SIM-GE AC3093 – Auditing and Assurance

Lecture 21 – Revision Q&A

Q1)

Cherry Blossom Co (Cherry) manufactures custom made furniture and its year end is
30 April. The company purchases its raw materials from a wide range of suppliers.
Below is a description of Cherry’s purchasing system.

When production supervisors require raw materials, they complete a requisition form
and this is submitted to the purchase ordering department. Requisition forms do not
require authorisation and no reference is made to the current inventory levels of the
materials being requested. Staff in the purchase ordering department use the
requisitions to raise sequentially numbered purchase orders based on the approved
suppliers list, which was last updated 24 months ago. The purchasing director
authorises the orders prior to these being sent to the suppliers.

When the goods are received, the warehouse department verifies the quantity to the
suppliers despatch note and checks that the quality of the goods received are
satisfactory. They complete a sequentially numbered goods received note (GRN) and
send a copy of the GRN to the finance department.

Purchase invoices are sent directly to the purchase ledger clerk, who stores them in a
manual file until the end of each week. He then inputs them into the purchase ledger
using batch controls and gives each invoice a unique number based on the supplier
code. The invoices are reviewed and authorised for payment by the finance director,
but the actual payment is only made 60 days after the invoice is input into the system.

Required:

In respect of the purchasing system of Cherry Blossom Co:

(i) Identify and explain FIVE deficiencies; and
(ii) Recommend a control to address each of these deficiencies.
(15 marks)
Q1) Suggested Answers

Deficiencies Controls
Requisition forms are completed by Requisition forms should be
production supervisors but are not authorised by the production manager
authorised. This increases the risk of or director prior to being sent to the
fraudulent purchases, or of goods purchase ordering department. This
being ordered which are not department should not process any
required, leading to unnecessary unauthorised requisitions.
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
The inventory system should be
updated to record
minimum/maximum required levels
of raw materials. When completing
the purchase order, the ordering clerk

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SIM-GE
cash outflows.
In addition, as the company does not
currently monitor inventory levels,
it could experience stock-outs
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.
Goods are being received without
any checks being made against
purchase orders. This could result in
Cherry receiving and subsequently
paying for goods it did not order.
In addition, if no check is made
against the purchase order, then the
company may have significant
purchase orders which are
outstanding, leading to loss of sales.
Purchase invoices are manually
filed by the purchase ledger clerk
and only updated to the ledger on a
weekly basis. Until the invoices are
input into the system, there is a risk
that they may be misplaced and not
entered. This would result in an
understatement of trade payables
and Cherry failing to make payment
to the suppliers on time.
AY 2020-2021
AC3093 – Auditing and Assurance
Lecture 21 – Revision Q&A
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.
A copy of the authorised order form
should be sent to the warehouse
department. This should then be
checked to the goods when received.
Once checked, the order should be sent
to the purchase ordering department and
logged as completed. On a regular basis,
an ordering clerk should review the
order file for any outstanding items.
The purchase ledger clerk should record
the invoices in the ledger on a daily
rather than weekly basis. If this is not
practical, then upon receipt of the
invoices, each should be attributed a
sequential number and filed. When these
are logged into the ledger, the clerk
should check that there are no breaks in
the sequence.
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SIM-GE AC3093 – Auditing and Assurance
Lecture 21 – Revision Q&A

Purchase invoices are not being All purchase invoices should be

agreed to the relevant goods matched to the related GRN; the details
received notes (GRNs) prior to should be agreed prior to the invoice
authorisation and payment by the being logged in the purchase ledger.
finance director. This could result in
invoices being paid for goods which
were not received.

Purchase invoices are not All purchase invoices should be

sequentially numbered. Failing to sequentially numbered and on a regular
sequentially number them means basis a sequence check of unrecorded
that Cherry’s finance department are invoices should be performed.
unable to monitor if all invoices
have been completely recorded; this
could result in a failure to make
payment to a supplier on time.
If the invoices are sequentially
numbered, then a sequence check
can be performed for any
unrecorded invoices.

Invoices are authorised by the The policy of making payment after 60

finance director, but payment is only
made 60 days after the invoice is
input. There is the risk that Cherry is
missing out on early settlement
discounts. Also, failing to pay in
accordance with the supplier’s
payment terms can lead to a loss of
supplier goodwill as well as the risk
that suppliers may refuse to supply
goods to Cherry.
days should be reviewed. Consideration
should be given to earlier payment if the
settlement discounts are sufficient. If
not, invoices should be paid in
accordance with the supplier’s payment
terms.

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SIM-GE AC3093 – Auditing and Assurance
Lecture 21 – Revision Q&A

Purchase invoices are not being All purchase invoices should be

agreed to the relevant goods matched to the related GRN; the details
received notes (GRNs) prior to should be agreed prior to the invoice
authorisation and payment by the being logged in the purchase ledger.
finance director. This could result in
invoices being paid for goods which
were not received.

Purchase invoices are not All purchase invoices should be

sequentially numbered. Failing to sequentially numbered and on a regular
sequentially number them means basis a sequence check of unrecorded
that Cherry’s finance department are invoices should be performed.
unable to monitor if all invoices
have been completely recorded; this
could result in a failure to make
payment to a supplier on time.
If the invoices are sequentially
numbered, then a sequence check
can be performed for any
unrecorded invoices.

Invoices are authorised by the The policy of making payment after 60

finance director, but payment is only
made 60 days after the invoice is
input. There is the risk that Cherry is
missing out on early settlement
discounts. Also, failing to pay in
accordance with the supplier’s
payment terms can lead to a loss of
supplier goodwill as well as the risk
that suppliers may refuse to supply
goods to Cherry.
days should be reviewed. Consideration
should be given to earlier payment if the
settlement discounts are sufficient. If
not, invoices should be paid in
accordance with the supplier’s payment
terms.

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SIM-GE AC3093 – Auditing and Assurance
Lecture 21 – Revision Q&A

reduction has occurred in order to

achieve profit targets, due to the
introduction of the bonus system. If this
is the case, then plant and machinery is
overvalued and profit overstated.

Due to staff availability, the company is
planning to undertake a full year-end
inventory count days before the year end
and then adjust for movements to the
year end.
During the final audit the year-end
inventory adjustments schedule should
be reviewed in detail and supporting
documentation obtained for all adjusting
items.

If the adjustments are not completed The audit team should increase the
accurately, then the year-end inventory extent of inventory cut-off testing at the
could be under or overstated. year end.

In October, a fire damaged inventory Discuss with management the basis of

such that it has been written down from the $0·2m scrap value attributed.
$0·9m to $0·2m which is its scrap value.
This write down should have been Review whether any of the goods were
charged to profit or loss. sold pre or post year end and at what
value; this should assess whether the
If the goods remain unsold after the year attributed scrap value is reasonable. If
end, there is the risk that the scrap value none have been sold, discuss with
is overstated and inventory overvalued. management the possibility of further
write downs.

An insurance claim for $0·7m has been Discuss with management whether any
submitted and the proceeds included response has been received from the
within profit or loss. insurance company and review the
related correspondence.
However, the company has not received
a reply from the insurance company and If virtually certain, the treatment
this would therefore represent a possible adopted is correct. If not, management
contingent asset. To comply with IAS 37 should be requested to remove it from
Provisions, Contingent Liabilities and profit and receivables.
Contingent Assets, this should not be If the receipt is probable, the auditor
recognised until the receipt is virtually should request management include a
certain. With no response to date, the contingent asset disclosure note.
inclusion of this sum overstates profit
and receivables.

The bank reconciliations for October Discuss this issue with the finance
and November both contain director and request that the December

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SIM-GE AC3093 – Auditing and Assurance
Lecture 21 – Revision Q&A

Q2)

You are an audit supervisor of Pluto & Co and are currently planning the audit of your
client, Venus Magnets Co (Venus) which manufactures decorative magnets. Its year
end is 31 December 2015 and the forecast profit before tax is $9·6 million.

During the year, the directors reviewed the useful lives and depreciation rates of all
classes of plant and machinery. This resulted in an overall increase in the asset lives
and a reduction in the depreciation charge for the year.

Inventory is held in five warehouses and on 28 and 29 December a full inventory

count will be held with adjustments for movements to the year end. This is due to a
lack of available staff on 31 December. In October, there was a fire in one of the
warehouses; inventory of $0·9 million was damaged and this has been written down
to its scrap value of $0·2 million. An insurance claim has been submitted for the
difference of $0·7 million. Venus is still waiting to hear from the insurance company
with regards to this claim, but has included the insurance proceeds within the
statement of profit or loss and the statement of financial position.

The finance director has informed the audit manager that the October and November
bank reconciliations each contained unreconciled differences; however, he considers
the overall differences involved to be immaterial.

A directors’ bonus scheme was introduced during the year which is based on
achieving a target profit before tax. In order to finalise the bonus figures, the finance
director of Venus would like the audit to commence earlier so that the final results are
available earlier this year.

Required:
Describe FIVE audit risks, and explain the auditor’s response to each risk, in
planning the audit of Venus Magnets Co.
(15 marks)

Q2) Suggested Answers

Audit risk Auditor’s response

The directors have reviewed the asset
lives and depreciation rates of plant and
machinery, resulting in the depreciation
charge reducing. Under IAS 16
Property, Plant and Equipment, asset
lives should be reviewed annually, and if
the asset lives have increased as a result
of this review such that the depreciation
decreases, then this change may be
reasonable.
Discuss with the directors the rationale
for any extensions of asset lives and
reduction of depreciation rates.
The revised useful life of a sample of
assets should be compared to how often
these assets are replaced, as this
provides evidence of the useful life of
assets.

However, there is a risk that this

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SIM-GE AC3093 – Auditing and Assurance
Lecture 21 – Revision Q&A

Q3)

You are an audit manager of Pink Partners & Co (Pink) and are planning the audit of
Golden Finance Co (Golden), a banking institution which provides a range of
financial services including loans. Your firm has audited Golden for four years and the
company’s year end is 30 September 2015.

At the end of August, Golden’s financial controller left and the new replacement is not
due to start until approximately two months after the year end. The finance director,
who is the sister-in-law of the audit engagement partner, has asked if a member of the
audit team can be seconded to Golden for three months to act as the temporary
financial controller.

You are aware that a number of the audit team members currently bank with Golden
and two team members have significant loans owing to the company.

Pink’s taxation department also provides services to Golden. They have been
approached by Golden to represent them in negotiations to resolve some outstanding
issues with the taxation authorities, for which the fees quoted are substantial.

The finance director has informed the audit engagement partner that when the audit is
complete, she would like the whole team to attend an evening watching the national
football team play a match followed by a luxury meal.

Required:
Using the information above:

(i) Identify and explain FIVE ethical threats which may affect the
independence of Pink Partners & Co’s audit of Golden Finance Co; and
(ii) For each threat, explain how it might be reduced to an acceptable level.
(15 marks)

Q3) Suggested Answers

(i) Ethical threat (ii) Managing these risks

The finance director is the sister-in-law Although the family relationship is only
of the audit engagement partner and established by marriage, as it is a sister-
hence there is a family relationship. in-law, it would be advisable for the
audit engagement partner to be removed
There is a familiarity and self-interest and an alternative partner appointed.
threat as the audit partner and the
finance director both hold senior
positions and therefore are in a position
to influence the outcome of the audit.

There is a concern that they may place

their family relationship above the needs
of the users of the financial statements.

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SIM-GE AC3093 – Auditing and Assurance
Lecture 21 – Revision Q&A

reduction has occurred in order to

achieve profit targets, due to the
introduction of the bonus system. If this
is the case, then plant and machinery is
overvalued and profit overstated.

Due to staff availability, the company is
planning to undertake a full year-end
inventory count days before the year end
and then adjust for movements to the
year end.
During the final audit the year-end
inventory adjustments schedule should
be reviewed in detail and supporting
documentation obtained for all adjusting
items.

If the adjustments are not completed The audit team should increase the
accurately, then the year-end inventory extent of inventory cut-off testing at the
could be under or overstated. year end.

In October, a fire damaged inventory Discuss with management the basis of

such that it has been written down from the $0·2m scrap value attributed.
$0·9m to $0·2m which is its scrap value.
This write down should have been Review whether any of the goods were
charged to profit or loss. sold pre or post year end and at what
value; this should assess whether the
If the goods remain unsold after the year attributed scrap value is reasonable. If
end, there is the risk that the scrap value none have been sold, discuss with
is overstated and inventory overvalued. management the possibility of further
write downs.

An insurance claim for $0·7m has been Discuss with management whether any
submitted and the proceeds included response has been received from the
within profit or loss. insurance company and review the
related correspondence.
However, the company has not received
a reply from the insurance company and If virtually certain, the treatment
this would therefore represent a possible adopted is correct. If not, management
contingent asset. To comply with IAS 37 should be requested to remove it from
Provisions, Contingent Liabilities and profit and receivables.
Contingent Assets, this should not be If the receipt is probable, the auditor
recognised until the receipt is virtually should request management include a
certain. With no response to date, the contingent asset disclosure note.
inclusion of this sum overstates profit
and receivables.

The bank reconciliations for October Discuss this issue with the finance
and November both contain director and request that the December

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SIM-GE AC3093 – Auditing and Assurance
Lecture 21 – Revision Q&A

and the firm could become overly reliant significant, additional consideration
on Golden. should be given as to whether the
taxation and/or non-audit assignments
should be undertaken by the firm.

The finance director has invited the As it is unlikely the football tickets and
whole team to attend an evening out luxury meal for the whole team has an
watching the national football team play insignificant value, then this offer
a match followed by a luxury meal. should be politely declined.

This represents a self-interest and

familiarity threat as the acceptance of
goods and services, unless insignificant
in value, is not permitted.

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SIM-GE AC3093 – Auditing and Assurance
Lecture 21 – Revision Q&A

unreconciled amounts, and the finance reconciliation is fully reconciled. The

director believes the overall differences reconciling items should be tested in
to be immaterial. Errors in bank detail and agreed to supporting
reconciliations could actually represent documentation.
large errors which net off to a small
amount. If the differences are not fully
reconciled, it could result in bank
balances being under or overstated.

In addition, unreconciled amounts in the Throughout the audit, the team should
bank could have arisen due to fraud. be alert to the risk of fraud and maintain
professional scepticism.

A directors’ bonus scheme was
introduced which is based on achieving
a target profit before tax. There is a risk
the directors might feel under pressure
to manipulate the results through the
judgements taken or through the use of
provisions.
Throughout the audit, the team will need
to be alert to this risk and maintain
professional scepticism.
Detailed review and testing on
judgemental decisions, including
treatment of provisions, and compare
treatment against prior years. Any
journal adjustments affecting profit
should be tested in detail.

In addition, a written representation

should be obtained from management
confirming the basis of any significant
judgements.

The finance director has requested that The timetable should be confirmed with
the audit commence earlier than normal the finance director. If it is to be
as he wishes to report results earlier. A reduced, then consideration should be
reduction in the audit timetable will given to performing an interim audit in
increase detection risk and place late December or early January; this
additional pressure on the team in would then reduce the pressure on the
obtaining sufficient and appropriate final audit.
evidence.
The team needs to maintain professional
In addition, the finance team will have scepticism and be alert to the increased
less time to prepare the financial risk of errors occurring.
information leading to an increased risk
of errors in the fin statements.

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SIM-GE
Q4) Suggested Answers
(i) Ratios to assist the audit supervisor in planning the audit:
2014
Operating margin 4·5/23 = 19·6%
Inventory days 2·1/11 * 365 = 70 days
Payable days 1·6/11 * 365 = 53 days
Current ratio 6·6/2·5 = 2·6
Quick ratio (6·6 – 2·1)/2·5 = 1·8
(ii) Audit risks and responses:
Audit risk
Management were disappointed with
2013 results and hence undertook
strategies to improve the 2014 trading
results. There is a risk that
management might feel under
pressure to manipulate the results
through the judgements taken or
through the use of provisions.
A generous sales-related bonus
scheme has been introduced in the
year, this may lead to sales cut-off
errors with employees aiming to
maximise their current year bonus.
Revenue has grown by 28% in the
year however, cost of sales has only
increased by 10%. This increase in
sales may be due to the bonus scheme
and the advertising however, this
does not explain the increase in gross
margin. There is a risk that sales may
be overstated.
Gross margin has increased from
44·4% to 52·2%. Operating margin
has decreased from 22·2% to 19·6%.
This movement in gross margin is
significant and there is a risk that
costs may have been omitted or
included in operating expenses rather
than cost of sales.
AY 2020-2021
AC3093 – Auditing and Assurance
Lecture 21 – Revision Q&A
2013
4/18 = 22·2%
1·6/10 * 365 = 58 days
1·2/10 * 365 = 44 days
6·9/1·2 = 5·8
(6·9 – 1·6)/1·2 = 4·4
Audit response
Throughout the audit the team will
need to be alert to this risk. They will
need to carefully review judgemental
decisions and compare treatment
against prior years.
Increased sales cut-off testing will be
performed along with a review of
post year-end sales returns as they
may indicate cut-off errors.
During the audit a detailed
breakdown of sales will be obtained,
discussed with management and
tested in order to understand the
sales increase.
The classification of costs between
cost of sales and operating expenses
will be compared with the prior year
to ensure consistency.
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SIM-GE AC3093 – Auditing and Assurance
Lecture 21 – Revision Q&A

Q3)

You are an audit manager of Pink Partners & Co (Pink) and are planning the audit of
Golden Finance Co (Golden), a banking institution which provides a range of
financial services including loans. Your firm has audited Golden for four years and the
company’s year end is 30 September 2015.

At the end of August, Golden’s financial controller left and the new replacement is not
due to start until approximately two months after the year end. The finance director,
who is the sister-in-law of the audit engagement partner, has asked if a member of the
audit team can be seconded to Golden for three months to act as the temporary
financial controller.

You are aware that a number of the audit team members currently bank with Golden
and two team members have significant loans owing to the company.

Pink’s taxation department also provides services to Golden. They have been
approached by Golden to represent them in negotiations to resolve some outstanding
issues with the taxation authorities, for which the fees quoted are substantial.

The finance director has informed the audit engagement partner that when the audit is
complete, she would like the whole team to attend an evening watching the national
football team play a match followed by a luxury meal.

Required:
Using the information above:

(i) Identify and explain FIVE ethical threats which may affect the
independence of Pink Partners & Co’s audit of Golden Finance Co; and
(ii) For each threat, explain how it might be reduced to an acceptable level.
(15 marks)

Q3) Suggested Answers

(i) Ethical threat (ii) Managing these risks

The finance director is the sister-in-law Although the family relationship is only
of the audit engagement partner and established by marriage, as it is a sister-
hence there is a family relationship. in-law, it would be advisable for the
audit engagement partner to be removed
There is a familiarity and self-interest and an alternative partner appointed.
threat as the audit partner and the
finance director both hold senior
positions and therefore are in a position
to influence the outcome of the audit.

There is a concern that they may place

their family relationship above the needs
of the users of the financial statements.

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