Audit and Assurance (AA)

Solution Pack
S. No Syllabus Area Question ACCA Exam Paper

1 Audit Framework and Regulation Ruby Ltd -

2 Audit Framework and Regulation Emerald Ltd -
3 Audit Framework and Regulation Bark Ltd -
4 Planning and Risk Assessment Brooklyn & Co Sep/Dec 2019
5 Planning and Risk Assessment Daffodil & Co Mar/Jun 2019
6 Planning and Risk Assessment Earl and Co Sep/Dec 2018
7 Planning and Risk Assessment Loganberry Mar/Jun 2018
8 Planning and Risk Assessment Dower Ltd -
9 Planning and Risk Assessment Head -
10 Planning and Risk Assessment Glass Ltd -
11 Planning and Risk Assessment Recorder -
12 Internal Control Amberjack Ltd Sep/Dec 2019
13 Internal Control Freesia Mar/Jun 2019
14 Internal Control Raspberry Mar/Jun 2018
15 Internal Control Murray Ltd -
16 Internal Control Becker Ltd -
17 Internal Control Nadal Ltd -
18 Internal Control Cherry -
19 Internal Control Knowledge -
20 Audit Evidence Spadefish & Co Sep/Dec 2019
21 Audit Evidence Hyacinth Co Mar/Jun 2019
22 Audit Evidence Jasmine Co Sep/Dec 2018
23 Audit Evidence Camomile Sep/Dec 2018
24 Audit Evidence Cranberry Mar/Jun 2018
25 Audit Evidence Pearl Ltd -
26 Audit Evidence Tickam Ltd -
27 Audit Evidence Mast Ltd -
28 Review and Reporting Pizza Ltd -
29 Review and Reporting Lesley and Co -
30 Review and Reporting Gavin Ltd -
31 Review and Reporting Bullfinch -
 Ruby Ltd - Answer
a)

Principles based approach

This involves a set of basic guidelines that provide a framework that can be applied to a range of ethical
situations.

The principles do not tell you exactly how each situation must be dealt with, but do provide best practice
guidelines.

A principles based approach is flexible and can be used in rapidly changing situations.

It is not an approach that is restricted by national laws or boundaries and it encourages the responsible
application of judgement.

Rules based approach

This is definitely an easier approach to follow because the specific rules are clearly defined.

However, this approach will need constant updating, as rules will need to be adapted to deal with new
and different situations.

It will also be quite de-motivating for auditors because it does not encourage the use of responsible
professional judgement - no thinking for yourself!

The ACCA Code of Conduct adopts a principles based approach.

b)

Regular change of auditors

Threat - This suggests that the client may be quite demanding during the audit and is an intimidation
threat because we may not feel that we can do our job without being questioned and pressured.

Action - It would be a good idea to contact the previous auditors - and maybe some of the other previous
audit firms as well - to establish what problems have been encountered with client 'interference ' to see if
it is too big a problem to manage effectively.

Fee Pressure

Threat - A client that is very concerned about fee levels can put pressure on the audit firm to 'cut corners
' during the audit so that things are done quickly, but work quality suffers as a result.

Action - The fee should be explained and agreed with the client before any work is undertaken. If the
client refuses to accept the fee level quoted then the work should be refused.

Specialist Industry

Issue - From a quality point of view, there is a chance that the staff assigned to the audit of Ruby Ltd
does not have enough specialised knowledge about the diamond industry.

Action - We must ensure that staff has the requisite knowledge. It may be advisable to use the work of
an expert as part of our audit work.

Bank Pressure
Issue - The pressure from the bank means time for the completion of the audit work is short so there is a
risk that work will not be done properly, and that the client may be tempted to manipulate the financial
statements in order to present a favourable view to the bank in order to increase the chances of getting
the loan.

Action - We must ensure that sufficient numbers of audit staff are available so that the work can be
completed on time. We must also ensure that professional scepticism is applied to the figures in the
financial statements in view of the increased possibility of manipulation.

Family Members

Issue - This is a potential familiarity threat. It would look as though the two staff who have relatives
working at the client would possibly overlook some issues because they do not want to fall out with
members of their own family.

Action - These two staff members should not be assigned to the audit of Ruby Ltd. They are, however,
free to work on any other unconnected audit engagements.

Request for Help with Accounts

Issue - The help with maintenance of accounting records and the preparation of financial statements is a
self-review threat because the audit firm would be giving an opinion on something that they have helped
to prepare.

Action - I would suggest segregation of duties. This is not a listed company so it is acceptable to
undertake the work, but there should be one team of audit staff doing the accounts work and a separate
team doing the actual audit.

Takeover Advice

Issue - Any advice creates a management, or advocacy threat. Any decisions on how the client is going
to operate - including what companies they may buy - should be made by the management of Ruby Ltd.
If we do it, then it looks as though we are making management decisions.

Action - We can help them by providing some guidance on the potential acquisition BUT we must ensure
that the management of Ruby Ltd are aware that the actual decision is down to them.

Making sure management are aware of this is called ensuring Informed Management, in other words we
make sure that management know what they are supposed to do.
 Emerald Ltd - Answer
The answer to this part is perfectly acceptable in a two column table.

a)

Objective

Internal and external audit have different objectives. Internal audit aims to add value to an organisation
by improving its operations.

An external audit provides an opinion on the truth and fairness of the financial statements.

Reporting

Internal auditors usually report to the board of directors or the audit committee.

External auditors always report to the shareholders.

Scope

The internal audit scope of work is determined by the client and will vary according to the desired
objective.

The external auditor can ask for any information or explanation that they consider necessary. The scope
of their work is determined by them.

Status

Internal auditors are usually employees of the client.

External auditors are totally independent of the client, never employees.

b)

Internal audit

The position of the internal audit function will be stronger. They will not have to report directly to the
board of directors. Neither will they be monitored and controlled by the board.

Reporting directly to the audit committee will improve their ability to act in the best interest of the
company as a whole, not just for the benefit of the directors.

This could directly help solve the current problems of a lack of support that are being experienced by the
chief internal auditor.

External auditor

The position of the external auditor will be stronger and more effective as well.

The audit committee is a very useful point of contact for external auditors.

They can use this channel of communication to voice any concerns about the internal audit work or the
activities of the main board.

Non-Executive director
At present there are no non-executive directors, but Emerald is going to appoint one to serve on the
audit committee.

Non-executive directors are able to use their business experience and to provide unbiased advice to
Emerald in order to help them operate effectively.

It would be advisable for Emerald Ltd to have a balance of executive and non-executive directors, so
more than one would be necessary.

Finance

The bank is more likely to provide the finance that is required Emerald Ltd.

Audit committees increase the confidence of possible finance providers, they see it as an extra level of
protection for their investment.

Shareholders

The introduction of an audit committee is likely to increase the confidence of the shareholders as well.

As well as making existing shareholders feel more at ease that Emerald Ltd is operating effectively, it
may also attract new ones which could mean more investment becoming available.

Finance Director

The increased confidence provided by the audit committee may make it easier to fill the gap left by the
departure of the finance director.

It may also enable Emerald Ltd to attract a higher level of employee.

The Hands on Approach

An audit committee would provide a control over the very close relationship that the current board has
with the operations of Emerald Ltd.

Even if the board is actually operating ethically and effectively, having a degree of autonomous input is
generally viewed as an improvement, something that will make them more responsible in the decision
making process.
 Bark Ltd - Answer
a)

An auditor CAN disclose confidential information in certain circumstances;

- A client may give you permission to do so. It is essential that this is documented in case the client tries
to deny giving consent at a later date.

- If disclosure is in the public interest, then an auditor can make disclosure of any necessary information.

There are also a number of situations where an auditor MUST disclose;

- We must disclose in order to comply with any quality control review that is being carried out by a
regulatory body, such as the ACCA.

- We must disclose if we are under investigation by a professional body.

- If we are required by law to act as a witness in a court case, then disclosure will also be necessary.

- Sometimes auditors will find that the client has broken the law, or is potentially going to do so. We
would have to disclose this.

- Some specific issues will need to be disclosed relating to any assurance client.
If they are guilty of terrorism money laundering or drug trafficking, then these must always be disclosed.

b)

Size of client

Threat

There could be an increased self-interest threat due to our concern over losing the large amount of fee
income that is obtained from Bark Ltd.

There are a number of services that are being provided on a recurring basis.

Safeguard

The level of recurring fees should be constantly monitored to ensure that it does not exceed the
permitted level. If necessary, some work could be passed on to a different firm. This would mean a loss
of some income but at least the client would still be kept.

Length of time

Threat

There is a familiarity threat associated with long association - carrying out an audit for a number of years
will make it look as though the audit firm is too relaxed in their audit work so may not do it properly.

Safeguard

Bark Ltd is not listed so all that needs to happen is that the relationship needs to be reviewed, but staff
could be swapped to be seen to be acting as responsibly as possible.

Advice
Threat

Tax and management consultancy advice can create a management threat. This is the danger that the
audit firm may be making decisions that are normally made by the client.

Safeguard

We should make sure that Bark Ltd has “informed management". This means that it should be clarified
with the directors that they know it is their responsibility to make the decisions and that we cannot do it
for them.

Former employee

Threat

There is a self-review threat because one of the audit staff used to work for the client. If they are involved
in the audit, then they may well end up reviewing their own work.

Safeguard

The former employee should not be assigned to the audit of Bark Ltd for the next two years. This is
considered to be an acceptable "cooling off” period.

Finance Director

Threat

There is a familiarity threat because of the personal relationship between one member of your staff and
the finance director of Bark Ltd. The perception would be that any required professional scepticism
would not be applied by the individual who is auditing the work of their own father.

Safeguard

The individual involved should not be assigned to the audit of Emerald Ltd. They have shown sound
ethical behaviour by informing us of the relationship though - we may not have found out otherwise.

Meal

Threat

This is a self-interest threat. It may be offered with the best of intentions, but it could be perceived as a
bribe to overlook any problems that may be found during the audit.

Safeguard

It is advisable for this tradition to be stopped. If the reason for doing so is explained carefully, then there
is no reason that it should sour the relationship with Bark Ltd.
 Brooklyn & Co - Answer
Part (a) – Fraud Responsibility

As per ISA 240 ‘The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements’, the
auditors are required to obtain reasonable assurance that the financial statements are free from material
misstatement. These misstatements can be caused by fraud or error.

The auditor also needs to obtain sufficient appropriate audit evidence regarding the assessed risks of
material misstatement due to fraud through designing and implementing appropriate responses.

The auditors maintain professional scepticism throughout the audit, considering the potential for
management override of controls and recognising the fact that audit procedures which are effective in
detecting error may not be effective in detecting fraud.

A discussion is held with the entire engagement team to ensure everyone is aware of the risks and
responsibilities for fraud and error. For members not present at the meeting, the audit engagement
partner should determine which matters should be communicated to them.

Part (b) – Ratios

20X5 20X4

Gross profit margin 4,500/23,200 = 19·4% 4,600/21,900 = 21%

Inventory holding period 2,100/18,700 * 365 = 41 day 1,600/17,300 * 365 = 34 days

Gearing ratio 13,000/(10,000 + 13,000) = 56·5% 11,000/(9,500 + 11,000) = 53·7%

Interest cover (450 + 290)/290 = 2·6 (850 + 250)/250 = 4·4

Part (c) – Audit risks and auditor’s response

Audit risk Auditor’s Response

The prior year management report highlighted

significant deficiencies relating to the purchases
cycle.
If these deficiencies have not been rectified, the
controls over purchases and payables may
continue to be weak leading to increased control
risk and risk of misstatements arising.
Discuss with management whether the purchases
cycle recommendations suggested by Brooklyn &
Co were implemented successfully this year. If
so, undertake tests of these controls to assess if
they are operating efficiently.
It is the plan of finance director to reduce the
estimated return rate for goods sold on a sale or
return basis to wholesale customers from 10% to
5%. IFRS 15 provides that revenue and cost of
sales should only be accounted for to the extent Discuss the basis of 5% assumption. Review a
that the company foresees that the goods will not period of 60 days to quantify the levels of return
be returned. For the goods which may be returned, in the specified period and compare this to the
the company should recognise a refund liability. assumed rate of 5%.

By reducing the return rate, there is a risk that

revenue and cost of sales may be overstated and
liabilities understated

A patent was purchased for $800,000 last year,

which has a useful life of four years. The carrying
amount in the forecast financial statements is
$800,000 which is the same as the prior year. Agree the useful life of the patent with the
supporting documentation. The amortisation
In accordance with IAS 38 Intangible Assets, this charge should be calculated and the appropriate
intangible asset should be amortised. It does not journal adjustment discussed with management,
appear that management has correctly accounted
for the amortisation and as a result, intangible
assets and profits are overstated.

Discuss the depreciation policy for plant and

Unusually high profits or losses on disposal are an
machinery with the finance director to assess its
indication that the depreciation policy of plant and
reasonableness. Review for other significant
machinery may not be appropriate. Therefore,
gains or losses on disposal of property, plant and
depreciation may be understated and profit and
equipment to assess the reasonableness of the
assets overstated.
company’s depreciation policies.

Discuss with the finance director the details of the

Harlem Co’s financial controller has allegedly
fraud perpetrated by the financial controller and
carried out a number of fraudulent transactions at
what procedures have been adopted to date to
the company. There is a risk that she may have
identify any adjustments which are needed in the
undertaken a significant level of fraudulent
financial statements. Additional substantive
transactions leading to an increased control risk
testing should be conducted over the affected
which has not yet been identified.
areas of the accounting records.

The financial controller was dismissed and is

threatening to sue the company for unfair
dismissal.
Discuss with management and request
A provision (or disclosure) for unfair dismissal is confirmation from the company’s lawyers of the
required to comply with IAS 37 Provisions, existence and likelihood of success of any claim
Contingent Liabilities and Contingent Assets. If from the former financial controller
Harlem Co has not done this, there is a risk over
the completeness of any provisions or contingent
liabilities disclosures.
 Harlem Co has had production problems which Discuss with the finance director whether any
have affected the quality of a significant batch of write downs will be made to the affected tyres,
tyres. In addition, the inventory holding period has and what, if any, modifications may be required
increased from 34 to 41 days. with regards to the quality.

A significant customer has been granted a six-

Review and test the controls surrounding how the
month payment break and the receivables
finance director identifies old or potentially
collection period has increased from 38 to 51
irrecoverable receivables balances and credit
days. An allowance for receivables has historically
control to ensure that they are operating
been maintained, and it is anticipated that it will
effectively.
remain at the prior year level.

Part (d) – Substantive procedures for valuation of trade receivables

 Obtain a breakdown of the opening allowance and consider if the receivables provided for in the
prior year have been recovered to assess the reasonableness of the prior levels of allowances.

 Review the aged trade receivables ledger to identify any slow moving or old receivable balances
and discuss the status of these balances with the credit controllers to assess whether they are
likely to be received.

 Review whether there are any after-date cash receipts for slow moving/old receivable balances.

Part (e) – Substantive procedures for disposals of plant and machinery

 For a sample of disposals, agree sale proceeds to supporting documentation such as sundry
sales invoices.

 Recalculate the profit/loss on disposal, and agree to the trial balance and statement of profit or
loss.

 Review the disclosure of the disposals in the draft financial statements, and ensure it is in line
with IAS 16 Property, Plant and Equipment.
 Daffodil & Co - Answer
a) Under IAS 320 auditors must establish materiality levels for the financial statements as a whole and
performance materiality levels for individual balances.
Overall materiality: Misstatements in the financial statements are material if either individually, or in
aggregate, they result in the financial statements not presenting a true and fair view of the position
and performance of the company. Thus, they could influence the decisions taken by users of the
financial statements.
A misstatement could be material due to its size, its nature or a combination of both.
The level of materiality is often calculated based on benchmarks, such as 5% of profit before tax.
However, it is ultimately based on the auditor’s professional judgment, considering factors such as
the needs of the users and the perceived level of risk.
Performance materiality is used to test individual transactions balances and disclosures. It is set at
a lower level than overall materiality and aims to reduce the risk that the aggregate errors in the
balances, transactions and disclosures exceed overall materiality.
b)
Audit Risk Audit Response
Over-reliance on internal audit’s (IA’s) testing Meet with IA and carry out a review of their
of controls, leading to an incorrect work. Tests on this should be carried out to
assessment of the strength of those controls. ensure its adequacy prior to placing any
This may increase detection risk if insufficient reliance on it. Some re-performance of the
substantive testing is carried out testing carried IA should also occur
The gross margin is forecast to increase Review the classification of costs between
significantly from 56% to 60%. This is cost of sales and operating expenses and
inconsistent will the forecast fall in operating compare to the prior year
margin from 21% to 18%
Investigate any inconsistencies
This may indicate misclassified expenses
which would create an understatement of cost
of sales and an overstatement of operating
expenses
Inventory should be valued at the lower of Sample testing of inventory items to ensure
cost and NRV, but Peony value inventory they have been valued correctly
based on selling price less average profit
Valuation testing to confirm selling price less
margin. If this is not a close approximation to
average profit margin is a close
cost then inventory could be misstated
approximation to cost
Inventory could also be misstated if the
Review timetable of, and controls over,
perpetual inventory counts are not fully
perpetual inventory counts
completed
Discuss with management the extent to which
The interim audit found significant exceptions
inventory records at the year-end can be
where the inventory in the warehouse was
relied upon and recommend a full year-end
lower than the inventory records. The year-
inventory count if necessary
end figures are likely to be based on the
records and therefore overstated.
Assets that had not been fully depreciated Discuss the depreciation policy with the
were identified as obsolete, suggesting the finance director and assess reasonableness
depreciation policy is insufficient
Enquire if obsolete assets have been written
Obsolete items should be written off to the off, and review any adjustments for
statement of profit or loss completeness
Depreciation may be understated, and profits
and assets may be overstated
Advertising costs relating to adverts shown in
the prior year should be expensed, not
included as a current asset as planned
If these costs are not expensed, current
assets and profits will be overstated
Outsourcing of the payroll function during the
year increases detection risk if Peony does
not have sufficient appropriate evidence to
confirm the completeness and controls over
the payroll cycle and liabilities at the year end
Errors during the transfer process could result
in the misstatement of wages and salaries
The loan of $3m should be allocated between
non-current and current liabilities and
adequately disclosed. Failure to classify it
correctly may result in misclassified liabilities
A redundancy provision will need to be made
if the announcement to staff is made before
the year end. If this is not done, or the
amount is insufficient, there will be an
understatement of provisions and expenses
Discuss the rationale for inclusion as a
current asset, and request evidence to
support the assessment of probable future
value
Review documentation to confirm the adverts
were shown prior to the year end
Request the amount is removed from current
assets and charged to operating expenses
Determine what records are held at Peony
since payroll was outsourced and how
controls over payroll are monitored
Confirm controls in place with the outsource
company
Discuss with management the controls that
were in place over the transfer process
Test the effectiveness of transfer controls
where possible
Perform substantive testing on the transfer of
information to the new system
Check the split of the loan by re-performing
the calculations carried out by Peony Co
Confirm $3m was received by checking loan
documentation.
Review disclosures to ensure sufficient detail
is provided
Discuss the status of the redundancy
announcement with management
Review the basis of, and recalculate, the
redundancy provision
 Earl & Co - Answer
Part (a)
Analytical procedures are useful when reviewing or auditing areas of the financial statements. In
particular for those that are difficult to obtain external evidence. ISA 315 identifying and assessing the
risks of material misstatement, and ISA520 Analytical procedures, state there are three stages to use
them as part of the audit.

Analytical procedures are used at the planning stage to compare the draft financial information with the
previous year, budgets or forecasts and industry averages. This is carried out as part of the risk
assessment process to help understand the entity and identify the risk of material misstatements.

ISA320 states we should use analytical procedures at the completion stage to ensure the evidence
collected throughout the audit is consistent with the financial statements and conclusions made look
reasonable.

They can also be used at the testing stage of the audit. Substantive analytical procedures and be used
to obtain sufficient appropriate evidence.

Part (b)

Ratio calculations – calculate 3

20X8 20X7
Gross profit margin 7410/19580 X 100 6190/16990 X 100
= 37.3% =36.4%
Receivables day 2750/19850*365 1780/16990*365
Ratio = 51 DAYS = 38 DAYS

Current ratio 4600/2780 3670/1190

=1.65 =3.08

Part (c)

Audit risks in scenario

Audit risk Auditors response

Darjeeling has spent $0.9m on the Obtain a breakdown of the capitalised

development of new product lines, some of development costs. Review the costs by
which are in the early stages of comparing to cost documentation and discuss
development. This is all in intangible assets. any changes required with the finance director.

There is a risk that some, of not all of this

does not reach the criteria required for it to
be an intangible asset as per IAS38. Assets
and profit may be overstated and expenses
understated.
Darjeeling have also purchased and Ensure the servicing and maintenance plan is
installed a new manufacturing line. All the $0.5m by agreeing to documentation. Calculate
costs have been capitalised including the correct treatment and discuss changes with
servicing and maintenance plan for $0.5m. the finance director.
This cost does not qualify as an asset
according to IAS16. It should be an
expense released over the 5-year plan and
therefore assets and profit are overstated
and expenses understated.

To finance the new projects, they have taken Agree the receipt of the loan with bank records.
a $4m loan from the bank to be paid over 8 Calculate the correct split and compare to the
years at 5%. disclosure of the note in the financial
statements.
There is a risk that disclosure of the loan
may not be adequate. The loan must be
split between current and non-current
liabilities.

Darjeeling has extended their credit terms to Increase testing on post year-end cash receipts
its customers if they increase their credit to identify further customers who may not yet
terms. In addition receivable days has have paid. Inspect customer correspondence
increased from 38 days to 51 days. further into the following year to identify
customers who may be struggling to pay and
There is a risk that this could increase sales ensure a thorough aged receivable analysis
that cannot be paid for if reasonable credit review.
checks are not carried out. This could lead
to an increase in bad debts. Receivables
and profit could both be overstated.

They have introduced a price promise to Discuss the basis used to form the $0.25
match prices with competitors. They can liability with the directors with a thorough review
claim the difference within one month of the of supporting documentation and calculations.
date of purchase of goods.

There is a risk that the refund liability they

have included may not conform with IFRS
15 revenue from contracts with customers.
As it is a new initiative the directors may not
have disclosed this correctly leading to over
or understated profits and liabilities.

There were faulty paint products detected in Obtain a breakdown of sales of the faulty batch.
the year due to customers complaining Ensure the sales have been removed for these
about the goods. in the year and that inventory and liabilities are
reasonable.
There is a risk that customer refunds may
not have been accounted for correctly.
Inventory figures should be adjusted for the
current year and provisions made for an
estimate of the refunds. This could lead to
overstated revenue, understated liabilities
and over/understated inventory.

There were other products that were not Ensure a detailed review of the inventory
sold but still faulty. valuation to identify the cost and NRV and
ensure the lower of the two has been used in
 There is a risk that valuation of these valuation.
products may not have been adjusted
correctly leading to inventory being
misstated.

There has been a fall in this year’s current Going concern testing should be increased.
ratio from 3.08 to 1.65. Any issues should be followed up with
The bank balance has also seen a change management to be satisfied that the going
from a positive $560k to an overdraft of concern status is reasonable. Any disclosures
$810k. included in the financial statements should be
carefully reviewed.
There is a risk that they are struggling with
cash flow. With the addition of the new $4m
loan to pay these are all going concern
indicators and going concern disclosure may
not be adequate in the financial statements.

Part (d)
Substantive audit procedures for faulty paint in inventory

Obtain a schedule of the faulty paint in inventory showing the cost and NRV breakdown and the returns
made by customers and cast it for accuracy.

From the schedule, agree the costs of damaged goods to production records to confirm the amounts
shown are accurate.

For products where the inventory should be adjusted, agree the adjustment required to the inventory
records to ensure this has been carried out.

For a sample of returns made by customers on the schedule, agree the return to any supporting
documentation and ensure it is adjusted in the ledger to confirm the accuracy of the returns adjustment.

Discuss with management what their plans are for production. Identify whether this is an isolated case or
if controls need to be reviewed to ensure further cases cannot arise.

Part (e)
Substantive audit procedures in relation to revenue.

Compare the current total revenue figure to the previous year and the budget and investigate significant
differences.

Obtain a breakdown of sales into product categories and compare to last year for each category and
budget and investigate significant differences and possible misallocations.

Calculate the gross profit margin for current and previous year and discuss significant differences with
management.

Select a sample of sales invoices in the year from the sales daybook, agree to the source documents
including the order and despatch note to ensure the accuracy and existence of sales recorded.

For a sample of sales invoices, recalculate the total and agree prices used with client price list to confirm
accuracy of total.
 Loganberry - Answer

a) Responsibilities of Loganberry in relation to fraud and error.

As Loganberry are the auditors, they have a responsibility to follow their international auditing
standards, including ISA240, the Auditors Responsibilities relating to fraud in an Audit of the
Financial Statements.

ISA240 states that the Auditors have a responsibility to assess the risk of fraud and error being
present in the Financial Statements in the form of material misstatements. Overall, the Auditors
have a responsibility to obtain reasonable assurance that the financial statements are free from
material misstatements, whether caused by fraud or error.

In order to comply, the Auditors must design and carry out appropriate audit procedures during
the course of the audit, which will help assess the risk.

The audit team must also ensure they communicate the risks and responsibilities to the whole
team. If the risk is high, the audit team must adapt their work and be aware of why they are
doing it.

If fraud or a significant risk of fraud is found, they must respond appropriately on a timely basis.

b) Audit risk and responses in relation to Blackberry Co. There are 8 needed.

Audit Risk Auditor’s response

Inventory includes raw materials and costs Discuss the inclusion of overheads with
of conversion, which includes general management and obtain a breakdown of
overheads. these costs to identify if they comply with
what is allowed as per IAS2.
As IAS2 does not permit general
overheads, there is a risk that some of
these costs are not allowed and inventory
may be overstated in the financial
statements.

There are 3 warehouses and full counts will
be taken on 2, 3 and 4 April, when the
year-end is 31 March.
There is a risk that the adjustments for
movements made after the year-end will
not be carried out accurately and inventory
may include material misstatements.
The auditor should attend all of the
inventory counts and observe the process
of adjusting for movements and inspect all
documentation to identify if it has been
controlled appropriately.

Blackberry has paid $1.1m to purchase a
patent that will help them gain competitive
advantage. This has been expensed.
IAS38 states that this patent should be
capitalised and then amortised over its
useful economic life. As a result, assets
and profit are understated.
The auditors must discuss this matter with
the directors and instruct them of the
correct treatment and the impact it has on
the financial statements and audit report if
not corrected.

Blackberry financed the patent with an The auditor’s must confirm the split for the
issue of shares at a premium for $1.2m
There is a risk that this share issue has not
been disclosed correctly in the financial
statements, and the equity split and
disclosure notes may be misstated.
share premium and ensure the amounts in
the financial statements are correct. They
must also confirm the $1.2m received was
from shares.

A significant fraud has been carried out The auditor’s must review the fraud
during the financial year. evidence and discuss what the procedures
were for identifying the amounts stolen
There is a risk that the full amounts from the company.
involved have not been identified and the
fraud impact may be misstated in the
financial statements.

The sales ledger processing has now been Discuss the transfer process with
outsourced after the dismissal of the management and what controls were in
individuals who carried out the fraud. place to ensure the new sales function is
effective for the company.
There is a risk that the controls over the
transfer process to the outsourced
company were insufficient and the sales
ledger may contain material
misstatements.

In December, the financial accountant was Discuss the potential case with
dismissed and has now threatened to claim management and inspect legal
against the company for unfair dismissal. correspondence to identify how possible
this potential liability could be.
There is a risk that disclosure of this
potential liability may be insufficient in the
financial statements, leading to a material
misstatement.

Now the financial accountant is no longer There must be an increased level of work
working for blackberry, there have been no carried out by the audit team on the
supplier statement reconciliations or purchase ledger, including a significant
purchase ledger control account sample of supplier statement
reconciliations carried out for the last 3 reconciliations, to identify potential
months of the year. misstatements.

There is a significant risk that there could They could discuss whether year-end
be material misstatements present and not purchase ledger control account
detected in the purchase ledger, leading to reconciliation can be carried out.
the financial statements.

There were other audit risks contained within the scenario. There were also other ideas for
auditor’s responses that could be used. Remember to stick to the number of risks required
in the question and write enough about them to gain maximum marks.
 Dower Ltd - Answer
a)

 Planning will help identify relevant audit risks, which is likely to make audit work more effective.

 Planning will enable effective staff allocation, to ensure the right level of staff is allocated to the
right level of assignment.

 Planning will help protect against liability claims. If a client accuses an auditor of not doing their
job properly, evidence of planning will re assure the client.

 Planning will help enable audit firms to pass any quality control checks that are carried out, either
internally or externally, by the profession.

b)

We could compare the client results and position for this year with the previous year and make a note of
any significant differences.

We could calculate some financial ratios for this year and compare them to last year and, again, make a
note of any discrepancies to be followed up at a later date.

We could compare the actual results for the financial year with any available budgets for the same
period.

c)

New computer system

The new computer system may not operate effectively due to inadequate testing or poor back up
facilities, which increases the risk of the figures it produces being wrong.

Warehouse extension

The costs incurred may be misclassified. All directly attributable expenses should be capitalised and
there is a risk that this has not been done.

Also the extension needs to be depreciated and may not have been. Alternatively, the warehouse may
have been depreciated but over an inappropriate length of useful economic life.

Bank Loan

The bank loan is dependent upon the audited financial statements, so there is a risk that the
management of Dower Ltd will manipulate the figures to show a very positive position in order to
increase the chances of receiving the loan.

This increases the risk of misstatement and makes our job harder.

Bonus

There is additional incentive for the management of Dower Ltd to manipulate the financial statements
because they are paid a sales related bonus.

The fact that sales has increased by 30% this year may well be an accurate reflection of performance,
but it may well be a falsification.
Lots of cash

Dower Ltd is a largely cash based business. Having lots of cash means that there is a chance that the
cash could get lost or stolen. As a result the cash position of the business could be overstated.

Money laundering is much more likely to occur in a cash based business, which will also increase the
risk of misstatement.

The vans

The vans are going to be used for longer than originally expected, so the useful economic lives should
be reviewed and changed. If this is not done, then the assets would be misstated.

Due to the age of the vans, some of them may need impairing. If this is not done, then assets will be
overstated.

Being sued

If it is felt that the customer will win their case, then a provision would be required in the financial
statements. There is a risk that this has not been done, which would understate liabilities.

If it is felt that the customer is not likely to win the case, then a disclosure note would be required for the
contingent liability. There is a risk that this may not have been done either.

Late payments

The fact that some credit customers have started to pay late will increase the risk of bad and doubtful
debts existing. If these have not been recognised then the current assets of Dower Ltd will be
overstated.

d)

Detection risk is the risk that our audit work will fail to identify a material misstatement. Basically, the
more we do, the more likely we are to find something wrong.

Detection risk can be decreased by;

- Changing the extent of our work - doing more.

For Dower Ltd, this could involve performing more audit work on a larger sample of vehicles seeing as
we expect there to be problems with valuation/ useful economic lives.

- Changing the nature of our work - obtaining a different, more reliable type of evidence.

For Dower Ltd, this could involve carrying out a direct confirmation of receivables which is an external
source, instead of relying on the client records to confirm the existence of the debt.

- Changing the timing of the work done - carrying out audit work at the year- end instead of waiting until
the final audit.

For Dower Ltd, this could involve counting and monitoring the cash at the year end, seeing as it is such a
large and high risk item.

e)

Quantitative materiality is when a value is used to determine the significance of an item.

Most items in the financial statements are said to be material if their value is high.

However, some things are material due to their nature - because of what they are. It does matter about
the value; it is the type of item that makes it a material one. This is qualitative materiality and an example
would be a transaction involving a related party.
 Head - Answer
a)

Audit risk is the risk that an auditor will arrive at an inappropriate audit opinion. It is made up of;

Inherent risk - the risk that material misstatements will occur due to the circumstances surrounding the
client and the environment in which they operate

Control risk - the risk that the client's system of internal control will fail to identify the misstatements that
exist

Detection risk - the risk that our audit work will fail to identify a material misstatement

b)

Guidelines
The strict guidelines that relate to the running of the charity are often complex and time consuming to
observe and apply. There is a chance that this has not been done properly by Head.

The auditors will have to spend time familiarising themselves with the detail of the legal requirements.

Breach
If these guidelines are breached, then Head may incur penalties and fines from the regulatory authorities
that may have been missed, so not recorded properly.

The auditors should consider direct confirmation with the regulatory authorities to confirm whether or not
this may have occurred.

Expenditure
The limit imposed on the level of permitted expenditure creates a risk that the level will be breached.
Management may even deliberately misstate the expenditure levels in order to create the illusion of
compliance.

More audit work should be done on the expenses of Head to ensure that misstatement has not occurred.

Donations
The donations come from different sources. There are potentially a large number of donors that will be
difficult to control so income could be lost.

This will be an area that the audit firm will need to concentrate on by doing a lot of testing trying, to
ensure that there is no understatement of income due to donations not being recorded.

Cash
Lots of the above donations would be in cash, which is easily lost or stolen, so increases the risk of
misstatement.

There should be extensive testing of the controls that relate to cash collection and cash recording to
ensure that Head has addressed this issue.

Tax situation
The complex tax rules may not be understood by Head, or may be deliberately avoided. Either way,
there would be misstatements as a result.

The auditors should discuss with the management of Head to establish the extent of the knowledge that
have about the regulations and the importance that is place upon them.
Expenditure
Capital and revenue expenditure having different definitions for accounting and tax purposes will
increase the risk of misclassification between the two if the definitions get mixed up.

Extensive analysis of all repairs, maintenance and capital items should be undertaken by the auditors to
try and maximise the chances of finding any misclassification errors.

Uncertainty over donation income

This may require disclosure in the financial statements and may even threaten the going concern status
of Head Ltd.

Auditors must carry out sufficient going concern procedures in order to form an opinion on whether the
correct basis of preparation has been used by Head and that any uncertainty has been adequately
disclosed.

c)

The control environment is the overall attitude that Head adopts to the importance of having well
controlled operations.

It may well be weak because of;

 A lack of understanding of the charity regulations surrounding Head.

 A lack of understanding concerning the complexity and importance of the tax rules.

 The fact that a lot of volunteers are involved in the operation of Head, who perhaps do not have
the same firm-wide values that employed members of staff may have.

 Insufficient emphasis placed upon the risks of having lots of cash.

 A lack of awareness as to how important it is for Head to keep a good relationship with its major
contributors.

 A possible lack of segregation of duties as everyone tries to help out wherever possible, instead
of sticking to clearly defined roles.

 The probability that no internal audit department or the audit committee exists. Either or both
would increase the potential for good control.
 Glass Ltd - Answer
a)

Purpose of working papers:

- To help with the planning of an audit.

- To document all work.
- To assist with review and supervision.
- To help ensure audit quality.
- To help achieve a standardised approach.
- To help protect against liability claims.

b)

Previous year audit file - this will tell us where the risk areas were last year as well as the audit approach
that was used.

Previous year financial statements - these will help us carry out relevant analytical procedures.

Forecasts / budgets - this will give us some going concern information as well as helping with analytical
procedures.

Store location lists -this will help us allocate staff and organise inventory count attendances.

Organisation chart / key staff members - this will help us assess the control environment and enable us
to arrange discussions with key personnel.

Internet search results - this could identify possible adverse publicity experienced by Glass Ltd that may
affect its operations.

Board minutes / memorandum and articles of association - these will help establish company structure
and confirm any significant events that may have occurred.

Lawyer correspondence - this would help confirm the existence of any court cases either for or against
Glass Ltd.

c)

The working paper does not give the name of the preparer, making it difficult to get any amendments
made if required.

There is no specific mention of the year-end to which the working paper relates - it could be a different
year in the wrong audit file and no one would know.

“The purchase day book is correct" is not actually an audit assertion. It is more of an objective than an
assertion, so the wrong terminology is used here.

There should be an assertion and an objective, so there is some information missing.

There is no specific reference to the actual document that contains the sample details, making it difficult
to find.

There is no explanation of how the sample was selected. There are a number of statistical and non-
statistical methods that could have been used, so it is important to clarify this.

There is no reference on the working paper so it may not get filed in the correct part of the audit file.
The conclusion contradicts the results. 5 items were not found but the conclusion says that everything
was agreed. This is not consistent.

The method is not specific enough. It just refers to details being checked. There should be a description
of exactly what is being agreed - prices? quantities? coding?
 Recorder - Answer
a)

1) Recorder is a new client for Piano. This is an audit risk as the auditors may lack a fundamental
understanding of the business and miss key information in identifying material misstatements. This
increases detection risk.

The auditors response will be to ensure the planning phase is longer, spend more time
understanding the entity and its environment and to include more experienced audit team members
so they can deal with issues in a speedier manner.

2) They purchase goods from South Asia and they are in transit for 2 weeks. This is an audit risk
because the delay in receipt of goods could cause errors in cut-off of payables and purchase
transactions. Only goods actually received should be recorded in these balances before the year
end.

The auditors response should be to increase sample sizes for cut-off testing for purchases from
South Asia to identify if the recording of goods in transit at the year end is accurate.

3) There is a new bonus for sales staff, giving them a target of increasing customer sign ups for
24 month phone contracts. This is an audit risk as it encourages sales staff to include sales
contracts that actually relate to the following year, to ensure their bonus is higher. It could also
potentially encourage fictitious contracts to be included to increase their sales.

The auditors response should be to increase cut off testing over sales made from the 24 month
phone contracts. They should also review any cancelled contracts after the year end and compare
to the previous year.

4) The receivable levels are considerably higher this year and there is a concern for the
creditworthiness of customers. This is an audit risk as it suggests there could be bad debts that
have not been adjusted. This means that the receivables balance could be overstated, along with
the profit for the year.

The auditors response should be to perform analytical procedures on the receivables balance.
Inspect the aged receivables list and investigate any slow moving and old balances with the client to
decide if adjustments are needed. They should also review the allowance for receivables and
consider whether the balance is adequate.

5) They have revalued all land and buildings this year. This is an audit risk as the adjustment to the
land and buildings balance may not be in accordance with IAS16, the property plant and equipment
standard. The balance could now contain a material misstatement and the disclosure in the financial
statements on this could be inadequate.

The auditors response should be to compare the process of revaluation carried out by the client to
the IAS16 standard. This should be done by enquiry with the client management. They should
identify if an expert had been used to conduct the valuation.

b)

The auditor should perform the following on the inventory count for Recorder at the year end

- The auditors should attend a sample of the monthly inventory counts. While present, they should
review the controls over the count and ensure they are happy they are adequate;
- The could also consider attending the final month inventory count at the year end, June 2014. This
would enable them to test for potential misstatements by counting a sample of inventory in the
warehouse and agreeing to the inventory records. Then also for a sample of items on the inventory
records, find in the warehouse and recount and agree to what was recorded;

- The auditors should ensure that each product line has been counted at least once in the year. The
monthly count sheets should be reviewed and compared to the product list and any products not
included should be flagged up to the client.

c)

The auditors should perform the following procedures on the bonus in question:

- They should obtain a schedule of directors pay, including the bonus, and add it up to confirm the
accuracy of the balance.

- They should then agree the bonus in the schedule agrees to the payroll records by matching the
individual amounts for each director to the payroll system.

- The auditors should then confirm they have been paid these amounts by agreeing the individual
bonus amounts on the schedule to the bank statements and cashbook.

d)

Auditors must keep client information confidential as it is one of the Ethical fundamental principles
followed by the profession.

Where a conflict of interest is present, the auditors must inform both clients of the conflict and must have
agreement from both parties before they can continue.

Each client should be recommended that they seek independent advice before they continue.

If both clients agree, then the audit firm must ensure they have separate engagement partners, and
separate teams for the audit work to be completed. If possible, separate offices should deal with each
client.

The auditors who are involved on either team could also sign confidentiality agreements to reinforce the
importance of keeping client information confidential.

Other controls such as a focus on physical security of client information. Locking client files away and
encrypted passwords on computer systems should be in place.

Training on confidentiality and its importance would also benefit the audit firm.
 Amberjack Co - Answer
Part (a) – Control objectives for sales and dispatch system

 To ensure that goods are only supplied to customers with reasonable credit ratings.

 To ensure that goods are dispatched for all orders on a timely basis.

 To ensure that the correct quantity of goods are dispatched, and they are of an adequate quality.

 To ensure that all goods dispatched are correctly invoiced at authorised prices.

Part (b) – Report to management

Board of directors
Amberjack Co
21 Under the Sea
Shorelife City
Shark Country
1 July 20X5

Dear Sirs,

Audit of Amberjack Co for the year ended 30 April 20X5

The report to management on deficiencies in internal controls identified during the audit for the year
ended 30 April 20X5 is enclosed. The appendix to this report considers deficiencies in the sales and
dispatch system, and provides recommendations to address those deficiencies.

Please note that this report only addresses the deficiencies identified during the audit, and if further
testing had been performed, then more deficiencies may have been reported.

This report is solely for the use of management and if you have any further questions, then please do not
hesitate to contact us.

Yours faithfully

An audit firm

Appendix

Control Deficiency Control Recommendation

During the period of the secondment, an

The credit controller is currently on secondment to
alternative member of the finance department
the internal audit department, and has not been
should be trained in the credit control role and
replaced. During this period, it does not appear
assigned responsibility for reviewing the aged
that anyone else has been responsible for
receivables listing and following up on any
monitoring ageing receivables.
overdue customers.
Credit limits are set by receivables ledger clerks.
Receivables ledger clerks are not sufficiently
senior and so may set limits too high, leading to
irrecoverable debts.
Goods dispatch notes (GDN) are given the same
number as the order number to which they relate.
The sales invoices are only raised on receipt of a
GDN, and without separate sequential numbers, it
is difficult for Amberjack Co to identify if any GDNs
are missing. If GDNs are missing and the
company fails to raise invoices in a timely manner,
this could lead to a loss of revenue.
After order processing, the sales order department
of Amberjack Co does not receive a copy of the
GDN.
Additional staff has been drafted in to help the
sales clerks produce the sales invoices. As the
extra staff will not be as experienced as the sales
clerks, there is an increased risk of mistakes being
made in the sales invoices.
The receivables ledger control account is only
reconciled at the end of April in order to verify the
year-end balance. If the receivables ledger is only
reconciled annually, there is a risk that errors will
not be spotted promptly and receivables may be
misstated.
Customer statements are no longer being
generated and sent to customers. Disputed
invoices may arise, leading to cash flow issues.
Discounts given to customers who purchased
goods during the 10% off weekend are manually
entered onto the sales invoices by sales clerks.
This could result in unauthorised sales discounts
being given.
Credit limits should be set by a senior member of
the receivables ledger department and not by
receivables ledger clerks. These limits should be
regularly reviewed by a responsible official.
GDNs should all be sequentially numbered using
a sequence which is different to the order
number. On a regular basis, a sequence check of
GDNs should be undertaken to identify any
missing dispatch notes.
The GDN should be amended to be at least four-
part. One copy should be sent to the sales order
department.
Only the sales clerks should be able to raise
sales invoices. As Amberjack Co is expanding,
consideration should be given to recruiting and
training more permanent sales clerks who can
produce sales invoices.
The receivables ledger control account should be
reconciled on a monthly basis to identify any
errors which should be investigated and
corrected. The reconciliations should be reviewed
by a responsible official and they should evidence
their review by way of signature.
Amberjack Co should produce monthly customer
statements for all customers and send them out
promptly.
During the period of any special offers, such as
the 10% off weekend, the authorised sales prices
file should be updated by a responsible official.
These changes should be reviewed for any input
errors, this review should be evidenced.
 Freesia - Answer

a)
(i) Description (ii) Advantages
Narrative notes Document the system. They explain  Easy to produce
each stage of the system and any following discussion or
controls involved system walkthrough
 Easy to understand
Questionnaires A list of questions for major  Time effective; quick to
transaction cycles to determine compile
 What controls exist  Missing controls can be
clearly identified
 Effectiveness of those controls

b) Tutorial note: You are only asked for SIX deficiencies, more have been provided here for tuition
purposes.
Control deficiency
Credit limits are set by
junior staff
Inappropriate credit limits
may lead to loss of sales
(if too low) or bad debts (if
too high)
Non-sequential customer
orders; makes it hard to
identify missing orders
and track timeliness of
dispatch. Missing or late
orders may reduce
customer goodwill
Lack of segregation of
duties in the cash receipts
system. This reduces the
timely identification of
errors, and increases the
risk of fraud
GRNs are not sent to the
department that placed
the order, so level of
unfulfilled orders cannot
be monitored potentially
leading to stock-outs and
loss of sales
Lack of controls over
invoice input; existing
control verifies
Control recommendation
Credit limits should be set
by senior member of sales
department and reviewed
regularly
Orders should be numbered
sequentially and checked
regularly to identify missing
orders
Posting bank receipts,
updating the sales ledger,
and carrying out bank
reconciliations should be
carried out by different
members of staff
GRN copy should go to the
warehouse, the ordering
department and the finance
department
GRN should be matched to
the purchase order
Unfulfilled orders should be
regularly reviewed and
followed up with suppliers
Invoices should be input in
batches and application
controls e.g. control totals
Test of control
Ask sales ledger clerks
who is authorised to set
credit limits
Sample test authorisation
of credit limits for new
customers
Carry out a sequence test
of sales orders and discuss
gaps identified with sales
team
Ask the financial controller
who carries out these tasks
Check ID logs in the
finance system to
determine who carried out
the tasks
Sample check GRNs to
ensure match to orders
Review unfulfilled orders
and discuss any overdue
items with ordering clerk
Using test data, input
dummy invoice batch
without using control totals
 completeness, but not
accuracy or validity
Suppliers may be paid
late, the wrong amount, or
not at all leading to loss of
suppliers and/or supplier
credit facilities
Out dated standard costs
used to value inventory,
leading to misstated
inventory and profit
Valuation may not be in
line with IAS2 which only
allows standard costs to
be used if they are a close
approximation to actual
costs
Overtime not authorised
before payment
Incorrect amounts may be
paid, increasing the
payroll cost
Checking bank transfers
against payroll records will
not identify missing, or
fictitious employees.
Incorrect or fraudulent
payments could be made
as a result
should be in place to check
accuracy and completeness
of input
Sequence checks in the
system should be
established to check input
completeness
Standard costs should be
regularly reviewed and
compared with actual costs
to ensure they are a close
approximation
Revised standard costs
should be reviewed and
authorised by the
production director
Suitably authorised
individual should review
overtime payments prior to
payment
The finance director should
sample check the payment
list to the HR records and
vice versa when authorising
payments and sign the
payment list to evidence the
checks
to determine what the
system will allow
Observe the invoice input
process and note the
controls utilized
Determine the date at
which standard costs were
last reviewed, and ensure
this review was evidenced
by the production director
Sample check overtime
payments for evidence of
authorisation and ensure
this took place before
payment was made
Review payment lists for
finance director signature
confirming the checks have
been carried out

c) Substantive procedures to audit accrual for employment tax payable:

 Compare accrual to the previous year and investigate differences
 Confirm accuracy of accrual by agreeing it to payroll records
 For a sample of employees, re-perform the calculation of the accrual
 Proof in total text by multiplying the June 20X9 payroll cost by the appropriate tax rate.
Compare to accrual and investigate differences
 Confirm completeness by agreeing subsequent payment to post year-end cash book and
bank statements
 Review tax authority correspondence to determine if there are any outstanding payments
and confirm these are included in the accrual
 Review disclosures relating to the accrual to ensure they comply with accounting
standards and legislation

d) Corporate governance weaknesses and recommendations

Weakness Recommendation
The finance director is an audit committee, The finance director should resign from the
this compromises independence audit committee; the committee should

The finance director sets director’s salaries.
Inappropriately high pay may be set if
directors set their own salary
Annual profit related bonus may encourage
directors to focus on the short term profit
rather than long term maximisation of
shareholder wealth
Liaising with shareholders is carried out by
the chairman only
comprise exclusively of NEDs
Directors pay should be set by a
remuneration committee consisting of NEDs.
NED pay should be set by the board as a
whole
Executive remuneration should be
restructured so that a significant proportion is
based on long-term success, eg share
options
All member of the board should liaise with
shareholders.
The annual report should include a statement
from the board explaining the steps taken to
ensure the views of major shareholders are
understood
 Raspberry – Answer
a) i) Five key controls the auditor may seek reliance on
ii) Test of control to perform to assess these controls

KEY CONTROLS OF PAYROLL TEST OF CONTROL

i) ii)
Raspberry has a human resources Discuss with members of the payroll and HR
department, which is responsible for setting department what the process for setting up
up all new employees. new employees is and confirm this is carried
out by HR.
This control reduces the control of the
payroll department over employee
information. It is a segregation of duty and
reduces the risk of payroll fraud.

Standard pre-printed forms are completed For a sample of recently appointed employees,
for each new employee in the HR inspect the joiner forms and verify they have
department, which are then sent to the been completed fully and payroll received the
payroll department. form before adding to the system.

These forms will ensure the payroll

department receives all the relevant
information needed for the new employee.

Production employees are issued with Observe the process of clocking in and out for
clock cards and must swipe them at the employees. Verify that this is supervised by
beginning and end of their shift. This is security staff.
also supervised by security staff.

This control will ensure employees are paid

for the hours they attend work. It reduces
the risk of payroll fraud.

The clock card information is linked to the Using test data, input dummy clock card
payroll system and links in the hours information and verify this has been updated in
worked. the payroll system.

This transfer of information reduces the risk

of human input error when calculating the
employee pay.

Exception reports are produced on a Inspect the exception reports produced during
quarterly basis. These relate to any the year and identify if there is any evidence of
changes in standing data and are reviewed review by the payroll director, for example, a
by the payroll director. signature.

This control will ensure any unauthorised

changes are picked up on a timely basis
and investigated.

(Note that there are many other key controls in the scenario that could have also been
included)

b) Five deficiencies in the payroll system and provide recommendations

CONTROL DEFICIENCIES RECOMMENDATIONS

The production supervisors determine Bonus decisions should be made by a senior

the amounts for the bonus to be paid official. The production director would be ideal and
to production staff. They then inform base decisions on standard feedback. Any large
the payroll department. bonuses could be authorised by the board to ensure
decisions are made fairly.
They may lack objectivity in making
decisions on who gets paid and how
much is awarded. This could lead to
excess amounts paid to friends and
could lead to staff morale issues if
paid amounts not deemed fair.

The payroll system automatically The payroll team should be responsible for making
calculates gross, net pay and other checks to the system to ensure it is running
deductions, but these calculations are properly. Taking samples of deductions and
not checked. performing recalculations would be recommended.

There is a risk that calculations may

be incorrect, leading to over or
underpayments relating to payroll.

Raspberry get the employee to The payroll department should keep records on the
complete the student loan form from loans and deductions to be aware of when the loans
the government and make payments are paid in full. They should also ensure regular
automatically until the employee tells reconciliations are carried out on the information in
HR the loan has been paid. the payroll system and the loan statement sent by
the government.
This could lead to overpayment of
loans if the employee fails to inform
them the loan is paid up. There could
also be fines imposed by the
government if the information sent is
not correct.

Holiday forms are supposed to be No annual leave should be allowed without a

completed and authorised by relevant completed holiday request form. This must be
line managers, however, this does not authorised and a record of annual leave remaining
always occur. should be kept.

Employees may be able to take more

annual leave than is allowed. This
could lead to a shortage in production
staff available and economic loss to
Raspberry.

Management accounts are produced Management accounts should be reviewed in more

but there is no review of variances in detail. Wages and salaries should be compared to
wages and salaries as there are no budget, previous periods and the previous year. A
overtime costs. breakdown of costs for each department would also
be useful.
If variances are not reviewed, it could
lead to errors not picked up.
Evidence of unauthorised decisions
being made will go undetected.
 (There were more deficiencies in the scenario that could also have been included in your
answer)

c) Assignments the internal audit department could carry out.

Internal Audit departments can have a varied role within an organisation. Some of the
assignments that could be carried out by them include the following;

System review

Raspberry will need to ensure their systems are up to date to be efficient and maximise
productivity. Internal auditors can carry out regular reviews of the computer systems in place
and recommend any changes required on a timely basis.

Compliance

Raspberry operates an electric power station and therefore will have to adhere to laws and
regulations. Internal auditors can review these and ensure compliance to avoid fines and
negative press.

Value for money audit

This is where internal auditors can carry out an assessment on whether Raspberry is getting
the best value for money for specific areas of their business. They review the economy,
efficiency and effectiveness when carrying out this work.

Controls review

Internal auditors review the controls within systems to ensure they are sufficient enough to
reduce error and fraud. They could review the cash controls at Raspberry, as cash is used
to pay production staff.

Fraud investigations

Internal auditors are often best placed for special investigations such as fraud investigations.
They may be asked to investigate where there is evidence of fraud. With payroll control
deficiencies increasing the risk of fraud, they can look at controls to reduce this risk for
Raspberry.

d) Substantive procedures to perform on year-end accrual for tax payable on

employment income.

Agree the accrual shown in the financial statements to the payroll records and supporting
client workings to confirm accuracy of balance.

Agree the amount to post year-end bank statements to confirm accuracy and completeness
of accrual.

Recalculate the accrual balance and investigate any significant differences to confirm
accuracy.

Compare the accrual to last years accrual balance and investigate significant differences,
verifying completeness and accuracy.
Inspect correspondence from the tax authorities to assess if there are further amounts to be
included relating to outstanding liabilities, verifying completeness.
 Murray Ltd - Answer
a)

Control Environment - This is the attitude and awareness of the management of the client company. It is
a question of how much importance is placed by them upon having a sound system of internal control.

Risk Assessment Process - This is the way in which the management of a company identifies the risks
that are relevant to its operations and the way in which these risks are addressed.

Information Systems - This is all the business processes that are relevant to reporting and
communication. It includes both automated and manual systems.

Control Activities - These are the individual policies and procedures to ensure that management
processes are carried out effectively.

Monitoring - All activities should be reviewed to ensure that they are operating effectively. If they are not,
then changes will need to be made.

b)

Sales order

Control objectives

To ensure that all orders are processed.

To ensure that goods are only supplied to customers who will pay on time.

Control activities

All sales orders should sequentially numbered.

A creditworthiness check should be carried out on all customers before the order is processed.

Sales despatch

Control objectives

All orders are despatched.

Good quality goods are despatched to customers.

Control activities

All despatches should be matched against orders before they are sent out.
All goods despatched should be quality control checked before they are sent out.

Sales invoicing

Control objective

Sales are recorded at the correct price.

Only valid, authorised sales are recorded.

Control activity

Invoice prices/values are agreed to an authorised price list.

Sales invoices are matched with authorised despatch notes.
This is not much volume for 12 marks, but the most important thing, with an answer such as this, is to be
brief and relevant. Also, only pick something as a control objective if you can think of a related control
activity - no good having one without the other !

c)

 Purchase orders are raised by a number of different staff members. This will mean that it is
difficult to confirm who is ordering what. Some things may get ordered twice, whereas other
items may not get ordered at al.

 There is no central ordering system. This means that Murray is unlikely to be able to take
advantage of any discounts that may be available for purchasing in bulk. Company costs will be
high as a result.

 Orders are handwritten. There is no mention of any sequential numbering which means that
orders may get lost - there may be a completeness issue.

 Not all goods received are not checked against the original order when they are received. This
could mean that the wrong goods are accepted into inventory.

 Goods received are not checked for quality before they are put into inventory. This results in
damaged goods being accepted into inventory.

 The goods received notes do not appear to be sequentially numbered. This will result in a
completeness problem; some goods received may get lost or not end up being recorded.

 The invoice prices / values are not checked against a price list. This could result in the wrong
amount being charged for goods.

 Nobody checks that the invoice has been coded correctly. This could result in misallocation of
expenses.

 The accounts clerk is able to create new suppliers in the purchase ledger. They may create a
fictitious one, or order goods from an unreliable supplier that is of poor quality.

 There is a lack of segregation of duties; the accounts clerk is involved in far too many stages of
the system with no one checking their work. This includes actually authorising the payments.
This will mean that errors or deliberate misappropriation will not be identified.

d)

All weaknesses that are found during the normal course of an audit need to be presented, with a
covering letter, in a report to management.

The covering letter will emphasise that the auditors have not found all existing weaknesses, they are just
highlighting any that they have come across as a result of their normal audit work.

The normal format for the weaknesses themselves is;

- Weakness.
- Consequence.
- Recommendation.

The covering letter will usually request a response from the client management, so we have an idea as
to what they are likely to do about the points raised in the letter.
 Becker Ltd - Answer
a)

Weakness Consequence Recommendation

The ordering system could be

Orders are manually This could be a completeness
integrated with the inventory and
transferred onto the problem because orders may
sales system, thus removing the
computerised system. get lost.
need for a manual transfer.

This will increase the risk of
Each order is given a random
lost orders so some customers
code.
may never receive their goods.
A numerically sequenced
number should be automatically
allocated to each order as it is
received.

The credit/debit card should be

The customer's credit/debit charged as soon as the order is
Card details may be wrong, or
card is charged AFTER the taken, or at least the future sale
false, meaning some good may
goods have already been should be authorised at this point
not end up getting paid for.
despatched. by confirmation with the card
company.

It should be a three part form

If there is a problem with an that is used so that one copy can
No copy of the Packing list is order, then the warehouse staff be filed in the warehouse for use
kept in the warehouse. has no way of checking the to rectify any potential problems
original order details. with the order.

The accounts department do A sales invoice should be raised

not appear to raise a sales Sales income may not be at the point when the accounts
invoice when they receive recorded. department are notified of the
notification of despatch. goods being despatched.

b)

The covering letter should say that the weaknesses included are the ones that were identified during the
normal course of the audit.

It should clarify that it does not include all of the weaknesses that may exist, just the ones that have
come to light in the audit.

It should also include reference to the fact that a response would be useful, so that we can confirm
whether or not the problems will still exist next year.

It should also include a disclaimer stating that we accept no responsibility for any unidentified
weaknesses.

c)

Benefits of an internal audit department

The overall control environment of the client will be stronger which would increase auditor and
shareholder confidence.
The internal control system will be more effective an able to identify control weaknesses more efficiently.

External auditors may be able to use and rely on the internal audit work in order to reduce the external
audit fee.

The internal audit function could save the client money be suggesting a series of controls that could
boost revenue and/or cut costs.

The directors of the client may improve their performance if they believe that their work will be monitored
more closely by an internal audit function.

d)

Audit committee responsibilities

 Directing and monitoring the work of the internal audit department

 Increasing the level of communication and co-operation between internal and external auditors

 Monitoring the activities of the executive directors and even disciplining them if they are doing
things that are worthy of such action

 The establishment of various sub committees, such as a Nomination committee and a

Remuneration committee
 Nadal Ltd - Answer

a) b)

Weakness Control Activity

The site foreman should observe the clocking
Employees can get someone else to clock them in
in/out procedure on a random basis.
because there is no control over the process.
The foreman at each site can create fictitious
The issue of new employee numbers should be
employees by taking advantage of the fact that they
authorised by a senior member of staff at head
can create temporary numbers.
office.
Overtime is automatically calculated by the
All overtime should be authorised and checked
computerised system so could be subject to error.
for accuracy before payment.
The two staff in the wages department can make
changes to the data for illness and holiday with no
All changes to holiday and sick pay should be
one checking their work so errors could go
authorised by a senior manager.
unidentified.

No confirmation is done on any of the calculations

carried out by the computer in respect of gross pay, A selection of calculations and deductions
net pay and deductions so errors may be made and should be confirmed by a member of the wages
not spotted. staff on a regular basis.

The computer system could produce a printed

The pay packets include a handwritten confirmation payslip to reduce the chances of errors being
of gross pay which may be inaccurate. made.

Each foreman is responsible for the distribution of

the wage packets so could misappropriate any
uncollected packets.
Cash being delivered in large quantities on a regular
basis to a number of sites increases the risk of loss
or theft, even if it is by secure courier.
Two people should distribute the pay packets
and any uncollected wages should be returned
to head office.
Nadal Ltd should actively encourage as many
employees as possible to be paid by direct
transfer into a bank account.

c)

Nadal Ltd should try to use a consultant who has a good reputation for a high quality of service.

They should go for someone who has relevant experience in designing systems for the construction
industry and the specific problems with having lots of employees that are mostly paid in cash.

Nadal Ltd should, ideally, find someone who is qualified as a computer software designer or a company
that has a lot of experience in selling bespoke packages to the construction industry.

Nadal Ltd would have to consider the fee level. On one hand, they may want a very competitive fee.

Alternatively, they may be willing to pay a higher price in order to try and guarantee a high quality
service.
Nadal Ltd may also wish to appoint a company that would be able to provide them with a number of
other services as well. This would be a quick and easy solution to a number of specialist issues that can
be dealt with “under one roof ".

It would also be essential to establish the legal situation with any software licence that will be required,
how long it will last and what kind of support will be available.

d)

Self interest

We may be tempted to recommend a software package that will make the audit easier and not one that
necessarily suits all of the client's needs.

Self-review

We may end up reviewing the system that we suggested should be adopted by the client - this is quite
likely to be what happens during the normal audit work.

Management

If we actually select the computer package for use by the client, then we will be making a decision that
should be made by the client's management, not us.

Increased negligence

We may over rely on the new system (we recommended it so it must be right) so the quality of our work
would suffer and the risk of being sued for not doing a decent quality audit would increase.

e)

- External auditors have no specific responsibility for the prevention and detection of fraud.

- They do, however, have to make sure that the audit work that they carry out gives them a
reasonable chance of finding MATERIAL fraud.

- To summarise, if a small fraud is missed we are ok but if we miss a big one then we are not
doing our job properly.

- Internal auditors are part of the client's system of internal control.

- One of the responsibilities of every client is to design a system of control that will prevent and
detect fraud.

- An internal audit function is a direct attempt to achieve this because internal auditors will test
controls and, potentially, uncover fraud.

- To summarise, internal auditors DO have a duty to prevent and detect fraud - it is assigned to
them by the client management by appointing them and directing their work.
 Cherry - Answer
Cherry Blossom Co’s (Cherry) purchasing system deficiencies and controls
Deficiencies
Requisition forms are completed by production
supervisors but are not authorised. This increases
the risk of fraudulent purchases, or of goods being
ordered which are not required, leading to
unnecessary cash outflows.
Orders are being placed for goods without the
inventory levels being checked first. This could
result in goods being ordered which are not
required, leading to unnecessary cash outflows.
In addition, as the company does not currently
monitor inventory levels, it could experience
stockouts resulting in the company being unable to
meet customer orders.
The purchase ordering department maintains an
approved supplier list; however, this has not been
updated for 24 months. As this list has not been
recently updated, the suppliers being used may
not be ideal with regards to price, quality and
delivery times. This could result in Cherry paying
increased costs for raw materials or receiving
poorer quality goods.
Controls
Requisition forms should be authorised by the
production manager or director prior to being sent
to the purchase ordering department. This
department should not process any unauthorised
requisitions.
The inventory system should be updated to record
minimum/maximum required levels of raw
materials. When completing the purchase order,
the ordering clerk should check the current level of
inventory on the system and only order if the
quantity is within the set parameters.
The company should set minimum authorised
reorder levels for inventory items.
The approved supplier list should be reviewed and
updated as necessary. Going forward, it should be
updated regularly, at least on an annual basis
 Knowledge - Answer
a)

A value for money audit is one of the many services that can be provided by the internal auditor. This
type of work is concerned with ensuring the entity makes decisions within the business that achieves
their overall objectives.

Examples include making decisions on suppliers to use, increasing credit terms to customers and
expanding their product range.
These decisions may have many benefits, but the business must consider whether there are any
drawbacks and whether these drawbacks outweigh the initial benefits.

Therefore the internal auditors can conduct a value for money audit. This looks at getting the best
possible service for the least resources. It is otherwise regarded as a review of the 3 E’S

The 3 E’s stand for:

- Economy. To review economy is to obtain the best quality of resources for the least amount of cost;
- Efficiency. To review efficiency is to gain the maximum output with minimum resources needed;
- Effectiveness. To review for effectiveness is to look at whether the project will achieve the
company objective or goal.

b)

ISA 230 is the auditing standard that tells us what is needed in terms of audit documentation and why
they should do it.

Here are a few ideas of the benefits:

- By recording evidence in the audit file, it proves that the auditor did the work. It makes them
accountable for their work;
- This then gives evidence that they followed the auditing standards and any other relevant laws and
regulations. It proves the work was completed in detail in case there was ever a need to prove it;
- The evidence documented will assist when forming the independent opinion on the financial
statements at the end of the audit process. As we know, audits can take a long time to complete
with a lot of detail to cover. The audit supervisors will need to review the work, and by having
documented audit work they will be able to assess what has been done and whether it is enough;
- Documentation will also assist the engagement partner. They will need to form the opinion on the
financial statements at the end of the audit process. They will, therefore, benefit from a review of
the completed audit work and notes regarding issues found during the audit when making this
important decision;
- By keeping a record of the work completed, the evidence obtained by the auditors and the
conclusions drawn from the work, it will assist with future audits. The following year’s audit team
will be able to review the work when planning what to do for their current year.

c)

Audit sampling is defined in ISA 530. The official definition is that sampling is ‘the application of audit
procedures to less than 100% of items within a population of audit relevance, such that all sampling units
have a chance of selection in order to provide the auditor with a reasonable basis on which to draw
conclusions about the entire population’.

The need for sampling is largely because they cannot possibly test every single transaction for every
audit. For a large number of statutory audits, there are too many transactions and therefore the auditor
must choose a sample to decide if there could be a material misstatement present in the balance. If
misstatements are found, the auditor will very often go on and increase the sample to test if there could
be a larger problem in the balance.

The other reason is that the auditor is not expected to provide absolute 100% assurance on the financial
statements. Remember they are supposed to provide reasonable assurance which required a high level
of detailed work in forming a conclusion. This does not expect them to look at every single transaction.
 Spadefish & Co - Answer
Part (a) – Exceptions in the receivables circularisation

The following procedures should be performed to resolve the exceptions:

Albacore Co

 With the client’s permission, the team should arrange to send a follow-up circularisation for
Albacore Co.

 If no response is received, then with the client’s permission, the auditor should telephone the
customer and ask whether they are able to respond in writing to the circularisation request.

 If there is still no response, then the auditor should undertake alternative procedures to confirm
the balance owing from Albacore Co. For instance, by agreeing to sales invoices to goods
dispatched notes (GDN).

Flounder Co

 With a difference of $5,850, the auditor should identify any disputed amounts, and identify
whether these relate to timing differences or whether there are possible errors in the records of
Triggerfish.

 If the difference is due to timing, such as cash in transit, this should be agreed to post year-end
cash receipts in the cash book.

 If the difference relates to goods in transit, then this should be agreed to a pre year-end GDN.

Menhaden Co

 The reason for the credit balance should be discussed with the credit controller or finance
department to understand how a credit balance has arisen.

 Review the payables ledger to identify if Menhaden is a supplier as well as a customer; if so, a
purchase invoice may have been posted in error to the receivables rather than payables ledger.

 If the difference is due to credit notes, this should be agreed to pre year-end credit notes
dispatched around the year-end date.

Part (b) – Substantive procedures for allowance for trade receivables

 Inspect the aged trade receivables ledger to identify any slow moving, and discuss the status of
these balances with the credit controllers to assess whether they are likely to be received.

 Review whether there are any after-date cash receipts for identified slow moving/old receivable
balances.

 Review customer correspondence to identify any balances which are in dispute or are unlikely to
be paid and confirm if these have been considered when determining the allowance.

 Inspect board minutes to identify whether there are any significant concerns in relation to
payments by customers and assess if these have been considered when determining the
allowance.
Part (c) – Going concern indicators

Some suppliers have been paid considerably later than usual and only after many reminders; hence
some of them have withdrawn credit terms meaning the company must pay cash on delivery. This
suggests that the company was struggling to meet their liability as they fell due and will also put
significant additional pressure on the company’s cash flow.

Marlin Co’s main supplier who provides over 60% of the company’s specialist equipment has just
stopped trading. If the equipment is highly specialised, there is a risk that Marlin Co may not be able to
obtain these products from other suppliers which would impact on the company’s ability to trade.

The overdraft has grown significantly during the year and is due for renewal within the next month. If the
bank does not renew the overdraft and the company is unable to obtain alternative finance, then it may
not be able to continue to meet its liabilities as they fall due.

Part (d) – Going concern procedures

 Evaluate management’s plans for future actions, including their contingency plans in relation to
ongoing financing and plans for generating revenue, and consider the feasibility of these plans.

 Review the company’s post year-end sales and order book to assess if the levels of trade are
likely to increase and if the revenue figures in the cash flow forecast are reasonable.

 Review any agreements with the bank to determine whether any covenants have been
breached, especially in relation to the overdraft.

 Review any bank correspondence to assess the likelihood of the bank renewing the overdraft
facility.

 Review post year-end correspondence with suppliers to identify if any have threatened legal
action or any others have refused to supply goods.
 Hyacinth Co - Answer
a) Inventory valuation (note only six needed to score full marks)
 Sample check WIP from inventory count to WIP schedule to check correct percentage
completion is recorded at inventory count
 Sample check of inventory items back to relevant cost sheets: invoices, time sheets and
overheads
 Review post year-end credit notes for returns that could indicate a write down is required
 Sample check cost of year end-finished goods with post year-end sales invoices to
determine if NPV is above cost or if adjustment is needed.
 Determine the basis of WIP valuation and assess reasonableness
 Identify slow moving inventory from aged inventory reports and enquire why they have
not been written down, or if allowance required
 Review board minutes and discuss with management the plans for selling defective batch
of Crocus and how the NPV of $90,000 was determined
 Confirm the value of the final adjustment for the damaged product, ask if the adjustment
has been made and follow through any write down to confirm

b) Research and development (note only four needed to score full marks)
 Determine the rationale for the 4 year useful life and assess reasonableness
 Agree closing balance from schedule of intangible assets to general ledger, trail balance
and draft financial statements
 For a sample of intangible assets, recalculate the amortisation charge and ensure it is
line with amortisation policy
 Discuss the stage of development of the new computer software projects and whether it
has been capitalised or expensed
o Agree costs for any expensed as research to invoices and to inclusion in profit or
loss
o Agree costs capitalised as development to invoices
 Confirm the ability to sell the product once complete and probable economic benefits
against market research reports
 Review intangible asset disclosures in the financial statements and confirm in
accordance with IAS 38

c) Sales tax liability (note only four needed to score full marks)
 Agree sales tax liability in trial balance to tax return
 Agree quarterly sales tax charged to 15% of last quarter sales Recalculate amount
payable to tax authority (sales tax charged – sales tax incurred)
 Compare year-end sales tax liability to prior year. Investigate significant differences
 Agree subsequent payment to post year-end cash book and bank statements
 Review correspondence with tax authority for outstanding payments. Ensure any
outstanding payments included in year-end liability
 Review disclosures to ensure sales tax is shown as a current liability and is in line with
accounting standards

d) Subsequent event
(i) $0.7m of inventory has been damaged in a flood that occurred after the year end. The
event is non-adjusting as it does not provide evidence of condition at the year end.
The inventory has no scrap value, and the directors do not expect to be able to claim for
it on insurance.
$0.7m is 10.9% of profit before tax and 3% of total assets, therefore this is material.
Material non-adjusting events do not need to be written down to zero in this financial
year, but the directors should disclose the details of flood and value of assets lost in a
note to the accounts.
(ii) Audit procedures:
 Agree net book value of damaged property, plant and equipment (PPE) to the
non-current asset register
 Physically inspect the damaged inventory
 Agree original costs of inventory to schedule of damaged inventory
 Review the condition of other PPE and inventory to ensure all damaged items
have been identified
 Discuss with management the basis of zero scrap value assessment
 Determine why management don’t believe they can claim on insurance. If a claim
was made, only the uninsured amount would need to be disclosed, which may
not be material
 Determine intention of management in relating to disclosing the event in the
notes to the financial statements
 Jasmine Co - Answer

Part (a)
Substantive procedures in relation to trade receivables

Obtain the aged receivables list. Add up to agree the total. Agree the total to the sales ledger control
account and trial balance to confirm accuracy and completeness of document.

For a sample of outstanding amounts from receivable customers on the ledger at the year-end, agree
the amount has been paid by tracing to the bank statements and investigate non-payments with the
client.

For a sample of GDN’s just before and after the year-end, agree to the sales invoice and ensure it has
been recorded in the correct accounting period.

Inspect the aged receivables list. Identify very old or slow moving accounts and investigate whether
adjustments are required with the client.

Calculate receivables days’ ratio for this and the previous year. Investigate significant differences with
the client.

Part (b)
Substantive audit procedures in relation to bank balances

With the permission of the client, write to the bank and request a bank report or letter confirming the
bank balances held by the client at the year-end.

Agree the bank accounts on the bank report with the trial balance and general ledger to confirm all bank
accounts are included in the accounting system and the total agrees with the balance in the financials
statements.

Obtain a copy of the bank reconciliation statements at the year-end and add up to confirm the totals
agree.

Agree the balance per the cashbook to the balance on the general ledger and trial balance.

For unpresented cheques listed in the bank reconciliation, agree the amounts to the cashbook and
ensure they were recorded before the year-end. Also agree the amounts have since cleared in the bank
account by inspecting post year-end bank statements.

Part (c)
Going concern procedures for Jasmine

Inspect bank correspondence for evidence of disputes or details of the bank overdraft review coming up
which could indicate cash flow problems.

Obtain the cash flow forecast. Conduct a detailed review of the content and assess the assumptions
made to ensure they appear reasonable. Discuss any issues with the client.

Discuss with the client management any plans they may have for managing the financing for the
company and inspect the board minutes since the year-end for evidence of any plans that may have
been discussed.

Inspect customer and supplier correspondence for evidence of disputes, which could lead to a loss in
customers or problems with production.
Inspect the management accounts since the year-end. Also inspect sales orders received since the year
end and compare to the previous year to assess whether sales volume is consistent or lower than
previously and if performance looks likely to aid Jasmine in improving their cash flow levels.

(d)
The outcome of the overdraft review is not going to be known before the audit is finalised and if it is not
reviewed this could have a significant impact on Jasmine’s future. We therefore have a material
uncertainty relating to going concern. This will affect the audit report whether they have disclosed
correctly or not.

If the disclosure is adequate, the opinion will be unqualified as the financial statements show a true and
fair view. However, the auditors have an obligation to draw attention to the issue.

They will therefore modify the audit report to include an additional paragraph section in the audit report
headed ‘material uncertainty relating to going concern’. This will make reference to the disclosure to
ensure the users are aware of how important it is.

If the disclosure is inadequate, the auditors will not be satisfied that the financial statements are showing
a true and fair view. They will modify the audit report by qualifying the audit opinion.

The outcome of the review is uncertain and so they would state that the issue is material but not
pervasive. They will therefore include an ‘except for’ opinion to ensure the users know that the rest of
the financial statements are true and fair except for the inadequate disclosure on this issue.
 Camomile – Answer
a)
i)

It is important for auditors to communicate throughout the audit with those charges with
governance for the following reasons:

Those charged with governance are responsible for the organisations financial reporting. If there
is anything specific that requires explanation regarding the client records or operations, they are
best placed to assist the audit team in understanding the entity.

By assisting the audit team it helps those charged with governance show evidence of their
responsibility for financial reporting matters.

ii)

Two examples of matters that the audit team may communicate are:

Any key audit risks that have been identified at the planning stage

Any significant matters such as material accounting adjustments that have been discovered
during the course of the audit.

b) Deficiencies in cash receipts and payments system

CONTROL DEFICIENCIES CONTROL RECOMMENDATIONS

The petty cash float is held at each of the
venues. To purchase sundry items,
employees get money from the tin and
then return any change and the receipt
back to the restaurant manager.
There should be a petty cash book kept
with details of amounts spent, description
of goods and name of employee.
Receipts should be kept for all expenses
and referenced in the book.

It is likely that mistakes will made and

purchases could be for non-business
expenses.

It has been noted by the internal audit
team that on some occasions the petty
cash float and receipts do not equal
$400.
If this is not regularly controlled it could
indicate money not being returned to the
tin after a purchase or receipts not being
handed in.
The petty cash float should be reconciled
on a regular basis, ideally weekly to
ensure the float and receipts agree to
$400. If there is a discrepancy, this
should be investigated that week to
increase the chance of errors being
resolved.

There is one log code for each of the five
tills in a restaurant.
There is no way of identifying the
employee taking the payment with this
Each employee should have his or her
own log in for the till. No payments
should be allowed to be taken without
using their own code.
system, which would make fraud easier
to carry out and not be detected.

At the end of the day the manager counts Despite it being a slower process, each till
the total cash and credit card vouchers should be reconciled individually and the
for all of the tills together. restaurant manager should investigate
discrepancies.
This would make it very difficult to identify
which till contained an error if differences
were found, increasing the risk of fraud.

The restaurant manager is the only 2 people should carry out this process.
person counting the till takings each day. By sharing this responsibility they can
check each other’s work and reduce
There is an increased risk of human error errors.
in recording this information. There is
also an increased risk of fraud as there is
no segregation of duties.

Cash is stored in safe at the venues, The safe should be locked by a code,
which is locked by a key, which is kept in which is only known to those authorised
the drawer of their desk. to have it.

There is an increased risk of the key

being lost or accessed by someone not
authorised, which could lead to theft.

They receive monthly credit card There should be a monthly reconciliation

statements for the 6 venues, which is
filed by the cashier.
There is no evidence that these
statements are reviewed against the
records held by the restaurants, which
could lead to payments to the restaurants
missing, and not detected.
of the credit card statements to the
vouchers. The amounts on the statement
should then be agreed to the bank
statements to ensure they have been
received.

The bank reconciliation is carried out
every 2 months.
This is not on a timely basis. Differences
detected may not be resolved easily
which could be due error or fraud.
The bank reconciliation should be carried
out on a monthly basis. It should also be
reviewed by someone senior and proof
shown such as a signature and date on
the reconciliation.
 Cranberry – Answer
a) Substantive audit procedures in relation to research and development expenditure

Obtain a breakdown of the research and development costs including the opening, closing
balances and additions amounting to $1.9m and cast to confirm accuracy.

Agree the closing balance to the trial balance, general ledger and financial statements.

Enquire with management, which of the nine new health and beauty products have been
completed and production commenced. Also, obtain details of the stages of development the
remaining projects are at present.

For research amounts expensed, agree to invoices and supporting documentation and ensure
they have been posted in the profit and loss.

For development costs, agree to invoices and supporting documentation and agree they are
allowed as per IAS38 by discussing with management and reviewing the standard.

b) Substantive audit procedures in relation to depreciation of property plant and equipment

Discuss with management and obtain evidence from them to explain why the change in
depreciation was made.

Review typical industry depreciation rates, useful lives of assets etc. and compare them to the
revised rates that have been introduced by Gooseberry. Discuss significant differences with
management.

Obtain a list of disposals made by them in the year. Recalculate the profit or loss on disposal
and review whether; based on the amount calculated, a change in rates is reasonable.

Inspect the non-current asset register and review the depreciation information to ensure the
revised rates have been applied.

Select a sample of assets and recalculate the depreciation charge and agree this to the amount
included in the asset register.

c) Substantive audit procedures in relation to the Bonus

Obtain a breakdown of the bonus payments made to the directors and recalculate them and add
up schedule to confirm accuracy.

Agree the director bonus payments to the payroll records and bank statements.

Inspect each director service contract to confirm the bonus entitlement agrees with what has
been paid.

Inspect the board minutes to confirm the board agreed the amounts.

Review the financial statements for disclosures relating to the bonus and assess with this is in
compliance with local legislation requirements.

d) Impact on audit report

The $440k does not meet the requirements of IAS38 currently and therefore should not be
shown as an intangible asset, and should be expensed.

This leaves assets currently overstated by $440k and profit overstated by this amount also.

This amounts to 6.9% of profit and 1.2% of net assets, which we can conclude is material to the
users of the financial statements.

If unresolved, the auditors would need to modify the audit report due to a material misstatement.

The matter is material not pervasive and therefore the audit opinion should show a qualified
except for opinion.

The basis for opinion paragraph should then include details of the misstatement. This would be
shown under the opinion paragraph.
 Pearl Ltd - Answer
a)

Inspection - This can either be physical inspection or the inspection of a document.

Observation - This is watching someone else do something, normally a member of the audit team will
watch a member of the client staff carrying out some kind of procedure.

Inquiry - This is when some kind of question is asked, usually a member of the member of the audit
team asks a member of the client staff, but it can be an external enquiry.

Confirmation - This usually means some kind of direct confirmation with a third party. It is normally
requested in written form.

Recalculation - As it sounds, this is when an auditor checks a computation that someone else
produced.

Re-performance - Instead of redoing a calculation, this is when a task is re-performed.

Analytical Procedure - This is a comparison between two groups of data with a view to identifying
either a consistency or inconsistency. Any unexpected relationship or inconsistency is then investigated.

b)

Inspection

We could inspect a sample of non-current asset purchase invoices to confirm the dates of acquisition.

We could inspect the plant register to confirm that all acquisitions of non-current assets are recorded
promptly.

Observation

We could observe a member of the client's staff updating the plant register for a new asset that was
acquired during the year.

We could observe the non-current asset count (like an inventory count) that should be carried out
periodically by the client's staff.

Inquiry

We could ask the client management to confirm the reasonableness of the chosen depreciation policy.

We could ask the client management to confirm whether and company assets are held on the premises
of any other companies.

Confirmation

A direct confirmation from the bank could be obtained in order to confirm whether any of the company
assets have charges over them that relate directly to any bank loans.

We could obtain direct confirmation form an independent, professional valuer to confirm the
appropriateness of a valuation for any item of Property, Plant and Equipment - usually done for land or
buildings, but can be done for any non-current asset.

Recalculation
We could recalculate the amount of depreciation that has been charged on a sample of non-current
assets to ensure that it is in accordance with the stated policy.

We could recalculate the total for the plant register total for accuracy.

Re-performance

We could select a sample of items included in the non-current assets count that was carried out by the
client staff, and then agree them to the physical asset, thus re-performing something already done by the
client.

We could re-perform an analysis of expenses that should already have been done by the client in order
to make sure that no capital items have been missed.

Analytical Procedure

We could compare the replacement policy adopted by Pearl Ltd with other similar companies.

We could carry out a global proof of depreciation. This involves recalculating the total amount of
depreciation for one category of Property, Plant and Equipment and comparing it to the stated policy.

This question is really good practice for applying the methods of obtaining evidence. More practice could
be obtained by using b) as a basic template and just swapping Property, Plant and Equipment for any
other area of the financial statements.

c)

We can obtain a management representation to confirm that the management of Pearl Ltd believe the
policy to be a reasonable one.

We can compare the policy that has been adopted by Pearl Ltd with other companies who use similar
assets in a similar way to confirm some kind of consistency.

We can inspect the plant register to establish the frequency with which items are replaced. If items are
replaced every three years but depreciated over, for example, five years, then we know that the policy is
not reasonable.

We can review the levels of profits and losses that have been recognised in respect of any asset
disposals. If they are large, then that will suggest that the depreciation rates are either too high or too
low.

We can look back at previous years to confirm that a consistent rate is being used. Too many changes
can suggest profit manipulation by using very high, or low rates, depending upon what profit level the
company wants to achieve.

d)

If a plant register is not maintained, then that means a lack of normal audit evidence that should really be
available.

The plant register is an accounting record and it is the duty of the client's management to maintain one.

The audit report would be modified by including a qualified opinion on the grounds of a lack of evidence.

It would not be serious enough to merit and adverse opinion because it is an isolated issue.
An explanation of the reason for the qualified opinion would be included in the basis of opinion which
would be included immediately after the opinion itself.
 Tickam Ltd - Answer
a)

Procedures for sales

 Compare this year's sales with the previous year's figure and ensure that any significant
fluctuation is explained.

 Compare month by month sales figures for this year and last year and investigate any unusual
trends.

 Obtain a sample of telephone and e mail orders and ensure that they are sequentially numbered
for completeness.

 Observe the client's staff giving verbal confirmation of orders by telephone.

 Select a sample of orders from the VMS and ensure that there are either email confirmations
sent to customers or that there is a record of a telephone confirmation instead.

 For a sample of orders recorded in the VMS, ensure that there is a sales invoice to accompany
it. This will confirm that all orders have been invoiced.

 Select a sample of sales invoices and confirm that they are sequentially numbered and that none
are missing. This will help verify that sales are not understated.

 Agree a sample of sales invoice prices to the standard price list to ensure that the sales valuation
is correct.

 Select a sample of sales invoices and perform any necessary recalculations on price, quantity,
sales tax etc to confirm mathematical accuracy.

 Consider using test data to interrogate the client's VMS system. We could try inputting some
orders that we have generated to see if they are processed correctly. This will confirm that the
VMS system is operating effectively.

 Some of the orders that are input should be designed to be rejected (perhaps a negative quantity
or an order for a 5- year hire) to see if the system will perform as expected.

 We should select a sample of orders and trace them through to the receivables ledger to ensure
that the receivables figure is complete.

 We should carry out a cut off test. A sample of orders from just before the year- end should be
selected and traced through to the sales invoices and the receivables ledger to ensure that they
are recorded in the correct accounting period.

 This should also be done with a sample of orders from immediately after the year end as well
with the same objective.

 We should inspect sales credit notes issued just after the year end to ensure that there is no
“window dressing". This is when the sales for the year are inflated by creating dummy invoices at
the end of the year and then reversing them with a series of credit notes at the beginning of the
following year.

 A large number of sales credit notes in the first month of next year could suggest that this is
happening.
b)

Procedures for Vehicles

 Things like using an expert, management representations and looking at board minutes have
been avoided here. They are valid IF they are used sparingly and a specific reason for each is
given.

 Compare the carried forward value for vehicles in last year's financial statements with the
brought forward figure used this year to confirm a correct starting point.

 The purchase invoices relating to new vehicles should be inspected to confirm the initial value of
the items.

 The dates on the invoices should also be confirmed to ensure that the items are recorded in the
correct accounting period.

 The figure for vehicles in the financial statements should be agreed back to the total for vehicles
that is in the plane register.

 A sample of vehicles should be physically inspected to confirm their condition. This helps with
confirmation of valuation as well (useful economic life ).

 A sample of vehicles should be physically inspected and traced back to the plant register. This
will ensure completeness.

 The same test should be done in reverse. A sample of vehicles should be selected from the plant
register and then the physical asset should be identified. This helps to confirm existence.

 A sample should be selected from the plant register and the depreciation calculation should be
re-performed to ensure accuracy.

 It should also be confirmed that these depreciation expenses are in line with the policy stated in
the financial statements of Tickam Ltd.

 A sample of sales invoices, relating to any disposals that occurred during the year, should be
selected and then we should confirm that these items have been removed from the plant
register. This will help verify that vehicles are not overstated.

 We should confirm the existence and the details of vehicle registration documents (VRDs) for
sample of vehicles. The VRDs will verify rights and obligations (ownership).

 We should review any profits or losses on disposal for the year. If the profits or losses are large
that may suggest valuation problems because the depreciation rate used is not reasonable.

 Another rights and obligations test would be to inspect repair and maintenance records, as well
as insurance documentation for all vehicles. Both should exist for all vehicles because they are
normal ownership expenses.

 We could compare the useful economic lives used by Tickam Ltd with other similar companies to
ensure that they are reasonable.

 We could inspect the plant register to identify how frequently the vehicles are being replaced and
then agree this to the depreciation policy, to ensure that it is reasonable.
 Mast Ltd - Answer
a)

It minimises the amount of disruption at the year-end by allowing inventory counting to be done all the
way through the year instead.

Due to the value of inventory being readily available all through the year, it will enable companies to
maintain greater control over the inventory level and value.

Any errors can be identified and corrected much quicker.

Slow moving and obsolete items can be identified much more quickly so the risk of a loss in value will be
minimised.

It may reduce the amount of work that external auditors have to do because they can rely on the system
instead of having to test it. This could cut the external audit fee.

b)

Procedure Reason

Review the results of the inventory checking To confirm that the work has been done to a
that has been carried out during the year by the decent level and can be relied upon by the
internal audit department. external auditors.

Observe an inventory count in progress. To ensure that the count is done in accordance
with the stated instructions.

Follow up on any errors and discrepancies that To ensure that errors are corrected so that the
are identified by the count procedures. process is effective.

Whilst observing a count, select a sample of This is helping to ensure existence of the
items that are on the inventory system and inventory that is recorded.
agree the physical existence of that inventory.

Perform the same test in reverse. Select a This is helping to ensure the completeness of
sample of physical inventory and agree it to the the inventory records.
inventory records.

Obtain a copy of the inventory count To ensure that the process is well controlled
instructions. and easy to follow for those carrying out the
counts.

c)

Integrity - All members should behave in an honest and straightforward manner in all of the professional
and business relationships.

Objectivity - Members should not allow bias or undue influence to affect their application of professional
judgement to all situations.

Professional Competence and Due Care - Members should ensure that their knowledge and skills are
sufficient to be able to act diligently and in accordance with professional standards.
Confidentiality - Information relating to clients must not be used for personal gain or disclosed to a third
party without the express consent of the client.

Professional Behaviour - Members should comply with laws in order to avoid any act that would discredit
the profession.

d)

The first thing to say here is that this is cause for concern and the auditor should ensure that they
continue to act with a very strong sense of professional scepticism.

We should remind the directors that we are bound by a code of ethical conduct that gives specific
guidance on maintaining client confidentiality. Hopefully this will re assure them.

We could confirm with them that we are used to dealing with this kind of situation, so our staff will use
the utmost discretion in everything they do.

If the directors still will not allow you access, then you will have no choice but to cease work.

The letter of engagement is the legal contract of employment that sets out the responsibilities of directors
and auditors.

If one party is basically saying that they will not fulfil their duties, then the audit is not viable.

If the letter had been signed and then we had discovered later that we did not have access to all records,
then it is likely that we would have modified the audit opinion.
Seeing as we know about it at the planning stage, it is highly unlikely that the audit would go ahead.

We should remind the directors that they will not be any more successful if they ask another firm to do
the audit - all audit firms should react in the same way.
 Pizza Ltd - Answer
a)

This is currently an adverse opinion. This means that there is a misstatement in the financial statements
that is not isolated to one or two specific areas.

It is being claimed that the omission of the provision combined with the depreciation miscalculation is a
pervasive issue.

Because the opinion is based upon the fact that there is a misstatement, there is no missing evidence,
so the opinion is not modified due to a lack of evidence.

This is a very serious type of modification because it is claiming that ALL of the financial statements are
wrong.

b)

I would agree that there is no missing evidence, so the audit report is correct not to modify on these
grounds.

I would also agree that no uncertainty exists, do there is no need for an emphasis of matter paragraph or
a going concern uncertainty paragraph.

However, an adverse opinion is too severe. There are two misstatements but apart from these two, the
rest of the information in the financial statements is correct.

It is possible to have two isolated misstatements and this is what we have here so a less extreme form of
audit modification would be appropriate.

I would go for a qualified opinion on the grounds of material misstatement with an explanation of the
reasons for this to be included in the basis of opinion section.

c)

Examination and certification

The word" certification" is not appropriate. This suggests that an auditor actually gives confirmation that
the financial statements are 100% accurate when we do not do this.

The word “certification" should be replaced with the phrase "independent expression of opinion”, which is
the highest level of confidence that auditors can give.

We will confirm that

The word "confirm” here is wrong. We never confirm anything. As has been said already, we give an
opinion which does give confidence but not as much as a confirmation would provide.

The word "confirm"' should be replaced by “we will give an opinion ".

The accuracy of the estimates

Due to their very nature, estimates cannot be accurate. They can be more or less appropriate, so this the
wrong use of language again.

All we can do is assess the reasonableness of the estimates and judgements that have been made by
the directors, so that is the wording that should be used.
No mention of materiality

The basis opinion section would state that we are protected by the concept of materiality, that we are
only expected to identify material misstatement and not all misstatement.

This should be clarified as part of the basis of opinion section.

Explanation

There should be an explanation, in the basis of opinion section, of the reason for the adverse opinion.
Currently, there is nothing. If the opinion ends up being qualified instead of being an adverse one, then
an explanation of the reasons for this would be required instead.

The basis of opinion is too short, lacks sufficient detail and uses misleading wording in its current format.

d)

A Key Audit Matter (KAM) is a new addition to the audit report format.

It is designed to help narrow the expectation gap by providing a bit more explanation as to what auditors
actually do.

A KAM is an audit area that involves a lot of time and judgement in order to audit it effectively.

All KAMs should be disclosed and explained in the audit report. We tell the users of the report how the
matter was dealt with.

A KAM is NOT a modification. We are not highlighting a problem; we are explaining how something
important to the audit has been dealt with correctly.
 Lesley and Co - Answer
a)

A hot review is a review of an audit file that takes place before the associated audit report has been
signed.

The main benefit is that any extra work that may be required as a result of the review can be undertaken
without the disruption of having to change the audit opinion/report.

A cold review is a review of an audit file that takes place after the audit report has been signed.

The main benefit of this is that we can evaluate the relationship and consistency between the work
carried out and the actual opinion provided, which is something a hot review is unable to do.

Most audit firms will carry out both types of review on a regular basiS.

b)

Sapling Ltd

The current modification is a disclaimer of opinion.

This should be used when the evidence that is missing affects the entire view given by the financial
statements.

This is NOT the case here - it is only two months’ worth of sales records that are missing, so this is an
isolated lack of evidence.

We should suggest that a qualified “except for", opinion is used instead on the grounds of a lack of
evidence.

A full explanation of the reason for the qualified opinion should be included in the basis of opinion section
of the audit report.

This should go immediately below the opinion itself.

Shrub Ltd

The current modification is a qualified "except for" opinion due to a misstatement.

There is no missing evidence and no uncertainty.

The misstatement of $200,000 is only. 8% of total assets and is MOT material, so the modification used
is not appropriate.

An immaterial misstatement will not result in a modified opinion, so the report should be a normal "clean
report” with no modification at all.

The misstatement, along with any other uncorrected, immaterial misstatements, will be given to
management in case they wish to adjust for them but it is not necessary for them to make any
adjustment due to the size.

Branch Ltd

The current opinion is unmodified which suggests that there is no misstatement and no lack of evidence.
The claim is not settled and represents an uncertainty that will remain unresolved until after the date that
the audit report is signed.

This uncertainty will NOT require material uncertainty regarding going concern paragraph in this case.
We can only include it if the uncertainty has been disclosed properly in the financial statements AND it
does not affect the going concern status of Branch Ltd.

The matter has not been disclosed, so we will need to use a qualified “except for opinion due to the
omission of the disclosure, with an explanation of the qualified opinion in the basis of opinion section.

There is no missing evidence and it is not serious enough to be a pervasive modification.

Leaf Ltd

An Emphasis of Matter Paragraph has been used here, but it is inappropriate to do so because there is
no uncertainty at all.

The actual audit opinion is currently unmodified which is also wrong.

The directors have failed to supply us with normal, expected evidence so a modified opinion on the
grounds of a lack of evidence is needed.

This is a deliberate attempt to conceal on the part of the directors, so should be considered pervasive.

A disclaimer of opinion should be used here, with a full explanation of the reason for it included in the
basis of opinion section of the audit report.

Twig Ltd

The current modification is an adverse opinion, which should be used if there is a pervasive
misstatement, one that affects the financial statements as a whole.

In this case, there is no misstatement at all in the financial statements so the opinion is wrong.

There is also no missing evidence so the opinion should remain unmodified.

There is an inconsistency that exists, however, between some of the Other Information ( in this case, the
environmental report ) and the financial statements.

Seeing as it is the Other Information that is wrong, an Other Information Paragraph should be included in
the audit report to draw attention to this.

This is a modified report NOT a modified opinion.

 Gavin Ltd - Answer
a)

Going concern is an assumption that a client is able to continue to trade for the foreseeable future.

The foreseeable future is at least one further year from the current accounting year-end.

An external auditor has to decide whether the true going concern status of a company had been
reflected in its financial statements.

If it is decided that this is not the case, then it is grounds for a modified audit report with various degrees
of seriousness.

b)

 Inspection of any correspondence between Gavin Ltd and the legal advisers to try and confirm
the most likely outcome of the court case and any cost that may be involved.

 Analytical procedures should be carried out on sales revenue. A comparison between the levels
of income before and after the court cases should enable us to confirm or deny any significant
fluctuations.

 An inspection of any correspondence between Gavin Ltd and the senior employee should be
carried out to confirm the accuracy of the story.

 An expert opinion may also be sought in order to confirm the claim that new techniques and
materials are required in order to prosper, but are not being pursued.

 Copies of the cash flow forecast and any other supporting documentation should be obtained
and examined to confirm the viability of the proposal.

 Discussion with the current and potential future, finance providers used by Gavin Ltd should take
place to try and confirm the prospect of sufficient funding being available.

 Discussion with the management of Gavin Ltd should take place in order to confirm that they
believe that the future prospects of the company are good, that Gavin Ltd is actually a going
concern.

 An inspection of board minutes and cash paid/received records since the year-end should be
undertaken to see if anything significant has occurred during the subsequent events period that
may affect the going concern status of Gavin Ltd.

c)

Uncertainty properly disclosed

This will NOT result in a modification to the audit opinion.

Instead the uncertainty will be highlighted by the inclusion of an extra paragraph in the audit report
somewhere below the audit opinion.

The paragraph will be called “Material Uncertainty relating to Going Concern" and should describe the
circumstances surrounding the uncertainty.

The paragraph will refer to a note in the financial statements that describes the uncertainty.
The paragraph will also state that the audit opinion is NOT modified as a result of the uncertainty.

Uncertainty not disclosed

An extra going concern uncertainty paragraph will NOT be used here.

If the uncertainty is not disclosed in the financial statements, then the uncertainty paragraph in the audit
report is NOT relevant.

The audit opinion will be modified instead.

The absence of a disclosure is a misstatement that would be considered material but not pervasive.

Therefore, a qualified "except for "opinion will be given on the grounds of material misstatement due to
the missing disclosure.

Wrong basis of preparation

The directors of Gavin Ltd claiming that the company will continue and the auditors saying that this is
wrong means that the financial statements are misstated.

There is no uncertainty so no going concern uncertainty paragraph will be relevant.

There is also no lack of evidence.

The misstatement would be pervasive because the wrong basis of preparation would mean that almost
all areas of the financial statements are valued and classified incorrectly.

This would require and adverse opinion. The financial statements do NOT give a true and fair view.

d)

Positive assurance is a high level of assurance and is usually associated with a normal audit of historic
financial information.

Negative assurance does NOT mean that something is wrong.

It is a lower level of assurance that is given due to less work being carried out or more uncertainty
involved with the particular assignment.

A cash flow forecast is a predictive document so a lower, negative level of assurance would be given in
this case.
 Bullfinch - Answer
Part (a) – Audit report elements and why included

The following elements should be included within an auditor’s report along with why:

Title – The auditor’s report shall have a title which clearly indicates that it is the report of an independent
auditor, this distinguishes this report from any other.

Addressee – The auditor’s report shall be addressed as required by the circumstances of the
engagement, this is determined by law or regulation but is usually to the shareholders. This clarifies who
may rely on the opinion and who may not, such as third parties.

Introductory paragraph – The introductory paragraph in the auditor’s report shall identify the entity whose
financial statements have been audited, state that the financial statements have been audited, identify
the title of each statement which comprises the financial statements, refer to the summary of significant
accounting policies and other explanatory information and specify the date or period covered by each
financial statement. This paragraph aims to clarify what time period the audit covers and which pages of
the financial statement have been audited, as not every page is audited.

Management’s responsibility for the financial statements – This section of the auditor’s report describes
the responsibilities of those in the organisation who are responsible for the preparation of the financial
statements. This paragraph along with that of the auditor’s responsibilities looks to make clear what the
role of management is, as well as what the role of the auditor is. It seeks to reduce the expectation gap.

Auditor’s responsibility – The auditor’s report shall state that the responsibility of the auditor is to express
an opinion on the financial statements based on the audit and that the audit was conducted in
accordance with International Standards on Auditing and ethical requirements and that the auditor plans
and performs the audit to obtain reasonable assurance about whether the financial statements are free
from material misstatement. Along with the management’s responsibility paragraph, it seeks to make
clear the role of the auditor and also what management’s role is. Also this paragraph seeks to explain
what an audit involves and that only material misstatements are considered, as opposed to all errors.

Opinion paragraph – When expressing an unmodified opinion, the auditor’s opinion shall either state that
the financial statements ‘present fairly’ or ‘give a true and fair view’ in accordance with the applicable
financial reporting framework. This paragraph details whether the financial statements are true and fair
or not.

Other reporting responsibilities – If the auditor addresses other reporting responsibilities in the auditor’s
report, these shall be addressed in a separate section in the auditor’s report titled ‘Report on Other Legal
and Regulatory Requirements’. This is important where there is local legislation which requires reporting
on; this needs to be clearly identified in the report as this is in addition to the requirement of the ISAs.

Signature of the auditor – The auditor’s report must be signed, this can be either the personal name of
the auditor or, the signature is on behalf of the firm, depending on the jurisdiction in which the auditor is
operating. This clarifies which firm or auditor has performed the audit engagement.

Date of the auditor’s report – The auditor’s report shall be dated no earlier than the date on which the
auditor has obtained sufficient appropriate audit evidence on which to base the auditor’s opinion on the
financial statements. The date of the audit report is important in the case of subsequent events which
impact the financial statements; the auditor’s role is different depending on whether the audit report was
signed or not when the subsequent event came to light.

Auditor’s address – The auditor’s report shall name the location where the auditor practises. This is
useful in case shareholders need to contact the auditors.
Part (b) – Subsequent event

A key customer of Bullfinch.com has just notified the company that they are experiencing cash flow
difficulties and are unlikely to make any payments for the foreseeable future. This information was
received after the year end but provides further evidence of the recoverability of the receivable balance
at the year-end. If the customer is experiencing cash flow difficulties just a few months after the year
end, then it is highly unlikely that the year-end receivable was recoverable as at 31 October and hence is
an adjusting event.

The receivables balance is overstated and consideration should be given to adjusting this balance, if
material, through the use of an allowance for receivables or by being written off. The total amount
outstanding at the yearend was $283,000 and is material as it represents 7·4% (0·283/3·8m) of profit
before tax and 2·5% (0·283/11·2m) of revenue. Hence, the directors should amend the 2014 financial
statements by writing down or writing off the receivable balance.

The following audit procedures should be applied to form a conclusion as to the level of the adjustment:
– The correspondence with the customer should be reviewed to assess whether there is any likelihood of
payment.

– Discuss with management as to why they feel an adjustment is not required in the 2014 financial
statements

– Review the post year-end period to see if any payments have been received from the customer.