affected
(ii) Explain why the audit risk component identified in (a) increases or decreases
(iii) Identify the key account balance (s) affected
(iv) Identify the prime audit assertion (s) to be tested

NB: The situations are independent of each other and are to be treated separately in your answers. For each component only your first answer (s) will
receive marks.
Description of audit risk Impact (i.e. Explanation as to why the Key account balance Prime audit assertion
increase or audit risk component (s) affected (s) to be tested
decrease) on the identified in (a) increases or (2 marks) (2 marks)
component of decreases
audit risk affected (2 marks)
(2 marks)
(a) Banana Ltd, a major Increased inherent Technological obsolesence Inventory Valuation and allocation
manufacturer and retailer of risk makes the I phone 3 obsolete (Banana Ltd will have to
mobile phones is struggling to sell write down the value of
supplies of I phone 2’s, following it’s I phone 2’s to Net
the release by Apple Ltd, of the I- realisable value which is
phone 4. The I-phone 4 is the most likely to be lower than
superior mobile phone on the cost following the
international market and demand release of I phone 4)
is high.

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 (a) Bill Berger was the CEO and Increased control Internal control in the credit Accounts Valuation and allocation
director of PeakPerformance Ltd, risk department may be affected receivable/Provision (Less controls increase
until he died unexpectedly. After his because reduced staff would for doubtful debts likelihood of poor credit
death, his son, Will Berger, became mean reduced segregation of policies (higher
the new CEO of PeakPerformance duties. doubtful debts) and a
Ltd and embarked on a cost-cutting poor debt collection
Morale of the staff will be low
exercise, which included a reduction policy.
hence they may not want to, or
in key staff in the credit department. care about, complying with
internal control policies.
(a) (c) Mr Big, the accounts payable Increased inherent Failure to record (include) two Accounts payable Completeness
manager had taken six weeks long risk folders of matched suppliers (not recording the
service leave and had failed to record invoices, receiving notes and matched documents
two folders of matched suppliers purchases orders means that means that the accounts
invoices, receiving notes and accounts payable is likely to be payable balance is
purchases orders before he went on misstated, i.e., understated understated)
leave. The error was discovered by
accident by the accounts payable
supervisor following year end.

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(d) During the planning stage of the
audit of Peak Ltd, the audit senior
assessed the sales control system to be
effective. But when testing sales, the
audit assistant traced two sales to
supporting documentation (invoices)
with dates for the prior financial year.
Increased Control Increased control risk because Sales AND Cogs Cut-off
risk it is likely that control (Sales and cogs are
procedures that ensure correct overstated because they
recording of sales is not belong to the prior year)
effective
AND
AND AND
Increased inherent Completeness (Cogs
Increased inherent risk as there
risk and sales understated in
will be a greater risk of material
prior year as not
misstatement in the financial
included last year)
report. It is reasonable to assume
that if two invoices from last
year were included in this year’s
sales, there may be more.
As a result current year’s sales,
COGS and profit will be
overstated and last year’s sales,
COGS and profit will be
understated
End of examination paper
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