Auditing and Other Assurance Services – Paper 15

Suggested Solutions for November 2012

ANSWER 1: Fast Telecom Group

a) Principal Business Risks : Identified & Described for Fast Telecom Group
- Service level delivery risks
Fast changing customer expectations and behaviour.
Network failure affecting transaction implementation.
Quality of service challenges, esp. during peak hours.
Poor customer care affects service delivery.
- Business Continuity Risks
Natural disasters such storms, floods, etc may company network infrastructure & result in
business loss.
Need for business continuity and disaster recovery planning.
- Competition Risks
More companies entering the industry.
New service range offered by competitors.
Pricing wars, promotions.
- Legal & Regulatory Risks
Changes in legal and regulatory requirement (e.g. SIM registration)
Failure to comply with laws and regulations.
Need to protect customer privacy and confidentiality.
Money laundering and anti-terrorism legislation.
- Technological Risks
Fast changing technology and emerging technology, new applications, new types of
connectivity, cloud computing etc.
- Business Integration
Failure to integrate Fast Telecom and Pride Telecom business operations.
Differences in organisation culture.
Differences in business processing i.e. differences in ERP, accounting systems, client
management systems, transaction processing etc.
- Revenue Growth
Failure to manage growth in clientele e.g. customers outstripping network capacity.
Wider area of coverage requires more investment in staff and outlets.
Need for continuous innovation.

- Human Resources
Loss of talented experienced staff to competitors.
Specialised skill set required, implies high cost of training and remuneration.
 Security Risks
Vandalism, electronic attacks (e.g. denial of service attacks)
Need for good customer security practices, authentication of customers, non-repudiation
and accountability of transactions.
- Risks of internal or external fraud
Such risks arise from the possibility of unauthorised access in this environment which can
lead or give rise to fraud.
-Other
Stiff competition in telecom industry
Acquired inherent risks from Pride telecom.
Risk that the ask price of pride telecom was arrived at erroneously.
Foreign exchange rates fluctuations.
Future cash flow problems from conditional instalment on goodwill

b) Implications of the acquisition of Pride Telecom for audit

planning
Individual financial statement audit
 We must plan the audit of the Pride Telecom financial statements, and then consider
implications for the audit of the consolidated financial statements.
 Develop an understanding of the company, including its environment and internal
control, as required by ISA 315 Identifying and Assessing the Risks of Material
Misstatement through Understanding the Entity and Its Environment.
 ISA 315 requires that the auditor obtains an understanding of internal controls
relevant to the audit. Therefore we must document our understanding of Pride
Telecom’s accounting systems and internal controls. This is important given that
Pride Telecom has different IT systems from Fast Telecom
 Consideration should be given as to whether the use of an expert is required.
 Consider use of computer-assisted audit techniques (CAATs) to obtain sufficient
evidence
 Plan to begin this work as soon as possible, to avoid any delay to the audit of either
the individual or the consolidated financial statements.
 Arrange with the client for members of the audit team to have access to the
necessary information, including the accounting system, and to hold the necessary
discussions with management.
 Perform a detailed preliminary analytical review on a full set of Pride’s financial
statements
 As this is an initial audit engagement, we are required by ISA 300 Planning an Audit
of Financial Statements to communicate with the predecessor auditor.
 Request access to their working papers, especially in respect of any matters which
appear contentious or significant.
 Review the prior year audit opinion as this may include matters that impact on this
year’s audit.
 As the opening balances were audited by another firm, we should plan to perform
additional work on opening balances as required by ISA 510 Initial Audit
Engagements – Opening Balances.
Consolidated financial statements audit
 Consider the implications of the acquisition for the audit of the Group accounts.
 Risk assessment and planned response to risks identified at individual company level
will also be relevant to the audit of the consolidated financial statements.
  Plan to obtain audit evidence in respect of balances and transactions which only
become relevant on consolidation, such as any related party transactions that may
occur.
 When performing analytical procedures on the consolidated financial statements,
we must be careful that when comparing this year’s results with prior periods, we
are making reasonable comparisons. This is because Pride’s results are only included
since the date of acquisition on 1 July 2012 and comparative figures are not restated.
 Materiality needs to be assessed based on the new structure.
 Finally, we must ensure that sufficient time and resource is allocated to the audit of
the consolidated financial statements as there will be additional work to perform on
auditing the acquisition itself, including the goodwill asset, the fair value of assets
acquired, the cash outflows, the contingent consideration, and the notes to the
financial statements. As this is a complex area we should consider allocating this
work to a senior, experienced member of the audit team.
(c) Risks of material misstatement
Introduction
Explain what material misstatement means
Changes to corporate structure through acquisitions causing the audit to be high
risk.
 Goodwill arising on the acquisition may be material to the consolidated financial
statements.
 IFRS 3 (Revised) Business Combinations requires that contingent consideration is
recognised at fair value at the time of the business combination, meaning that the
probability of payment should be used in measuring the amount of consideration
that is recognised at acquisition. This part of the consideration could therefore be
overstated, if the assessment of probability of payment is incorrect.
 The same risk factors apply to the individual financial statements of Fast Telecom, in
which the cost of investment is recognised as a non-current asset.
 The other component of the goodwill calculation is the value of identifiable assets
acquired, which IFRS 3 requires to be measured at fair value at the date of
acquisition. This again is inherently risky, as estimating fair value can involve
uncertainty. Possibly the risk is reduced somewhat as the fair values have been
determined by an external firm.
 Goodwill should be tested for impairment annually and a test should be performed
in the year of acquisition, regardless of whether indicators of impairment exist.
There is therefore a risk that goodwill may be overstated if management has not
conducted an impairment test at the year end. If the impairment review were to
indicate that goodwill is overstated, there would be implications for the cost of
investment recognised in Fast Telecom’s financial statements, which may also be
overstated.
 Looking at the consolidated revenue and profit figures, it appears that the group’s
results are encouraging, with an increase in revenue. However, this comparison is
distorted, as the 2012 results include six months’ revenue and profit from Pride
Telecom, whereas the 2011 results are purely Fast Telecom.
 Possible manipulation of financial statements financial statements may have been
prone to manipulation through pressure to overstate revenue and profits in order to
secure a good sale price for the company.
  If Pride is not using the same IT system, there may be problems in performing
consolidation
 Recoverability of receivables
 Incompleteness of the payables/liabilities – cut off
 Improper valuation of goodwill
 Harmonising the different Accounting policies and procedures.
 The competence of senior management in charge of the preparation of financial
report
 Harmonising year ends for pride and Fast Telecom
 Different Accounting policies for both companies
 Consolidation process adjustments i.e. cut off, accuracy, completeness.
(d) Reliance on the work of the consultant
Introduction: When designing and performing audit procedures, the auditor shall consider
the relevance and reliability of the information to be used as audit evidence.
Competence and capabilities of that Consultant.
Information regarding the competence and capabilities the consultant may come from
sources, such as:
• Personal experience with previous work of that consultant.
• Discussions with that consultant.
• Discussions with others who are familiar with that consultant’s work.
• Knowledge of that consultant’s qualifications, membership of a professional body or
industry association, license to practice, or other forms of external recognition.
• Published papers or books written by that consultant.
Objectivity of the consultant.

• Whether any elf-interest threats, advocacy threats, familiarity threats, self-review

threats and intimidation threats exist.
• The safeguards that have been implemented against such threats.
Obtain an understanding of the work of that consultant.

• Whether any professional or other performance standards and regulatory or legal

requirements were applied.
• What assumptions and methods are used by the consultant, and whether they are
generally accepted and appropriate for financial reporting purposes.
• The nature of internal and external data or information the management’s consultant
uses.

Terms of the Consultancy Agreement.

Evaluate the consultant’s agreement or engagement letter to understand:

• The nature, scope and objectives of that consultant’s work.

• The respective roles and responsibilities of management and that consultant.
• The nature, timing and extent of communication between management and that
consultant, including the form of any report to be provided by that consultant.
Evaluate the appropriateness of that consultant’s work as audit evidence.

• The relevance and reasonableness of that consultant’s findings or conclusions.

• The relevance and reasonableness of any of significant assumptions and methods used.
• The relevance, completeness, and accuracy of that source data used in making the
valuation.

(e) Scope of a due diligence assignment compared to an audit

 When conducting a due diligence assignment, the scope is focused primarily on fact
finding. This means that although the most recent set of financial statements will
form a crucial source of information, the investigation will draw on a much wider
range of sources of information, including:
– Several years’ prior financial statements
– Management accounts
– Profit and cash flow forecasts
– Any business plans recently prepared
– Discussions with management, employees and third parties.
 The aim of due diligence, in contrast to an audit, is NOT to provide assurance that
financial data is free from material misstatement, but rather to provide the acquirer
with a set of information that has been reviewed. Consequently no detailed audit
procedures will be performed unless there are specific issues which either cause
concern, or have been specifically selected for further verification. For example, the
acquirer may specifically request that the due diligence exercise provides an
estimate of the valuation of acquired intangible assets.
 The type of work performed will be quite different, as a due diligence investigation
will primarily use analytical procedures as a means of gathering information. Very
few, if any substantive procedures would be carried out, unless they had been
specifically requested by the client.
 Due diligence is much more ‘forward looking’ than an audit. Much of the time during
a due diligence investigation will be spent assessing forecasts and predictions. In
comparison audit procedures only tend to cover future events if they are directly
relevant to the yearend financial statements, for example, contingencies, or going
concern problems.
 In contrast to an audit, when it is essential to evaluate systems and controls, the due
diligence investigation will not conduct detailed testing of the accounting and
internal control systems, unless specifically requested to do so.
Conclusion
Due diligence provides necessary information for the directors of an acquiring
company to decide whether to go ahead with an acquisition, the timing of the
acquisition, the value of consideration to be paid, and to assess the operational
impact of the acquisition. Due diligence should be viewed as a risk management tool,
which is crucial when a significant acquisition is being considered. That a due
diligence exercise has taken place will increase stakeholder confidence in the
acquisition decision.
ANSWER 2
a) (i) Transactions which may indicate the existence of previously unidentified related
parties.
 Transactions with abnormal terms of trade such as unusual prices, interest rates,
guarantees and repayment terms
 Transactions which lack an apparent logical business reason for their occurrence
 Transactions in which substance differs from form
 Transactions processed in an unusual manner
 High volume or significant transactions with certain customers or suppliers as
compared with others
 Unrecorded transactions such as the receipt or provision of management services at
no charge.
 Complex transactions e.g. use of special purpose entities.
(ii) Recommended procedures
 Review prior year working papers for names of known related parties
 Review the entity’s procedures for identification of related parties
 Inquire as to the affiliation of those charged with governance and officers
with other entities
 Review shareholder records to determine the names of principal
shareholders or obtain a list of principal shareholders from the share register
 Review minutes of the meetings of shareholders and those charged with
governance and other relevant statutory records such as the register of
directors’ interests
 Inquire of other auditors currently involved in the audit or predecessor
auditors as to their knowledge of additional related parties
 Review the entity’s income tax returns and other significant information
supplied to regulatory authorities
 Perform detailed tests of transactions and balances
 Review accounting records for large or unusual transactions or balances
paying particular attention to transactions recognised at or near the year end
 Review confirmations of loans received or receivable and from banks as they
may indicate guarantor relationships
 Review investment transactions
 Obtain written representations
 During the audit, the auditor shall remain alert, when inspecting records or
documents, for arrangements or other information that may indicate the
existence of related party relationships or transactions that management has
not previously identified or disclosed to the auditor.
 If the auditor identifies significant transactions outside the entity’s normal
course of business when performing the audit procedures required by
paragraph 15 or through other audit procedures, the auditor shall inquire of
management about:
The nature of these transactions; and whether related parties could be
involved.
 Review significant contracts and agreements not in the entity’s ordinary
course of business.
  Review specific invoices and correspondence from the entity’s professional
advisors.
 Review Life insurance policies acquired by the entity.
 Review significant contracts re-negotiated by the entity during the period.
 Review significant Internal auditors’ reports.

(i) What an auditor needs to do in relation to matters in the letter of representations

that the auditor considers material.
 Seek corroborative audit evidence from sources inside or outside the entity
 Evaluate whether the representations made by management appear
reasonable and consistent with other audit evidence obtained, including
other representations
 Consider whether the individuals making the representations can be
expected to be well informed on those particular matters
(ii) Basic elements of a Management Representation Letter
 Be addressed to the auditor
 Contain specified information
 Be appropriately dated and signed
 Ordinarily be dated the same date as the auditor’s report
 Be signed by members of management having primary responsibility for the
entity and its financial aspects based on the best of their knowledge and
belief
(iii) When requested Written Representations Not Provided
If management does not provide one or more of the requested written representations, the
auditor shall:
(a) Discuss the matter with management;
(b) Re-evaluate the integrity of management and evaluate the effect that this may have on
the reliability of representations (oral or written) and audit evidence in general; and
(c) Take appropriate actions, including determining the possible effect on the opinion in the
auditor’s report in accordance with ISA 705, having regard to the requirement in paragraph
20 of the ISA.
ANSWER 3 Kalungu Limited:
a) (i) Matters to take into consideration when determining the sufficiency and
appropriateness of the audit evidence needed to obtain regarding opening
balances
 The accounting policies followed by the entity.
 The nature of the account balances, classes of transactions and disclosures
and the risks of material misstatement in the current period’s financial
statements.
 The significance of the opening balances relative to the current period’s
financial statements.
 Whether the prior period’s financial statements were audited and, if so,
whether the predecessor auditor’s opinion was modified.
(ii) Recommended procedures to undertake to determine opening balances.
  Consider whether opening balances reflect the application of appropriate
accounting policies and that those policies are applied consistently in the
current period
 In case of any changes in the policies, consider whether they are
appropriate and properly accounted for and presented and disclosed
 When prior period financial statements were audited by another auditor,
obtain evidence by reviewing predecessor auditor’s working papers
 Consider professional competence and independence of the predecessor
auditor
 In case of a modification in the previous report, consider the effect this
would have on the current report
 Consider code of ethics prior to communicating with the predecessor
auditor
 If prior period financial statements were not audited, perform other
procedures
 Obtain some evidence as part of current period’s audit e.g. for
receivables, payments in current period may indicate existence, valuation
etc.. at the prior period end
 Obtain confirmation with third parties

b) (i) Distinguish between a material inconsistency and a material misstatement of fact

Inconsistency – Other information that contradicts information contained in the
audited financial statements. A material inconsistency may raise doubt about the
audit conclusions drawn from audit evidence previously obtained and, possibly,
about the basis for the auditor’s opinion on the financial statements.
Misstatement of fact – Other information that is unrelated to matters appearing in
the audited financial statements that is incorrectly stated or presented. A material
misstatement of fact may undermine the credibility of the document containing
audited financial statements.
(ii) Material Inconsistencies
 If, on reading the other information, the auditor identifies a material inconsistency,
the auditor shall determine whether the audited financial statements or the other
information needs to be revised.
 If revision of the audited financial statements is necessary and management refuses
to make the revision, the auditor shall modify the opinion in the auditor’s report in
accordance with ISA 705.2
 If revision of the other information is necessary and management refuses to make
the revision, the auditor shall communicate this matter to those charged with
governance, unless all of those charged with governance are involved in managing
the entity
 Include in the auditor’s report an Other Matter(s) paragraph describing the material
inconsistency in accordance with ISA 706; 4 or 2 ISA 705, “Modifications to the
Opinion in the Independent Auditor’s Report.”
 Withhold the auditor’s report; or
 Withdraw from the engagements, where withdrawal is possible under applicable law
or regulation.
Material Inconsistencies Identified in Other Information Obtained Subsequent to the
Date of the Auditor’s Report
 If revision of the audited financial statements is necessary, the auditor shall follow
the relevant requirements in ISA 560
 If revision of the other information is necessary and management agrees to make
the revision, the auditor shall carry out the procedures necessary under the
circumstances.
 If revision of the other information is necessary, but management refuses to make
the revision, the auditor shall notify those charged with governance, unless all of
those charged with governance are involved in managing the entity, of the auditor’s
concern regarding the other information and take any further appropriate action.
Material Misstatements of Fact
 If, on reading the other information for the purpose of identifying material
inconsistencies, the auditor becomes aware of an apparent material misstatement of
fact, the auditor shall discuss the matter with management.
 If, following such discussions, the auditor still considers that there is an apparent
material misstatement of fact, the auditor shall request management to consult with
a qualified third party, such as the entity’s legal counsel, and the auditor shall
consider the advice received.
 If the auditor concludes that there is a material misstatement of fact in the other
information which management refuses to correct, the auditor shall notify those
charged with governance, unless all of those charged with governance are involved
in managing the entity, of the auditor’s concern regarding the other information and
take any further appropriate action.
Section B
ANSWER 4: KWES LIMITED
Briefing notes
To: Audit partner
From: Audit manager
Re: Initial going concern assessment
Introduction
Events or Conditions That May Cast Doubt about Going Concern Assumption
The following are examples of events or conditions that, individually or collectively, may cast
significant doubt about the going concern assumption. This listing is not all-inclusive nor
does the existence of one or more of the items always signify that a material uncertainty
exists.
Financial
• Net liability or net current liability position.
• Fixed-term borrowings approaching maturity without realistic prospects of renewal or
repayment; or excessive reliance on short-term borrowings to finance long-term assets.
• Indications of withdrawal of financial support by creditors.
• Negative operating cash flows indicated by historical or prospective financial statements.
• Adverse key financial ratios.
• Substantial operating losses or significant deterioration in the value of assets used to
generate cash flows.
• Arrears or discontinuance of dividends.
• Inability to pay creditors on due dates.
• Inability to comply with the terms of loan agreements.
• Change from credit to cash-on-delivery transactions with suppliers.
• Inability to obtain financing for essential new product development or other essential
investments.
Operating
• Management intentions to liquidate the entity or to cease operations.
• Loss of key management without replacement.
• Loss of a major market, key customer(s), franchise, license, or principal supplier(s).
• Labour difficulties.
• Shortages of important supplies.
• Emergence of a highly successful competitor.
Other
• Non-compliance with capital or other statutory requirements.
• Pending legal or regulatory proceedings against the entity that may, if successful, result in
claims that the entity is unlikely to be able to satisfy.
• Changes in law or regulation or government policy expected to adversely affect the entity.
• Uninsured or underinsured catastrophes when they occur.
The significance of such events or conditions often can be mitigated by other factors. For
example, the effect of an entity being unable to make its normal debt repayments may be
counter-balanced by management’s plans to maintain adequate cash flows by alternative
means, such as by disposing of assets, rescheduling loan repayments, or obtaining
additional capital. Similarly, the loss of a principal supplier may be mitigated by the
availability of a suitable alternative source of supply.
b) Recommended audit procedures for cash flow :
 Discuss with management the reasons for assuming that cash collection from
customers will improve.
 Consider the validity of the reasons in light of business understanding.
 Enquire as to the nature of the additional resources to be devoted to the credit
control function, e.g. details of extra staff recruited.
 For the loan receipt, inspect written documentation relating to the request for
finance from Related Company.
 Request written confirmation from the company regarding the amount of finance
and the date it will be received, as well as any terms and conditions.
 Obtain and review the financial statements of the related party, to consider if it has
sufficient resources to provide the amount of loan requested.
 Regarding operating expenses, verify using previous months’ management accounts,
that operating cash outflows are sufficient.
 Enquire as to the reason for the increase in operating cash outflows.
 Verify, using previous months’ management accounts, that interest payments
appear reasonable.
 Confirm, using the loan agreement, the amount of the loan being repaid per month
 Enquire whether any tax payments are due in the six month period.
 Agree the opening cash position to cash book and bank statement/bank
reconciliation, and cast the cash flow forecast.
 Ensure that a cash flow forecast for the full financial year is received as six months’
forecast is inadequate for the purposes of the audit.
  Obtain a breakdown of items included in forecast operating expenses and perform
an analytical review to compare to those included in the 2012 figures, to check for
any omissions.
Conclusion to briefing notes
Kwes Limited is experiencing going concern problems. In particular, the lack of cash,
and the significant amounts due to be paid within a few months of the year end cast
significant doubt over the use of the going concern assumption in the financial
statements. The company has requested finance from a related company, but even if
this is forthcoming, cash flow remains a significant problem.

ANSWER 5: FERO & CO. CERTIFIED ACCOUNTANTS:

a) Matters to be included in a letter of engagement for a review assignment.
 The objective of the service being performed
 Management’s responsibility for the financial statements
 The scope of the review, including reference to the ISRE and the relevant
national standards or practices
 Unrestricted access to whatever records, documentation and other
information requested for in connection with the review.
 A sample of the report expected to be given
 The fact that the engagement is not expected to be relied upon to disclose
errors, illegal acts or other irregularities including fraud and defalcations
 A statement that an audit is not being performed and that an audit opinion is
not to be expressed
 Pointing out that a review engagement will not satisfy any statutory or third
party requirements for an audit.
b) Memorandum
To: Audit partner
From: Audit Senior Manager.
Date: 28 NOVEMBER 2012

RE: Recommended general procedures to be undertaken in carrying out

a review of financial statements.
Introduction.

The following procedures should be carried during a review of financial statements.

 The engagements should be planned, including obtaining or updating knowledge
of the business.
 We should consider and evaluate the work performed by others such as internal
auditors, consultants, etc
 We should document matters important in providing evidence to support the
review report in accordance with the ISRE 2400.
 Inquiries concerning the entity’s accounting principles and practices.
 We should make inquiries concerning the entity’s procedures for recording,
classifying and summarising transactions, accumulating information for
disclosure in the financial statements and preparing financial statements.
 Inquiries concerning all material assertions in the financial statements
  We should perform analytical procedures designed to identify relationships and
individual items that appear unusual.
 We should make inquiries concerning actions taken at meetings of shareholders,
BOD and other meetings that might affect the financial statements
 We should read the financial statements to consider on the basis of information
received whether the financial statements appear to conform with the basis of
accounting indicated.
 We should obtain reports from other practitioners engaged to audit or review
the financial statements
 We should make inquires of persons having responsibility for the financial and
accounting matters concerning matters such as whether all transactions have
been recorded, FS prepared in accordance with the basis of accounting indicated,
changes in business activities and accounting principles and practices
 We should obtaining written representations
 We should review Post Balance Sheet Events.
Conclusion.
 We should endeavour to perform our review procedures in compliance with the
requirements of ISRE 2400
c) Format of the review report
 Title
 Addressee
 Opening or introductory paragraph describing the nature of the review
 Scope paragraph describing the nature of the review
 Statement of negative assurance
 Date of the report
 Practitioner’s address
 signature